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Replacing an income in retirement

by Elizabeth Moran | Aug 12, 2014

When an investor puts their SMSF into pension phase, they face a new problem they may not have considered which is how to draw down enough money each year to meet the minimum pension payment.

This sometimes requires a different mix of assets to the ones that they have acquired during the accumulation phase when their main goal was simply to build up their wealth.

The superannuation rules stipulate that SMSF investors aged 65 to 74 must withdraw five per cent of their total assets, 75 to 79 year olds must take six per cent, 80 to 84 year olds seven percent and so on up to a significant 14 per cent for those over 95 years.

Even though investors may not want or need the funds, they must nevertheless be paid.

This can create a number of unforseen problems. If your SMSF contains a single residential or commercial property (maybe one that houses your business), how do you withdraw 7 per cent of the value assuming the asset generates an annual cashflow of 5 per cent? What happens if there is a period when the property is vacant?

Selling the property or borrowing against it is the logical solution, but that may not be a decision you would want to take.

Similar quandaries can occur with shares. In stressed market conditions dividends can be cut, reducing income, forcing investors to sell assets to ensure they withdraw an increasing pension. Which shares do you sell?

Including assets in your SMSF that offer known payments that can match those pension withdrawal limits is one way to alleviate stress and meet the minimum requirements.

These assets include annuities which provide you with a known cashflow over the longer term and provide certainty no matter what happens in the market. In exchange for the known payments over very long horizons you hand over control of the investments to an investment manager.

There are other investments where you remain in the driving seat. Indexed annuity bonds (known in the market as inflation indexed annuities) offer a compelling option. Investors pay a lump sum up front then the company returns principal and interest, indexed to inflation until maturity. The bonds are tradeable so can be sold if needed and they can be transitioned if needed. These bonds are very long dated and linked to inflation, similar in that way to annuities, providing important protection.

lndexed annuity bonds are typically public private partnerships (PPPs) where there’s a public need for funding to help build infrastructure.  Often the cash flow stems from a government entity making the investments very low risk and providing investors with significant certainty.

For example the JEM NSW Schools PPP is a financing vehicle established by the Axiom Education (Axiom) consortium which was contracted to finance, design, construct, maintain and manage 11 schools in NSW.

The construction and design phase of the project is now complete with Axiom responsible for the upkeep and maintenance of the sites until 31 December 2035.

At the end of the contract, Axiom will hand over the school facilities to the NSW state government. The JEM NSW Schools indexed annuity bond will pay principal and interest each quarter until it matures in 2031, when it will have repaid the funds in full.

A portfolio of five index annuity bonds with an initial outlay of $504,683 will generate growing quarterly payments of $9,687, delivering approximately $37,156 in the first year or 7.4 percent of the invested sum. The total projected cash returned over the life of the investments, assuming inflation runs at 2.5 per cent, is $787,243, an increase of $282,560 or 55 per cent of the initial invested sum. This strong income stream would be enough for investors up to the age of 84 to meet the minimum SMSF withdrawal requirements without selling assets.

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