Investments that are not in your best interest

Nest egg: Investing in cash may not be a good strategy for retirement.
Nest egg: Investing in cash may not be a good strategy for retirement.

Judging by the emails pouring in, many retirees are concerned about the best place to invest their money now that interest rates appear to be headed ever-downward. A diversified portfolio is probably the best way to go for most people, but you also need to think about how numbers work, and get yourself a strategy that is right for your own goals and risk profile.

The reality is that you can't depend on bank interest to get by if you are retired. Suppose you had $900,000 in cash, which is above the pension cut-off point - the most you could expect to earn on that these days would be around $9000 a year. And even if rates went back up to 3 per cent, the return would still be only $27,000 - obviously you would have to be prepared to draw down on your capital to maintain your cashflow.

Let's think about a couple in their mid-70s who have $250,000 outside superannuation and are watching their returns shrink to 1 per cent or even less.

They will probably be on a part age pension, but need to withdraw money from their savings to balance their budget. Let's assume they need $20,000 a year in addition to what the age pension provides. Keep in mind that as their capital reduces their age pension should increase.

Let's run some numbers using the Retirement Drawdown Calculator on my website, www.noelwhittaker.com.au, to look at the effect of the rate of return on their finances. Let's assume that they keep $100,000 in the bank, draw their $20,000 a year out of it, and invest the other $150,000 in a quality share trust. In the "good old days" they would have earned 3 per cent a year and there would be $9,745 left at the end of the fifth year - if earning just 1 per cent the money would still last for five years, but the balance at the end of that period would be $3081.

The difference is minimal because the rate of return has a small effect over a relatively short term like five years.

If the remaining $150,000 was invested in an index fund, which by definition cannot go broke, they should receive an income of about 4.2 per cent on the initial investment, irrespective of any fluctuation in the value of their portfolio. That comes to $6300 plus around $2700 of franking credits, which should give them a net income return of 6 per cent, or $9000 a year. Let's assume they re-invest the $6300 each year to magnify the compounding effect, but keep the franking credits for pocket money.

If the fund averaged 9 per cent per annum (income and growth) which is the historical average, after five years their initial $100,000 should be almost used up, but their portfolio should be worth around $230,000.

By now, they should be celebrating their 80th birthdays, and the fact that they have continued to grow their capital despite the low interest-rate environment, while taking as much as they needed from it.

I appreciate that share values fall as well as rise, but the index has never failed to make a new high after a fall. Certainly, there may be times when they might need to reduce their rate of drawdowns, if markets become especially volatile, or spend some of the dividends instead of re-investing them, but the scenario outlined above should leave cash for dead over the long-term.

This is not only a lesson in how numbers work - it is also a wake-up call to get used to share-based investments at an early age. No other asset class offers the benefits of shares.

Pension Q&A

Question. We receive a smallish aged pension and benefit from grandfathering for both drawdown rate and superannuation income. We are planning to downsize but the difference in house values is smallish We plan to settle on our current house mid-January and settle on the new house in May. Centrelink have advised that deemed income from the sale will knock us off the pension in January. They said we can then reapply in May after we pay for the new house but we will then lose both grandfathering arrangements.

Is this correct? Is there any way we can maintain the pension during this period, such as holding the proceeds of the sale in trust, or prepaying for the new home?

Answer. Centrelink tell me that when a customer sells their principal home, the portion of the proceeds which they intend to use to purchase a new principal home, will be exempt from the assets test for up to 12 months. The exemption period will apply from the date their principal house is sold.

However, while the proceeds are exempt from the assets test, they apply the deeming rules to the exempted asset amount, with deemed income amount being included under the income test. This includes any proceeds kept as cash, in a bank account, held in a solicitor's trust account, managed investments, investments in superannuation funds, bonds, insurance products or even loans made to individuals or trusts.

If you are able to pay for all or part of the house you are purchasing, the portion of the property you own would become an asset until they started living in it. Whilst the amount paid would not be deemed, the asset value assessed for the property may affect the rate of pension under the assets test.

Centrelink recommend that anybody in a similar situation should speak with one of their Financial Information Service officers. This is a free service and available by calling 132 300.

Question. A while ago in this column you advised a pensioner couple about the relative merits of gifting, versus loaning money to a child.

Would the method you described in relation to a loan rather than a gift avoid the Centrelink rules about gifting more than $10,000 annually and $30,000 in five years in respect to the Centrelink asset assessment for aged care? Also, would the loan be classed as an asset for the aged care assessment purposes.

Answer. There is a vast difference between a gift and a loan. As you point out it's possible to gift $10,000 a year with a maximum of $30,000 over five years, and provided you keep within the limits, the money gifted is no longer assessed by Centrelink. Gifts in excess of the limits are treated as a deprived asset for five years but then cease to exist for Centrelink purposes. Loans continue to be assessed by Centrelink for as long as the loan is in existence. This could be many years depending on the circumstances. The same rules apply to the aged care means assessment - the loaned monies would be assessed as an asset and deemed to earn income.

  • Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. noel@noelwhittaker.com.au