NetActuary

COME CELEBRATE WITH NETACTUARY

NetActuary is back in the SMSF Actuarial certificate business! Yes, this has been a long wait!! That is even more reason for a celebration you too can share.

A number of initiatives are planned for the coming months. As an opening special all account-based pension actuarial certificates submitted in the first week of July will be processed for a fee of only $11 inclusive of gst.

The 2017-18 actuarial certificates need a different approach to previous years. It is no longer adequate to mechanically process them. Many fund circumstances have alternative possible approaches and strategies that need to be evaluated to determine which is in the client’s best interest. While NetActuary will use extensive production system support, this will be combined with a careful actuarial judgement. All calculations will be undertaken personally by the qualified actuary who signs the certificate. The turnaround will be prompt, but always subject to what needs to be done.

Will this cost more. No!! Our account-based pension actuarial certificate maximum price will be $132 inclusive of gst. There will be a guarantee of no fee increases in the next two years. Lodgement is simple – on NetActuary.com.au is a data form or simply send us the general ledger download from any of the SMSF accounting systems.

We also have a profound interest in helping with all types of legacy pension aspects including actuarial adequacy and tax exemption reports. For more information see the website or phone Brian Bendzulla on 03-6224 1145.

 

 

 

 

Objective Orientated Investment Strategies

Soon trustees will be reviewing their investment strategies as part of the fund end of year tasks.  I hope this year a greater emphasis and thought will be devoted to the outcomes, risks and objectives before setting the investment strategy.

As a trustee, you are required to review your investment strategy regularly to ensure it continues to reflect the purpose and circumstances of your fund and its members.  An SMSF investment strategy must take into account the following:

• The risks involved in making, holding and realizing the SMSFs investments, their expected return and cash flow requirements of your SMSF.
• The diversification and composition of your SMSF investments.
• The liquidity of your SMSF investments, having regard to expected cash flow requirements.
• The SMSF’s ability to pay current and future benefits to the members.
• Whether to hold insurance cover for each member of your SMSF.

An important requirement for you as trustee of your SMSF is to have an objective orientated investment strategy before you start to make decisions about how you want to invest your SMSF’s money.

Before retirement, one can have a greater focus on growth and be less concerned about fluctuating markets.  After retirement, having to sell assets (e.g. shares) at a time of low values can seriously speed up how fast assets run down.  This is called sequence (of returns) risk.  A way to mitigate the risk is to hold an appropriate amount of cash or liquid assets.  To do that exercise properly involves some projections. Firstly, one needs to know how much of the retirement income will come from the Age Pension.  This varies over the years.  Secondly, one needs to work out the likely flow of income from dividends  and interest.  NetActuary can assist with those projections.

The next key aspect of an investment strategy is to consider the diversification of your SMSF’s assets.  Diversification of your retirement savings across different assets and regions is key to protecting your fund from volatility in financial markets over the long-term and total losses from individual holdings.

While it is important to keep track of events that affect financial markets and your superannuation savings, it is important to remember that superannuation is for the long-term and that sometimes short-term decisions can do more harm than good.  A good investment strategy that keeps members disciplined and focused on the long-term is essential.

With any decisions that you make as a trustee in relation to your fund’s investment strategy and asset allocation, the important things to keep in mind are:

• Try to avoid taking undue risks with your underlying investments, which increases the likelihood of short-term losses.  For example, think twice before moving from relatively stable shares to speculative shares – even if you think a short-term win will come to your SMSF.
• If the fund is considering payment of an income stream, ensure the cash flow from the asset allocation is sufficient to pay the required amount.
• If there is a relatively long timeframe before benefits become payable from the fund, the potential capital growth of the investment is an important consideration.
• Consider the effects of inflation and protect against the reduction in the real value of the fund’s investments.
• All trustees and members of SMSFs have a range of attitudes towards risk and how they see their fund’s investments performing over time.  When it comes to the fund’s investment strategy and asset allocation, it is important to carefully consider its overall risk profile or tolerance – including the impact of asset allocations on the overall investment portfolio.

The above draws one’s attention to the trade-offs that are involved.  One wants answers to questions like “how much less likely are unacceptable investment outcomes from a small reduction in the rate of return?”  NetActuary can also give you some insight into this trade-off with our economic and investment volatility modelling system.

Your investment strategy does need to be reviewed at least once a year and this will be evidenced by your approved auditor.  It is also important to review your strategy whenever the circumstances of any of the members change – or as often as you feel it is necessary.  The following practical tips will help you keep on top of your obligations:

• Put your investment objective and strategy in writing.
• Set an investment objective that you can achieve with the underlying investments you are comfortable to invest in.
• There is no template for an investment objective and strategy, but make sure they reflect how you intend to invest your SMSF’s money.
• The investments you actually make must be contemplated by the investment strategy you have set.
• Additionally, document your actions and decisions – as well as your reasons – and keep them as a record in order to demonstrate that you have indeed satisfied your obligations as a trustee in this important area.

This is not just an area for the wealthy.  Indeed, in many ways it is more important for those retirees who must make their retirement monies work efficiently.  The deemed returns for Centrelink financial assets rewards those who achieve good returns.

Brian Bendzulla

Ouch! ASX200 at 4900

Being retired means a lot less capacity to withstand financial shocks.  NetActuary has a particular interest and focus in helping retirees with these risks.  There is a tendency for retirees and their advisers to concentrate on longevity risk.  However, the market and sequence risks need as much attention.  The current plunge in the sharemarket is a prime example about why a risk management plan for sequence risk should be part of every retirement income plan.

For retirees living off the income and capital of their investments, it’s not just the long term average return that impacts on their financial position, but also of the timing of those returns.  Put simply, you don’t want to sell BHP shares at $14.77 (the price at the time of writing this blog) to provide the monthly groceries when you could have topped up your cash bucket at $35 or $40 in most of the past 5 years.  It will cancel off vastly more shares.

NetActuary’s risk management reports show SMSF returns how to set the asset sector allocations optimally for the risk/return trade off AND also how to manage liquidity/cashflow to limit sequence risk.  While at the moment we are flat out with Age Pension change mitigation exercises, we want to bring the focus back at some stage to post retirement risk management.  It’s important for retirees.

The NetActuary Team

Closing Corporate Defined Benefit Plans

It has been quite a few years since most corporate defined benefit plans have been closed to new members.  As the membership is run down, a point is reached where the cost of operating the arrangement is expensive on a per member basis.  In such a situation the company naturally would like to consider closing the plan by converting the remaining members to an accumulation arrangement.

To obtain the consent of the affected members involves designing the transfer value offer and future contribution levels.  Often a top up amount is involved and this has the potential to trigger excess contribution tax.  The expected tax impact for the member needs to be incorporated in the calculations.

The illustrations for the member need to be on a year by year basis as the resignation benefit in the defined benefit arrangement may not smoothly link to the early retirement benefit design.  When considering whether the new arrangement is likely to be better, death and salary continuance benefits need to be factored in, as one must for administration fees.  At a practical level the member will want reassurance that the new covers will not be subject to medical requirements.  There is potential for the individual to redirect this resource to retirement asset build up if that is their preference.

Benefit projections should be on a number of bases to allow the affected member to judge variability of outcomes.  It’s important to point out that these alternatives do not indicate upper or lower bounds of all possible outcomes.

It’s right and proper that the accumulation design should have a greater expected retirement sum.  The member has more risk, for example, that at retirement returns may be poor – what is called sequence of return risk.  Where I find this risk difference really problematic is when a member is giving up pension rights.  Here the member is taking over the payment duration risk (mortality risk), the rate of return that can be achieved (market risk), inflation risk etc.

From an employer sponsor point of view, these exercises are facilitated by the existence of a decent surplus.  Interestingly, there is a parallel at the SMSF level.  A point may be reached where the cost of SMSF structures do not offset the tax advantages – especially since tax free thresholds and SAPTO may mean little tax on non-super assets.  With a shorter planning duration, the interest component in each payment is less.

The NetActuary Team

More Than the Murray Report

There are many aspects of the Murray Report that could affect a retirement plan.  Some of these could be direct (such as prohibition of property loans in an SMSF) or indirect with (for example) less growth in bank dividends because of new capital requirements.  However, I think we need to go way beyond the future of the financial sector changes, but be proactive on what might blow up in the client’s face in the next 10 years.  It’s currently a time of uncertainty – all the way from an individual to a global level.

We need to know where the investment returns are going to come from to help provide that sustainable retirement income.  The level of interest rates is unusual and extreme.  Ignoring the short term, these rates will (at some stage) return to more normal levels.  If the defensive component is in managed structures and not directly held, the outcome could be ugly.  Clients still remember the GFC.  The MYEFO Statement due shortly is not going to be pretty.  Tax receipts will be down.  The numbers will be bad.  The client will want you to provide a solution.

They might be tempted to consider property.  House prices in Sydney are crazy.  A lot of these residential investments are interest only.  We have gotten used to demand outstripping supply due to Australia’s population growth being one of the highest in the developed world.  Some 155,000 new houses and apartments are required each year currently.  Next year, some 195,000 are planned for construction.  So – for the first time in a very long time – there will be an oversupply.

One is not talking about an immediate problem, but what is becoming clear is that in the next 10 years or so there are huge potential dangers.

What is the solution?  The more you look at these risks the more evident it becomes that the need is to have retirement income covered by secure investments like fixed term annuities to have the capability to sit out troubles.

Post Retirement Portfolio Planning Seminar

 

NetActuary and New South Wales Treasury Corporation (TCorp) are jointly sponsoring a complimentary workshop in Perth on how to structure a portfolio to assist with managing market and sequence risk.

Stephen Hart will show you how to:

• Construct a portfolio using a government guaranteed income stream to partially or fully fund living expenses.
• Protect income streams from the long term erosive impact of inflation.
• Position retired portfolios for growth to better manage longevity risk.
• Insulate portfolios from sequence risk.

 

Brian Bendzulla will be presenting techniques available to manage post retirement uncertainties.   These are more numerous than most retirees probably realise, and include:

• Offsetting longevity, market and inflationary risks with Age Pension entitlements.
• Buffering by setting the payment duration and investment returns conservatively.
• Exporting the risk e.g. inflation indexed investments.
• Rebalancing or setting up a control cycle - a massively powerful technique sorely under-utilised in a more formal disciplined manner.
• Trading "or more" for greater certainty.
• Cashflow matching/immunisation; liquidity management; laddering; diversification; etc.

Individual circumstances are too diverse for rule of thumb approaches.  Careful analysis is required.  We will show you how to:

• Quantify sequence risk;
• Project Act Pension entitlement contribution to sustainable retirement income;
• Optimise the defensive growth portfolio construction to meet client risk tolerance; and
• Many other aspects.

The details of this half day seminar are:

Where:     Hyatt Regency Perth
When:      Tuesday 28th October, 2014
Time:        08:45 for an 09:00 start

If you would like to join us at this complimentary seminar in Perth, please email me at brian@netactuary.com.au and I will have an invitation sent out to you.

Brian Bendzulla
The NetActuary Team

Future Retirement Income Planning

Changed retiree attitudes and environment; the pending influx of accountant trained advisors and the emergence of enhanced  computational tools means a fundamental re-evaluation of how one participates in the retirement income planning space is critical.  Currently, there is much fear generated about adequate resources and a focus on “when will the private monies run out”.  The new approach must show strategies and techniques that allow a high probability that private resources will last the required distance.  It will have far more emphasis on risk management and present results in a stochastic manner rather than deterministic average outcomes.

The Major Risk to be Managed

The top five risks a retiree will need to manage are: 

1. The uncertainty of the planning duration because they don’t know how long they (and, if relevant, a partner) will live.  This is the longevity risk.
2. Since private retirement income will come from both investment earnings and capital drawdowns, there will be uncertainty about what these returns will be – the market risk.  There is an increasing awareness that the order of the returns is important in determining capital usage – the sequence risk.
3. Even at modest steady inflation of 2% - 3% p.a. the purchasing power of a dollar will halve in 20 years.  The inflationary risk has in some past periods been a lot more than this.
4. The government may change the rules about how retirement income is taxed or what Age Pension may be received – the sovereign risk.
5. Miscellaneous risks that range from losses caused by fraud, non-compliance, expense levels etc.

Strategies Available

There are a number of techniques which allow the retiree to control these uncertainties far more than they probably realise.  Some of these are:

a)      Retirement income comes from both private sources and the Age Pension.  One never “runs out” of retirement income because this safety net is there.  Most retirees will receive at least a part Age Pension at some stage of their retirement.  If you live longer than expected you receive more Age Pension than on average you expected at outset.  The same with receipts if your investment returns are lower than expected.  This is “offsetting” the risk.  The relevance of this aspect depends on the level of your assets and desired retirement income.

b)      You can set the required income duration conservatively long and the anticipated   investment returns modestly.  This technique is called “buffering”.  The problem is that it leaves assets to your estate that you may prefer to see supporting a better standard of retirement income.

c)      Transfer the problem to someone else – fully or in part.  This technique is called "exporting” the risk.  There are many products to consider from whole of life immediate annuities to inflation linked fixed term annuities and more complex arrangements.  The issues can be lack of flexibility, value for money (especially on early death) and control of capital.

d)      Rebalancing or setting up a control cycle.  This is a massively powerful technique sorely underutilised in a more formal disciplined way.  It can be thought of as similar to the steering on a car.  Small adjustments are made frequently to the retirement vehicle to keep it on track to complete the retirement journey.  The age of death for those who survive to various durations creeps slowly upwards.   But life is not forever and – with the magic of compound interest – only modest adjustments are needed to (say) the planned cost of living yearly increases to keep the plan in balance.  A more simple way to envisage this (and one I prefer) is to regard it as setting aside a small yearly premium to set up your own deferred annuity.  The aim might be, for example, to have 10 years net of Age Pension resources available at age 90.  It allows the focus to be on the highest sustainable income at the years when retirees are likely to be alive and active, while prudently providing for retirement income for the smaller group that survives to an advanced age.

e)      Trading as Robert Merton expresses it “or more” for greater certainty.  If you can meet your desired income with less volatile investments, your security and certainty increases.

f)       Cashflow matching and the similar concept of “immunisation”.  Here you match the desired retirement income (the liabilities) with matching asset income.  It then doesn’t matter how markets vary.  A retiree’s needs are income not market values.  What is a particular area of research and application at NetActuary is to create partial immunisation with good quality dividends besides the more usual fixed interest.

g)      Careful liquidity management to control the sequence risk issue.  We find products such as inflation linked fixed term annuities very useful to keep a higher level of growth assets while at the same time creating the ability not to be forced to realise assets at depressed prices.

h)      Laddering of fixed interest and fixed term annuity products to reduce down the reinvestment yield risk.

i)        Careful asset sector and product selections that has some inflation protection.  Inflation is a friend of borrowers and the enemy of retirees.

j)        Diversification to reduce investment volatility and fraud risks.

k)      Selection of competent advisors, administrators or product suppliers to reduce compliance penalty risks.

l)        Utilisation of tax free threshold and Senior Australian Tax Offsets to hold non-superannuation monies to reduce sovereign risk.

m)   Watching the emergence of new products such as deeply deferred annuities.  Annuities are the opposite of insurance.  You get a better the deal the later you buy and the worse your health if “impaired life” annuities are available.

n)      Future innovation.  A current area of research at NetActuary is to use the intergenerational opposite needs of accumulation/drawdown to create more certain outcomes.

Centrelink Age Pension 

Much of the current financial planning for retirement income is for higher net worth individuals.  The need is to take these services to the mass market.  Indeed, couples and individuals with modest retirement assets probably need risk management help even more than a rich individual.  An essential starting point will be to be able to integrate Age Pension entitlements into the retirement plan.  Retirees need to be encouraged to have a realistic – not fearful/cynical – view about future changes.  “What happens if there is no Age Pension” is not a constructive conversation.  Evaluating later eligibility ages lower indexation and some post age 60 investment/benefit taxes would be far more productive.  Capital usage, patterns, the step down on first death, grandfathering or deemed income test decisions, refreshing deductibles, sheltering super assets in a younger partner etc. all affects the present value of future Age Pension receipts that can be obtained for a client. 

Enhanced Computational Tools

Dealing with risks and in the stochastic world means the computational tools need to be more sophisticated than those generally in use at the moment.  One will need to be able to evaluate how the anticipated age at death creeps up for those who survive.  If one’s anticipated life expectancy at birth is age 80, for those who survive to age 80 life expectancy is not zero – it has crept up.  Rebalancing, especially for a couple, looks more like a “heat map” rather than a path.  Money lasts forever if the payment is half the opening balance, but it is not a good plan.  Showing how to rebalance for circumstances that emerge would provide far more comfort and security than retirees have at the moment.  That should be a measure about how good the retirement plan is – how comfortable and secure the client feels about the future. 

Retirement income planning is not about wealth management.  It’s about achieving the desired income.  So tools to allow the evaluation of optimal defensive assets in a retirement portfolio are needed.  This also has to be integrated with liquidity management to enable management of sequence risk. 

Pre Retirement Planning

The challenges here are not so much academic or computational, but how to deliver efficiently and engage the audience.  Naturally, the closer they get to retirement the more interest there is likely to be.  I find that it’s easier to model what is needed by starting on desired retirement income and retirement date rather than working from where they are at the moment.  This starkly shows the cost of retiring well ahead of Age Pension age.  Once you have that value then one can consider what current balances and contribution levels, tax efficiencies and tidying up assets like holiday homes can accumulate to by retirement. 

Post Retirement Planning 

It is a concern that the debate is too produce-orientated – especially about annuities.  I personally hope there is a future for annuities for at least part of the retirement income needs over and above the age pension entitlements.  Without some adjustment for impaired lives and better returns, it is probable that annuities will not appeal to retirees as much as flexible drawdown arrangements.  It will be interesting to watch what happens in one of the world’s largest annuity markets – the UK – now that retirees will no longer be forced to purchase an annuity. 

In the US (which has no compulsory annuitisation) about 9% ends up in annuities.  However, these are typically fixed duration annuities – not guaranteed life. 

Alternative products tend to be too complex to have much appeal for purchasers.  I personally think the future for retirement planning advice is to be able to run a more sophisticated, efficient version of what the industry fund Equip Super is doing with its three bucket strategy MyPension service.  Its tag line is “Equip MYPension – ready to fill your retirement with confidence”.

The NetActuary Team

 
 

Dividends and Sequence Risk

Liquidity management is very important in the management of sequence risk.  In broad terms, we have shown that a fixed term annuity is more efficient for this need than a refilled cash bucket.  However, the evaluation model also makes allowance for liquidity from other sources such as dividends.

At the moment, in the “aft cast” modelling we assume that dividends will be at the S&P ASX 200 dividend rate.  All the ASX Indices come in both price return and total return variants.  Cash dividends are applied on the ex-date of the dividend.  Dividend franking credits are not included in the total return calculations.  Consequently, for a tax exempt investor such as a superannuation fund, the post franking credit yield is slightly more than 1% higher than the pre franking credit yield.  Excess franking credits are refundable for super funds.

The actual stocks held by a super fund may have a different average dividend yield to the overall ASX  200 average.  Many retirees seek out good dividend paying shares for their SMSF.  NetActuary is putting together a comprehensive database of dividend payments and level of franking to allow this to be quantified quickly.  It may only be an incremental improvement to the computer model to help manage market/sequence risk – but it’s a worthwhile one.

A new template is being put together for the post retirement sustainable income and risk management report.  This will be loaded onto the NetActuary website shortly.

The NetActuary Team

Just Right

A higher sustainable retirement income is possible with a better investment return.  Consequently, some market risk is needed.  However, too high a proportion could lead to the risk of an unacceptably low residual asset value after (say) 10 years.  It is important to get the sweet spot right in the mixture of defensive and growth assets. 

The graph below shows the trade off between return, a disastrous outcome and meeting the required target return.

There is another risk to worry about.  This is sequence risk – or the risk of having to sell equities at depressed prices.  By making some of the defensive assets ones that yield high cashflow (e.g. fixed term annuities) this can be alleviated.

 

As a financial planner, you work out the optimal drawdown to maximise tax efficiency with a TTR strategy.  You evaluate all levels between 4% and 10% to see the maximum.  It is different for each individual.  Similarly, here one needs to evaluate in steps between totally defensive and fully growth assets to the optimal trade off for that individual.  This requires a lot of projections.  NetActuary has built a calculator to take the hard work out of that task.

 

It shows the probability of meeting 10 year residual asset objectives and also the danger associated with each of these of wiping out a substantial part of the starting assets.

This calculator helps us produce our post retirement risk report more efficiently.  This report looks at: sustainable retirement income levels; Age Pension entitlements over the years; longevity, market, sequence and inflation risk control.  It’s available as a para-planning report for you to use in your client work.

The NetActuary Team

 

 

IPA and SPAA Presentations

Straight after the Federal Budget is handed down, I am presenting a number of workshops and sessions on Practical Pension Planning.  Whilst these are for the Institute of Public Accountants and SPAA in NSW, I know they make non members welcome but at a slightly higher cost than members.

The IPA workshop is from 09:00 – 12:30 at the IPA offices in Kent Street, Sydney.  I am going to look at: 

• The Age Pension and whether to use the grandfathered provisions or the alternative income means test; strategies to improve entitlements over the years; and any Federal Budget changes.
• Legislation and Taxation of income streams and whether legacy pensions should be converted.
• How to calculate the sustainable level of retirement income on various bases and which to use.
• An outline on how to manage longevity, market, sequence and inflationary risks, and the various techniques available.

The SPAA sessions will be a précis of this material into about an hour format.  The various presentations are: 

Sydney Central	Macquarie Bank Building 1 Shelley St Tue 20 May 2014	07:30 - 09:00
Gosford	Shelly Beach Golf Club Tue 20 May 2014	17:30 - 19:00
Newcastle	Noah's at the Beach Wed 21 May 2014	07:30 - 09:00
Baulkham Hills	Nexus Cafe Norwest Thu 22 May 2014	07:00 - 09:00

The approach will be practical and focussed on how effectively and efficiently we can assist retirees to have a secure and comfortable retirement.  With the clock ticking down to 31 December, there is going to be a massive demand for analysis to assist with the necessary decisions.

If any other professional organisation, dealer group, accountancy or financial planning firm would like to avail themselves of this material, please don't hesitate to call Brian on (03) 6223 2320.

The NetActuary Team