2023 in Review – My first year of full retirement

This year has been my first full year of retirement. We did a couple of interstate trips (to Cairns and Adelaide). I moved my super into a retirement account, which means slightly less tax.

The bad news is that every asset class has gone backwards in real terms. And because I don’t have an income, this isn’t covered up any more :(. The good news is most of the decline has been in real estate.

Because of the high inflation, I’ve been tracking the change in spending power since Jan 2022. It’s gone backwards in real terms by about 4.5% since then. Which is a bit disappointing considering our spend levels are quite low.

Headline Figures

	2023	2024	Percent Change
Cash	$347,623	$341,331	-1.8%
Superannuation	$2,305,764	$2,256,664	-2.1%
Primary Residence	$2,207,866	$1,938,000	-12.2%
Investment Property	$771,001	$520,600	-32.4%
Shares	$236,936	$226,940	-4.2%
Total Assets	$5,869,191	$5,282536	-10.0%

The percentage change on assets that are not real-estate was -2.3%. The investment property significantly declined in value, however this was really due to an inaccurate original valuation. Super went down slightly, however we are now drawing from Super rather than contributing. Share performance has been disappointing.

Spending and Income in 2023

Spending in 2023 was about $50.5K. However, we had an extraordinary cost of $11K as we removed our ageing pool (and also spent quite a bit on landscaping afterwards). Once the pool removal cost is accounted for our spending was about $39.5K, which is quite low, especially taking into account inflation. Maybe the retirement lifestyle really does result in lower spending.

The percentage spend against financial (non-realestate) assets is 1.8%, which is well below the “4% rule”. If I take into account rent received, the spend is 1.4% and if I remove the once-off extraordinary cost, it is 1%!.

Here is out spending breakup:

Per month spending is shown below:

Income in 2023 was $26K.

Updated Spending Patterns

My online calulator shows a spend of $155K, If we sell the investment property at a later date, it goes up to $169K.

Conclusions

Our spending levels remain low, especially when compared with financial assets. Although assets have gone backwards, the decline has been mostly in real-estate, which is not a big concern to the retiree. I’m thinking about splashing out on big holiday in Europe. Stay tuned to the next update to see if it happens!

2022 in Review

Well, I did end up working for most of this year, but I think I’m calling it a day now. Not really an early retirement at 60, but good enough!

This year has not been a good year for self funded retirees. Super has gone backwards, and that’s not taking into account inflation. With inflation, it’s gone down about 11%. This is the first year when average planned expense has gone down (and that’s taking into account I received a good income and spent quite a bit less than planned!). Still,the previous year involved quite a jump in spending power so when combined with this year we are going quite well.

Headline Figures

	2022	2023	Percent Change
Cash	$359,305	$329,813	-8.2%
Primary Residence	$2,165,099	$2,327,500	7.5%
Superannuation	$2,299,271	$2,187,632	-4.86%
Investment Property	$443,126	$731,500	65.1%
Shares	$221,801	$224,797	1.35%
Total Assets	$5,488,603	$5,801,243	5.7%

The investment property value is taken from the bank evaluation, and looks like they have it in error. If I make it the same as last year, total asset vaues have gone up by about 0.5%. I made contribitions of $90K to my wif’e’s super (and Super overall still went down..) and $10K in shares. Sydney housing prices are now declining, so valuations are likely to decline soon.

Spending and Income in 2022

Spending in 2022 was about $47K, which is a little bit higher than the average of the last few years. We had some house maintenance costs of about $4K (we upgraded our electric switch box and our hotplate blew up), and the inflation of the last couple of years most likely contributed.

Here is our spending breakup:

Per month spending is shown below:

Income in 2022 was quite high at $165K, and savings were about 71% of income.

Updated Spending Patterns

Here are the updated spending patterns:

Average planned expense of $147K represnts a real decline of about 3.5% since last year, the first year in which a decline occured (despite earning about $140K in non-passive income and spending about $93K less than planned!).

My online calculator produces a similar result ($148K):

And if we sell the investment property some time in the future, the spend level goes up quite a bit (about $166K, although this is inflated a bit by the questionnable valuation):

Conclusions

By working this year and spending less than our planned expenditutre levels, we ended up with about $233K of surplus savings (compared to not working and spending according to planned levels). But our planned expenditure went backwards in real terms. This can be attributed to the real loss of about 11% in the value of Super.

Hopefully next year will be better!

2021 in Review

Another year and another review. I’ve been working as an IT contractor this year, but, in terms of employability, I think my age if finally catching up with me. My latest contract will end in a few days and I think that might be it!

This year has been a very good year for asset values, but of course, what goes up can also come down (and most likely will!).

Headline Figures

	2021	2022	Planned 2021
Cash	$490,941	$334,861	$92,328
Superannuation	$1,904,632	$2,142,843	$686,557
Primary Residence	$1,636,052	$1,658,700	$1,134,261
Investment Property	$360,088	$360,050	$275,573
Shares	$0	$206,711	$0
Total Assets	$4,391,713	$4,703,165	$2,188,720
Asset Change		7.09%

	Change from 2021 to 2022	Change from Planned to 2022
Cash	-31.79%	431%
Superannuation	12.51%	177%
Primary Residence	1.38%	44%
Investment Property	-0.01%	31%
Shares	N/A	N/A
Total Assets	7.09%	101%

Total asset growth was 7.1%. I get the property values from the bank evaluation, which hasn’t been updated for a while, and isn’t reflecting the latest boom in prices in Sydney. If I use valuations from a popular real-estate site, the real value of the total assets change is 16.6%.

I have invested some of the cash funds ($200K all up) in a Vanguard Aussie Share ETF. I plan to keep this for quite a while and use Super prior to using the shares.

Spending and Income in 2021

Spending in 2021 was just over $40K, which was quite good and lower than last year (this may have had something to do with the lockdowns…!). Taking into account rent received, the total outgoings were under $30K. Considering the pension is about $38K we are doing quite well!

Here is how our spending was broken up:

We had two minor (single vehicle!) car accidents which caused the car expenses to be quite a bit higher than last year. Per month spending is shown below:

Income in 2021 was $115K (I only worked part of the year) and savings were about $75K, about 65% of income (a little less than last year).

Share income was $3.1K, but the last $100K was only recently invested, and the first $100K has been in the market for about 9 months. So looks like I might expect an income of about $8K per annum (maybe more with the infamous franking credits), and this will be very handy. Rental income at $10K was higher than usual.

Updated Spending Patterns

Here is the updated spending patters assuming we stay in the PPOR (I have added shares to Super as a good approximation):

Average planned expense is now $141K, which is about a 19% increase from the figure last year (taking into account inflation). Note that this year for the first time average planned expense is higher than income!

If I use my online calculator, the figure comes out at $143K, a bit higher.

If I include the sale of the investment property at a later date, I get the below:

Conclusions

I expect an income of about $30K next year (2 x tax refunds and one more monthly pay). That means we will have about $360K in cash. If we keep our spending to our historic levels (which we may not want to do – i.e. we may want to enjoy ourselves more!), and taking into account rental income and assuming that deposit rates can keep up with inflation, that is enough for 12 years. That is plenty to exist on if there is a major crash, so I think the cash level is about right now (and definitely has been too high previously).

This year I have invested in shares, and also used so-called neo-banks for improved term deposit rates (which are still lousy!).

When I hit 60 next year, I will move all the Super into a Pension account. I don’t expect to necessarily spend the minimum amount, so, depending on the state of the market, some may stay in cash or some may go back into Super accumulation of shares.

Inflation last year (Sept 2020 to Sept 2021) was 3%, which is historically quite high, and significantly higher in the US. This makes investing more complex as it mitigates against holding large amounts of cash. Time will tell which is the best investment mix.

The 2021 Federal Budget

I’ve just finished my contract (located in another state) and just about to start another one (now back in Sydney). I haven’t had time to summarize the changes introduced the budget to date, but I am now able to do so.

Here are the major changes:

Removal of $450 income threshold for Super Contributions

Employers are required to pay superannuation  to employees who are over 18 when their earnings are greater than $450/month. The budget scraps the $450 limit. Employers are now required to contribute for all levels of income. The proposed start date is July 2022.

Works Test abolished for those between 67 and 74

At the moment, you cannot contribute to Super (concessional or non-concessional) if you are over 67 and cannot pass the works test (i.e. “you have been gainfully employed during the financial year for at least 40 hours over a period of no more than 30 consecutive days”). In 2020, the maximum age was changed from 65 to 67 and in 2019 it was changed from 65 to 66 provided you had less than $300K in super (!).

This budget provision changes the maximum age and you can now contribute up to the age of 74 without having to pass the works test (excluding personal deductible contributions i.e. those made from after tax income and claimed as a deduction). A similar provision was introduced in the 2016 federal budget, however this was scrapped later in the year when the maximum super amounts were revised. This provision should be quite handy for retirees wishing to contribute any surplus funds when expenditure is less than minimum super withdrawal amounts or contributing any asset sales.

Pensions Loans Scheme

The pensions loans scheme was changed significantly in the 2018 budget. These changes made it a lot more attractive to retirees and doubtlessly more popular. The changes in this budget make it even more attractive by enabling lump sum payments (up to 26 fortnight’s worth of advance payments in any 12 month period in up to two lump sums) and also introducing a no negative equity guarantee (i.e. if you live long enough so that you have no equity remaining, you don’t go into debt). The present interest rate is 4.5%, This provision is proposed to commence on 1 July 2022.

Age Threshold for contributions from PPOR sale

In the 2016 federal budget it was announced that it would be possible for each member of a couple (or a single person) to contribute up to $300K of the proceeds of their PPOR to super (as non-concessional contributions). In order to be eligible, you had to be over 65. This age has now been reduced to 60. This provision is proposed to commence on 1 July 2022.

New Thresholds

Although not part of the budget, thresholds will increase on 1 July 2021 in line with indexing provisions as per the below

• Concessional contribution cap to go from $25K to $27.5K
• Non concessional cap to go from $100K to $110K
• General transfer cap to go from $1.6M to $1.7M
• The Total Super Balance Cap increases from $1.6M to $1.7M

Summary

The 2021 budget changes relating to early retirees have been small, but all positive. For us, the change in the works test, and the pension loans scheme may be of benefit.

My Online Retirement Calculator

Well, I’ve been retired for 3 months and looks like I’ve landed a contract starting next week.

I’ve been working on an online calculator and it’s now in a reasonable state. It’s lacking a lot of features that I would like, but I’ve run out of time for the moment. If you have a look, I think you’ll agree it has a lot more features than other available Australian online calculators already. Putting in this additional flexibility has been quite time consuming, and adding features has the potential to as well!

Rather than putting the whole project on ice, and waiting until it is perfect (i.e. never!), I’ve decided to put it out there. Some important caveats are that this calculator is really for people approaching retirement and wanting to find out when is the best time to retire. It’s also been developed under Google Chrome desktop, and this is the best means of running it (I don’t have the resources to do extensive testing!). The program is a BETA version and it’s also my first Javascript program!. If you spot any issues, please let me know!

I have found the existing calculators lacked precision, so have made this one more exact (e.g. it asks you the day you intend to retire, your birthday etc). Don’t be too put off with this, as you can change them later with sliders in the main page. You can also see how your assets change, and there is a numeric table which accompanies the graph. In addition, there is a “Mortality” graph which shows you the probability that you (and your partner if relevant) will be alive.

I’m not going to dwell on the calculator, other than to show, once again, how it relates to our situation!

Here is the graph showing expenditure by age. I assume we will live to 90, and we sell the investment property around September 2040. I’m already seeing a benefit here because previously my spreadsheets did not allow the sale of the investment property. Selling it makes sense as it can significantly increase the spend levels.

Note that when we sell the investment property, the funds go to cash. Later versions will allow this to go into another asset class. The same with if your super exceeds the 1.6M cap when you retire; excess will go into cash rather than, for example, remaining in the accumulation account or going into an ETF or similar.

And here is the graph showing the financial assets.

Here is the graph showing the mortality information.

Have a go and if you have any feedback, please let me know.

2020 in Review

Time for another review. I finally retired a few weeks ago (although I am still open to contract work!). I am now finding I am taking less interest in my finances. Why? I think it’s because most of my anxieties prior to retirement were about when I could retire. Now that I’ve done it, I’m not so worried any more. I’ve read this is quite a common experience, and it’s good that I can focus on enjoying my retirement now.

Headline Figures

	2020	2021	Planned 2021
Cash	$593,536	$476,642	$184,236
Superannuation	$1,505,607	$1,849,157	$668,531
Primary Residence	$1,218,772	$1,588,400	$1,131,105
Investment Property	$322,391	$349,600	$275,292
Total Assets	$3,640,306	$4,263,799	$2,261,166
Asset Change	-1.79%	16.99%

	Change from 2020 to 2021	Change from Planned to 2021
Cash	-26.92%	158.71%
Superannuation	22.82%	176.60%
Primary Residence	30.33%	40.18%
Investment Property	8.44%	26.99%
Total Assets	15.92%	88.57%

Total asset growth was an impressive real 16% (mostly due to a significant increase in the PPOR, but also due to reasonable real Super Growth of about 8.5%).

Spending and Income in 2020

Spending in 2020 was about $42K, which was a little less than last year, and much as expected. I’m thinking this is about our budget if we live reasonably modestly and with a few discretionary items. When I say modestly, this still includes regular restaurant meals, coffees, etc!

Here is how our spending was broken up:

Not too different than last year. Per month spending is shown below:

Income in 2020 was $143K made up as per the below:

Total savings was about $101K, or about 71% of income (slightly higher than last year).

Updated Spending Patterns

Here is the spending pattern if we stay in the PPOR (something looking more likely):

Average planned expense is now around $116K, which is about a 9% increase from last year , taking into account inflation. The planned expense dwarfs the actually expenditure from 2020, so I think it is a reasonable time to retire.

Here is the planned expense assuming a 2% reduction in spending to 75, and then selling the PPOR at this age:

Expense has gone up about 13% from last year taking into account inflation.

Conclusions

2020 has been a roller coaster of a year, but in the end has been quite benign from a financial point of view (and was actually quite a good year!). Now that I’ve retired, I might work on an online financial calculator (although I have many other competing interests). As we no longer have an income, subsequent years’ planned spending should settle down at around $116K, although if our future spending tracks our historic spending, it may grow.

I think the approach I’ve taken has been the right one. Tracking expense and working out planned expense and making sure the latter is quite a bit less than the former is a good means of working out when you can retire.

A couple of recent challenges I need to think about:

• Interest rates for term deposits are now very low, and actually lower than inflation in some cases. This is not something I planned on (I assumed banks would provide about 0.5% higher than inflation in my model). Also, the mainstream banks provide even lower interest rates. Using third tier banks should be OK as deposits are guaranteed below $250K, but this involves shuffling around funds, something that itself is a bit risky. In any event, the discrepancy against the model is not huge (maybe about $2K per year with the amount we have in cash at the moment, and this will reduce with time).
• Once I get to 60, I will need a good strategy for managing the funds in Super. I assumed in my model that I would move all funds to an account-based pension (in order to get the reduced tax), and spend more than the minimum withdrawal required. But we may end up spending less than the minimum, in which case we will have surplus cash. Should we only move some into the account based pension so we can withdraw less (and get the higher tax on the amount remaining), or should we put the lot into the account based pension and put the surplus into a Super-like fund? Maybe a subject of another post…!

2019 in Review

Time for another review. Well, I haven’t retired yet, but I did try! I quit my job towards the end of the year and casually looked for another for about a month. I’m now back working…!!

This year has been mixed from the point of view of asset growth. Sydney real-estate continues for fall, but Super growth has been good. Let’s dive into the details.

Headline Figures

	2020 Dollars
	2019	2020	Planned 2020
Cash	$625,977.39	$593,536.27	$273,808.53
Superannuation	$1,222,880.92	$1,495,141.14	$646,452.10
Primary Residence	$1,459,079.73	$1,210,300.00	$1,124,083.15
Investment Property	$372,933.90	$320,150.00	$273,100.00
Total Assets	$3,680,871.95	$3,619,127.41	$2,317,445.52
Asset Change	-5.56%	-1.68%

	Change from 2019 to 2020	Change from planned to 2020
Cash	-5.18%	116.17%
Superannuation	22.26%	131.28%
Primary Residence	-17.05%	7.67%
Investment Property	-14.15%	17.23%
Total Assets	-1.68%	56.18%

Total asset growth has been approximately -1.68% or -$62K. Cash went down due to more Super contributions.

So, another year of negative asset growth (in spite of working!).

The main reason that assets have gone down is the decline in the Sydney housing market. It’s been going down for about 2 years now. My original assumption back in 2015 was that housing growth would be about 2.83% (just above an assumed inflation rate of 2.77%). While we are tracking above this, it’s not by much (7.89% above expected). Real-estate is a long term asset, so I am not very concerned about this (especially as we may never leave the PPOR!). Super showed some strong growth (about 16% excluding contributions) and this partially offset real-estate decline.

Here are some graphs shedding some light on the impact of the housing market. Each bar represents the value at the beginning of the year in the x axis.

The PPOR (as assessed by the bank) showed some strong growth in the years 2016 and 2017, but some strong declines in 2018 and 2019. In fact, the value of the home hasn’t changed since beginning of 2016.

Total assets by year haven’t increased since the beginning of 2018, despite high savings rates.

But excluding the PPOR, assets have increased:

The year 2018 showed weak growth due to Super performing poorly.

Spending and Income in 2019

Spending in 2019 was about $43K, which is quite a reduction on last year and is pretty much as expected.

It’s broken up according to the below:

Per month spending is shown below:

Income in 2019 was about $134K net of tax (slightly less than last year due to gap between jobs).

Total savings, including Super contributions, was about $91K, which represents about 65% of income, which is quite good (but not quite as good as living OS when it hit about 81%!).

Updated Spending Patterns

Here is my standard spending pattern which involves a reduction in spending of 2% a year until 75, and then selling the PPOR at this age. Note that I have now inflation-adjusted historical expenses and income (previously this was not done).

This is quite a bit different than last year. The reason is that the value of the house has fallen quite a bit so there is less to spend after 75. However due to a good savings rate and good growth in Super,  average expense, when adjusted for inflation, has gone up 4.85%.

And here is the spend level if we stay in the PPOR:

Average planned expense is now around $106.1K, whereas last year it was about $90.7K, a 13.5% increase taking into account inflation, which is quite good. Again, this can be explained by the good super performance, the high rate of saving and the reduction in the time required to be funded (by 1 year!).

Interestingly our projected spend is now at 96% of employment and rental income (the graph above includes super + interest in the historical income).

And here is the planned spending levels assuming we stay in the PPOR compared to the plans back in 2015.

Not too different actually, however in 2015 we planned to sell the PPOR at 64.

And if I didn’t work in 2019…

If I retired at the end of 2018, and didn’t work in 2019, our estimated spend for the period past 2019 would have been $101.2K, which is an increase on the projected $90.7K calculated in the 2018 in review post (or $92.2K in 2020 dollars), or a real increase of about 11.5%. The reason for the increase is the lower than projected spend in 2019 ($42K rather than $90.7K) and the good performance of Super.

Conclusions

Another year and finances are tracking OK. Real-estate has gone down, but Super has gone up. If you read my retirement timing posts, a reasonable conclusion might be that we can expect a crash in the value of super soon. And working an extra year or two might be sensible to build up a buffer…

 

 

The Australian Retirement Funding System – Is it Fair?

In this post we measure the fairness of the Australian Retirement Funding system using a common-sense metric. One of the challenges in working out if any retirement  funding system is fair or not is coming up with a measure of “fairness”. However, there is an immediately obvious choice.

We look at the lifetime amount of tax paid as a percentage of the overall lifetime income received. We do this with and without consideration to benefits (we consider the Age Pension a negative tax when considering benefits). A fair system might be one in which the ratio of the percentage of tax paid over a lifetime to the percentage of tax paid as part of your annual salary while working is similar across income levels.

The Australian system is often criticized for favoring the well-off and we intend to see if this is the case. Prior to commencing this post, I suspected that the Australian system does indeed favour the rich, mainly because contributions are pre-tax with a flat rate contributions tax of 15%.

Assumptions

We will make certain assumptions during this analysis. We will assume that the person under analysis is single, works from the age of 22 until 66, makes 100% of their income from the age of 32 until 66, 50% at 22 increasing to 55% at 23, 60% at 24 etc. We assume a pre-tax contribution rate of 9.5%. We assume that the person plans to live to 90 and in retirement spends a fixed amount each year which results in Super running out at 90. We assume a standard real Super return rate of 6%. We assume no inflation and no wage growth/Standard of living increases. We assume tax rates as of May 2019 remain the same. We assume that there are no additional contributions to Super beyond the statutory requirements and there are no additional income producing accumulated assets. We assume accumulation mode earnings tax of 8%.

We also assume that Super is not drawn down until retirement age (66) and if the Super accumulation account exceeds $1.6M at any time prior to retirement concessional contributions continue to be made to Super until 66. At 66 a maximum of $1.6M is transferred to the Pension mode account. At this stage when we draw a retirement income the minimum amount is removed from the pension account (as per Super rules) and the maximum from the accumulation account. When the accumulation account reaches an amount where it is more sensible to invest in a vehicle outside super (i.e. when it can be expected that total tax is less than 15%), we move funds from it into an investment account with the same earnings profile as Super. We have not made use of SAPTO for this analysis.

We assume there are no tax minimization schemes to reduce taxable income both when working and in retirement. That is no negative gearing, family trusts, company tax rates etc. Maybe these will be shutdown soon. These schemes may introduce unfairness, but they are not part of the retirement funding system and their unfairness should be assessed as a separate exercise.

These assumptions could be made more realistic at the expense of more complexity. However, the purpose of this exercise is to get a rough understanding of the fairness of the system and further refinements are not expected to make a great deal of difference.

Amount of Tax Paid as percentage of overall income

In this section, we will look at the ratio of the percentage of tax you pay over your lifetime to the percentage of tax you pay when employed over the course of a year. We might consider a system fair if this ratio is independent of income.

The diagram below shows the amount of tax paid by a Tax payer as a percentage of their wage (exclusive of Super). As you can see, the system is progressive; the more you earn the higher tax percentage you pay.

Now let’s work out this statistic for each income level:

Lifetime Tax Paid / (Lifetime Tax Paid + Lifetime spendable income received).

This is a measure of the amount of Tax you have paid in your lifetime as a percentage of your total lifetime income.

We’ll also work out this statistic:

(Lifetime Tax Paid – Age Pension Received) / (Lifetime Tax Paid + Lifetime spendable income received)

This is a measure of the amount of lifetime Tax you have paid less any subsidies (in this case the Age Pension) as a percentage of total lifetime income.

You can see that the lifetime rate of tax is lower that the rate incurred by the tax payer during their working life. We might have expected this as very little tax is paid in retirement (although some is under our assumptions, as not all funds can be moved to the tax free Pension account when the total super balance exceeds 1.6M).

Let’s now look at the ratio of the  percentage of tax paid during your lifetime versus the percentage of tax paid when working.

We have done this below for tax and also tax less benefits.

That is we we look at these ratios:

(Lifetime Tax Paid / (Lifetime Tax Paid + Lifetime spendable income )) / (Annual Tax Paid when working/ Annual income when working exclusive of Super)

and

((Lifetime Tax Paid – Lifetime Benefits) / (Lifetime Tax Paid + Lifetime spendable income )) / (Annual Tax Paid when working/ Annual income when working exclusive of Super)

You can see that once we take into account Age Pension benefits, the higher your salary, the higher the ratio of your lifetime tax percentage to Salary Tax percentage.

Using the metric that we described at the beginning of this section, we can again consider the Australian retirement funding system to be fair.

Yearly Spend After Retirement Versus Prior to Retirement

We can also compare an individual’s post-tax pre-retirement income with their income in retirement. If the multiple is independent of income, this sounds like it might be a reasonable measure of fairness. However, it’s not quite as good as the original measure. Just because a person had a high income during their working life doesn’t mean they are entitled to a high income in their retirement. The sums need to add up.

We can see what this multiple actually is though.

It turns out that,  if you contribute the 9.5% each year and work between 22 and 66, your retirement income will be about 50% higher than your working life income (even more for low income retirees due to the pension)!

Here is the diagram showing the multiple of income in retirement versus peak working life income (after tax and after super)  with and without the 1.6M transfer-to-pension-mode limit.

You can see that that:

• If you have a low income, your retirement income multiple is quite a bit higher than other income multiples. This is due to the Age Pension.
• If you have a pre-tax super inclusive income of above about $100K, your retirement income multiple is between 1.5 and 1.6 for all incomes up to the maximum ($250K). High income earners appear to start being advantaged towards the higher end of the multiple at around $200K.
• The people with the worst outcome are earning about $100K – $140K.
• The 1.6M limit change disadvantages high income earners, but not significantly.

This is a strange result as we would expect high income earners to be significantly advantaged due to the fact that their Super contributions come from pre-tax income, and therefore not subject to progressive taxation. We would expect them to have a significantly higher multiple of their post tax income.

Let’s look at what happens if we remove the Age Pension and the 1.6M limit.

You can now see the effect of the pre-tax contributions by the people with higher incomes. Without the Age Pension, using our metric the system is definitely unfair with retirement income increasing as a percentage of pre tax income prior to retirement. The Age Pension (and to a smaller degree the 1.6M limit) helps to make the Australian Super system considerably fairer.

Now, if we add in the Div293 tax change mooted by the Labour party (changing the limit for high income earners to pay 30% contribution tax from $250K to $200K), you can see that the system becomes even fairer:

In fact, changing to a value of $185K seems about right in terms of making the system the most fair using this measure:

If we add in the Pension mode Tax originally promoted by Labour (15% earnings tax for earnings over $75K in Pension mode), while being aware of the pitfalls in modelling this with a standard return rate (as described here), we get this diagram:

You can see that once an income of approximately $200K is reached, this measure doesn’t actually have an impact. This is because when Super accounts are high near retirement, a significant proportion is kept in the accumulation account (or other investment account outside super if it is more advantageous to do so). In order to minimize tax, we want to move as much out of this account as possible by using it for spending. The problem is we must withdraw 5% (between 66 and 74) of the Pension mode account. As this is being run down by the new tax, we can’t move this out as quickly resulting in more tax on the accumulation account.

What happens if we vary the return rate

We’ve assumed a 6% real return rate, which although a bit lower than the average Australian Super rate since inception, it’s still quite a bit higher than rates used in modelling exercises. Here are the results for some other rates.

You can see that the system advantages lower income earners more if we assume lower rates.

Challenges

We’ve seen that the Australian retirement funding system appears to be quite fair. However, this is not the way it is often portrayed in the media. Let’s look at some of this commentary and common arguments.

This article makes the following arguments:

MANY people would argue that it is fair enough that they get a tax deduction on their superannuation. After all, if you’re a wage earner then the government is making you put aside 9 per cent of your salary, and a higher percentage in the future – money you cannot get your hands on until you are at least fifty-five.

What that argument ignores, though, is the large-scale redistribution of wealth that is taking place within the superannuation system. In reality, it’s people on lower incomes who have a right to feel cheated. And if you’re young, you have a right to feel doubly dudded. The tax concessions are distorted not only in favour of people on higher incomes but also to advantage older generations.

The tax deduction for super operates like a flat tax, with contributions and interest earnings taxed at 15 per cent from the first to the last dollar of income. That means the deduction is worth much more to those on higher incomes, who pay marginal tax rates of 38.5 per cent and 46.5 per cent.

What this argument ignores is that when the Super system is combined with the Age Pension system (the two major pillars of the retirement system), people on lower wages are disproportionately advantaged. They achieve higher multiples of pre-retirement income in retirement, sometimes considerably so.

And this:

Treasury calculated last year that the top 1 per cent of income earners receive an average of $510,000 in retirement support from the government, all of it through tax concessions, compared to $250,000 for the bottom 10 per cent, almost all of it through the age pension. 

What this also ignores is that the tax paid by the top 1% during their working life is enormously higher than the tax paid by the bottom 10%. The ratio of lifetime tax less benefits paid as a ratio of lifetime income again favours people on lower wages, with people on especially low wages paying negative lifetime tax.

And this:

The tax concessions discriminate between generations, too. Because superannuation income is tax-free from age sixty, once again, the higher your income, the more tax you save. As Bank of America Merrill Lynch economist Saul Eslake puts it, “I can’t think of any single policy reason, as distinct from a baser political motive, why people over the age of sixty or sixty-five should pay less tax on the same amount of income than people under the age of sixty-five.” The politics are driven by demographics: the rapidly rising numbers of baby boomers who are retiring. Over the next decade and a half, more than 60 per cent of the total assets of superannuation funds are expected to shift from pre-retirement accumulation accounts to retirement benefit accounts.

There is a good policy reason for not paying tax during the Super drawdown mode. The reason is that the present system (the system in which the Australian Age Pension system is combined with the Australian Super system) is already progressive. If the super drawdowns were taxed on exit, for example at salary earnings rates, while maintaining a flat tax on entry and a flat tax on earnings, the system would be extraordinarily progressive and a poor vehicle for building up wealth for retirement.

Conclusions

In this post we’ve proposed some metrics to assess the fairness of the Australian retirement funding system. We’ve also modeled the likely income available to persons in retirement with various salary levels and then applied the metrics to the resulting spending profiles.

The outcome is very surprising. The Australian retirement funding system, which I expected to unfairly favour high income earners is, when using the proposed metrics, unexpectedly fair. For salaries above about $90k, the regressive nature of Australian Superannuation is countered almost exactly by the progressive nature of the Australian Age Pension system. For salaries less than $90k, salary earners tend to be favoured.

This is good news for pending retirees as it should mean the system will be more stable and less likely to change. Less change makes it easier to plan.

In the next post we will look at some schemes used in different countries and compare these with the Australian system via the metrics described in this post.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The 2019 Federal Budget

This post describes the impact of the recent 2019 Federal budget on early retirees or pending retirees. The impact has actually been very small this year and only two measures have been introduced. Note that these measures have not become law and may not be if the Labour party is successful in the coming election (which seems quite likely!).

Flexibility for people aged 65 and 66

We noted in the the Australian Super and Age Pension Rules post that:

“you cannot make non-concessional contributions to Super if you are over 65 unless you pass the works test. You cannot make contributions if you are over 75. Refer here for more details.”

In the 2019 Federal budget it was announced that voluntary concessional and non-concessional contributions can be made to Super for 65 and 66 year olds without having to pass the works test. This will apply from 1st July 2020.

Spouse Contribution Tax Offset Age limits increased

In addition to the above we noted that in relation to Tax offsets for contributions to spouse superannuation accounts:

“The offset is a small amount of no more than $540 (in 2019). You are only eligible for a full offset if your spouse earns less than $37,000, and for a part offset if your Spouse’s income is more than $37,000 but less than $40,000. Your Spouse must be under age 65, or if they’re between 65 and 69, they must be able to pass the works test.”

The above Spouse age limit is now 74 rather than 69, again from 1st July 2020 (note the works test must still be met).

How will this affect us?

If we are considering selling our home and wish to put the $600K into Super using the policy announced in the 2017 budget, AND an additional bring forwards amount of $600K from the proceeds without having to pass the works test, we could now do so at 66 rather than 64. It’s a very small benefit, but something to bear in mind.

Conclusions

The 2019 Federal Budget has very little impact on early retirees or pending retirees. The two measures introduced are of minor benefit.

 

 

 

Retirement Timing – Part 2

In the previous post we learned that, through the use of the Schiller Ratio (otherwise known as the CAPE), it was possible to gain a good indication of the likely performance of stock markets over the subsequent 20 years.

In the Sequencing Risk post, we learned that, even if we experience a series of returns with a high average return, the sequence of the returns can have a huge impact on our spend levels in retirement. We also learned that one effective way of mitigating sequencing risk was to build up a savings buffer.

If we could predict poor returns in the near term (in addition to the mid/long term) prior to a proposed retirement date, this would be very useful, as it would be a good indication that we may be impacted by sequencing risk. It would allow us to make a more informed decision on the appropriateness of working a bit longer to build up a savings buffer.

This post looks at the Yield Curve as a tool that may help with predicting poor returns in the short term.

The Yield Curve

A yield curve is a graph showing several interest rates (or yields) across different contract lengths. Normally the longer the contract length, the higher the yield, although increases in yield normally diminish as the contract length increases. The theory is that a purchaser of a longer term security will want to be compensated at a higher rate due to the higher uncertainty over the longer period.

This diagram shows how the yield of US treasuries has varied over time (to about 2016).  You can see that the yield curve for a particular year normally slopes upwards as the contract length is extended, although this is not always the case.

The slope of the US government security yield curve turns out to be a good predictor for growth in the US economy in the short term. An inverted yield curve (i.e. a curve with negative slope) has also been an accurate predictor of pending US recessions.

The diagram below shows the 10 US year treasury rate less the 2 US year treasury rate since the mid seventies, with the areas shaded in grey being US recessions. You can see that once the 2 year rate exceeds the 10 year rate, a recession always follows shortly afterwards (typically 12 months).

And here is another showing the relationship between US GDP growth and the US Yield curve (10y vs 2 y):

When the 10 year – 2 year differential becomes negative, US growth becomes negative shortly afterwards.

At the time of writing (4th December 2018)  2 year rates are 2.80% and 10 year rates are 2.91%.  The yield curve is not yet inverted, but it’s getting pretty close.

The Australian Yield Curve

Of course, Australia has its own government yield curve.  However, it turns out that Australian Growth is not tightly coupled to the Australian Yield curve shape.

US Growth Versus Australian Growth

The graph below plots US Growth versus Australian Growth.

You can see that, in most cases, US growth and Australian growth have been closely related. Both the US and Australia experienced low or negative growth in 1982, 1991 and 2001. The US had a large drop in growth during the GFC in 2009, but a similar drop was not experienced in Australia. During the most recent period, growth of the Australian economy has become heavily dependant on exporting minerals to China, and this may be a reason for the decoupling.

An inverted US yield curve predicts a US recession fairly well, and, with the exception of the most recent US recession, a US recession has also been indicative of an Australian recession or slowdown.

US Growth and Australian Superannuation

OK, what we are really interested in is the relationship between US Growth and Australian Superannuation funds! The relationship using AustralianSuper balanced fund as a representative fund is shown in the diagram below.

As you can see, growth in the US economy and the performance of the AustralianSuper balanced fund is closely related. This is unsurprising as a significant percentage of the AustralianSuper balanced fund is made up of Australian and US stocks, and these are both correlated with US growth. As an inverted US Treasuries Yield curve is a strong predictor of a US recessions, we can see that an inverted US Treasuries Yield is also a predictor of negative AustralianSuper balanced option returns (and likely most other funds with significant Australian and/or US stock exposure).

Conclusion

The US treasuries Yield Curve is a tool that can be used to predict US recessions. An inverted Yield Curve has predicted 7 of the last 7 recessions in the US.

US recessions are defined by reductions in US Growth and US growth is correlated with the AustralianSuper balanced fund returns (my Super fund!).

As such, an inverted US Treasuries Yield curve is a likely predictor of negative returns from the AustralianSuper balanced option fund and most likely with other Australian Super funds with significant exposure to Australian and/or US funds.

If you are considering retiring soon, and would like to mitigate Sequencing Risk, the information from the Yield curve may be an important factor in your retirement planning.

 

 

 

 

 

 

 

 

 

Retirement Timing – Part 1

In the last post we looked at sequencing risk and showed how a bad sequence of Super returns can impact your spend levels in retirement.  We presented a number of strategies for mitigating sequencing risks, and showed that the only one of the presented options that was likely to be successful was the strategy of developing a buffer.

It’s not only the impact of a bad sequence of returns that would benefit by the use of a buffer, but mitigating the impact of a prolonged period of poor returns (such as occurred in the 70s)  might also benefit by buffering.

A method of forecasting poor market performance in the mid term (or at least the likelihood of poor market performance) would be handy as it would allow us to know if building up such a buffer is likely to be necessary.

In this post we look at an accepted method of forecasting returns in the market over the next 10 or 20 years, which is the length of period we would be most interested in as a retiree or pending retiree.

Price Earnings Ratio

The price earnings ratio for a company is its share price divided by its Earning Per Share. The most common method of working out the Earnings Per Share is to divide the net income from the most recent 12 month period by the weighted average number of shares on issue during this period.

A company which is expected to grow and/or presents low risk will typically have a high P/E ratio and vice-versa.  The average US equity P/E ratio between 1900 and 2015 is about 15.

The P/E ratio can be worked out for entire markets by weighting the P/E ratio of component stocks by their market capitalisation. At the time of writing, the US market P/E ratio is 19.3 and the ratio for the Australian Market is 17.8.

Schiller Ratio

Schiller’s ratio, otherwise known as the Cyclically Adjusted Price Earnings ratio (or CAPE) is a variation of the Price Earnings Ratio and is defined as the price divided by the average of 10 years of earnings adjusted for inflation.

The CAPE can be used as an indication of a stock (or market) being overvalued or undervalued by comparing the present P/E ratio with the CAPE (although, on the other hand, a recently elevated P/E ratio might also be indicative of a recent innovation at the company/in the economy). A high market CAPE has also been correlated with low future market returns in the subsequent 10 to 20 year time frame and vice-versa.

The average CAPE for the US S&P composite index in the 20th century was 15.21. The present CAPE for US equity markets is 29.4 and for Australian equities it is 17.8. By historical standards, the US CAPE is very high. More information on international CAPE and PE ratios may be found here.

The diagram below shows the CAPE for the S&P composite index at various times versus subsequent 20 year returns.

You can see that, in general, the higher the CAPE, the lower the expected return over the next 20 years. Given the present US CAPE value, it looks like we are in for a run of poor returns from US markets.

Most Australian funds have international shares in their portfolio. In addition Australian market performance is highly correlated with the performance of US markets. The AustralianSuper balanced option, for example, has, at the time of writing, about 34% international shares and 26% Australian Shares. On this basis, we might expect a high CAPE to impact on the returns of Australian Superannuation funds. We examine this proposition in the next section.

The Schiller Ratio and Australian Super Funds

Pending Australian retirees are likely to be most interested in how the the Schiller ratio relates to real returns from Australian Super funds, because most Australians use Super to fund their retirement.

The diagram below shows the relationship between the S&P 500 Schiller ratio (the average over a year) and the real performance of the AustralianSuper balanced option over the next 10 years and over the next 20 years.

We would expect the CAPE and the returns to mirror each other and we do roughly get this behaviour with the mirror around CAPE =25, Return = 5.00%  line.

Scatter diagrams can be a bit more instructive:

You can see from the above, the relationship is fairly clear cut. The least squares best fit line shows returns reducing as CAPE increases, with a reduction in return of  0.16% (0.07%) for every increase in CAPE value for 10 (20) year returns. We can see, however, that even when the CAPE is quite high, we still get reasonable returns albeit lower than the average.

There are also some anomalies and these are shown in the table below:

Year	CAPE	10 Year Average Subsequent Returns
1997	30.8	7.37%
1998	35.9	5.75%
2007	26.7	3.63%

If we use the least squares best fit line to predict the returns from the present (December, 2018), given the present CAPE of about 30, we would expect a real average return of about 5% over the next 10 years and about 5.5% over the next 20 years. This is quite a bit higher than the value we have been using to work out spend levels (2.8%), but also quite a bit lower than the average AustralianSuper balanced option return season since inception (6.7%).

Conclusion

A high US market Schiller ratio is correlated with poor US market returns for the subsequent 20 years. Australian market returns are correlated with US markets.

At present, the Schiller ratio for the US markets is very high. If past correlations are a guide, this would indicate that we are in for a run of poor returns from the US and Australian markets during the next 20 years, a timeframe of interest to pending retirees.

Although most pending retirees will be interested in the likely performance of the markets in the next 10-20 years, they will often be more interested in the likely performance of Australian Superannuation funds over this period.

We have examined the relationship between the Schiller Ratio and Australian Super funds, using the AustralianSuper Balanced option as an example and discovered there is a similar relationship. We have found, however, that even at high CAPE ratios, returns are reasonable and higher than we have used for planning.

These correlations are useful information to pending Australian retirees as it informs the amount of savings that may be required to fund retirement.

 

 

 

 

 

 

 

Sequencing Risk

Sequencing risk refers to the risk of running out of funds due to the order of the returns from your investments.

The average yearly return of your investments may be the same in two scenarios, however the order of the returns may result in wildly different outcomes. Generally if you receive good returns when you have a large amount of funds (generally near the beginning of your retirement), and poor returns when you are low on funds (generally near the end of your retirement), you will do well (and vice-versa)

Is sequence risk something we should worry about, and if so, what can we do about it?

In this post I will look at some hypothetical scenarios based on past real returns, examine some proposals on how to mitigate the risk, and then look at our situation in particular.

Sequencing Risk – An example

The real returns from AustralianSuper for their balanced option from 1987 (its inception date) to now (2018) are shown below:

You can see that in most years the return has been quite good, but there also have been some years with quite large negative returns (the GFC!).

Now, let’s assume you are 65 and have $1M in Super with AustralianSuper balanced option. For simplicity, we will assume there is no Aged pension.

In the first scenario, we assume we get the returns commencing in 1987 and ending in 2009 i.e. starting from AustralianSuper’s balanced option inception date and ending at the GFC.

In the second scenario, we assume returns in the reverse direction. i.e. starting from the GFC and going backwards to the inception date.

The average yearly return in Scenario 1 is the same as Scenario 2.

We’ll assume that we spend the same amount every year and it is the amount ($86,453) which makes Super zero at age 88 with the average return during the period for all years. (6.7%).

Here is the value of capital by year:

 

You can see that sequencing risk is real. Capital runs out during age 78 for scenario 2, but there is still plenty of capital left (about $388K) at age 88 for Scenario 1. A huge difference!

What can we do about Sequencing Risk

There are no easy solutions for mitigating Sequencing risk. Here are some I have thought about.

Keeping some of your funds in cash

The idea here is you keep some of your funds in cash and spend it prior to using the funds in your shares. If you have a bad return at the beginning (the time you are most vulnerable), then it is not quite so bad as the negative return does not affect cash. As you run down your funds, the impact of negative returns becomes smaller so there should be less need to hold cash.

The diagram below shows what happens if we hold $450K in cash and $550K in Super and spend $86,453 each year while running down the cash before the shares.

 

As you can see, this strategy barely improves on the GFC at beginning scenario, and makes the GFC at end scenario considerably worse. It doesn’t work!

Moderating your Spending

This strategy involves reducing your spending when your funds go down. The idea is you might be able to recover your funds by using the subsequent higher returns and a lower spending rate. In the example below, we have the GFC at the start, and we work out how much to spend each year based on assuming returns will be the average for remaining years and make funds at 88 equal to zero.

The average spending in this approach is about $64K (rather than $86K), or about 74% of the original planned spend. Compared with the GFC at end scenario, we also have $388K less funds at 88. This strategy doesn’t really work either, but it does at least ensure you do have some funds throughout your retirement!

Here is the spend per year:

Building up a buffer/Working extra years

The idea here is you build up more funds than you would require assuming average returns each year, just in case you have a sequence of bad returns at the start. You might have an idea that bad returns are due if you have had a recent sequence of very good returns, or if you have been using predictive tools such as those discussed in this post. In the diagram below, we assume we work 2 more years, and save $60K each year of working, and of course we save the run down of funds during those two years. We also assume we spend the standard $86K each year once we do stop work. The diagram below shows what happens here assuming we have the GFC at the start.

In this scenario we don’t actually run out of funds and we have about $147K at the end. This strategy works (at least in this limited case).

Timing the Market

Another strategy would be to retain some funds (or perhaps a percentage of funds) as cash and to use these funds to invest in Super (or shares if this is not possible) when the market drops more than a certain amount during a year. The idea is you keep some funds to buy low.

As an example, I have assumed that at the end of each year, the cash/shares ratio is re-balanced to a certain percentage. If the return drops to less than -10% over a year (only once in the last 30 years for AustralianSuper), the cash is used to purchase shares at the end of the year and we stop rebalancing I.e. we maintain 100% in shares moving forwards.

Here is a diagram showing the age at which funds run out assuming various cash percentages and commencing at different years between 1987 and 2009..

 

This strategy doesn’t seem to work because most of the time the spare cash is dragging down the returns. In general, the higher our cash percentage, the lower the Age at which funds run out.

Sequencing Risk in our Situation

OK, let’s take a look at our situation. Our situation is a bit different than the above example as we have the Age Pension, which should moderate to some extent the impact of Sequence risk (when funds go down, income from the Pension increases). In addition, we work out how much to spend each year on the basis of our planned returns of 3.2% and making assets at 90 equal to zero (i.e. the same as the “Moderating Your Spending section” above.)

I assumed that we experience the AustraianSuper returns, starting in a year as per the below diagram:

These are historical returns, but I’ve added in 2019-21 figures by adding in another GFC (to offset the recent good returns). For any given starting point, once we get past 2021, we start at 1987 again. I assume we don’t sell our house. Here is the average spend per year with a start date on the x-axis:

 

Notice that even in the worse years to commence, the average spending is about $107K per annum, much larger than our planned $90K as discussed in the 2018 in review post. The reason for this is that, for the purpose of modelling how much we will have to spend, we have assumed real returns of 2.8%, in accumulation mode and 3.2% in pension mode, while AustralianSuper returns are on average 6.7%. in accumulation mode and about 7.2% in pension mode. Effectively we have built a buffer by assuming average Super returns that are a lot lower than commonly occur in real life.

The result of assuming lower returns when planning spending levels but actually experiencing higher returns (although not necessarily in the desired order!) is that typically  we end up spending less in earlier years and more in later years, something we don’t really want because we would prefer to spend more when we are younger and healthier. This is the price to pay for protecting ourselves against sequencing risk.

The below shows the spending pattern that would result from retiring in 1987:

And here is the worst average spend (resulting from retiring in 2008):

The lowest annual spend is three years in and is about $75,240 or about 83% of initial expense. The worst average corresponds to this sequence of returns:

Why did we choose the return of 2.8% when we did the original modelling? Well, it’s the return the calculators on the net use! Maybe they are setting this return rate low to protect us from sequencing risk (or maybe to cause us to  deposit more funds with the company publishing the calculator!).

Going back to our “Sequencing Risk – An Example” section, if we use a return rate of 3.3% to work out the spend level that causes funds to run out at 88, our calculated spend levels would have been about $63K. If we spent at this level and received AustralianSuper returns starting from the GFC, we would not have run out of funds (at 88  we would have about $145K). i..e the strategy of building up a buffer based on using lower than real-life returns would have worked.

Our Situation and Working Extra Years

Ok, what happens if we were not happy at the prospect of the worst case average spend ($107K). Well, we could work an extra year. Let’s assume we do this and save $80K, while spending about $50K while working.

In this case, our average spend from the retirement age is $116K . The updated diagram is shown below.

Working an additional year (a total of 2 years) results in the an average spend of $133K, quite an improvement, and the updated diagram is again shown below:

Conclusions

Sequencing risk is real.

And there are not many things you can do about it.

The best strategy I am aware of is to build up a buffer. One way of doing this is to assume lower returns than those experienced in real life to work out your desired spend levels. In this case if you have a sequence of poor returns early in your retirement, you are still likely to achieve your desired spend levels because subsequent returns will be higher than expected and will frequently be enough to bring you back to your desired spending levels.

My investigations show that if you are using the real return levels used by online calculators (about 3.2% in Pension mode) to work out your spend levels, you have implicitly included a buffer, as the actual real returns (at least over the last 30 years) in Pension mode for a good Super fund is about 7.3% (*).

(*)  – Although, read the next post!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018 in Review

Another year and another review! After a number of stellar years with net worth increasing many hundreds of thousands of dollars each year, from a financial point of view this year has not been so good:

Headline Figures

	2019 dollars
	2018	2019	Planned 2019
Cash	$799,290.81	$615,513.66	$358,159.27
Superannuation	$980,465.39	$1,202,439.45	$618,957,60
Primary Residence	$1,692,756.74	$1,434,690.00	$1,104,167,18
Investment Property	$359,851.45	$366,700.00	$268,262.19
Total Assets	$3,832,364.38	$3,619,343,11	$2,349,546
Asset Change	12.64%	-5.56%

	Change from 2018 to 2019	Change from planned to 2019
Cash	-22.99%	71.85%
Superannuation	22.64%	94.27%
Primary Residence	–15.25%	29.93%
Investment Property	1.90%	36.69%
Total Asset	-5.56%	54.04%

Total asset growth was approximately -5.56% or -$213K.

This year has not been as good as other recent years. The reason for this is:

• The value of the family home, as assessed by the bank, has lost quite a bit of value. The Sydney housing marker is on the way down at the moment. It’s not a big deal as we won’t be selling up for a while if ever…!
• Our spend this year was much higher than other years, as we have spent on quite a few extraordinary items. More on this later.
• Superannuation has not performed well this year. I made about $225k in contributions this year (concessional and non-concessional and across two financial years) and growth has been about $220k, allowing for inflation. Which means Super went backwards slightly this year.

The good news is that we’ve made some nice house improvements and now have one less year to fund in retirement!

Spending and Income in 2018

Spending in 2018 was about $71K, which was much higher than other years and was broken up as shown below.

Per month spending is shown below:

If we take out discretionary and work expenses, and remove rent received, spending works out to about $41K, which is not too bad (but still quite a bit higher than living overseas!).

Medical expenses were high due to my wife’s medical insurance in March and requirement for a Crown in October.

In September we had to do some significant renovations on the rental property, hence the large negative income from the rental property this month.

Debt is often classified as as good or bad debt, and I’ve classify our discretionary spending as such in the table below:

Discretionary Costs	Amount	Value (1-10)	Comment
iPAD	-$1,250.93	2
Elec Mower	-$563.72	4	Reduces petrol cost.
Air Conditioner	-$1,443.75	3	Adds value to the house
Alarm Upgrade	-$950.00	4	Adds Value to the house and imporves security
Electrical upgrades	-$643.50	6	New lights. Adds value to house
Solar System	-$9,000.00	10	Reduces power bills. Short payback time
New Mirrors	-$1,130.00	3
Credenza	-$3,132.00	1	Nice addition to Study
Picture Framing	-$384.70	3
Outdoor Tiling	-$7,133.40	8	Adds Value to the house
New Couch	-$4,697.00	3
Fridges	-$1,487.00	N/A	Required after returning from O/S
Removals	-$1,720.00	N/A	Required after returning from O/S
Total	-$33,536.00

Moving forwards, discretionary costs should be more leisure related.

Income in 2018 was about $138K net of tax. Lower again from last year in high taxing Australia!

Total savings, including Super contributions, were about $65K, which represents about 47% of income; not a bad savings rate but a lot lower than previous years. Note that the rent from the investment property was lower than expected due to requirement for major renovations.

Updated Spending Patterns

I’ve retained the standard spending pattern from last year:

You can see average planned expense is almost the same as income this year.

Below is the spending pattern assuming we stay in the PPOR:

Average planned expense is about $90.7K, whereas last year it was about $85.1K, about a 6.5% improvement (or about 4.6% taking into account inflation).

And here are the planned spending levels compared with the plans back in 2015.

You can see that over the last few years expenses are going up and income is coming down! Not too much of a worry as additional expenses are mostly discretionary and income is not so important so close to retirement.

And if I had retired at the end of 2017…

If I retired at the end of 2017, the computed spending per year beyond 56 assuming we stayed in the PPOR until 90 would have been about $85K again, a slightly lower spend due to inflation. We might have expected this to go down due to the low Super growth, or up due to the lower spend (despite extraordinary items!) than planned in 2018. Seems like these two have almost cancelled each other out.

Conclusions

This year hasn’t been a good year from the point of view of asset growth. Still, another year has gone by which is no longer required to be funded by savings/super, we have made some significant house improvements and investment property renovations and, assuming we stay in the PPOR, our planned spending levels have increased by about 4.6%.

In our retirement our non discretionary expenses are likely to be about $41K per year, and our budget for expenditure will be about $90K per year if we stay in the PPOR.  Which means about $50K in discretionary expenses per year, which is quite high.

We also have a number of backup plans which should help if things go south (e.g. sell or move into investment property).

I’m thinking of retiring a the end of 2018 (i.e. in a few weeks!). The one thing that worries me a bit is the recent wobbles in the Stock market, and sequencing risk. I’ll do a post on sequencing risk shortly.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retirement Countdown – Cost Tracking

Prior to entering into retirement, it’s a good idea to get a handle on your monthly costs. That way you can understand if the budget you are proposing to live on will be adequate.

While I’ve been tracking my costs, unfortunately we’ve been living overseas most of this time, so our Australian costs might be a bit different.

To find out what our costs have been, I worked out our costs for December 2017 through to June 2018 inclusive.

Excluding discretionary costs, our costs less rental income have been about $2,850 per month. If I also exclude discretionary, petrol and work expenses, it’s about $2700  per month (or about $32.4K per year). If I look at costs without the rental income, they are about $3,500 per month or about $42K per year.

The discretionary costs are meant to capture costs which we wouldn’t normally pay during the course of a year. This year they have been quite high (mainly because of our return to Oz) and have included a new Solar system, new furniture, a new alarm system, cost of returning furniture from storage, new fridges and various others.

In the latest year end review,  in one of the options we are proposing to stay in the PPOR with a budget of about $80K per year. This means roughly we should have about $42K for regular expenses, and about $38K for any other additional expenses (e.g. unexpected house maintenance or medical expenses, holidays etc).

How do our costs stack up against other people in retirement? This report helps with a response to his question.

They find that the actual costs in retirement are quite low, tend not to vary by income, tend not to vary by age, and tend to vary by location (with Sydney and Melbourne being much higher than elsewhere).

The average spend per year in 2014 across Australia was about $31K (about $33.5K in 2018 dollars). In Sydney it was about $44K (about $47.6K in 2018 dollars).

Conclusions

On the basis of our costs to date, the option of retiring at the end of the year and staying in the PPOR is looking good from a financial point of view. Our non-discretionary costs are modest and well within budget.

 

 

 

 

 

 

 

 

 

 

 

Aged Care

In this post I take a look at Aged Care from a financial point of view. Some may think that by the time you go into Aged Care you are living out the last years of your life and your finances are not a high priority. However I think the finances of Aged Care are worthwhile investigating in order to get answers to the following questions:

• To what extent is the quality of Aged Care available to you dependent on your financial assets. i.e. should you try to preserve assets to pay for aged care?
• If Aged Care quality does depend on your financial assets, how much should you try to preserve?
• If one partner goes into Aged Care while the other is quite healthy, how does Aged Care impact on the finances of the person not in Aged Care?
• If both partners eventually end up in Aged care, or if one remaining partner is in Aged Care, how does Aged Care impact on the amount left to beneficiaries?

After the analysis in this post, I answer these questions in the conclusions.

What is Aged Care?

Aged care is care for the elderly regulated by the Federal Government and can take several forms. These forms are:

• Help at Home. In this type of care, you remain in your home and Aged Care staff visit you to provide assistance required.
• Short Term Help. This type of care is provided when you have a temporary set back which means you require some form of additional care.
• Residential care. In this type of care, you move to a residential care facility and are provided with care 24 x 7.

The type of Aged care I will focus on in this post is Residential Aged Care.  The costs of other forms of Aged care do impact on the costs of Residential care because certain costs are capped across all types of Aged Care. This means that if you are provided Home care, for example, and then move into Residential Care later, your costs in Residential Care may be lower. If I have time, I’ll look at other forms later.

Aged Care is subsidized by the government and means tested.  If you have assets or income above government defined thresholds, you will need to contribute some of your assets/income towards Aged Care. As mentioned above, some of these costs are capped, meaning that if you are in Aged Care for an extended period, costs may be less.

The Aged Care system is the responsibility of the Federal Department of Health. This government department provides the funding to support Aged Care services, regulates the costs of the services, manages the accreditation of the Aged Care homes and oversees the legislation for Aged Care.

This web site provides details of the Aged Care services provided in Australia, while this site is also quite useful. Information on other forms of Aged Care may be found at these sites as well (e.g. Home Care).

Who uses Residential Aged Care?

The diagram below shows the proportion of the population that uses Residential Aged Care:

You can see it is used mostly by people over 85, and also females tend to outnumber males. Also, in all likelihood, the average person probably won’t use Aged Care at all.

Here is a diagram showing the number of people entering into Aged Care by age:

Most people don’t come out of residential aged care alive!:

The diagram below shows how people leave by length of  stay. The longer you are in an Aged care home, the more likely you are likely to leave as a result of death.

All of the above diagrams are sourced from here.

This diagram shows that most people coming into Aged care are on the Pension:

Most females are widowed , and most males are married:

If residents last the first 6 months, they are likely to stay longer. Note that 48% of males are only in Aged care for less than 12 months.

The above diagrams are sourced from here.

How do you get access to Residential Aged Care?

In order to get access to Aged Care Service you must:

• Register with “My Aged Care” by calling the My Aged Care contact number on this site.
• Based on your conversation with the My Aged Care representative, you may be referred for a formal assessment.
• Assuming the result of your assessment is referral to an Aged Care home, you then:
  • Work out the costs
  • Find an Aged Care Home
  • Apply and accept an offer
  • Enter into agreements, and then
  • Manage your services.

More information may be found on the “My Aged Care” web site.

What are the Residential Aged Care cost components?

Aged care costs can take a while to understand (this was certainly my experience!). I’ll try to make them a simple as possible. Because the Government subsidizes aged care, there are lots of rules around access to this care. One important thing to note is that one way or another you will get into Aged Care if you need it (even if you have no assets).

Aged care costs are made up of three major components. These are:

The Basic Fee

The Basic fee is 85% of the Basic Single Pension and as of March 2017 was $48.44/day.

It’s a fee that everyone is required to pay. You will normally have no difficulty paying this fee because of access to the Aged Pension (or other assets if you are not eligible or only partially eligible).

Note that once a couple are separated due to one entering an Aged care home, if the couple are eligible for the Aged Pension as per income and asset limits (which are the same as the couple limits at present), each person will receive the Single Pension. The maximum assets  at which the part pension cuts out are presently slightly higher than a normal couple in this instance.

The Means Tested Care Fee

The Means Tested Care fee is an additional fee that covers care based on your assets and income.

Some important notes about the means tested care fee, and its interaction with the Aged Pension are shown below:

• The Means Tested Care Fee depends on your assets and income. The value of your assets and income for  the purposes of the Aged Care asset and income tests are derived in much the same was as the Aged Pension income and asset assessments (although there are some important exceptions, refer below).
• If you are married, your joint income and assets are divided by 2 for the purposes of working out Aged Care assets and income.
• If you still own your PPOR, the value of this asset is capped at $159,631 (at March 2017) from the point of view of the Aged Care asset test.
• If you have a “Protected Person” in your home, then the value of the home is not included in the Aged Care assets test. A Protected Person is:
  • A spouse or dependent child
  • A carer who is eligible to receive an Australian Income Support Payment, who has been living there for at least 2 years
  • A close relative who is eligible to receive an Australian Income Support Payment and who has been living there for at least 5 years..
• Assuming a protected person is not in your home, once you move into Aged Care your home can be exempted for up to 2 years under the Centrelink Aged Pension assets test but will be assessed for Aged Care immediately.
• If you are a member of a couple and your spouse leaves the family home, but does not leave due to illness or Aged care, the home ceases to be exempt from the Aged Pension assets test after the longer period of:
  • 12 months from the date the spouse vacated the home
  • Two years from the date the resident entered Aged Care.
• If you are a member of a couple and your spouse remains in the family home while you enter Aged care, you are considered to be a home owner for the purpose of the Aged Pension asset test.
• If you are a member of a couple and  your spouse remains in the family home while you enter Aged care, and your spouse dies, a two year Aged Pension asset exemption period for your home commences on the date of the spouse’s death.
• If you are in Aged Care, and you retain your home and do not have a protected person in the home, you are considered to be a home owner for the purposes of the Aged Pension asset test for 2 years from the date of entering Aged care, and a non home owner thereafter.
• If you are in Aged Care and single and sell your house, you are considered to be a non home owner for the purposes of the Aged Pension asset test.
• If you are in Aged care and a member of a couple, and your partner is not in Aged care and the house is sold with the intention of buying another home, you are considered to be a home owner for the purposes of the Aged Pension asset test for 12 months from the date of the sale. If a new home is not purchased within 12 months, you will be considered to be a non home owner.
• If you keep your home and rent it, your net rent will be assessed for both Aged Care and Centrelink Aged Pension.
• The Refundable Accommodation Deposit, the amount you put down for your accommodation (more on this in the next section) is included as an asset when computing the Aged Care means tested care fee, but not the Aged Pension.
• The Aged Care means tested care fee is capped at $26,041 (March 2017) per year. There is also a lifetime cap on the Aged Care means tested care fee of $62,499 (March 2017). The cap is indexed.
• Gifting rules apply to the method of calculating the Aged Care means tested care fee, the same as the Aged Pension.
• Financial assets are deemed to generate income, as per the income Aged Pension test.
• The Aged Care means tested care fee changes as your assets change. As your assets go down, the means tested care fee will be reduced.
• The Aged Care means tested care fee can be no more than what the govt would pay for care (Subsidy and primary supplements). I’m still looking to clarify what the Govt subsidy actually is.

Some good information about the treatment of the family home and its impact may be found here.

Here is a diagram showing the Aged Care means tested care fee as a function of assets and income. Note that I have assumed that the Aged Care means tested care daily fee is capped at $26,401/365 = $72.33. This is not strictly true as in practice the fee will could be higher in the first part of the year and zero in the remainder (but averaging out to $72.33)/day, assuming you don’t die!).

The formula used can be found in the End Notes of this post. The area circled in red is where there is no Means Tested Care fee.

The Accommodation Fee

The accommodation fee is the fee which is used to cover the capital cost of the accommodation. When you are assessed as eligible to enter Aged Care, you will need to apply to Aged Care homes for suitable accommodation. The amount you have available in funds will be a factor in determining your acceptance. The accommodation will usually consist of a room, which may or may not be shared with other residents and may or may have dedicated or shared toilet facilities. The value of the fee is refunded to your estate when you leave the Aged Care home, less any additional fees incurred (more on this later).

Aged care homes are not allowed to price accommodation at more than, in Mid 2018, $550,000 unless exempted by the government authorities.

Aged care homes publish the price of accommodation on this web site:

https://www.myagedcare.gov.au/service-finder/aged-care-homes

Here are some examples in Sydney:

Facility	Location	Room Name	Room Type	Cost	Extra Service Fee	Cost of room + Extras	Comment
Uniting Kari Court	St Ives	Secure Living	Single Room + ensuite	$503,000	$0	$79.38
Bupa	St Ives	Premium	Single Room + ensuite	$800,000	$0	$126.25	24-25 Sqm, BIR, King Single Bed
Bupa	St Ives	Superior	Single Room + ensuite	$775,000	$0	$122.30	As above
Uniting Wesley Gardens	Belrose	Spacious Living	Single Room + ensuite	$510,000	$0	$80.48
Uniting Wesley Gardens	Belrose	Companion Living	Shared room and shared bathroom	$421,000	$0	$66.44	Max 2 occupancy
Uniting Wesley Gardens	Belrose	Secure Living Banksia	Single Room and ensuite	$452,000	$0	$71.33
Uniting Wesley Gardens	Belrose	Companion Living	Shared room and shared bathroom	$390,000	$0	$61.55	Max 4 Occupancy
Turramura House	Turramura	Private Single	Single Room + ensuite	$400,000	$64	$127.12
Turramura House	Turramura	Premium Single	Single Room + Shared bathroom	$300,000	$56	$103.34
Turramura House	Turramura	Deluxe Single	Single Room + Shared bathroom	$200,000	$56	$87.56
Turramura House	Turramura	Standard Shared Room	Single Room + Shared bathroom	$100,000	$56	$71.78
Unniting Mullauna	Blacktown	Spacious Living	Single Room + ensuite	$429,000	$0	$67.70
Blacktown Nursing Home	Blacktown	Level 2 Southern Extra	Single Room + ensuite	$380,000	$30	$89.97
Blacktown Nursing Home	Blacktown	Level 3 Northern	Shared Room + no bathroom	$325,000	$0	$51.29
Blacktown Nursing Home	Blacktown	Level 3 Southern	Single Room + ensuite	$380,000	$0	$59.97
Blacktown Nursing Home	Blacktown	Level 3 Northern A	Shared Room + no bathroom	$250,000	$0	$39.45

You can pay for the accommodation in a lump sum, a daily fee or a combination. The daily fee is an interest fee on the outstanding amount owing, using an interest rate of 5.76% (as of March 2017). Once signed-up, the interest rate does not vary. The amount you pay as the lump sum is known as the Refundable Accommodation Deposit (RAD), and the daily fee is known as the Daily Accommodation Payment (DAP). As of Mid 2018, the average RAD is about $320,000, and the average DAP is around $60. The refundable fee is refunded to your estate when you leave Aged Care.

Note that, assuming you pay the full RAD, the Aged Care home is essentially being funded by the interest on the RAD. If the inflation (and likely interest rates) should vary during your stay, you will be getting a good (high interest rates) or bad (lower interest rates) deal.

Instead of you paying the RAD, it is possible for a family member to pay it in the form of a loan. However in this circumstance, the RAD is included as an asset and not offset by the loan. Also, when the resident dies, the RAD is refunded to the member’s estate, so appropriate legal contracts should be in place.

When you pay the lump sum for the accommodation, you must be left with at least $46,500 in assets (as of March 2017). If you choose to pay only a part of the lump sum, you don’t need to  have the income or the assets to cover the full value of the outstanding amount; if you run out of assets or income stops, then the daily fee can be taken from the principle i.e. the lump sum you have already paid (a bit like a reverse mortgage). As you are most likely to stay at the Aged Care home for a comparatively short period (e.g. 2-3 years) you typically don’t need a lot of cover. What happens if you run out of principle? Well, this is an interesting question and I haven’t found the answer to this. It may be that Aged Care homes are unlikely to accept you if this is a possibility i.e. you will need to look for a cheaper room or maybe they will put you in a cheaper room when you run out of capital.

What happens if you have no money at all (or very little)? Well, we mentioned at the beginning that everyone will get access to Aged Care one way or another.

If your income and assets are in the red are circled in the Means Tested Care Fee diagram above, then you are classified as a “Low-means Resident”. In this case there is a different formula to work out how much to pay, and the fees will be heavily subsidized by the government. Note that once classified at a Low-means resident you will always be one (even if you win the Lottery!).

When you enter an Aged Care home you may not immediately have the funds to pay the RAD (e.g. if you have to sell the home at short notice). When you enter the facility, you have 28 days to decide to pay for the accommodation. If within those 28 days you decide to pay a RAD, you have 6 months to pay. If you make a decision after 28 days to pay a RAD, it is due as agreed between yourself and the home. DAP is to be paid in the interim.

Additional Fees

In addition to the three major cost components described above, aged care homes may also offer chargeable additional services. These could include, for example, hair dressing, premium meals etc. You can see these fees in the examples provided above. In some cases these additional fees may be significant!

Fee Changes

Fees are increased twice a year – 20 March and 20 September, in line with increases in the Age Pension.

Questions I still don’t know the answers to!

After extensive research on the Internet there are still a couple of questions for which I do not have answers (despite all the blurb on the Internet!), mainly around criteria aged care homes use for acceptance and how the marketplace for Aged care works.

Let’s say you are Single and have $250K in cash as your only asset. You would like a reasonable quality Aged Care home and notice that a room becomes available in a nearby Aged Care home, and the RAD is $400K.

Now, you could actually afford this by:

• Putting down a RAD of $200K.
• Using the remaining $50K to fund the DAP (which would be $31.65/day), although not 100% sure this is allowed e.g. it could be reserved for medical expenses etc. Note however, that the use of the principle certainly is allowed.
• Paying a means tested care fee of about $9.50
• Receiving the full single Aged Pension to pay the Basic Fee.

The remaining $50K, if used to pay the DAP would fund about 4.3 years (more than the average  duration in an Aged Care home of about 2.5 years). After this the Aged Care home could take money from the principle, which is permissible,  to find the accommodation payment, which would fund many more years.

Let’s say you only have $150K. Then you could:

• Put down a RAD of $100K.
• Use the remaining $50K to fund the DAP (which would be $36.59/day).
• Means Tested fee would be zero.
• Receive the full single pension to pay the Basic Fee.

Again the $50K would fund about 3.7 years of living, and the $100K many years after this.

My question is are these arrangements common or accepted by Aged Care Homes? If so, what is the typical amount of funded years that is acceptable?

And what happens in the unlikely event that you live longer than the funds permit?

This article states that this practices does occur, and here is an extract:

Aged Care Steps technical manager Lara Hansen says that if paying the RAD in full isn’t feasible and there are only enough assets to fund a partial RAD payment, then they could also elect to deduct the DAP from the RAD paid.

“This removes the DAP from cashflow requirements by deducting from the RAD instead. This will result in slightly more aged care fees over time, as the DAP is calculated on the unpaid RAD. As the unpaid RAD decreases the DAP will increase,” says Hansen.

It also means a reduced lump sum payment back to the estate at the end, which in Cronk’s case would mean a reduced final retirement savings pool.

Here is a diagram showing the number of years of funding assuming that the shortfall in the DAP can be funded by remaining funds not used for the RAD and the RAD itself (in that order). The number of years is capped at 18. If funding from the $50K is not allowed, each item in the “Amount of Capital” axis will need to be increased by $50K.

Here is a diagram showing the amount of capital required to fund a room of a given value, assuming the Aged Care home uses the criteria that at least 5 years of funding is available from the RAD and the additional funds (approx $50K) which is not allowed to be put towards the RAD:

You can see that to afford a room worth $400,000, for example, you only need about $110K of capital. If the funds not allowed to be put forwards for the RAD (About $50K) is not allowed, then the amount in the “Amount of Capital” axis would need to be increased by $50K. In this case, to afford a $400K room, you would need about $160K of capital.

Maximum or Minimum RAD?

In this section I look at the question of how much of the RAD you should pay, assuming you have at least some funds to pay it. Should you pay the RAD, or should you pay the daily fee (the DAP)? In this section I look at payments for the first year only.

Assets in Superannuation

Minimum RAD

First, let’s assume that you are Single (couples will be similar, but assets will be divided by 2) and you have all your assets in Superannuation and you are looking at a room with a contract value of $400K.

If you pay no RAD, then you must cover the payment with the Daily Fee. Here are the components of your the Aged care fee in this case:

You can see that if you had $1,000,000 in Super, for example, the total fee would be about $60K per year. Note the means tested care fee is about $17K and if you stay in the home long enough, this may reach the lifetime $62K cap. Also, for each year you stay, the means tested fee will be reduced due to the declining assets.

How much of this fee will be covered by other sources of income? We show the Aged Pension in the below graph, and also show the income that would be derived from the money that would otherwise be in the RAD (i.e. retained in the Super system), and assume a 6% return:

You can see that there is no Aged Pension eligibility at high levels of assets. This is because the total Super assets are high.

Maximum RAD

OK, now lets assume that you pay the most RAD that you can and again the contract value of the room is $400K.. Remembering that you must leave about $50K outside the RAD, here is the diagram showing the fee:

You can see there is now no accommodation fee where this RAD can fully cover the cost of the room and the overall fee is quite a bit lower. But we would expect the fee to be lower because we are no longer generating income from the Super invested in the RAD.

We can also show how much of the above fee is covered by other sources of income (in this case, the pension):

Note that even with the example of $1M in financial assets, there is still some pension payable. In this case the RAD is not included as an asset for the purpose of the Aged Pension test.

Comparison of the approaches

We can now compare the two approaches in terms of the amount payable after taking into account other sources of income (e.g. Pension, Super returns for funds not invested in the RAD):

There is a clear winner. It’s best to maximize the RAD.

The reason that it’s best to maximize the RAD is that the money you put towards the RAD does not cause the Aged Pension to go down and it means you do not have to pay the accommodation fee. The accommodation fee (the amount you pay if you pay no RAD) is about the same as the money earned from Super (the money you keep if you pay no RAD ). The maximize RAD strategy is better because you get more of the Aged Pension.

Other Asset classes

The above analysis assumed that funds were in Superannuation as this made the analysis quite a bit easier (e.g. no Tax!). In reality most people will be selling their home and will be at an age where it is not possible to invest the funds into Super.

If the funds are invested in bank deposits the returns are likely to be lower, and if the funds are invested in Super-like assets (e.g. Exchange Traded Funds etc) then the returns are likely to be similar or lower due to Tax. In both cases, the advantages of maximizing the RAD will be exacerbated.

Approaches to Funding Aged Care Funding

In this section I look at various common scenarios and some strategies on approaching Aged Care funding. I look at the strategies for Single people and Couples and look at them using three criteria:

• The comfort of the person going into Aged care (i.e. the quality of the room etc.)
• The amount of funds left to beneficiaries
• The impact on the remaining person not in Aged Care (for couples)

Lets look at the Single Person first.

The Single Person

Single Person in their own home and on the Aged Pension, no other assets

Most people will enter aged care late in life, and it is likely that they will have few assets at this time, so I believe this will be a common scenario.

Selling the House

The most obvious solution in this case is selling the house and using the proceeds to fund a RAD.

A high end or low end room could be purchased. Lets look at each case in a hypothetical scenario. We’ll assume the house is worth $1,000,000 in each case, the proceeds are held in a bank account generating 3% returns and inflation is running at 2%. We’ll also assume the person in Aged care does not have any additional expenses and each of the various parameters used to calculate the Pension, the means tested care fee etc goes up with inflation.

High End Room

Lets assume that the room is priced at $700,000 and the person going into Aged Care pays the full value of the RAD. In this case the Pension will be high, but there wont be much income generated from the Bank account.

Here is a diagram showing the income (Pension, Bank Returns) and costs (Means Tested Care Fee, Basic Fee, Tax) associated with this scenario (adjusted for inflation, and also, for simplicity, assuming the Means Tested Care Fee is only adjusted yearly). I also assume that the Means Tested Care Fee cap does not change with inflation once you commence Aged Care.

You can see the Means Tested Care Fee trailing off as the cap is reached. After 4 years the value of the assets has been reduced to about $902K (adjusted for inflation – i.e. in the dollars at commencement), or about equivalent to $25K per year.

Low End Room

Now let’s assume that we choose a low end room with a RAD of $350,000. In this case the Pension will be low and the Means Tested Care Fee will be a similar amount. But we will get some funds from Bank interest.

In this case, total value of assets has been reduced to $893K after 4 years, which is lower then than the high end room.

A comparison of total assets by Room RAD

This diagram shows the value of total assets after 4 years by value of the RAD:

You can see the optimal value is around $500K. The reason that the optimal is in the middle is because if the RAD is too low, the Pension goes down, and if it is too high then you still get the full pension that would be available from a lower RAD, but don’t get the interest from the bank.

This diagram shows the value of total assets by value of RAD by length of stay in the Aged care facility:

You can see assets declining as time goes on, but the asset decline decelerates after about 4 years (as the Means Tested Care Fee cap is reached). There also seems to be a sweet spot of about $500K for the RAD.

Keeping the House

What about keeping the house.? If the extended family wants to keep the house in order to avoid transactions costs and to keep it as an inheritance, one strategy would be to keep the house, and rent it out. How would this strategy fare?

Here are some rules relevant to this scenario:

• If you still own your PPOR, the value of this asset is capped at $159,631 (at March 2017).
• Your former home can be exempted for up to 2 years under the Centrelink Aged Pension assets test but will be assessed for Aged Care.
• If you keep your home and rent it, your net rent will be assessed for both Aged Care and Centrelink.

There are some other rules which are relevant to this scenario:

• In most states, Land Tax will be payable on a home that is rented out. I’ve added this in on the assumption that this is about $4K per year, net of any taxation offsets.
• Capital Gains Tax is payable on the sale of the house, but only if the property is rented out for 6 years or more.
• Assuming the property is rented out for a period of less than 6 years, the beneficiary of the property can receive a CGT exemption if it is sold within 2 years.

These rules don’t look too good. Let’s assume you keep your PPOR of $1M and rent it out for a net of $30K per year. We’ll assume a capital growth on the house of 3%.

In this case the pension and the after tax rental income in most cases do not cover the Means Tested Care Fee, the basic fee and the accommodation fee. For the purpose of analysis, we’ll assume that we can get access to funds at approx 5.77% to cover any shortfall. These funds may be made available from a reverse mortgage, and the recently announced Federal Government Reverse Mortgage scheme may be a good choice.

High End Room

Let’s assume we enter into an agreement for a $700K room, and, as all our assets are tied up in the house, we pay the DAP.

Here is the diagram showing the costs and income:

You can see the costs are quite a bit more than the income due to the high value of the accommodation payment. Also, the part pension (already small due to rental income) disappears after year 2 because the exemption of the PPOR Aged Pension test expires after this. The MTF also disappears in year 3 due to the income becoming lower due to the pension being removed, and also the cap on the PPOR. Also relevant to this scenario is the change from homeowner to non homeowner status for the purpose of the Aged Pension asset test after year 2 (although in this case, there is no pension payable after year 2 due to the home being included in the assets test after year 2!).

After 4 years the net assets are about $918K.

Low End Room

Now let’s again assume a low end room of $350K. Here is the diagram showing costs and income:

There is a similar pattern, except now costs are closer to income. Due to the capital growth of the house, the net assets after 4 years are about $1.01M.

Comparison of Total Assets by room RAD

Comparison of different RADs and length of stay

Here is a diagram showing how the net assets vary by different RADs and different lengths of stay using the rental approach:

This is quite a bit different than the house sale strategy and here you can see that, if you wish to preserve your assets, it is better to get a cheap room (especially if you are planning to live for a while!).

Selling the House versus Renting

Finally here is a diagram showing net assets under each of the two approaches:

 

Surprisingly a rental approach is better than a selling one in most cases (and, taking into account transaction costs for selling, even more so).

The reason this is surprising is that we showed earlier that, at least for the first year, it was better to pay as much of the RAD as possible (in this case the RAD is not  counted as an asset when working out the Aged Pension; if we don’t purchase the RAD the funds are counted as an asset). Keeping the house and paying the DAP is kind of like selling the house and not paying the RAD, so we might have expected this strategy to be worse.

When we compared maximizing the RAD with Zero RAD, we only looked at the first year. The diagram below confirms that it is quite a b it worse for other years as well (at least in this situation):

 

The reason that the result of renting the home and paying the full DAP does not have a similar outcome to selling the house, putting the proceeds into a bank account, paying zero RAD and the full DAP is that, by renting the home:

• The house is not counted as an asset for the purposes of the Aged Pension asset test for 2 years from the date of moving into aged care. You are likely to get an Aged Pension for this period.
• The value of the house is capped at approx $159K from the point of view of the Means Tested Aged Care Fee. Hence this fee is not likely to be very large.

 

Other Strategies

There are other strategies, and some of them are described here. These involve annuities, trusts etc. If I have time, I may come back to these.

The Single Person with assets other than the family home

Another common scenario will be a Single person with other assets, such as Superannuation or an investment property. Each of these will need to be handled on their merits, and working out the best approach can use similar tools to that shown here.

Summary for the Single Person

In summary, I have looked at two scenarios, one where a single person has their own home valued at $1M and this person sells it to fund Aged care, and another whereby the a single person has their own home valued at $1M and it is rented with any shortfall funded by a reverse mortgage.

In the case where the single person decides to sell the home, the best strategy to preserve assets is to pay the full RAD for a room priced at around $500K. There isn’t much asset loss if a contract for a higher priced room is entered into, so if there is a room at a higher price that is significantly better, there may be a case for a better quality room.

In the case where the single person decides to rent their home, the best strategy to preserve assets is to enter into a contract for the cheapest room possible.

If there is a choice between selling and renting, the best strategy, from an asset preservation point of view, is to rent out the house and stayer in a cheaper room. However, if the length of stay is envisaged to be 6 years or more, it may be better to sell.

Of course if asset preservation is not an issue, then go for the best room possible!

The Couple

Couple living in their own home with no other assets

When a member of a couple goes into Aged Care and the couple does not have assets outside the family home, then, assuming the home is not sold, the person going into the Aged Care facility will be treated as a low-means resident. Their Aged Care service will be provided by the Single person Aged Care pension which they will be receiving once they have entered the home. The family home will be exempted from the Aged Care means test as there is a protected person in the home. The person remaining in the family home will start receiving the Single Age pension.

What if the person moving into the home would like a better room? One approach is to use a Reverse mortgage. We looked at these here.

Reverse Mortgages

Let’s assume the couple are living in a house worth $1M and one member is going into Aged Care, and a decision is made to fund the costs of Aged Care with a reverse mortgage with the funds drawn down as required (i..e not a lump sum). One good thing about this approach is that there is no impact on the Pension, and the income stream received from the Reverse Mortgage is not included as assessable income and therefore does not contribute to the MTF, and the PPOR is not included as an asset from either the Aged Care or Aged Pension point of view.

Let’s look at the financial impact of this approach. Here are the income and costs associated with entering into a contract for a $700K room, assuming a reverse mortgage rate of 6%. Note that the overall cost for 4 years is about $156K.

Here is a diagram for the income and costs for a $500K room. Cost for $500K room over four years is approx $105K.

And here is a diagram for the income and costs for $350K room. Cost for a $350K  room over four years is approx $67K.

And finally, here are yearly costs for a variety of types of rooms:

You can see the cost increasing over the duration of the stay. The reason for this is the compounding interest on the reverse mortgage.

One important thing to note about the reverse mortgage is that interest costs continue to grow in a compound way even after the member of the couple has left Aged care.

Couple living in their own home with other assets

What if the couple has other assets? Well in this case the other assets can be used to fully or partially fund the room, with a reverse mortgage used to top up living expenses for the remaining member of the couple as required. This strategy makes sense because otherwise the assets may reduce the pension or increase the MTF.

Summary for a couple

In summary, we have shown that when one member of a couple goes into aged care, a viable strategy may be to use a reverse mortgage to fund the costs of Aged Care. Costs increase in a roughly linear fashion as the value of the room increases.

Our Strategy

Our Strategy may vary according to when (and if!) one of us needs to go into Aged care, and our finances at the time. Assuming we stay in the PPOR until we die (as described in one of the approaches here) and, for the sake of argument, I need to go into Aged care at the age of 85, we will most like sell the investment property (about $380K) to fund Aged care. and maybe use some of the Super to top up the amount used to fund the RAD from Super. At this age will are estimated to have about $237K in Super, which is not a great amount! Alternately we could sell the primary home with one member going into the investment property and the other going into Aged Care.

Overall Conclusions

At the start of this blog, we asked:

1. To what extent is the quality of Aged Care available to you dependent on your financial assets. i.e. should you try to preserve assets to pay for aged care?
2. If Aged Care quality does depend on your financial assets, how much should you try to reserve?
3. If one partner goes into Aged Care while the other is quite healthy, how does Aged Care impact on the finances of the person not in Aged Care?
4. If both partners eventually end up in Aged care, or if one remaining partner is in Aged Care, how does Aged Care impact on the amount left to beneficiaries

To what extent is the quality of Aged Care available to you dependent on your financial assets. i.e. should you try to preserve assets to pay for aged care?

From our examples you can see that the more funds you have available, the better quality room you will have (i.e. not shared with others, dedicated ensuite etc). I don’t really have enough experience with seeing the actual quality of accommodation and care to determine if the paying the extra is worth it. In addition, the utility of the accommodation versus the cost will vary by person, so this question will need to remain partially unanswered.

We do have an elderly relative in Aged Care with a room value of $500K and and additional service fee of $70/day. The facility is excellent, but the fees are very high!

If Aged Care quality does depend on your financial assets, how much should you try to reserve?

Again, this question is difficult to answer as it depends on the utility of the accommodation versus the cost. We did see that:

• The Government presently caps the value of accommodation at about $550K, but there is an exception  process.
• You do not need to pay for the full value of the room because fees can be drawn from the RAD. We saw that to afford a room worth $440K, for example, you only need about $210K in capital (assuming that an Aged care home will accept you if you have 5 years of funding, and also that the $50K in assets not eligible for putting into the RAD cannot be used to fund daily fees).

If one partner goes into Aged Care while the other is quite healthy, how does Aged Care impact on the finances of the person not in Aged Care?

We saw that for the couple with low amounts of funds but having the family home, the use of reverse mortgages can help with improving the quality of care for the person going into aged care. For a couple with a family home worth about $1M, for example, the cost of a $500K room would be about $25K per year (including interest, accommodation fee etc). Once the resident left Aged Care, additional fees would be ongoing because of the outstanding interest on the Reverse Mortgage amount. We also saw that the person going into Aged care could do so at zero cost and no reverse mortgage assuming the low means resident accommodation provided was acceptable.

If both partners eventually end up in Aged care, or if one remaining partner is in Aged Care, how does Aged Care impact on the amount left to beneficiaries

Taking a single person with a family home worth $1M, and few additional assets as an example, we analysed two strategies to funding Aged Care. These are selling the home and keeping the home and renting it.

In the first strategy we saw that, in terms of preserving assets, that it was best to enter into a contract for a room worth approximately $500K. This also has the happy coincidence of providing a good quality room. We also saw that it was sensible to pay a much of the RAD as possible.

In the second strategy, we saw that, in terms of preserving assets, it was best to enter in a contract for a room with the lowest value possible.

When comparing these, we saw that, in terms of preserving assets, it was better to use the rental strategy in most cases but especially so if a cheaper room was deemed to be acceptable and the duration of the stay was expected to be short.

Putting it online

Aged care funding is complex and is another excellent candidate for online calculators.

End Notes

The formula used to compute the Aged Care payments may be found here. The basics are also shown below.

Means Tested Care Fee

To work out the Means tested care fee, you need to work out the values below.

Income Tested Amount

Income Tested Amount = (0.5 *  (Income – Income free Area Amount)) / 364

Asset Tested Amount

Asset Tested Amount is

0 if Assets < Asset Free area Amount

(0.175 *  Assets) / 364  if   Assets > Asset Free Amount and Assets < First Asset Threshold.

(0.175 * (First Asset Threshold – Asset Free Area Amount) + 0.01 * (Assets -First Asset Threshold)) / 364 if Assets > First Asset threshold and Assets < Second  Asset threshold

(0.175 * (First Asset Threshold – Asset Free Area Amount) + 0.01 * (Assets -First Asset Threshold) + 0.02 * (Assets – Second  Asset Threshold)) / 364 if Assets > Second  Asset threshold.

Means Tested Amount

The Mean Tested Amount = Income Tested Amount + Asset Tested Amount.

Means Tested Fee

Means Tested Fee = Means Tested Amount – Maximum Accommodation Supplement Amount

At the time of writing, the thresholds and other constants above are:

Income free Area Amount = $25,711.40

Asset Free Amount = $46,500

First Asset Threshold = $159,423.20

Second Asset Threshold = $385,269.60

Maximum Accommodation Supplement Amount = $54.29

Accommodation Subsidy

The Government will pay up to the Maximum Accommodation Supplement Amount ($54.29) per day towards your accommodation. However,  the means tested amount is the maximum of zero and the Maximum Accommodation Supplement Amount – the Mean Tested Amount.

Interest on unpaid RAD

The interest on unpaid RAD is .00576 * Value of the unpaid RAD (per year).

Asset Threshold

A resident must be left with at leadt $46,500 after choosing a RAD level..

 

 

 

The 2018 Federal Budget

This post provide a quick overview of the 2018 Federal Budget as it relates to pending or actual early retirees. Not many measures impacting early retirees were announced in this budget, but those that were can only be described as beneficial. Let’s have a look at the most important ones.

The Pension Work Bonus

If you are on the Aged Pension, you can now earn an additional $50 per fortnight without a reduction in pension. We discussed the original pensioner earnings limitations in the Australian Super and Age Pension Rules post.

The Pension Loans Scheme

We discussed this in the Downsizing post. The Pensions Loans Scheme is a Government-run reverse mortgage scheme for pensioners, which, until now was only available under these circumstances:

• You (or your partner) must be over Age Pension age.
• You must have equity in Australian Real-estate.
• You must not be drawing the full age pension.
• Your ineligibility for the full age pension must not be due to both the assets test and the incomes test.

If you were eligible:

• The most you could receive is the difference between the Age Pension and your present part Age Pension (which may be zero). The amount is paid fortnightly (i.e. it cannot be taken as a lump sum) and is not taxable. So, for example, if you are not eligible for the Age Pension at all, you could receive up to the Age Pension.

As mentioned in the original post, these rules are pretty restrictive and would only really apply if you have illiquid assets in addition to your PPOR which you cannot access to cover living expenses.

In the new scheme, there is no longer the restriction that you are not drawing the full age pension, and also the amount that you can borrow is the amount that brings you up to 150% of the Age Pension. So, for a couple at present rates, this would be approx $53,360.

I predict that this scheme will be quite popular as the interest rate is lower than private schemes (but does have the restriction of the amount you can borrow, e,g, no lump sums).

Works Test and Super Contributions

In the Australian Super and Age Pension Rules post we mentioned that “you cannot make non-concessional contributions to Super if you are over 65 unless you pass the works test.”.  You can now contribute to Super during the first 12 months after 65 if your Super balance is less than $300K without having to satisfy the works test.

How will these measures affect us?

As usual, we will look at how these measures will affect us.

The new Pension Loans Scheme looks attractive and something we could use, depending on how long we are looking at staying in our current residence and how much funds we need. It’s something we would assess further into retirement.

The other measures don’t really impact us.

Conclusions

The 2018 Federal Budget does not have any major impacts on pending or actual early retirees. The most significant one is the updated Pensions Loans Scheme, which, depending on circumstances, could be quite attractive.

 

 

 

 

 

2017 in Review

Well, I am finally back in Australia and have been very busy settling back in. I’ve managed to get another job here but took a break for about a month. Here is a quick  summary of how we fared in 2017 from a financial point of view.

Headline Figures

	2018 dollars
	2017	2018	Planned 2018
Cash	$840,760.42	$782,850.94	$437,494.56
Superannuation	$714,561.12	$960,299.10	$590,309.79
Primary Residence	$1,493,685.95	$1,548,500.00	$1,080,354.98
Investment Property	$283,360.30	$352,450.00	$262,476.91
Total Assets	$3,332,367.79	$3,644,100.04	$2,370,636.24

	Change from 2017 to 2018	Change from planned to 2018
Cash	-6.89%	78.94%
Superannuation	34.39%	62.68%
Primary Residence	3.67%	43.33%
Investment Property	24.38%	34.28%
Total Assets	9.35%	53.72%

You can see that:

• Cash declined. The reason for this is a significant Super contribution ($156,000).
• Super went up significantly, both from contributions and organic growth (over 12%!).
• Property was fairly stable

Spending and Income in 2017

Spending in 2017 was about $56K (excluding Rent), much higher than other years. However, most of this was extraordinary items (car, home improvements, etc). When these items are removed, spending is at about $36K, similar to other years. We went on one overseas holiday this year. If Rent received less rent paid is added in, spending declines to about $30K.

Income in 2017 was around $182K, quite a bit lower than last year. I took a month off and I am no longer in a contract job so the pay is lower. We saved just over $100K.

Updated Spending Patterns

I’ve now changed my standard spending to leave the PPOR when I am 75 rather than 64, and also put a decline in spending starting at 56. Here is the updated plans versus actuals:

I’ve also tweaked my calculator so that I can put in a spending amount per year rather than work out the spending that makes super zero at 90. Based on my spending patterns to date, I think it is unlikely I would spend more than $80K per year. Here is the spending pattern assuming we spend this amount and don’t leave the PPOR.

Conclusions

2017 has been another good year financially. I think I’ll probably retire at the end of the year!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The 2017 Federal Budget

The 2017 Federal Budget has come and gone. Unlike other recent budgets, the Federal Government seems to have lost interest in picking on us pending retirees! Of course the superannuation rules haven’t been left completely alone, and I describe the changes here. As usual, I will describe the rule changes, and then show how they impact on our situation.

Contributing the Proceeds of your home sale to Super when you are over 65

In the 2016 budget it was announced that retirees could contribute to Super up to the age of 74 without satisfying the works test. I commented at the time that this would be quite handy for us, because it would permit us to sell our house after I turn 65, while retaining the ability to move some of the proceeds into Super. However, this provision was scrapped when the 2016 federal budget provisions relating to superannuation were revised later in the year.

In the 2017 Federal Budget a similar policy has been announced. This policy allows  persons over the age of 65 to use the proceeds of their home sale to make non-concessional Super contributions of up to $300,000 for singles and up to $600,000 for couples. The house must be owned for at least 10 years and passing the works test is not required. Furthermore any such contribution does not count against the annual $100,000 non-concessional Super limit (assuming you are still eligible to do make Super contributions – you must be able to pass the works test and be under 75 to do so). You can also contribute this amount even if your total superannuation balance is more than $1.6M. Note there is still a limit of $1.6M on the amount of Super that can be transferred from accumulation mode to Pension mode. The contribution can be made at any age after 65 (and not just below the age of 75).

Its not clear if the title to the property needs to be in both members of the couples names. The budget papers do state:

“This measure will apply to sales of a principal residence owned for the past ten or more years and both members of a couple will be able to take advantage of this measure for the same home.”

For the purposes of this post, I assume both members of the couple are eligible irrespective of title.

Other changes

Some other changes were also announced, however these are not particularly significant for the pending early retiree:

One off Energy Supplement payment for Age pensioners.

A small once-off payment will be paid to Age Pensioners.

Stricter residency requirements for Age Pension eligibility

Access to Pensioner Concession Card for Age Pensioners who will lose   under new 2017 Age Pension rates

How will these changes affect us?

In our original plan, we planned to sell our house at 64 in order that we could contribute the proceeds into Super using the Bring Forwards rule. At that time (2.5 years ago, this is a long time in the Super industry and in Sydney Real-estate!), you could contribute up to $540K per person. Given the projected value of the house, this meant we could move all the proceeds into Super.

The new rules in the 2016 budget wound back the amount that could be contributed under the Bring Forwards rule to $300K each. This meant that we could no longer move all the proceeds into Super. However, we could mitigate the amount of taxable funds outside super via the $300K limit.

With the new 2017 budget rule, we can delay the sale of the house, and still get the benefit of being able to place some of the funds into tax free Super. This is a real advantage, and something that would be of value to us.

How much of a benefit is it?

Assuming we want to stay in our property after I reach 65, it is possible to put a monetary value against the value of this policy. i.e. how much better off can we expect to be as a result of this policy, assuming we want to leave our primary residence after 65.

However, to work it out properly you would need to take into account the age at which the house is sold, how the SAPTO policy works (relevant because SAPTO allows some earnings to be subject to to tax rebates) , and how the funds received from the house are invested outside Super (with and without the policy). If some of the funds are invested in shares, a probabilistic approach would need to be taken (similar to the ALP Super Analysis post). It can be done, but it is a lot of work, and right now I don’t have time!

To get a basic understanding, however, we can look at what happens in the first year after selling the house under various assumptions (e.g. if the funds are in shares, cash etc), and compare the taxation with and without the policy:

In the 2016 in review post, I assumed that we would contribute $600K to Super from the sale of the house at 64 and the surplus (approx $900K) would be placed in cash. Using the assumed cash rate of 2.7%, no tax would be payable in any subsequent years as the income generated would be below the tax free threshold (approx $12K each in the first year).

If the $600K could not be contributed to Super, but instead it was contributed to Super like assets outside the super system with a 6% return, we might expect an income of approx ($600000 * .06 + 900000 * .027)/2 = $30,150 each or $60,300 combined. Under SAPTO + LITO we can expect a combined tax rebate of $3,169 + $890 for a total tax of approx $4,540-$3169-$890 =$481 or about $240 each.

If instead of putting the surplus funds into cash we put the funds into Super like assets, assuming a return of 6%, in the first year, we would expect an income of $90K combined.  No tax rebate is available via SAPTO, and approx $325 would be available via LITO, so we could expect tax of approx $6,172 – $325 = $5847 each. Note that the expected actual tax paid would be higher as the return is variable and higher taxes are paid when returns are high, and no refunds are provided when returns are low or negative.

Assuming we could put $600K of the funds into tax free Super our taxable income would be $52K combined. SAPTO will provide a combined tax rebate of up to $3204 and tax owing would be $1,672 each. As LITO will provide a further $445, no tax would be owing.

The table below summarizes the above:

	Tax in First Year (each)
$600K in Super, $900K in cash	$0.00
$600K in Super like assets, $900K in cash	$240
$600K in Super, $900K in super-like assets	$0
$1.5M in Super-like Assets	$5,847

Is this policy a con?

This policy is covered here, and is subject to a lot of negative feedback in the article and also in the associated comments. Mostly along the lines that if I sell my house, downsize and put some of the funds into Super I will lose my Age Pension, so why should I do it and what value is it.

I think this criticism misses the point.  Rather than just hanging on on the Age Pension, many people would prefer to downsize, and release a whole lot of funds which can be used to enjoy oneself. Yes, the age pension will be lost while you have the funds, but think of all those cruises, trips etc you can have while you are funded! The Age Pension of course will eventually return. This policy allows those who wish to follow this path to invest some of the funds from their house sale into the tax free Super system and avoid taxes that would otherwise be due without the policy.

Conclusion

The 2017 federal budget has made one significant change that will impact on early retirees. This change allows persons over 65 years of age to contribute some of the funds received from the sale of their home to Super. This is a positive change, and will especially help those planning to downsize as it will allow them to reduce the amount of taxable funds outside super after their house sale.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Risk and Return

In this post we look at the relationship between the riskiness of a portfolio and the corresponding expected spending patterns in  retirement. This will help with answering the question of what percentage of a portfolio should be in risky assets such as shares and what percentage should be in cash.

As usual I look at ourselves as a case study. In this post I look at one model of spending only. I assume we are a couple until 90, and then if we are still alive, we go onto the age pension only. At the end of each year, we work out the spending level for the next year by calculating the spending level for the remaining years that will make assets at 90 equal to zero, assuming the return on the portfolio for the remaining years is equal to the expected return, and spending is the same for each subsequent year (or in accordance with a specified spending pattern). This model has been discussed in previous posts.

If I have time, I will update the post to include mortality-based spending for the single person and the couple.

Portfolio Returns

For simplicity, in this post I assume that your portfolio is made up of shares and cash only. That is, there is no opportunity for further diversification into property etc.

In order to work out the returns and volatility of a portfolio with a certain percentage of shares and a certain percentage of cash, we need to know the returns and volatility for each of these asset classes.

For cash, I have assumed a real return of 0.5%, and a volatility of zero. That is, the bank will always give you 0.5% above inflation.

For shares, we need to look at historic returns. We did this back in the Retirement Calculations Post. Here is a graph that shows a 30 year moving average of real geometric returns (including dividends) for returns of the Australian Share market since 1953:

You can see that there is no overall trend for returns, and the average is around 8%.

And here is a similar graph showing a moving average for volatility:

You can see that volatility is increasing over time, and the average is around 17%.

If we have a mix of n% shares and m% cash, the return will be  0.08n + 0.005m, and the volatility will be n*.17.

Portfolios and Spending

We can now see what happens in our particular case if we invest  the proceeds of Super into various proportions of Shares and Cash.

Like the previous post, we use the staring position described in the Tweaks and Mathematical Diversions post, however now we use post-January 2017 age pension rates rather than pre-January 2017 age pension rates, and we will also use a more realistic spending drop of 1% per year from 65 through to 85.

The diagram below is an animation showing the spending patterns (note that in order to generate each individual graph, we only did 1000 runs, so it is not so smooth).

What is interesting here is that the average spend per year goes up quite a bit when we increase the proportion of shares, and there isn’t much downside. That is the likelihood of a low spend does not increase that much when we increase the proportion of shares.

The below graph should help with understanding this better. Note that the expected percentage of retirement below threshold statistic is a straight-forward average to 90 – that is it does not incorporate mortality data.

You can see in the graph that average spend increase quite a bit by increasing the percentage of shares (it nearly doubles if we increase the percentage of shares from 0% to 100%) and in most cases the expected proportion of retirement spent below various thresholds decreases when we increase the share ratio. An exception to this is the ASFA threshold, but there is only a minor increase.

The other interesting thing is that the expected percentage of retirement below the thresholds in the above diagram decreases sharply from a 0% to a  50% share percentage, and then drop off much more slowly.

Conclusions

In this post we have shown, under the assumption that share market returns for each year are normally distributed and independent, and follow historic averages, that it is sensible to have our Super assets invested in a portfolio with 100% shares. This portfolio mix provides the highest average spend, and offers very little downside over alternatives. This is a surprising result as most investment advisors advise reducing exposure to shares as you get older.

Mortality and Risk

Introduction

In this post we provide information on retirement spending patterns when presented with both investment risk and mortality. To date we have considered these separately. This post builds on the work in previous posts:

In the Retirement Calculations post we  worked out the spend per year assuming we are on the age pension only at age 90 and also assuming we would like a constant spend to 90 where possible (or at least a constant spend subject to specified percentage drop at various ages).

In the More on Risk post we worked out how our retirement average spending will vary if we assume annual Super returns vary independently according to a normal distribution and  the spend per year during each year of retirement is worked out by solving for a constant annual spend for remaining years while being on the age pension only at age 90. As an aside, in the ALP Super Tax post we showed how the spending each year will vary (rather than just the average).

In the Mortality post we got rid of the assumption that we need to be on the aged pension only at 90, and instead assumed that in order to work out our spending for a given year, we would assess our likely longevity at the end of the year and spread our remaining funds from the present age to a longevity-dependent future age.

In this post we combine the concepts in the Mortality and More on Risk posts.

Because we are getting into some serious number crunching territory now, I will focus on the Single person.

Single Person – Mortality and Risk

In the Tweaks and Mathematical Diversions post we worked out the spend per year using us as an example, commencing in 2015 and using pre-January 2017 age pension rates. We also assumed a drop in spending at 70 of 10% and another drop at 80 of another 10%.

The below graph is an update, now showing for a single person rather than a couple, using post-January 2017 age pension rates rather than pre-January 2017 age pension rates, and also using a more realistic spending drop of 1% per year from 65 through to 85. You can see that there is very little aged pension!

Now, lets assume that Super returns are normally distributed, with a volatility of 6.21% (the same volatility we assumed in the More on Risk post). The graph below shows the variation in the spending per year for each age. The green band represents 60% of the outcomes and the blue + green band 80%. That is 60% of the time the spend per year will fall within the green band, and 80% of the time the spend per year will fall within the green + blue bands.

You can see that as time goes on, there is more uncertainty about the spend per year. Also, because we only have access to cash to 60, there is not much variation prior to 60.  Because we only have access to a limited amount of Super prior to the house sale, the variation prior to 64 is also less than after 64.

Now lets look at spending assuming we take in to account mortality. The graph below shows the spend per year assuming we moderate spending according to mortality information, and the spend per year is based on spreading funds from the present date to the whereby we will only be alive with a probability of 10% (for a male).

You can see that our drop in spending continues beyond 85 because of the reduction due to ageing and the spend per year falls below ASFA comfortable about 96.

Finally we can now show the mortality-based graph taking into account volatile super returns:

You can see that at around 89 90% of the time our spending will be above ASFA comfortable, while at 98 90% of the time our spending will be below ASFA.

Couple – Mortality and Risk

The below graph shows the spending for a couple, assuming we run out of funds at 90, and again we reduce spending by 1% from 65 to 85.

Here is the graph showing the variation in spending assuming variation in Super returns.

We can also show how spending for a couple varies when we plan to reduce our spending in accordance with our expected longevity. However, we are in some serious number crunching territory now, so this will need to wait until later!

Conclusion

We can combine the spending approach described in the mortality post with the approach used in the More on Risk post to show how mortality-based spending is likely to vary if we introduce super return volatility. This may be a useful graph to display on an interactive web site.

In the next post we will look at how spending varies with the riskiness of our investment portfolio.

Downsizing

Many pending retirees are planning to downsize in retirement. Downsizing has the benefit of releasing funds from the sale of the family home. Other potential benefits including moving to a home which is easier to maintain and also moving to a location more suitable for retirement.

There can be disadvantages to downsizing however.  Downsizing often involves moving out of a familiar and desirable neighborhood and away from friends and relatives.

This post looks at financial strategies which can help retirees who would like to delay downsizing. Specifically we look at private and public sector Reverse Mortgages and also Home Reversion schemes.

As usual, we will use ourselves as case study.

Our Example

Let’s look at our case. In the 2016 in review post I updated a plan whereby we will sell the family home and move into another already owned property in a seaside town.

To recap:

• I am married with no children, and am now 54. We are Australians but living overseas at the moment. We intend to come back to Australia at some stage (present date unknown!). The plan assumes we retire in early 2017, although this may change.
• We own a house in a capital city which we intend to sell when I get to 64. Some of the house sale proceeds will go into superannuation at this time using the bring forwards rule, and remainder will go into cash.
• We own an investment property.
• We have Super and Cash assets.
• Another property in a seaside town is a possible inheritance. This plan assumes that we move into this property when we sell our main residence, and it only becomes available to us at this time. However, if this does not eventuate, we will move into our investment property. This plan assumes the former, but the latter will have similar outcomes.
• We intend to spend 10% less when we get to 70, and another 10% less when we get to 80. This reflects our likely spending requirements.

Here is the estimated spending pattern under this plan (with 2015 and 2016 shown as actuals):

You can see the age pension becoming available at around 84. You can also see that our annual expenditure over the last 2 years has been very low (less than $40k!).

Here are the assets (in 2017 dollars), with actuals from 2014, 2015 and 2016:

You can see the house being sold at 64, and some of the assets going into Super and some going into Cash (now that the non-concessional limit has been reduced, as per the 2016 budget, not all of the funds can go into Super).

Now, let’s assume that we want to delay the sale of the house and the move to another location (aka Downsizing). In the absence of any additional strategy, this will involve a lower level of spending prior to selling the home, and a higher level afterwards. Here is an updated plan assuming we delay the move by 10 years and that we don’t leave until 74:

You can see that we are now eligible for the Age Pension at 67, ineligible again at 74, then eligible again at 84. Also, due to the limited amount of liquid assets prior to 74, our spending prior to 74 is lower than after 74. Ideally we would like to spend more in early retirement and less in later retirement in accordance with our chose spending pattern (10% less at 70, and another 10% less at 80) and we can no longer do this. Still, the spending levels are perfectly acceptable to me at least!

Here are the corresponding assets:

Note that I have assumed that the bring forward amount coming from the house sale can be invested in Super like assets. This should be a reasonable assumption given the SAPTO offset, but to understand the implications of this approach fully, a probabilistic approach would have to be used (refer here for an example).

Also, you can see the Super (and Cash) running out just prior to the house sale.

Here is a more extreme example whereby we plan to delay the move to 80:

You can see that expenditure prior to 80 is quite a bit lower than the spend in other plans.

Reverse Mortgages

One strategy to help delay the house sale while at the same time minimizing the impact on funds available for spending is based on the use of Reverse Mortgages. While Reverse Mortgages have received a lot of adverse publicity, regulations on these types of products have recently improved, and there are some real advantages. Firstly and most importantly you can access the equity in your home without having to sell it. Also, most reverse mortgage products allow you to access the equity in your home as an income stream or on an as-needs basis. That is, you don’t need to access the funds as a lump sum. This means that the income source from your home should not impact your Age pension, and also you only pay loan interest on the funds you have drawn. Finally most reverse mortgage products stipulate that there can be no claims on your other assets if you end up owing more on your reverse mortgage than your home is worth, and you cannot be forced to leave your home (this is known as the “no negative equity guarantee” or NNEG).

Disadvantages or include a high interest rate (which might be expected due to the longevity risk worn by the financial institution), the fact that you can only mortgage a percentage of your home (the percentage normally increases as you age) and the need for close management of the loan as the amount owing can increase quickly due to compounding (especially as the interest rate is variable and not fixed).

SEQUAL is an industry association that promotes home equity products and the maintenance and enforcement of strong consumer protection principles for the industry and it is generally recommended that you choose a product from a participating member.

So, lets take a look at how a reverse mortgage would work. I am using as an example the Commonwealth Bank product. At the time of writing, this product allows a reverse mortgage of between 20% (if aged between 65 and 70) and 40% (if over 85) of the value of the family home (this percentage is known as the Loan to Value Ratio or LVR), with overall maximum limits of between $275K and $425K. The annual interest rate charged is 6.37%. As the level of detail in the CBA pdf is not that great, I have made certain assumptions about the product. Refer here for these.

Here is the diagram showing the spending patterns if we sell the family home at 74, and take out a reverse mortgage that commences at a time that results in our spending patterns being leveled out. I have assumed an interest rate of 6.37% throughout the mortgage.

You can see that there is no increase in spending after selling the house and we maintain the 10% reduction at 70 and 80. Under the plan, the reverse mortgage value gets to about 19% of the house value. The total real (2017 dollars) of the amount borrowed is $257K. If we borrow more than this then spending prior to selling the house is too high, and if we borrow less, then it is too low.

Here is the diagram showing the assets (real values):

I have again assumed for the purpose of this post that I can contribute the bring forward amount of house sale proceeds to Super-like investments.

Note that the light Blue House Value is the value nett of the outstanding reverse mortgage amount. You can see the value declining near the time it is sold.

You can also see that during the period between taking out the reverse mortgage and selling the house there are no super or cash assets.

What about if we wanted to stay until 80?

Well, this is more complicated because the optimal solution involves borrowing more than the upper limits imposed by the CBA product. Here is the optimal solution, assuming there are no limits on how much we can borrow against the mortgage:

In this solution, the Reverse Mortgage gets to about 53.5% of the house value, and the real amount borrowed is approx $602K.

And here is the solution within the CBA limits:

Here the real value borrowed is approximately $272K. Note that this is  less than the $325K available if we started the loan at 74 because of the interest charged and also the discounting of the value of the loan by inflation.

What about another Reverse Mortgage!

It is possible to reverse mortgage our downsized second home in order to release another income stream. This would elevate spending again. If we are over 85, we could release 40% of the house value and this could feed into higher spending prior to 85.

Would we want to do this, if so when, and what are the disadvantages?

Here is the diagram for the second reverse mortgage, assuming we take it out so that drawdown funds are available up until 90, and assuming that we sell the house at 74:

You can see that the funds released in the second reverse mortgage mean that the first reverse mortgage cannot bring forward enough funds to maintain our spending pattern. i.e. after the house sale our spending will now increase rather than remain flat.

Also, at 90, we are living on the Age Pension. As described in the mortality post,  at the age of 87 it is more realistic to assume that we will live past 90, so a lower spend should be planned for. It is possible to combine this post with the mortality post to work out when it is best to take out a reverse mortgage assuming a plan based on expected longevity. I might do this later!

There is one significant advantage and one significant disadvantage to a second reverse mortgage.

The significant advantage is that the reverse mortgage never needs to be paid back because we will not be moving to another home.

The significant disadvantage is that there is potentially a small (or no) residual to be paid to any  beneficiaries on death, and also, in the event that one of us needs to go into Aged Care, the lack of a property may impact on the quality of the Aged Care service. I’ll do a post on Aged Care soon in order that we can understand this better.

Using the Reverse Mortgage as described above, here is reverse mortgage value as a percentage of the house value.

So, for example, if we were go into Aged care at 94, approximately 50% of the house value would be available to fund Aged Care.

The Pension Loans Scheme

There is an alternative to the private sector reverse mortgages. The Pensions Loans Scheme is a scheme administered by the Federal Government and has the following characteristics:

In order to be eligible:

• You (or your partner) must be over Age Pension age.
• You must have equity in Australian Real-estate.
• You must not be drawing the full age pension.
• Your ineligibility for the full age pension must not be due to both the assets test and the the incomes test.

And:

• The most you can receive is the difference between the Age Pension and your present part Age Pension (which may be zero). The amount is paid fortnightly (i.e. it cannot be taken as a lump sum) and is not taxable. So, for example, if you are not eligible for the Age Pension at all, you could receive up to the Age Pension.
• The fortnightly interest rate is 5.25% (effectively 5.4% annual rate). According to this article, the rate is fixed.
• You can continue to borrow while the value of the loan is less than Age Component Amount * (Value of Realestate Assets – Guaranteed Amount)/$10,000. The Guaranteed Amount is the amount  that you wish to retain on death. If you have more than one property, you can choose which to use in the assessment for a loan.
• You can find the Age Component amount here (buried in the act documents!). Effectively you can borrow from 17% (at 55) to 67% (at 90).
• You must pay back the loan when you die or when you sell the home.
• I couldn’t find anything on the no negative equity guarantee (i.e. there can be no claims on assets outside the collateral in the event that the loan exceeds the value of the collateral). However, I believe that this would apply.

Could we use this type of loan and if not, for whom would it be attractive? Under this loan, the most income per year you can receive is the Age Pension. This assumes that you are not eligible for the any Age Pension e.g. you have at least $823K in assessable assets. Or if your assets are lower,  you could receive a lower amount. The problem is, if you have these assets, you are unlikely to want to take out a loan and pay the loan interest rate! i.e. it would be more sensible to use your assets for living expenses rather than taking out a loan, but if you do this, you eventually become ineligible to take out the loan!

Seems to me that there aren’t many circumstances where this loan would be attractive. Maybe it has been deliberately made so in order not to compete with private sector products. Some people have recommended that the Age Pension eligibility criterion be removed for this product.

Home Reversion Schemes

Home Reversion Schemes are another type of scheme which permits pensioners to access equity in their homes. The idea behind this type of scheme is that you can sell a proportion of your home for a lump sum. When you sell your home, go into aged care, or die, the vendor of the product receives the agreed percentage of proceeds.  The lump sum you receive is a proportion of the percentage value of the home, with the proportion getting larger the older you are.

There is only one vendor of Home Reversion Schemes in Australia, Homesafe. The characteristics of their scheme are:

• The scheme is only available to home owners in some postcodes of Sydney  and Melbourne.
• You must be over 60.
• The land value of the property must be at least 60% of the value of the property, as assessed by an independent valuer.
• The maximum percentage of the home that can be sold is 65%.
• Normally the lump sum is between 35% and 65% of the percentage of the value of the home at the time the contract is signed. This will normally vary according a number of parameters, one of the most important being age.
• You retain title in the home.
• Because you receive a lump sum, this may impact on your pension.

The percentage of the house value that you receive is not published, so it is difficult to assess what kind of deal you are getting. Assuming that you don’t leave the family home, then this is equivalent to receiving a lump sum injection while sacrificing a percentage of the home for use in Aged Care or to leave to beneficiaries. Further modelling for our own situation would be dependent on availability of percentage discounts assigned to the house percentage.

Vendor Risks

It is interesting to look at the vendor risks for these types of products.

For the Reverse Mortgage product, the main risk is that the value of the outstanding loan becomes higher than the value of the property. This is more likely to occur where the property value declines or does not increase as fast as expected, the owner remains in the property for a longer time than planned, or interest rates increase to a higher level than planned. These are mitigated to some extent via the aged-dependent Loan to Value Ratio, a higher than normal interest rate, and also, where the loan is taken progressively, including the interest in the amount that can be loaned.

For the Home Reversion product, the main risk is that the value of the lump sum is not recovered (with interest) when the home is sold. This is more likely to occur in the same set of circumstances, i.e. the . property value declines or does not increase as fast as expected, the owner remains in the property for an especially long time, or interest rates increase to a higher level than planned. These risks can be mitigated by ensuring the percentage of the home given as a lump sum is appropriately discounted.

Conclusions

If you are planning on downsizing to help finance your retirement, the use of private sector Reverse mortgages can help with extending your stay in the family residence. We have shown that in our case, under certain assumptions by using Reverse  Mortgages we can delay the move from our family home by about 10 years with only minimal impact on spending patterns.

The Federal Government also offers a type of Reverse Mortgage service, however there are very few instances where this services is likely to be useful.

Home Reversion Schemes may also be of help to the retiree, especially when you want to quarantine a proportion of your home for beneficiaries or help with Aged Care.  It has not been possible to model how we could use a Home Reversion product because not all details are available/published.

Would I use one or more reverse mortgages?

Comparing my original spending plan with the plan using two reverse mortgages, the spending levels are roughly the same, except that in the latter, I can maintain spending levels and leave my home in 20 years rather than 10. Still, I would prefer not to manage a reverse mortgage if I didn’t have to, and having a sightly lower level of spending may be an acceptable trade-off (so the plan to leave at 74 without a reverse mortgage, which only involves a $10K reduction in spend prior to the house sale may be perfectly acceptable). The risk of interest rates going higher, and the capital in the home disappearing quickly is a real one, and something I would prefer not to deal with.

I think I will see how are our actual spending levels pan out in the first years of our retirement and if there is a real need for additional funds to see if a reverse mortgage is likely to make sense.

(*) The information on the CBA website is a bit light on details. I placed a few calls to CBA, but call center staff were not that knowledgeable either and suggested an appointment at a branch!

I have made some assumptions to help with the analysis. The general principles in this blog should remain valid, but if some of the assumptions prove incorrect, there may be need to be some minor adjustments.

I assumed:

• The Bank will continue to loan you money while the outstanding value of the loan is less than the maximum limit. If you take the loan as a lump sum, then this means you can borrow the full amount of the maximum limit. However, if you take the loan progressively,  then you can only continue to draw down funds while the outstanding value of the loan is less than the maximum. As the outstanding value will increase due to interest and fees, and the real maximum value declines over time, this effectively means the real value that you can borrow will be less than the nominal maximum amount. I have based this assumption on the somewhat cryptic comment in the CBA product pdf: “Should the borrower/s choose to draw down the facility on a periodic basis, the full amount of the facility limit may not be available due to the capitalised effect of interest and fees.”
• The loan limit applicable is the limit at the time you took out the loan. That is, if for example, you have an outstanding reverse mortgage loan and you turn 85, you don’t get access to more funds reflective of the increased maximum loan at this age.
• I didn’t factor in any fees other that Interest. That is, I didn’t factor in setup fees, withdrawal fees (if any) etc. These should only have a minor impact on the overall result and introduce unwanted complications.
• I assumed maximum loan limits increase with inflation, although once the loan is taken out the limit is fixed.

Note that:

• I have worked out the amount owing on the loan based on similar techniques described in the “Mathematical Diversions” post.
• The total amount owing on the loan can be a lot more than the loan limit because there is no fixed date for paying it back. This is why the bank limits the amount you can borrow and this varies by age!

2016 in Review

Well, it’s time to do a quick review of 2016 (actually my year is up to my birthday in 2016, which is in November).

In this post, I will look at how we have fared during the year, with the general aim of producing the types of diagrams which are good candidates for outputs from an interactive web site. But before we begin, we have to look at yet more rule changes!

Superannuation Changes after the 2015/16 budget but before 2016/17!

Non-concessional caps

The 2015/16 budget announced a $500,000 lifetime retrospective non-concessional super contribution  cap, as explained here. This policy has now been scrapped, and in its place is an indexed $100,000 non-concessional contributions annual cap, that applies from the commencement of the 2016/17 financial year. In addition to the cap, there is a new rule which states that you cannot make non-concessional contributions if your Total Superannuation balance is more than $1.6M.

Your “Total Superannuation Balance” is made up of the present value of your accumulation account(s) and the current value of the the initial value of any pension mode accounts that you may have created.

There are also some more complicated rules about the bring forwards rule when your total superannuation balance is near $1.6M (e.g. if it is more than $1.4M but less than $1.5M you can only contribute $200K using the bring forwards rule and then only over a maximum period of 2 years) and also during the transition from the old $180K limit to the new $100K limit. More details may be found here.

Works Test for over 65

One good thing about the 2015/16 budget was the scrapping of the works test for superannuation contributions after 65. From our point of view, this rule change was very handy as it meant that we no longer had to sell our house prior to 65 in order to be able put the proceeds into Super. Unfortunately this scrapping provision has itself been scrapped..

Energy Supplement

Although not a rule change, I missed this one in the original budget analysis. In the 2015/16 budget the Energy Supplement (an additional payment that was originally supposed to compensate pensioners for the Carbon Tax) will no longer be available to new pensioners.

Headline Figures

	Actuals		Planned 2017
	2016	2017
Cash	$717,616.21	$823,947.81	$514,539.91
Superannuation	$628,935.69	$701,926.45	$564,647.01
Property	$1,415,135.68	$1,732,773.87	$1,317,744.64
Total Assets	$2,761,687.57	$3,258,648.13	$2,396,931.56

The table above provides information on actual amount on assets in 2016 and 2017, and the projected figures from the baseline plan developed near the end of 2014. All figures are in 2017 dollars (using an inflation rate of 1.3% for 2016 year).

	% change from 2016 to 2017	% change from 2015 baseline for 2017
Cash	14.82%	60.13%
Superannuation	11.61%	24.31%
Property	22.45%	31.50%
Total Assets	17.99%	35.95%

The above table provides the percentage changes.

You can see that

• Cash grew strongly due to the good savings rate. I will move some of this to Super soon.
• 2016 was a very good year for Sydney property and it is growing much faster than projected in 2015.
• Superannuation continues to grow strongly due to good organic growth (about 6.5% in real terms) and contributions.

Spending in 2016

We spent about $35K in 2016 (excluding rent). This included two overseas holidays, and two return trips to AU for my wife. It was a little bit more than last year, but still under our budget of $40k. $35K is  4% more than the old age pension ($33.8K now that the energy supplement is no longer available), so looks like we are containing our costs quite well.

The total outgoings were about $117K.

Total income was about $229K.

Updated Spending Patterns

Because of the changes in the bring forwards rule, unfortunately it will no longer be possible for us to put all the proceeds of our house sale into Super. We will now only be able to contribute $600K ($300K each).

The diagram below shows this clearly. We  will be sitting on some cash after the house sale:

The diagram below shows the updated spending pattern. You can see that I earned slightly less than last year and we spent slightly more.

The ratio of our projected spending to 70 to our employment + investment property income in 2016 is now about 73%. Financial planners normally state that this ratio should be between 70% and 80%, but of course this is entirely fallacious as the ratio should be based on spending, not income!

The ratio of our present spending to average projected spending after retirement is about 30% (or looking at it the other way around, the ratio of average projected spending to present spending is 334%!).

The average spend in the 2016 graph was $98,400 (in 2017 dollars) and is now $115,010, about a 17% increase. If we look at after retirement only, the spend is now $117,200 and was $100,200 (again around a 17% increase).

The diagram below shows how the new spending pattern compares with the baseline spending created back near the end of 2014. All figures are in 2017 dollars. You can see that spending has increased quite a bit and we will now not be eligible for the pension until 84 (when there will be more than a 50% chance that at least one of us will no longer be alive!). Also, as we are spending less than the amounts planned in the baseline pattern, our spending in subsequent years continues to increase.

2016 in Review Conclusions

2016 was a good year for us from a financial point of view and we are now in a much better position than was planned towards the end of 2014, despite adverse changes in legislation in the intervening period. I will probably contribute an additional $120K in Super in the next week or so, although this will only result in a marginal increase in average spend if we spend at planned levels.

I would like to  produce an interactive web site which can produce similar diagrams to those in this post (and in the remainder of the blog), as I think this would be helpful to other pending retirees. It has certainly been helpful to me, and much more so than the existing online calculators.

I will be working for some of 2017 as I am on contract and I don’t really know what will happen after this. We will have to see!

Analysis of the ALP Super Plan

In this post I take a look at the Super plan that the ALP has proposed to be implemented should they be elected into government. This analysis is especially timely as the 2016 Australian Federal election is approximately one month away, and significant changes to the Super system were recently announced by the LNP government as part of the 2016 Federal Budget. These LNP changes are unlikely to be become law if the ALP wins the Federal election.

What is the ALP Super Plan?

Information on the ALP Super plan may be found here.

The first section of this site describes a policy that taxes Superannuation returns in Pension mode in excess of $75,000 at 15%. The information on the ALP site is actually quite confusing (perhaps deliberately so) because it first states:

“The proposed measure would reduce the tax-free concession available to people with annual superannuation incomes from earnings of more than $75,000. From 1 July 2017, future earnings on assets supporting income streams will be tax‑free up to $75,000 a year for each individual. Earnings above the $75,000 threshold will attract the same concessional rate of 15 per cent that applies to earnings in the accumulation phase.”

and then states:

“This measure will affect approximately 60,000 superannuation account holders with superannuation balances in excess of $1.5 million”

These statements are inconsistent because you may very well have significantly less than $1.5M in superannuation assets but still have more than $75,000 in superannuation income for a particular year. In fact this is quite likely because the average Super fund typically returns in excess of the 5% assumed by the ALP (e.g. the Australian Super balanced fund has averaged 8.69% per year since 2004, and this includes the GFC).

The $75,000 threshold appears not to be indexed to inflation. Most commentators (e.g. here, here and here) have concluded that the $75,000 is not proposed to be indexed, although some have speculated otherwise (e.g. here). To quote from the second commentary:

LABOR’S proposed superannuation tax on wealthy retirees could eventually hit more older Australians because it will not be automatically indexed to inflation.

…

Opposition treasury spokesman Chris Bowen yesterday said a future Labor Government would consider lifting the $75,000 threshold when necessary but dismissed automatic indexation.

“I would expect any government of the day would monitor the thresholds to ensure that the original policy intent was being met and would respond accordingly,’’ Mr Bowen told the National Press Club.

For the purposes of this post, I have assumed it is not indexed. Should authoritative information become available which contradicts this assumption, I will update the post.

The second part of the site describes a plan to reduce the Higher Income Superannuation Charge (HISC) threshold from $300,000 to $250,000. I won’t look into this second part as it will not impact many Australians (and a similar policy is already part of the LNP Plan).

Who will be impacted by the ALP Plan?

The ALP plan looks fairly benign (after all, not many people have over $1.5M in super), but we will investigate to see if this is actually the case. The policy can and will impact many people with considerably lower balances than $1.5M because:

• Super returns are, on average, higher than 5%.
• Super returns are not the same every year, but actually have a fairly high variation. During the years that Super returns are high, the government of the day will collect a high tax from Super members, while when the returns are negative, the retiree will suffer the losses with no compensation. An example I provided earlier may be found here.
• The $75,000 limit is not indexed. So, the $1.5M limit (which will actually be smaller in any case if the average return is used) will diminish overtime. The process will be accelerated when we move away from the present historically very low inflation rates.

How to mitigate against the effects of the policy

The obvious mitigation to this policy for a couple is to split Super between individuals. That way each individual essentially receives half of the returns, and there will be less likelihood of being subject to the tax. This kind of splitting is likely to be less easy under the new LNP rules regarding non-concessional limits (should they become law).

Another mitigation is to move some of your funds outside the Super system. In 2016, income below $18,200 per year is tax free. Furthermore if you are above retirement age, SAPTO allows, in 2016, a tax rebate of up to $57,948 for a couple. If you have funds in the super system and believe that you may be subject to the tax, then you could place some of your funds in, for example, a combination of cash and index trackers such as this one.

As an example, say you are below retirement age but over 60, have $2M in super, the Super rate of return for the year under analysis is 10%, and the Index funds/Cash combination you invest in also returns at this rate:

Tax without Super Splitting, No index fund: $18,750

Tax with Super splitting, No index fund: $7,500

Tax with Super Splitting, $500,000 in Index fund: $2,584

Tax with Super Splitting, $364,000 in Index fund: $2,040

Note that the latter is the optimal (retrospective) solution for a 10% return. By making assumptions about the distributions of returns from Super and the Index fund, it would be possible to provide a recommended optimal mix between the Super fund and the Index fund. If the ALP form a government in 2016, I may do this in a later post.

Further mitigation strategies would include postponing selling your (tax exempt) PPOR until existing Super assets are reduced.

See here for more information on mitigation.

An Analysis of our Situation

As usual, I will look at how this policy will impact on us.

I will look at the impact of the tax through three models, increasing in order of sophistication and realism, and also compute power!

Model 1 – Assumes a constant Super return each year with no variation, and a constant spend. This is the model used by the ALP when determining the impact of the tax.

Model 2 – Assumes a constant spend and variable Super return.

Model 3 – Assumes a variable Super return and a spend that is calculated at the end of each year that would result in Super being zero at 90 under the assumption of standard inflation and Super returns for remaining years.

Model 1 – Constant Super Return with no variation

In this section I will assume a constant Super return of 5.5% in the accumulation phase and 6% in the pension phase, as per the analysis described in the Tweaks and Mathematical Diversions post. At 6%, we would need more than $1.25M in the Super pension phase account to be subject to the tax.

Here is the spending plan prior to the tax, this time showing, for the purposes of comparison, the tax in accumulation mode.

Super Returns are always the same, no Super splitting

If I  deduct 15% of any earnings above $75,000, as per the ALP Super tax without Super splitting, it appears that the policy is fairly benign. Here is the spending plan with the ALP tax policy in operation:

As you can see, there is not really too much difference (about $700 per year).  Total ALP Super tax is approx $25.6K in 2015 dollars and to get back to our original spend, we would need an additional approx $30.5K.

Super Returns are always the same, Super splitting

OK, what if we split Super between accounts? Well, in this case there is no impact because Super is always below $2.5M, the amount that would be required to cause tax to be levied, assuming a 6% return.

Super Returns are always the same, Effect of Inflation

Unlike most other policies, the ALP Super Plan is impacted by higher inflation, so let’s see what happens when the rate of inflation increases.  We can expect a higher tax as the $75K is not indexed. In addition, Super returns will be higher, so we can expect higher taxes.

Here is the diagram with no Super splitting, and assuming an additional 3% inflation becomes the norm, for a total of inflation rate of 5.73%. Total ALP Super tax is now $145K in 2015 dollars. As you can see, this is quite significant when compared to the accumulation tax.

And here is the same diagram, but now assuming we split Super. Total ALP Super tax is now approx $77K in 2015 dollars.

The diagram below shows the effects of various inflation rates. For reference, and as a sanity check, the spend with zero tax is also shown. As expected, spend does not change much with increasing inflation without the tax.

And here is information on the historic inflation rates in Australia (from the ABS site). You can see that inflation has been pretty stable since about 2001.

Note the region between the two horizontal bars is the RBA target range for inflation.

Model 2 – Constant Spend and Variable Super Return

Now lets take a look to see what happens when we have variable returns. We can expect higher tax and lower spend when we take into account variable returns, because the Super member will get hit for higher taxes in the good years, and will not be compensated in the bad years.

Luckily an analysis of the impact on retirement of variable returns has already been completed in the More on Risk post. In this post we looked at, amongst others, the impact of variable super returns on the length of time that Super would last assuming a constant spend.

Here is the graph showing the distribution of ages at which funds run out, assuming there is no tax as described in More on Risk. I have used, for the moment, the Age pension rules prior to the 2015 budget changes as described in this post. Note that the spend levels here are the spend levels which cause Super at 90 to be zero assuming no Super return variation (which is an average spend level of $90,463, as described here):

Note that the average age is 90.36. I have colour coded showing the 60% of results that are less than 20% percentile and higher than the 80% percentile as green , and the 80% of results which are less than the 10% percentile and higher than the 90% percentile as green and blue.

The diagram below provides summary data for a number of scenarios using the colour coding above:

And here is similar information for the amount of tax:

Constant Spend, Super Returns are variable, Sensitivity to Volatility

As Super returns become more volatile, we can expect the average age funds will last to be reduced. This is indeed the case.

Here is how the Age at which funds run out varies as we increase volatility, assuming this time we split super, and spend at the rate where we solve for super being zero prior to the 2015 budget changes and any taxes:

You can see that the average age to which funds last declines as volatility increases, but not significantly so.

And here is the average total ALP Super tax (in 2015 dollars) by volatility:

Note that the volatility of the Australian Super Balanced fund returns over the last 17 years is about 7.5%, and the volatility of the Vanguard ASX Index fund over the last 10 years is about 21%.

Finally, here is the Age funds last until by Volatility without the Tax:

You can see that the average does not vary much, but total variation increases quite a bit.

Constant Spend, Super Returns are variable, Tax by Age

The diagram below provides details of the average ALP Super tax by Age when assuming variable returns, and also assuming we do not split Super. The spend levels are those which make Super at 90 equal to zero for the standard fixed returns of 6.0% and the ALP Super tax without splitting. For comparison, I have included the taxes for the fixed returns. Total ALP Super tax for variable returns is about $75.5K, while total tax for fixed returns is about $25.6K. I have assumed post 2015 Budget pension rates.

Here is the distribution of the amount of tax by age. Note that I have not included the zero tax possibility in the diagram as this would tower over the other probabilities (in most years zero tax is paid after 64):

Model 3 – Variable Super return and a spend that is calculated at the end of each year to make Super zero at 90.

OK, before we start modelling the ALP Super Tax increases with model 3, let’s look at the results of this model with the updated pension rates (the More on Risk post had the old pension rates). I will also present the results of this model in some different ways:

Here is the spend per year for this model using the new pension rates:

Here is a graph showing the spend in more detail, this time including the full distribution for each year:

The result is not so smooth as only 4000 runs were done.

OK, let’s take a look at the results for the ALP Super tax. The graph below shows the average spend for the spend prior to the 2015 pension changes, after the changes, the ALP super tax with splitting, without splitting, and without splitting and 5% inflation:

And there are the taxes for the last three policies:

 

Why I dislike the ALP Super Tax!

The ALP has given two reasons to support the introduction of their Super Tax:

1. The majority of the Super Tax concessions go to the top income earners, and these concessions are unlikely to reduce future Age Pension expenditure significantly.
2. The cost to the Tax payer for the Super Tax concessions in the form of forgone revenue is large and growing and is not sustainable.

The ALP Super Tax will indeed have the effect of reducing Super tax income concessions in Pension mode to top income earners, and this is a good thing. However, it will not impact the Super accounts of these same people when in accumulation phase (unlike the LNP policy, which restricts the amount that can be contributed).

The Tax will also have the effect of gradually affecting more and more people as the $75K limit is eroded by inflation, eventually affecting everyone. In addition, significant chunks of people’s life savings will be eroded in the event of high inflation or high market volatility, both of which are outside the control of the retiree. The government will gather more tax, and more people will be find themselves on the Age Pension sooner. The tax is a disincentive to getting ahead, not only for high income earners, but also for average person.

Conclusion

When I started this post, I suspected that the ALP super plan would have a significant impact on people like me, mainly because of the high taxes in high return years. I gave an example to show how this would work. In order to better understand the impact of the tax on us, I have used three models:

• In the first model, I assumed that Super returns are always the same, and solved for Super being zero at 90. I looked at splitting and not splitting super funds between individuals in a couple, and also looked at the impact of an increase in inflation.

• In the second model, I assumed that Super returns are normally distributed and the spend per year (adjusted for inflation) is static. I worked out how the age at which Super funds run out is impacted, and how much additional tax is due. I looked at splitting and not splitting super funds between individuals in a couple, and also looked at the impact of the Super return volatility.

• In the third model, I assumed that Super returns are normally distributed and the spend to be used for each year is worked out in advance as the value that makes Super at 90 zero, assuming a constant spend and standard rates for Super and inflation for remaining years. I looked at splitting and not splitting super funds between individuals in a couple, and also looked at the impact of 5.7% inflation.

These models showed that in our situation:

• If we do not split Super between accounts, the ALP super plan will result in an additional tax of $25.6K (model 1), $66K (model 2) or $68K (model 3).
• Super splitting can significantly reduce tax ($25.6K to zero in model 1, $66K to $27.8K in model 2 and $68K to $25K in model 3).
• Tax to be paid and average spend is very sensitive to increases in inflation. The higher the inflation, the more real tax to be paid and the less to spend. Tax goes up quickly with inflation increases.
• Tax to be paid is also sensitive to Super return volatility, although quite a bit less sensitivity than to inflation. The more volatility, the higher tax to be paid.

Given the sensitivity to inflation, and the inability of the retiree to influence it, it would make sense to index the $75K threshold to inflation.

 

 

 

 

 

 

 

 

 

 

The 2016 Federal Budget

Well, it seems that the Government of the day can’t resist tinkering with the Super and Pension system during each federal budget. In 2016 the LNP Government is no exception, and in fact, there have been some major changes in the 2016 Federal Budget. In this post I will describe how the most relevant changes will impact retirees, early retirees and, continuing with the theme of using us as a case study, our situation in particular.

I will also look at some interesting aspects of the changes, and also have a brief look at the ALP alternative.

Reasoning behind the Changes

The government has made clear that it believes that the purpose of the Super system is to:

• Assist retirees to obtain the assets required to enjoy a comfortable retirement
• Reduce the cost to the government of providing retiree support by providing incentives to people to contribute towards their own (no more than “comfortable”!) retirement.

According to the government, it is definitely not supposed to:

• Provide tax-free income on earnings in retirement where those earnings are in excess of the amount required for a retiree to achieve a “comfortable retirement”.
• Provide assistance to retirees to accumulate assets in excess of the amount required to achieve a “conformable retirement”

Of course, a “comfortable retirement” is a relative term, but the government has sought to define the amount of income required to achieve it via this legislation.

Note that it is perfectly possible for a person to enjoy a retirement with more funding than the funding required for the government defined “comfortable retirement”, it’s just that the retiree will not receive any tax benefits for the excess funding.

In view of the above,  a raft of measures have been introduced in this budget  aimed at reducing existing large (tax-free) pension-mode Super accounts and, moving forwards, making it difficult for individuals to transfer excessive amounts of funds into the Super system (including the low tax accumulation accounts).

To my mind, these measures are very sensible and long overdue. In Australia today there are some individuals with over $100M in their Super account. Why should the community be supporting the tax free returns generated by these extremely rich individuals?

What are the major changes that will impact early retirees

There are four major changes that will impact on early retirees. These are:

A Cap of $1.6M on the amount that can be transferred to retirement phase accounts

Retirement phase accounts are the so-called account based pensions. This measure is saying you can transfer no more than $1.6M from your accumulation account into your account based pension. Note that normally you are eligible to do this at 60, and most people will do this as soon as possible in order to reduce the accumulation mode tax (normally around 8%) to zero.

Although not stated in the budget papers (page 40 onwards), according to this web site, it seems that the $1.6M cap will be indexed  “in $100,000 increments in line with the Consumer Price Index, similar to the treatment of the age pension assets threshold.”. It would be good to see a government site confirming this.

If you wish to make multiple transfers into your account based pension (e.g. if you sell your house, or receive an inheritance), you can do so.

According to the budget papers:

“The amount of cap space remaining for a member seeking to make more than one transfer into a retirement phase account will be determined by apportionment.”

This means that if you contribute, say 50% or $800K now, then you can contribute your remaining 50% of the cap limit at a later date (which may be higher, as the cap limit will increase along with inflation).

The other aspect of this policy is that if you have more than $1.6M in your account based pension now, you are considered to already have reached your Cap, and must move any excess out. You can move it into your accumulation account (and then presumably take it out as a lump sum at a later date). Note that you are typically taxed at about 8% in the accumulation account. Those few Australians that have over $100M in their Super accounts still get a good deal by having a very low tax rate on their savings. It has been speculated that the low tax in the accumulation account may not be low enough, and those with high super balances may move the excess into negative gearing, thus putting upward pressure on property markets.

Note also that, moving forwards, there is no limit to the amount you can have in your  account based pension. Once you have transferred the $1.6M into your account based pension, if it grows to $3.2M that is fine and you wont suffer any penalty.

This measure comes into effect on the 1st July 2017. It will help the government reduce oversize Super accounts.

 

A lifetime Cap of $500K on non-concessional contributions

This measure is saying that you cannot contribute more than $500K in non-concessional contributions during your lifetime. Non-concessional contributions are the post tax contributions that you make direct to your super fund. The $500K will be “indexed to average weekly ordinary time earnings” and according to this web site, will be “indexed in $50,000 increments”.

According to the budget papers:

“To ensure maximum effectiveness the lifetime cap will take into account all non- concessional contributions made on or after 1 July 2007, from which time the Australian Taxation Office has reliable contributions records, and will commence at 7.30 pm (AEST) on 3 May 2016. Contributions made before commencement cannot result in an excess.”

Basically if you have already made non-concessional contributions, then they will be counted in the lifetime limit if made after 2007 (which makes me feel better about not making additional non-concessional contributions prior to the budget!).

Given that the median house value in Sydney is around $1M, and many people will be downsizing in their retirement, this seems a bit restrictive, especially if you are single. However, at least for couples, when you look at the tax free limit on earnings (about $18K per individual), this may not be as restrictive as first thought.

It’s not clear at the moment if this new regulation will co-exist with the existing yearly limits on non-concessional contributions and the “bring-forwards” rule.

This measure has immediate effect (assuming it is passed into law) and again will help the government reduce the possibility of oversize Super accounts.

Lower Concessional Cap to $25K from July 2017

The concessional cap for all Australians will change to $25K (it is presently $30K if you are under 50, and $35K if you are over 50). Many retirees contribute excess amounts of concessional contributions when nearing retirement as it is at this time excess funds are often available (e.g. mortgage paid off, kids left home). The ability to contribution over $25K per annum will no longer be available after this measure comes into effect. Again, this will help the government reduce the possibility of oversize Super accounts.

Note that this concessional Cap has been changed so many times now, it is highly unlikely it won’t be changed again!

Harmonising contribution rules for those aged 65 to 74

Retirees can now contribute to Super up to the age of 74 (previously it was possible to contribute to Super after 65, but you had to satisfy the works test). In addition, it will be possible to claim tax deductions for Super contributions up to this age.

This is quite handy,as if you are planning to downsize your home and put the proceeds into Super, you no longer need to do this prior to 65.

What are the other Changes?

There are a number of other measures related to Super and retirement announced in the 2016 budget. In brief these are:

Catch up contributions – To support people with uneven work histories (e.g. women taking a break from employment), it will be possible to carry forwards concessional contribution caps on a 5 year rolling basis (however, only if you have less than $500K in super).

Extension of Low Income Super Contribution (LISC)

Now it will be called LISTO.

Lower the threshold for 30% concessional tax limit

Now $250K rather than $300K.

Tax offsets for spouse contributions

You can make a contribution to your low-income Spouse’s super account and receive tax benefits. The low-income threshold has increased from $10.8K to $37K.

Transition to retirement income streams

The assets supporting a TRIS will now be taxed at 15%. Previously assets were not taxed after 60 and a withdrawal rebate of 15% to income prior to 60. With this provision, TRISs become less attractive.

Tax exemptions on retirement products

Tax exemptions will be extended to some additional retirement products, e.g. Deferred annuities. Deferred annuities allow you to purchase an income stream that is applicable once you pass a certain age. It is kind of like insurance (i.e. in case you live longer than expected). It will be interesting to see if these products are competitive/useful.

How do these change affect us?

In accordance with the theme of this blog, I will take a quick look at how these changes impact on our plan.

Negatives

According to our original plan, we planned to move the funds in our accumulation accounts into pension mode accounts when I am 60 (in 2023) in order to immediately get the tax free benefits of the account based pension. The value of the accumulation account at this time is now estimated to be approximately $748K (in 2016 dollars).

When I am 64, in 2027, we planned to sell our house, and move the estimated proceeds of   $1.13M (in 2016 dollars) into first accumulation accounts and then the pension mode account. The age of 64 was chosen because this was the last age at which funds could be transferred into Super without having to pass a works test.

In relation to the $1.6M cap, these amounts are not a concern because:

• We need to transfer approx $1.9M into account based pensions.
• Because there are two of us,  we can split the transfers between each of our account based pension accounts (e.g. when we plan to sell our house we can make contributions to different accounts). Effectively we have a limit of $3.2M, and we will be well below this.
• Even if I continue to work for some time, it is unlikely we will breach this cap.

In relation to the non-concessional contribution limit the maximum we can move into our accumulation accounts is $1M, or $500K each. As we need to move $1.13M, this new measure will impact us. However, again, this is not of especial concern because:

• The income tax threshold of approx $18K will mean that we can invest outside Super and are likely to receive tax free returns.
• We can take advantage of SAPTO once we reach retirement age.

The change in concessional cap will limit our ability to boost Super contributions if I continue to work in Australia. As this is not presently in our plans, it shouldn’t have an impact.

Positives

We no longer need to sell our house at 64, and we can sell it up to an age of 74. This is quite handy as there is no longer an artificial constraint regarding when we can move.

In Summary

In summary, these measures are fairly benign to our situation. The greatest impacts are:

• If real-estate really takes off, due to the non-concessional limit, we may not be able to enjoy tax free returns on all the proceeds of the sale of our house.
• There is no longer a requirement for us to sell our house before 65. We now have more flexibility and can sell anytime up to 75.
• If I decided to work in AU, the amount of concessional contributions I can make is reduced. I wont be able to receive the same amount of tax benefits I would otherwise have received. As I am now 53 and paid off the mortgage, this is the time in my life that I do have excess funds to contribute to Super.

How do these changes interact with the proposed ALP Super Plan

One day the ALP will be back in power. If they introduce their Super policy, how will this interact with the LNP one?

The ALP intend to tax Super earnings above $75K at 15%. Note that:

• The government will experience windfall taxation in good Super return years, and low tax in poor super return years. The overall effect for the retiree is that they will be hit hard in good years, but when returns are negative or low, they will not receive a refund from the government.
• Effectively retirees with a balance of $1.5M + X will experience a higher tax than 15% on earnings on X. The amount can be determined by Monte-Carlo simulation (I might look at this later!). Refer to End Notes for an example.
• The $75K limit is not indexed. As time goes on more and more of your Super will be subject to the ALP Super tax.

Under the LNP plan, your pension-mode balance can exceed $1.6M, especially if you transfer the maximum amount from your accumulation fund at 60 into  your pension account to get the benefits of compounding.

I think the ALP tax  will be a hard sell, as, because the LNP policy already has the effect of restricting the amount of funds that can be placed in Super, the ALP policy will be seen as a Tax grab as its only real impact will be taxation and will not be associated with any incentives to members.

Limits to Super Contributions

Given the goal of most of the headline measures is to limit the amount that can be transferred into Super accounts, it is interesting to look at how much the average person can expect to have in Super given particular concessional contribution amounts.

The graph below illustrates the amount of Super at 65, given a yearly concessional contribution indicated on the x-axis, and an assumed Super real return of 2.77% in accumulation mode, and 3.25% in pension mode. It also assumes contributions start at Age 20.

You can see if you contribute near the maximum of $25K, the most you can expect is about $2.3M in your accumulation account. Of this amount, only $1.5M can be transferred into your pension-mode account. Also note that the graph is a rough estimate at this stage; most people will have a lower salary in their 20s, and will also be less likely to contribute large amounts of Super while paying a mortgage and raising children during their 30s and 40s.

Are these measures retrospective?

Bill Shorten is claiming that some of the new measures are retrospective.

There is some truth in this:

• If you have assets above $1.6M in Super now, then you may have to modify your plans to take into the account that your income in retirement may be lower than expected (although as mentioned earlier, the determined retiree may decide to use negative gearing).
• You may not have bothered to split Super assets within a couple prior to the budget coming into force. For example, you may have received an inheritance and put it into one Super account. Now, in an effort to get below the $1.6M threshold you can transfer some into your spouse’s account, but you have needlessly used up some of your own non-concessional limit.
• If you were planning to boost your Super with non-concessional contributions, then this option is now curtailed, especially if you have already made non-concessional contributions. Your income will be less than expected.

However, the government’s supporting argument is that the levels of assets permitted in Super are more than enough to support a very comfortable retirement, and tax payers should not be supporting other Australians to achieve tax free earnings on balances in excess of the amount to provide this level of retirement.

More complexity!

One disadvantage of these measures is that the Super system is now getting awfully complicated. A small army of otherwise productive people will be required to administer, advise, monitor and regulate the new policies. Unfortunately the cost of this army will be borne, one way or the other, from Super returns.

Changes, Changes, and more changes

The Super and Pension system seems to change radically each year. The system in ten years time may have little resemblance to the existing system. It makes it very difficult for pending retirees to plan.

Conclusions

• For most Australians the Super changes announced in the 2016 budget are fairly benign. You would need to have, or planning to have, a large Super balance to be impacted (which is exactly the intention of the measures).
• One of the attractive measures to retirees is the removal of the works test for contributions to Super up to the age of 75. If you are planning to sell your house and contribute the proceeds to Super, you can now delay this decision.

6. End Notes

ALP Super Tax example

I consider 3 years of super returns and two examples. In the first example, exactly 5% is returned every year. For simplicity, I assume there is no drawdown of funds, and taxes are paid from another source:

Initial Super	$2,000,000
Super Return	5.0%	5.0%	5.0%	Total Tax	Average return Per Year	5.00%
Value of Super	$2,100,000	$2,205,000	$2,315,250		Total Return (3 years)	15.76%
Tax	$3,750	$4,500	$5,288	$13,537.50

Here is an example where the same effective return is achieved at the end of 3 years, except the returns are a lot lumpier:

Initial Super	$2,000,000
Super Return	20.00%	-20.00%	20.59%		Average return Per Year	5.00%
Value of Super	$2,400,000	$1,920,000	$2,315,250		Total Return (3 years)	15.76%
Tax	$48,750	$0	$48,038	$96,788

You can see in the first example, the retiree pays approx $13K in Tax, while in the second example the retiree pays approx $97K, even though the total Super return over 3 years is the same.

The Telstra Super Calculator

I came across the Telstra Super Calculator recently and it is quite good. It is now officially my favourite calculator! It can be found here.

If you haven’t used this yet, it is highly recommended as it has a number of features which can help early retirees, and also has a number of unique features.

It has the following features:

• It allows you to Retire at any age (many calculators enforce a minimum limit)
• It allows you to contribute money to Super  (as a non-concessional contribution). Unfortunately it does not allow you to contribute more than $180,000 (i.e. no accommodation for the “Bring Forward” rule), and also only allows you to contribute prior to retirement.
• It allows you to see how your plans would fare in various typical Super performance scenarios.
• It includes information on how likely you are to outlive your super.

Unfortunately it doesn’t support many of the features required to properly model early retirement:

• It doesn’t allow you to survive on cash prior to accessing Super. It forces you to start spending your Super at 60 if you are retired earlier that 60.
• It doesn’t allow you to contribute to Super after your are retired.
• It doesn’t support the “Bring Forward” rule when making contributions prior to retirement.
• It doesn’t support different levels of spending as you age.
• It doesn’t support logical mortality-based decisions on reduced spending as you age.

Still, it is a nice calculator. It’s not actually in the interests of these Super companies to support modelling early retirement as they would like to encourage you to work as long as possible (so that you can lodge nice large balances  with them!).

I would like to compare this calculator to all the other calculators I have looked at, but unfortunately legislation has changed since then, so it is no longer possible.

I will show here how it can be used in my situation as of beginning of 2016.

Using the Calculator

For my situation, I will once again have to model using starting at 64, because the calculator does not support the Bring Forwards rule and living on cash prior to retirement.

Given the assets at the beginning of 2016 (Cash $708K, Super $615K), the amount of Super I will have at 64 is now calculated to be $1,598,695 in 2016 dollars. Note I have removed the reduction in spending at 70 and 80. If I now use the calculator and set:

• My retirement age to be 64 and my spouse to 62.
• An investment income of $5,136
• An investment asset of $260K
• Use the Balanced return of 7.2%, adjusted by -1.2% (for a return of 6%)
• Percentage fees to 0%
• Insurance premiums to $0
• Inflation to 1.7% (1.7% because the Telstra calculator uses a wage inflation discount of 1%, and I do not use this)

Then the Telstra calculator produces this:

My calculator comes up with $98,500, so this is pretty close. Note that the Pension doesn’t cut-in until 84. This is because of this assumption relating to the calculator:

” In the projection, the Age Pension is indexed with wage inflation, while the asset and income test thresholds are indexed in line with price inflation.”

Because I am effectively discounting the Age pension by the inflation rate rather than wage inflation, this means the Age pension is indexed to inflation and the asset and income test thresholds are discounted by inflation less 1% (Hence the later Pension age, and also the slightly lower overall spend). Or in other words, I can’t exactly map my model to the Telstra assumptions.

There are ten investment performance scenarios that can be tested. Here are the results, showing the age at which funds run out:

The average is 90.4, and standard deviation 4.75. This can be compared with my More on Risk post, which does something similar (except 64,000 scenarios are tested!).

Conclusions

The Telstra calculator is a nice calculator and has some features which can help the early retiree. If you are nearing retirement, I recommend you give it a go.

 

 

 

 

 

 

2015 in Review

Well, I haven’t blogged for a while. The main reasons are that I am still working (and spending very long hours at work!) and also I am not happy with my Mortality post and want to fix it up prior to proceeding [2016 – It is now fixed and I am quite happy with it!]

Anyway, I thought I’d make an exception and do a brief update on 2015 in review. In this post I will look at:

• Assets at the beginning of 2016 versus beginning of 2015
• Spending in 2015. Prior to retirement it is important to understand spending to see if the proposed budgeted spend in subsequent years is reasonable.
• Income in 2015
• Investment performance in 2015.
• Comparison of my plan developed at the beginning of 2015 with the new plan that has been generated on the basis of  actual results now available at the conclusion of 2015.

Headline Figures – Assets

Below are the planned and actual asset figures for the beginning of 2015 and the beginning of 2016 (all adjusted for 2016 dollars).

	Actual 2015	Planned 2016	Actual 2016	% Change on 2015 Actual	% Change on 2016 planned
Superannuation	$528,514.92	$542,765.73	$620,864.45	17.47%	14.39%
Property	$1,298,443.74	$1,299,767.73	$1,396,975.00	7.59%	7.48%
Cash	$604,505.09	$591,117.04	$708,406.92	17.19%	19.84%
Total	$2,431,463.74	$2,433,650.50	$2,726,246.37	12.12%	12.02%

Note that:

• Because I worked in 2015, and spent less than expected, Cash is better than planned (I was planning to live on some of the cash in 2015).
• Because I made a Super contribution and Super performed better than expected, Super is better than planned.
• Because of the recent increases in Australian real-estate prices, property is better than planned.
• Property values are derived from my bank estimates of property values, interpolated linearly over months during which the value does not change.

Spending in 2015

Total outgoings in 2015 were $114.6K. Of this $16.6K was employment tax, $30.1K was rent, $34.8K was a super contribution, $1.5K was withholding tax. Actual living expenses were approx $31.4K.

Interestingly the living costs were less than the age pension, which is quite surprising! Unfortunately our spending is in a foreign country, so these costs are not entirely indicative of future living costs.

I budgeted $40K for living costs in 2015, so we came in quite a bit below budget.

Here is the breakdown of living costs (total $31.4K). Note that I have tried to include a category whenever I have details of the associated costs:

Note that:

• My wife spent about 10 weeks in AU, hence the AU living costs.
• Water, Gas and electricity costs here are MUCH lower than Australia. Why are they so high in AU!
• Overall, costs are quite low here (excluding rent).

Income in 2015

Total income was $237.6K, made up of sources as below.

This income was dispersed as follows:

Note that:

• If I divide the amount spent (about $31.4K) by the employment income less tax (about 164K), this shows we are spending about 19% of our income, which is quite good!
• In my original plan, we estimated an post tax employment and investment property income of $25k, so this was quite clearly exceeded by quite a bit (as the original plan was to retire 2 months into 2015).

Investment Performance in 2015

Superannuation

Super was planned to increase at a real rate of 2.8%. The actual return (from my Super account numbers, not from the published Super figures!) was 6.92%. According to the ABS, http://www.abs.gov.au/ausstats/abs@.nsf/mf/6401.0, the CPI from Sep Qtr 2014 to Sep Qtr 2015  was only 1.5% (the Dec to Dec figure is not available at present), which means the real rate of return for Super was 5.42%, much better than the predicted 2.8%!

Note that all figures are in 2016 dollars (i.e. I have modified the 2015 figure for inflation).

Cash

We have some cash in Term deposits and some in savings accounts. The interest earned, after withholding tax (10%, remembering that we are living in a foreign country) was about $14K, which represent a return of only about 2.3%. This is still above the 1.5% inflation, but not by much!

Note that figures are in 2016 dollars.

Comments on Investment Mix

Our original goal was to hold enough cash to last us until we have access to Super. As we can get access to Super when I am 58, and can get a lump sum to last us to 60, then it’s  clear that we probably should put $220K into Super.  Being risk averse, my heart tells me to leave this in Cash, but I guess that it is not  the right thing to do. So, I should do this transfer soon..

2015 Plans versus actuals graph

Here is the original spending plan at the beginning of 2015. This plan covers 2015 and beyond.

Note that this is in 2015 dollars.

And here is the updated plan with 2015 actuals. This covers 2016 and beyond.

Note that this is in 2016 dollars.

And here is the plans versus actuals.

Note that this is in 2016 dollars (including the 2015 figures). Also the surplus employment income also includes the difference in rent paid and rent received (about $2K).

Here is how the average spend has changed. All figures are in 2016 dollars.

Some relevant points:

• You can see that the pension has gone down quite a bit due to legislation changes. Whereas previously it was estimated we were eligible for the part pension at 74, now it is estimated that we will need to wait until 81!
• Notwithstanding the pension decrease, the overall spend amount has gone up slightly as I have not retired and the income received is a lot higher than originally planned. The amount to spend prior to 60 has gone up quite a bit
• Investment rental income was about $6K rather than $5K, slightly higher than predicted.

2016 and beyond

I am now thinking of working throughout 2016. The AUD exchange rate has gone down quite a bit, so effectively I have received a very large pay rise, which is kind of keeping me on. The work is quite interesting as well. It seems that I may be slipping into the one more year syndrome….

Still, I would really like to do some traveling!!

 

 

 

Age Pension Indexation

One deeply unpopular measure in the 2014 Federal budget was the removal of the existing indexation system used for the Aged Pension. This measure was never passed by the Senate and so never became law. In the 2015 Federal budget the original indexation system has been officially reinstated.

The Age Pension indexation system involves increasing the pension twice a year by the maximum of the increases in the CPI and a special pensioner living cost index (the PBLCI). It is also “bench-marked” to male total average weekly earnings (MTAWE). For a home owning couple the benchmark rate is 41.76% of MTAWE. If the increase in the pension resulting from the maximum of the CPI and the PBLCI is less than the benchmark rate, which has been occurring in the majority of cases to date, then the benchmark rate applies, as described here.  If the benchmark rate is less than the increase due to the CPI/PBLCI increases, then the CPI/PBLCI rate applies.

This article argues that this system is unfair, over-compensates pensioners and suggests that CPI indexation is more appropriate. I half agree with this article, however CPI indexation is not the answer as this tends to under-compensate. The reason is that if the pension is indexed to CPI it is likely that the amount of funds received from the pension will not allow pensioners’ lifestyle to keep pace with improvements in the way the rest of Australians live. To give an example published elsewhere,

For example, if the latest model washing machine has increased in price, it is compared to the model it has replaced to see if it has any improvements compared to the previous model.  If it has any improvements, the price increase reflected in the CPI is adjusted downwards by the estimated value of the improvement(s).  So, if for example the current model has increased in price by 4% and it is ascertained that the improvements account for half of the 4% total price increase, the CPI will only reflect a 2% price increase.  The trouble is, if you can’t buy the superseded model, then your pension hasn’t been adequately increased to meet the new price!

If you accept that pensions should be indexed to community standards, then indexing to CPI is not appropriate. However neither is indexing to MTAWE because:

• The community is made up of males and females. The pension should be bench-marked to TAWE rather than MTAWE.
• The median income more accurately reflects community standards than the average, so benchmarking to the median is more appropriate.

This article provides more information about the effects of making these types of changes (along with  lot of other pensioner-unfriendly changes!).

2015 Federal Budget News Flash

In this post I have a quick look at the Federal 2015 Budget. I am writing this on the Friday prior to the budget, but it seems some of the budget details are available now:

http://www.abc.net.au/news/2015-05-07/budget-government-to-outline-changes-to-age-pension/6450946

How do the changes to the budget affect self funded retirees?

The major changes that have been introduced are changes to the Full Age Pension and Part Pension asset thresholds. After the changes the maximum amount of assets that you can own while still being eligible for the Part pension will be reduced (from $1.15M to $823K for a home-owning couple), and the maximum amount of assets you can own prior to losing the full pension will be increased (from $286.5K to $375K for the same couple). This changes will come into effect during Jan 2017.

Essentially if you are presently on the Part Age Pension and do not have many assets, you will either experience no change or will be better off, while if you are asset rich, you will be worse off (in some cases significantly so).

As usual, I look at how this will effect our circumstances::

• Previously it was estimated we would be eligible for the part pension at 74, but now the estimate is that we will have to wait until we are 80 to be eligible.
• If we spend the same amount that we were planning prior to the changes, we will run out of money just after 88 rather than my 90th birthday. That is, we have lost two years of funding.
• If we adjust our spending so that we run out of funding at 90, then our average spend goes down by about $2000 per year, and
• We can match my pre-budget level of spending if we save an additional $69,500. That is essentially we are about $69K worse off!

The good news is that the full Pension indexing to AWE, which was slated for removal in the 2014 budget, will be retained and the amount of assets you are allowed prior to losing the full pension has been increased. It seems that the 2014 Budget eligibility changes to the Commonwealth Seniors Health Card (and the Seniors Supplement changes?) may be shelved (although this needs confirmation).

The reasoning behind the changes is that the Age Pension is really meant as a safety net rather than as a supplement to savings.

Before 2015 Budget

After 2015 Budget:

Conclusions

• One of the important aspects of planning for your retirement is financial planning. It’s important to most people to understand how much they need to save in order that they have a good chance of attaining a certain level of income.
• While a certain amount of savings may help to obtain a desired income level, there are many risks that may result in a lower income than expected. Significant risk categories include Market Risk, Longevity Risk, and Legislative Risk. For each type of risk, there may be a mitigation strategy which can help to reduce either or both of the probability of the risk occurring and the overall impact of the risk.
• The 2015 Budget change is an example of a legislative risk being realized. If you have recently retired, have a reasonable amount of assets, and don’t have much prospect of returning to work, you are now likely to have less income than planned.
• Of course, legislative risk doesn’t go away after the 2015 budget. There are many other legislative risks. Taxing superannuation returns is just one example, and is proposed by the Australian Labour Party, http://www.alp.org.au/fairer_super_plan. Taxing pension returns is already in place in the UK, and thresholds are quite low. We could see the labour party introduce their proposed policy here, with thresholds creeping down as successive governments seek new sources of  revenue.
• How to mitigate against legislative risk? Well, one possibility is to  to try to reduce your investments in asset classes that the government is likely to further regulate, for example superannuation. Another is to save more than is recommended fully realizing that governments are likely to change the rules during your retirement or while you are saving for your retirement. That is, you could form a buffer against future government intrusions into your savings. Unfortunately this is likely to make you an even bigger target for confiscatory governments. Alternately, rather than working those extra years and then being constantly disappointed as governments take chunks out of your wealth, it might be best to realize that income is a means to an end, that is enjoyment of life. Australia provides a good safety net for pensioners in the Age pension, and this is likely to continue. It might make sense to spend up in your early retirement while you are healthy and active, get the enjoyment from your savings, and then live modestly when you hit old age. It is possible to model this kind of approach and this may be the subject of a subsequent post.

Mortality

In this post I will use morality statistics to help with planning for retirement. Integrating mortality statistics into retirement planning is complex, but also rewarding. As such, this post is a bit longer than usual and may take a bit more effort to understand. The post is divided into two main sections:

• The first section considers how mortality statistics can help with retirement planning for single people, i.e. not part of a couple. I have chosen to discuss this first as some of the results and reasoning in this section are used for the second section.
• The second section considers how mortality statistics can help with retirement planning for couples

Mortality statistics can, and will, be used to:

• Create graphs illustrating longevity information.  These graphs can be used to give you an idea of how long you are going to live and provide other useful information.
• Create spending plans that take into account how long you are likely to live.  To date, we have used an arbitrarily chosen age of 90 as the date we require funds to last. We can create more sensible plans now that we have mortality information.
• Provide information on the funds you can expect to leave to beneficiaries on death. Now that we have mortality information, we can work out the expected value and distribution of funds left on death.

This post should help with the Aged Care post which I will develop soon. I am interested to find out how Aged Care impacts on the expected value of assets which we can leave to beneficiaries.

Mortality Statistics

Australian Life tables can be accessed here:

http://www.abs.gov.au/ausstats/abs@.nsf/mf/3302.0.55.001

These tables provide, amongst others, the statistic qx – “the proportion of persons dying between exact age x and exact age x+1. It is the mortality rate, from which other functions of the life table are derived;”

This statistic is available for Males and Females (and also each state of Australia) and is the only stat I have used in this post.

Mortality and the Single Person

Before we start, let’s look at the information that can be provided by mortality statistics to help with planning retirement for the single person.

Single Person Mortality Statistics

We can work out the following:

1. The probability of being alive at a particular age, given we are alive at another age. The diagram below shows this information for an Australian male who is alive at 52.

This graph can be generated by observing that the probability of being alive at n, given that the person is alive at 52 is simply:

2. The probability of death between n and n+1, given that you are an Australian male and alive at a given age. The diagram below shows this for age 52.

This graph can be generated by the following formula for the probability of dying between n and n+1, given the person is alive at 52:

3. The expected age of death for an Australian male, given that you are alive at a certain age. For a 52 year old male, this is approx 82.4. The formula used to determine the expected age of death give you are alive at n is:

Below is the graph showing the expected age of death for an Australian male for each age from 52 onwards:

4.  The age at which an Australian male will be dead p% of the time, given that they are alive at age n. This is similar to the expected age of death. To work out this age, we need to look at the graph in point 1 above. Say for example, I am an Australian Male alive at 52, and I want to know the age at which 90% of the time I will be dead. To find this figure, we look at this graph:

You can see from the above graph that at age 52, 90% of the time the Australian male will be dead by the age of approximately 93.

Mathematically, we choose the age n that satisfies the below:

The graph below provides this information for an Australian Male starting from the age of 52. The information is superimposed on the average age of death for reference:

OK, now have done some preliminaries, we can progress to working out spending patterns and remaining assets for the single person.

Single Person Spending Patterns and Remaining Assets

Let’s take a look at how the single person fares with the existing standard model in which we solve for running out of money at 90. Here is the latest couple spending pattern, as documented in the Mathematical Tweaks and Diversions Post:

The spending pattern for the single person is similar, except we are now using the Single Pension:

Notice that the Age Pension amount has gone down significantly, and consequently the average expense. One of the assumptions we question in this post is the validity of choosing 90 as the age at which we decide we don’t need any more money. Why was this chosen, and is it a sensible decision?

The graph below is the same graph as the graph in point 4 of the previous section, except now we have added the green line corresponding to the age of 90.

From this line we can see that there is approximately 23% chance that the retiree will be alive at 90. So, using the spending level in the above single person spending graph, there is a 23% chance that the retiree will run out of funds and be on the Age Pension only.

Rather than choosing an age at which we target to funds to run out, and then work out the probability that we will run out of funds, we can do it the other way around. That is we can chose a probability of running out of funds that we are comfortable with, and then work out the age we should target. So, for example, if I found a 10% chance of running out of funds to be more acceptable, I should target an age of just over 93 (the red line in the graph above, and also shown as the yellow line below). Settling on an age of 93, of course, would reduce the spending amount available each year as the funds would need to spread over more years.

So, let’s assume I have settled on acceptable probability of running out of funds (rather than age of running out of funds), and for the sake of argument it is 10%. This tells me I should plan to live to just over 93, and I should moderate my spending to allow for this. During my second year of retirement (the first year always involves spending $40K), I spend the amount worked out by the model to spend between 53 and 54. This is shown in the diagram below (note there is some spending in year 93 as I should plan to live to approx 93.4 rather than 93):

The column in yellow now becomes the spending amount for my second year of the spending plan I am generating (an adaptive spending plan).

Now let’s look at the third year of retirement. At the start of this year I still want to spend at a level that means there is only a 10% chance of running out of funds. However,  there is now a new age at which I should target to achieve this goal and it is slightly more than the original target age.This is shown as the yellow bar in the diagram below.

I now need to work out my spending levels again to work out what I should spend between 54 and 55, and it will be slightly less as the age that my funds (less the amount spent between 53 and 54) need to last is slightly more. This process continues over each year or retirement, with the amount to spend declining each year (slowly at first, more quickly later).

After going through the above process, the plan using 10% as the figure for the chance of running out of funds generates the adaptive spending plan shown below:

This type of plan is more sensible than the original fixed spending model, because it takes into account the fact that for each passing year that we live our expected lifespan increases. It is sensible to spread our remaining assets over a time period that takes into account our expected remaining lifespan, rather than spreading them over a period up to a fixed age (e.g. 90).

Note that I have implicitly assumed that an individual would like to maintain the same probability of running out of funds throughout their lifetime. That is, at the commencement of each year, an individual will work out the age at which they are likely to be alive with no more than, say, 10%, and divide up funds between now and then. I think this is a reasonable assumption. If an individual would like to spend a percentage amount less (e.g. 10% less at 70 and another 10% less at 80, as per above), this can be accommodated by the model as described in other sections.

Here is an animation showing how the spending pattern varies by the chosen probability of running out of funds:

Note the “Expected Average Expense” in the top right of the above graphs. In the original fixed spending model, we worked out the spend averaged over all the years starting from the year of retirement and ending in the year we run out of funds. Now that we have mortality statistics, we can work out a more meaningful statistic, the expected average spend level, i.e. average spend levels weighted by probability of death at a given age. If E_i is the spend per year, this Expected Average expense is generated by the formula below:

In the adaptive spending plans, spending declines as we age. It no longer makes sense to think of the age at which funds run out, as we did for the fixed spend model, it now is more sensible to look at when spend levels decline below an acceptable threshold.  ASFA publish figures on the annual funds that represent a comfortable spending level for singles and couples with and without home ownership. According to this press release,  for a single person who owns their home the comfortable threshold is in early 2015, about $42.6K. Using this figure as an acceptable threshold and a probability of not running out of funds of 10%, you can see in the above diagrams that spending will not be less than the threshold until about age 96. You can also see in the mortality graph earlier in the post, that the probability of being alive at 96 is quite low (a few percent). We can also work out the expected proportion of our retirement below the ASFA threshold (or any other threshold for that matter). The diagram below shows the expected percentage of retirement below the ASFA limit and below $50K and $60K per year against the percentage probability of running out of funds. It also shows the age of falling below the ASFA limit, and the probability of falling below the ASFA limit.

Using this diagram, if I have a certain expected maximum expected proportion of time spent below ASFA in mind, I can choose a probability on the left hand axis and see how that maps to the probability on the horizontal axis using the green line. This probability can then be used to generate a spending pattern. So, if I would like to have an expected proportion of my retirement below ASFA of no more than 0.5%, I would choose a probability of not running out of funds of 90%, and this would generate the 10% adaptive spending plan shown at the start.

Of course, the expected proportion of time spent below ASFA will increase as we age (and eventually be 100% if we live long enough).

The diagram below makes the mapping between expected proportion of retirement below ASFA with expected average spending levels more explicit:

The other thing we can do now that we have mortality statistics is work out the expected value of assets left behind to beneficiaries. Because we know the amount of assets at each age for a particular spending pattern, and now know the probability of dying at that age, we can work out the amount we can expect to leave behind. The more conservative the spending pattern (the lower the probability of running out of money chosen), the more we can expect to leave behind.

For the spending pattern with a probability of running out of funds of 10%, the graph below shows the probability distribution for the amount of funds left behind:

The graph below shows trade-offs between raising/lowering the probability of running out of funds chosen for your spending pattern, the expected spend level and the expected amount for beneficiaries. You can see that as the probabilities become more conservative, the expected average spending levels decline, and the expected funds remaining on death increase.

Conclusions – Mortality and the Single Person

In conclusion, in this section we have:

• Shown how we can develop a logical way of spending your funds which takes into account both your present funds, and the expected remaining duration of your life.
• Shown how this spending pattern varies in accordance with how much you value spending in the here and now versus how much you would like to avoid the possibility of living with a reduced income in later years (specifically having a high proportion of time in retirement spent below the ASFA comfortable standard). This variance is controlled by a single parameter.
• Shown that it is possible to generate a probability distribution and an expected value of funds remaining on death using the developed spending pattern and how the these vary with the above mentioned parameter.

Mortality and the Couple

OK, now that we have looked at using mortality statistics to gain financial insights into the spending levels during retirement for a single person, let’s now look at the married couple.

To begin with, we will look at some mortality graphs which will be of assistance when working out spending patterns and assets.

Couple Mortality Statistics

We can work out the following related to couple mortality:

1. Most people know that females, on average have a longer life expectancy than males. Not only that, but in most partnerships, the female is usually a few years younger than the male. Put these together and the female partner will usually end up outliving the male by quite a bit. The below graph shows the probability of being alive for subsequent years for a 52 year old Australian male and a 52 year old Australian female.

2. The below graph shows the probability of each person in the partnership being alive assuming that the male is two years older, the male is 52, and the female is 50:

3. The below graph shows the probability of death between n and n+1 for both the male and female, assuming the male is 52 and two years older than the female. You can see that the death rates for the female occur quite a bit later than the male.

4. The below graph provides some information on likelihood of both partners being alive, one only alive and both dead, assuming the male is 52 and the female is 50. Interestingly by the time the male is about 81 there is a 50% chance that one one of the couple has died. Note that the age pension  shifts down to the single pension when one of the couple dies, so the couple spending patterns that have used the assumption of the couple pension until 90 are not really realistic.

5. Here is a graph which compares the probability of at least one partner in the couple being alive against the probability of the male being alive. You can see there is quite a difference. Because spending occurs while  the couple or a single person survives, we can expect quite a bit of reduction in the expected beneficiary amount when comparing the couple with the single person.

6. Lastly here is a graph showing the expected number of years to live for a couple proceeding through retirement with the male age 52 and female age 50. You can see that the female has quite a few more years than the male.

Couple Spending Patterns and Remaining Assets

Now let’s look at how we can use mortality statistics to work out appropriate spending levels for the couple, and also determine the expected assets remaining. We will use the same kind of ideas as used for the single person. However, for the couple, it is a bit more complex as we need to take into account all the possible combinations of the age of death of each person in the couple.

Firstly, each member of the couple will need to choose a probability of running out of funds which is acceptable to themselves. This will be used when the other member of the couple dies, i.e. when they become single. This is a personal choice and reflects how much the individual values spending in the here and now versus reducing spending now in favour of conserving savings that could possibly be used in the future. Information on how this can be chosen is discussed in the first part of this post.

Secondly we need to work out the spending levels while a couple. To work out these values, two factors need be agreed on by the couple, by mutual consensus. These are:

1. The planned spending level, in terms of a percentage of the spending level for the couple, for the surviving partner. Costs for a single person will be less than for a couple, but more than 50%. 60% might be a reasonable figure and and I have used this figure as the default figure in this post.
2. An agreed acceptable percentage probability of running out of funds, assuming a constant spend while a couple, and a constant spend for the surviving partner in accordance with the percentage above. Note that “running out of funds” means that, using the planned spending levels above, at least one member of the couple is alive at the time that all funds run out. I will use 20% for my default here.

These two numbers are used to determine the spending levels of the couple while they are a couple. Some strategies used to select these numbers are to choose numbers that sound reasonable, to use the default values as mentioned above, or to look at graphs showing how various parameters (such as expected proportion of retirement below ASFA levels) vary as we change them. This latter option is explored later in the post.

Now we will look into how we can generate couple spending levels. Note that by using the couple spending rules above, we can work out, for a particular level of spending, which age combinations of death  will have funds remaining, and which will result in running out of funds. In general, the longer we live or the higher our spending level, the more likely we are to run out of funds. As we know the probabilities of each of the age combinations of death, we can work out the probability of running out of funds for a particular spending level. We want the maximum spending level possible, while still ensuring that the probability of running out of funds for either member of the couple is less than the couple nominated amount. This determines the spending level to be used as the beginning of a year.

The diagram above provides some more information on this approach. It shows the probabilities of all the possible combinations of ages of death for the couple (starting from the male age of 52), and is colour coded to show in which of these we run out of funds given a proposed spending level. The area colour coded in green is the area in which we do run out. The sum of probabilities in this area is less than 20%. The spending level is chosen as the maximum level possible while still keeping the green area less than 20%.

In keeping with the techniques used for the single person, we want the amount to be spent to be adaptive. That is, it varies each year into retirement based on the additional information that we are both alive. The spending level for a couple in our situation, with the choice of 20% for the probability of not running out of funds for either of us, and a value of 60% to be used for as the percentage of spend for the surviving partner is shown below.

Note the similarity with the adaptive spending plan for the single person. Each point on this graph has the property that, moving forwards, if we spend at the nominated level while a couple, and at 60% of this value when one member of the couple dies, then we can expect that there is no more than a 20% chance that either person in the couple will run out of money (i.e. both will die before the funds are depleted). In addition, the spend level is the maximum level that has this property.

Now that we have the spending levels while we are a couple, the next thing to do is to work out the spending levels when one of us becomes single. Now we just use the same approach as the first section in this post, i.e. the approach used for the single person, using the percentage of not running out of funds nominated by that person.

Here is the graph which shows the spending level at each age combination, including the couple spend levels already worked out:

The graph below should help with understanding this diagram:

When you are a couple you proceed down the first red line in the above diagram. That is you spend at the rates down the diagonal spike in the middle of the graph. When one partner in the couple dies (shown in the above as the female partner dying at approx 86), the remaining person in the couple spends in accordance with the second red line.

Note that:

• The total average expected spend can be worked out in a similar way to that used with the single person i.e. by working out the average spend for each combination of death, multiplying by the probability of this combination and summing. In this case, it is approx $79K, which is quite low.
• The diagram is colour coded showing  which age combinations are above (blue) or below (green) the ASFA comfortable spending levels (taking into account if we are a single or a couple at the time).
• By summing up all the probabilities that are blue, you can work out the likelihood of not falling below the ASFA comfortable spending level. In this case it is 59%, which is not that high! You can also work out the proportion of retirement expected to be below ASFA for both members of the couple, the male and the female (again using a similar technique used to calculate the average spend). In this case it is 4.27%, 3.1%.  and 4.77% respectively. As you might have expected, the female, due to her longevity, is expected to have the highest proportion below ASFA.
• You can see that on most occasions the spend rate for the couple is higher than the single. The reason for this is:
  • We are planning for the single person to have a spend of 60% of the couple.
  • The differences in the conservativeness of the single spending plan and the couple spending plan. If for example, the single spending plan is quite conservative, we would expect a lower spend than the spend that is used by the couple at the same age.
• Note that if the female dies early then the male spend level is just as high as the couple. The reason for this is that the male has more funds than necessary to get through the average lifespan, because the spend level for the couple takes into account the longer lifespan of the female. This counters the lower single age pension.
• While the diagram looks symmetric, it is not because the female and male partners have different mortality statistics, and therefore different spending patterns. Also if there was a large gap in age between members of the couple, the diagram would be much more asymmetric.

Here is the spend diagram from another perspective, this time showing the lower spend of the female:

We can also work out average spending levels in a few different ways

Average spending while we are a couple: $86,949

Average spending for Female when Single: $49,677

Average spending for Male when Single: $56,486

Overall average spending for Female: $76,062

Overall average spending for Male: $81,162

Overall average spending: $78,244

Here is a diagram showing the assets for each combination of age of death:

We can weight this by the probability of each combination of age of death to determine the expected value of assets remaining on death.  In this case it is approx $530K.

Working out the best parameters for the couple

In this section we see how the spending patterns are affected by changing the chosen probability of running out of funds as a couple, and the chosen percentage of couple spend chosen for the single. This is done by showing how the spending patterns visibly change as we modify the parameters.

Varying the Single Spending Percentage

The factor we use for the single spending when working out the couple spending model is a bit mysterious. When this factor is low (e.g. 60%) it tends to:

• Increase our spending while a couple and decrease it while we are a single.
• Increase the expected proportion of retirement spend under ASFA
• Increase in the overall spend
• Reduce the expected value of assets left to beneficiaries.

If you especially value your time while a couple (which I do!), I recommend a low value for this figure.

The graph below shows how the overall spending changes with this parameter is shown below.

This graph shows how the assets change with this parameter (not a great deal!):

These graphs provide more aggregate information for the changes. This one shows how the % of time spend below ASFA varies with the figure.

This one shows the how the spend levels vary:

This one shows how the expected assets remaining for beneficiaries vary:

Varying the probability of running out of funds for the couple

OK, now we can look at varying the percentage probability of running out of funds for the couple. We expect that by increasing this we would see an

• Increase in the couple spend,
• Increase in the overall spend,
• Reduction in the amount of funds left to beneficiaries
• Increase in the expected amount of time spent under ASFA

In other words, much like a reduction in the Single spending percentage. This figure should be increased if you prefer to spend in the here and now, and are less concerned with preserving funds for the later years of retirement.

Let’s see if our predictions bear out. I have kept the percentage spend of the couple spend for the single person fixed at 60%, and the single probability of running out of funds fixed at 10%,

Here is the graph showing how the % of time spend below ASFA varies with the couple prob of running out of funds. As expected, this proportion increase as the couple probability increases.

And here is the graph showing how spending levels vary. As expected, spend levels for the couple and overall spending increase, although the latter not significantly so. Single spending levels decline quite a bit.

And here is the graph showing how expected assets remaining for beneficiaries vary. As expected they decline as the % prob of running out of funds for the couple increases.

Combined Scatter Diagrams

Finally here are the combined scatter diagrams:

Why have our spending levels and Assets to beneficiaries dropped

You can see from the original overall spending graph and the previous section, average spending levels have dropped by about $10K (or about 11%) when compared with the original couple spending model, and also the amount of funds left by the couple to beneficiaries has dropped about $350K (or about 42%) when compared to the amount left by the single person. Why is this?

The average spend has reduced because:

• In the new model, the couple must set aside funding for future years every year while in the original model we only set aside funds until 90.
• In the new model, it is expected that in many years the Single Pension will be used rather than the higher couple pension. In the original model, the couple pension was used at all times.

The average spend is increased because:

• We are now averaging the expected spend as weighted by age of death. The lower spend in later years will be given less weighting.

The expected funds left to beneficiaries is reduced because:

• We now have a couple spending money and reducing the remaining funds available on death. When one partner dies, the other partner continues to spend. The average lifespan of the combined partner entity is significantly longer than the male individual.

Conclusions

Working out spending levels while incorporating mortality statistics has been a lot of work! Probably more than the rest of the blog combined. Is going to this level of complexity and detail worth it?

I think it is, for these reasons:

• Previously we just chose an age at which we wanted our funds to last. This choice didn’t relate to anything meaningful, such as the expected percentage of retirement spent below the ASFA retirement standard. With mortality statistics we can select a spending pattern which relates to something real.
• Previously we spent the same amount right up to the age at which we chose to run out of funds. This is not realistic behaviour because any rational person would reduce their spend when they realize that there is a good chance of exceeding this age. You can use mortality statistics to work out how you should reduce your spend to anticipate this possibility.
• Previously we had no idea how our spending plan would impact on the amount of funds we are likely to leave beneficiaries. With mortality statistics, we see how the expected value of funds left to beneficiaries relates to the the spending pattern adopted.
• When we use mortality statistics the estimated average spend is different than the spend worked out previously. In fact under most circumstances it will be lower. This additional information may help to determine a good time for retiring.

Seniors Discounts and Concessions

During this post I will look at the discounts and concessions that become available in your retirement. In keeping with the financial theme of this blog, I look at them mostly from a financial point of view.

I will look at:

• The Seniors Card
• The Seniors Health Card, and
• The Pensioner Concession Card

Seniors Card

The Seniors Card, provides access to transport concessions and discounts from participating businesses. It is free, administered by the states and territories and is not means tested. There are reciprocal arrangements in place which allow the use of the card in other states.

To be eligible to use the card, you need to  be 60 or over, not working more than a number of hours per week (20 in NSW, averaged over the year), and a permanent resident of the relevant state. In NSW you also need to have a Medicare card.

I will look at the NSW scheme as an example. Let’s look at the types of concessions available.

Transport Concessions

The main Transport concessions are:

• Half priced tickets on ” buses, light rail, Sydney Ferries and Sydney and intercity trains, NSW TrainLink Regional train and coach services and Great Southern Rail services.”
• Pensioner Excursion Tickets, which provide unlimited all day travel for, in early 2015, $2.50. The excursion ticket can be used for “unlimited travel all day in Sydney, Newcastle, the Hunter, Central Coast, Blue Mountains, Bathurst and Illawarra areas, by train, bus, ferry and light rail.”, but excludes “NSW TrainLink Regional services, charter services, event buses”.
• Country Pensioner Excursion Tickets, which allows regional rail travel within NSW for, in early 2015, $2.50. Because it cannot “be bought or used for travel to or from locations or pass through the area bounded by and including Sydney, Nowra, Goulburn, Bathurst, Scone and Dungog”, this ticket seems to be targeted at traveling between country towns, or at least from the border of urban regions to country towns.
• Regional Excursion Daily Ticket, which is the same as the Pensioner Excursion Ticket, but applicable to local bus networks in regional areas.

These concessions are excellent. Given the slower pace of life you can expect when you are retired, the above concessional rates, the availability of excellent public transport schedule apps and the convenience of the Opal card, public transport may be an acceptable alternative to owning a car.

Assuming my wife and I travel within Sydney 4 days a week, our annual transport costs would be $1,040. Without concessions, the cost would be more like $5000 (assuming $12 per day, rather than $2.50). In comparison, according to the NRMA, the cost of running a Mazda 3 would be approximately $9,360 per year. Substantial reductions in public transport costs make public transport more attractive when compared with car ownership.

Discounts from Participating Businesses

There are various discounts available from the NSW Government (e.g. 50% discount for Taronga Zoo, 10% discount for WEA courses), and very few from private businesses. None of the discounts appear to be from business that you would use regularly.

The Seniors Health Card

The Seniors Health card is a card that provides Health Care Concessions. It is administered by the Commonwealth Government and is means-tested. It appears that the benefits available under this card are a subset of the benefits under the “Pensioner Concession Card”. However there are different eligibility requirements. You may not be eligible for the Age Pension, but you may be eligible for the Seniors Health Card.

The main criteria for access to the Seniors Health Card are:

• Being above the Age Pension age (67 for me at the moment),
• Being able to pass an incomes test.

Note that there is no assets test. The amount of income permitted for a couple, in early 2015, is $82,400. Deeming rules apply to account based pensions. In my case, assuming the strategy we are planning in Retirement Calculations, the maximum deemed income + our rental income (in real 2015 dollars) we are expecting is $45,836, well below the limit. So, whereas we would not be eligible for the pension until around 74, we would be eligible for the Seniors Health card at 67 (maybe later if the Pension age goes up).

Seniors Health Care Card Benefits

The main benefit of the Seniors Health care card appears to be discounts on PBS medicines. This page provides information on the maximum that you can be asked to contribute for medicines with and without the Concession card. Once you have the concession card, the most you can expect to contribute per year is, in early 2015, $366 (rather than $1,454 with $6 for each prescription after the safety net is exceeded).

The other benefit of having the Seniors Health Card is that you will have access to:

• Senior Supplements. For a couple, this is worth, in early 2015, $1,346.80. Note that the Government removed  this benefit in the 2014 budget, but it has not managed to pass the Senate. At least for now, this benefit is still available.( [2015] – This benefit ceased in June 2015 after the Greens made a deal with the LNP).

• The Energy Supplement, For a couple, according to this site,  this is worth about $551.20 per annum. This was not removed in the 2014 budget.

Pensioner Concession Card

The Pensioner Concession card provides the same Health Care Concessions as the Seniors Health care card, but also provides access to additional state and territory based concessions.  To be eligible, you need to be eligible for the Age Pension.

Pensioner Concession Card Benefits

In NSW, the benefits described in the Seniors Health Care card benefits section, and the benefits described below are available to holders of the Pensioner Concession Card:

• A reduction of $151 (in early 2015 dollars) on your quarterly water bill. Additional concessions on Storm Water charges (if applicable).
• A rebate of $235 (in early 2015 dollars) on your annual electricity bill (this i
• A rebate of $250 on annual council rates.
• Elimination of RTA vehicle registration fees and vehicle taxes. This can be worth approximately $350.

In addition, some other transport concessions become available when you get a Pensioners Card:

• Four one way free economy train tickets per year in regional NSW.

How long will these concessions last?

The 2014 federal budget eliminated the federal government portion of the joint state/federal government funding for most of the state-administered concessions. From my research above, most of these concessions are still in place, but may not be here for long! More information here and here. It appears that State Government is, for the moment, paying the shortfall. These cuts may be more about the Federal Government bullying the State Governments to support increases to the GST rather than cost reduction.

How do these Concessions impact our Retirement Plan?

Assuming these concession remain in place during our retirement (a big assumption), we can expect the following financial benefits:

After 60:

• Up to $8000 per year, assuming we use public transport rather than own a car.

After 67 (may be 70):

• Maybe around $1,000 per year due to savings in PBS prescriptions
• Around $551 for the Energy Supplement.
• Around $1350 for the Seniors Supplement (although there is legislation pending Senate approval to remove this).

After 74:

• Around $1000 per year due to savings in council rates and electricity and water bills.
• 2 x regional NSW train trips/year free.

As you can see, the major real benefit are transport concessions (hopefully they will keep these as it will save me buying a car!). Surprisingly, and contrary to my preconceptions prior to writing this blog, eligibility to the Age Pension does not result in significant concessions becoming available.

Conclusions

There is a grab-bag of concessions available to older Australians. The eligibility to the benefits vary in accordance with age and assets. Some of these concessions may not be available much longer, or may be less generous, as the Federal Government cuts back on supporting funding to the States, and as eligibility for federal concessions is tightened.