QUESTION
Background
Michael is age 66 and Karen is age 62. Both are in very good health and have full private hospital cover with a $1,000 excess. Karen is an only child and she is very close to her mother and father who are both alive and quite active at ages 86 and 84 respectively. Michael’s parents and three sisters are also all alive and healthy.
Karen works full time as a receptionist in a doctor’s surgery, earning $35,000 p.a. (before tax) plus superannuation guarantee contributions. She has been with the practice for the past five years and loves her work.
Michael is due to retire in one month from his position as an OHS compliance manager with a mining company, which he has held for the past 11 ½ years. His before tax salary package is $68,000 p.a. plus nine percent superannuation. He will receive his superannuation account balance when he retires. He will also receive a payment of $22,500 from his employer upon retirement, which includes $5,400 unused annual leave accrued in the past two years and $8,600 unused long service leave accrued since Michael commenced work with this employer. The remainder is an employment termination payment for his service with the employer.
Michael and Karen have two daughters: Zoe, who is 38, widowed with two teenage sons; and Nicole, age 32 and single. Michael and Karen would like to be able to provide monetary support if needed to Zoe and Nicole.
Michael has life and total and permanent disability insurance equivalent to three times his current gross salary attached to his employer superannuation fund. Karen has $200,000 death and total and permanent disability cover attached to her superannuation fund.
Both Michael and Karen have Wills, which were reviewed four years ago. They have appointed each other as power of attorney.
They own their own home, which has no mortgage. They have comprehensively insured their car, home and contents.
Over the last few years, both Karen and Michael have been actively learning about and discussing retirement. They have been keen readers of newspaper articles and educational literature covering retirement issues and also attended seminars on retirement strategies. They both feel they have a relatively good understanding of investment, superannuation and retirement issues.
Michael and Karen have a similar approach to investing. They understand the basics, but rely on good professional advice when making decisions. They have made mistakes in the past, and want to avoid a repeat of those as they get closer to retirement. They are very keen to obtain professional advice to ensure they are able to live the life they have always wanted to in retirement. They want to ensure their money lasts as long as they do, access the aged pension if possible and minimise their tax – after all, they have been paying tax their whole lives.
Goals and objectives
Having completed a budget, Michael and Karen have determined that they currently spend approximately $50,000 p.a. net (after tax) on their day-to-day living expenses (not including travel, loans or other commitments).
Karen plans to continue to work on a full-time basis for another three years and will then retire.
The couple plans to upgrade to a new car when Karen retires and expect to spend another $30,000 doing so.
They feel comfortable with having liquid funds available of at least $25,000 for emergencies.
They are prepared to direct any surplus funds into superannuation investments to prepare for their retirement.
They plan to live in their current home for the duration of their retirement and would like it on to pass to Zoe and Nicole in their estates.
Karen is quite insistent about keeping her existing shares as she would like to leave them in equal shares to her grandchildren upon her death.
Karen and Michael would like to do whatever they can to assist their family, both now and from an estate planning perspective.
Michael and Karen Lockhart
Present situation – current assets
PERSONAL ASSETS Value
Family home (owned as joint tenants) estimated value $800,000
Family car (purchased 2006) $46,000
House contents – market value $43,000
INVESTMENT ASSETS Value
JOINTLY-OWNED INVESTMENTS
Bank account (at call)
Earning 5.2% p.a. interest $6,300
Cash management trust
Earning 7.5% p.a. interest $175,000
Investments held in Michael’s name
Personal superannuation (taxed fund) $135,500
- Commenced in 1995
- Employer pays into this fund
- Tax-free component is 20%
- Taxable component is 80%
- Michael has selected a balanced asset allocation
- No nominated beneficiary
Investments held in Karen’s name
Share portfolio
- Assume overall dividend rate of 5.5% p.a. 100% franked
- All shares have been held for at least 12 months
| Company |
Number of shares held |
Average cost base per share |
| ANZ | 1,025 | $5.543 |
| BHP | 1,520 | $7.615 |
| IAG | 985 | $3.016 |
| Telstra | 1,485 | $3.950 |
| Woolworths | 1,000 | $12.025 |
Personal superannuation (taxed fund) $196,550
- Originally commenced in 1995
- Employer pays into this fund
- Tax-free component is 10%
- Taxable component is 90%
- $10,919 is unrestricted non-preserved
- High growth asset allocation
- Karen has established a binding nomination naming Michael, Nicole and Zoe as beneficiaries in equal shares
LIABILITIES Balance
Credit card debt $0
- Credit limit $4,000
- Balance repaid each month
Assignment questions
Question 1
Michael is not sure about what he should do with his superannuation and the payments he will receive from his employer when he finishes work in one month.
a) Explain what options are available to Michael with respect to the payments he will receive upon termination of his employment and his superannuation balance.
b) Calculate the resultant tax treatment of the payment with respect to those options. Show all workings where relevant.
Note: You must address each of the four payments i.e. annual leave, long service leave, the employment termination payment and superannuation, individually.
[insert student response]
a) Upon termination of his employment, Michael will have the following options available to him:
i. employment termination payment:-
with his Employee Termination Payment, Michael has an option to:
- Contribute it towards his Superannuation
The new rules focus on restricting how payments are made into super (rather than how they come out). The rules for New ETPs result from the abolition of RBLs, and new contributions caps.
The two main ways a New ETP can be paid into super are: by the member or by the member’s employer.
A New ETP must be paid directly to the member (or employee). The member then decides whether or not to pay the New ETP into their super. The most the member can pay in is limited by the non-concessional contributions cap of $150,000.
Old ETPs could be paid into super because the amount people would roll into super was governed, ultimately, by how the benefit was going to be taxed on the way out: namely, by the soon-to-be abolished RBLs. (But an Old ETP can no longer be paid into super.)
Now, most benefits won’t be taxed on the way out. So the government has imposed the limit on how much you can put in, and on how you can do so.
ii. superannuation;-
b)
i. employment termination payment
ETP PAYMENT * (Number of days before 1st July 1983 / Total days service)
ii. superannuation
- ·How to calculate tax on ETP’s
The first step is to determine the tax free component of an ETP. Any length of service before 1st July 1983 is tax free. To calculate the tax free component use the following formula:
ETP PAYMENT * (Number of days before 1st July 1983 / Total days service)
The next step is to calculate the tax on the assessable component of the ETP (total ETP payment less any tax free portion). The tax you pay on the ETP will depend on
- Your preservation age – This is the age in which retirees can access their superannuation. Currently the preservation age is 55 years. If you reach this age when you are paid an ETP, you are taxed at a reduced rate.
- The ETP threshold – all payments in excess of the threshold are taxed at the top marginal rate, regardless if you have reached the preservation age.
|
until 30th June 2011 |
under 160,000 |
over 160,000 |
| Under 55 years | 31.5% | 46.5% |
| 55 years and over | 16.5% | 46.5% |
Question 2
The couple is concerned their current superannuation arrangements will be inadequate to provide for their future. They would like to know how they can increase the balances of their superannuation funds.
Showing calculations where relevant:
a) Estimate the total capital the couple will need to accumulate in order to achieve their preferred lifestyle in retirement.
b) Analyse any gaps between the total capital required to achieve all of their retirement goals and their current financial position.
c) Identify all of the types of superannuation contributions generally available to individuals to increase their superannuation savings.
d) Explain the rules, restrictions, advantages and disadvantages of each type of contribution individually.
e) Discuss which specific contribution types you would recommend for Michael and Karen, providing justifications for your response.
[insert student response]
Question 3
Karen has heard from friends about the transition to retirement strategy and is wondering whether it would be suitable for her.
In your own words:
a) Briefly explain the purpose and operation of the transition to retirement provisions.
b) Develop a transition to retirement strategy that would be appropriate for Karen in the context of the couple’s goals and objectives, providing complete ‘before’ and ‘after’ taxation calculations illustrating the effectiveness of the strategy you would recommend for her.
c) Outline the advantages and disadvantages of the strategy. Assume no superannuation benefits have previously been taken. Show all workings.
Your calculations must include the client’s investment income, Medicare levy liability, any applicable tax offsets and credits, the effect of the income stream payments and contributions tax.
[insert student response]
i. Medicare levy liability,
ii. applicable tax offsets and credits,
iv. the effect of the income stream payments and contributions tax
Question 4
Michael has made no nomination of beneficiary for his superannuation benefit, while Karen has nominated Michael and her daughters equally as her beneficiaries.
In your own words:
a) Briefly explain who is able to receive superannuation benefits upon the death of a member during the accumulation phase and the methods by which benefits can be paid.
b) Identify the two methods of nominating a beneficiary for superannuation members and the advantages and disadvantages of each.
c) Outline the tax treatment of superannuation lump sum death benefits.
d) Discuss the effect of Karen and Michael’s current beneficiary nominations with reference to these issues.
[insert student response]
Question 5
Michael and Karen would like to access social security payments if possible.
a) Calculate whether the Lockharts would be entitled to any Centrelink Age Pension or other Commonwealth Government benefits based on the current structure of their investment portfolio at the time of Michael’s retirement. Show all workings and include a discussion of the concession card/s they may also be entitled to.
b) Describe two current, legally acceptable strategies that could be employed by the couple to enable them to maximise any Centrelink benefits in their final retirement.
c) Describe the likely advantages and disadvantages associated in adopting those strategies.
[insert student response]
Question 6
Karen (age 62) will retire when she turns 65. Michael retired one week ago.
The clients require advice on how to invest all of Michael’s final payments and how they can boost their superannuation balances over the next three years before they are both fully retired. They would also like to know what their financial situation is likely to be at this time and if their retirement goals are achievable.
Based on the facts presented in the case study, prepare a comprehensive report describing the strategies and investments you would recommend the couple undertake to satisfy all of their stated goals and objectives both now and in preparation for Karen’s retirement in three year’s time. Your report must include detailed reasons why you feel such strategies would be suitable for the couple.
In preparing your report you must clearly address all of the following issues:
Ensure that all stated goals/objectives, concerns and issues are identified.
Make recommendations to address all of their goals/objectives and concerns, both financial and non-financial, with an appropriate strategy. Your recommendations must be explained (including the advantages and disadvantages of each one) and justified.
You must make recommendations for the next three year’s to enhance their financial position in preparation for Karen’s retirement.
You should clearly show the financial position of the couple prior to and after implementation of your recommendations using cash flow tables. Your calculations must demonstrate that their net income goals, both for the next three years and in full retirement, can be achieved.
You should discuss the couple’s likely financial position at (Karen’s) retirement and outline the income options, including Centrelink payments and income streams that are likely to be available to them at and from that time.
You must show all calculations, including those for tax, income streams and possible Centrelink benefits. Where spreadsheets or projections are used they must be explained.
You are not required to provide a complete SOA to answer this question however you are required to provide comprehensive advice to the clients on all aspects of their situation and make recommendations as to how to address all of their goals and concerns.
You must address, explain and make recommendations concerning risk management and their estate planning needs as they relate to superannuation and retirement planning.
Where assumed rates of return have not been specified, you may wish to make your own assumptions as to projected rates of return on investments that may be recommended. Any such assumptions must be realistic and have a reasonable basis which is clearly explained. These assumptions must be stated at the beginning of your response to this question.
For any existing investments you recommend Karen and/or Michael retain, the estimated rates of return provided must be used.
SOLUTION
Superannuation & Retirement Planning
Superannuation & retirement Planning
Question 1
a) Termination payments and superannuation balance available to Michael on retirement :
The termination payment is available to Michael is $22,500 (which includes $5,400 unused annual leave accrued in the past two years + $8,600 unused long service leave and the remainder is an employment termination payment for his service with the employer)
Superannuation balance of $135,500.
After retirement, Michael’s constant income inflows will stop and also his pattern of consumption will change. There are numerous alternatives available in terms of retirement planning. He has to plan the retirement payment options in advance that are before getting retired. There are retirement experts in financial services or consulting firms where he should seek the advice from the experts. Experts can make him aware him of all the options available in the market and then advice him which options are more suitable to him. Experts can guide him which option will help him to achieve his future goals.
Superannuation is a saving plan in which funds are accumulated over a period of time. In superannuation method money is kept aside on a fixed interval basis for a certain period. This money either invested in some interest earning option or invested in a project. Superannuation is a saving plan available to the employees working in organizations. The contribution to the Superannuation plan is voluntary not mandatory. The employer and employee both can make the contribution as per their deliberation.
There are many options available to Michael on his retirement. These options are varying from options of guaranteed returns and less risky to options of highly volatile returns. The options with guaranteed returns are such as government bonds, fixed deposits, public provident funds, employee provident fund etc. whereas options of volatile and risky but higher returns are shares, futures, options, commodities derivatives, mutual funds etc. After retirement Michael should go for fixed returns options because they are safe and less risky.
b) Calculate the resultant tax treatment of the payment with respect to those options. Show all workings where relevant.
Michael does not have to pay tax on superannuation benefits because he is over 60 years of age. But he will have to pay tax on $22,500 received on retirement.
Question 2
a) The total capital the couple will need to accumulate in order to achieve their preferred lifestyle after the retirement.
In terms of the couples objectives and goals after retirement:
Expenses/year $ 50,000*10 (suppose for 10 years)
New car $ 30, 000
Liquid funds $ 25, 000
$ 555,000
The couple will need at least $ 5, 55,000 accumulated amount to achieve their preferred lifestyle and the goals. They need this amount without liquidating the shares which they want to leave as inheritance for their grand children.
c) Analysis of gaps between total Capitals required achieving retirement goals and the couple’s current financial position.
Total assets of the couple $ 889,000
Joint Investment assets $ 181,300
Karen’s Income before tax for 3 yrs $ 105,000
Personal (taxed fund) superannuation $196,550
Investments held by Michael $ 135, 500
Retirement benefits to Michael $ 22,500
Investments held by Karen $ 38, 178
$1,394,350
Income for using fund their after retirement life =
Joint Investment assets $ 181,300
Karen’s Income before tax for 3 yrs $ 105,000
Personal (taxed fund) superannuation $196,550
Investments held by Michael $ 135, 500
Retirement benefits to Michael $22,500
Total before tax = 618350
Surplus assuming no tax = 640,850 – 5, 55,000 = 85,850
The gap between total capital required achieving retirement goals and the couple’s current financial position is surplus $ 85,850 if they do not contribute to the superannuation fund and do not liquid their shares. That means the couple need to invest in the guaranteed return options for next three years before retirement. They will need at least 30% return on borrowed funds and 15-20% returns if they use their own funds.
d) Identify all of the types of superannuation contributions generally available to individuals to increase their superannuation savings.
There are mainly two types of superannuation funds. One is complying fund and the other one is non- complying fund. The complying superannuation fund is regulated by SIS, whereas the non complying funds are not regulated by SIS. The both kind of superannuation funds, complying and non- complying are available to individuals and organizations. The advantage of superannuation fund is that all the transactions are efficient and transparent in it. Similarly deemed covenants are also good superannuation fund option due to their strict governing under SIS act.
e) Explain the rules, restrictions, advantages and disadvantages of each type of contribution individually.
The superannuation funds are regulated by SIS act and hence transaction are very efficient, transparent and strictly regulated. It provides safety to the funds if there is any misuse of the funds or misappropriation of the fund. The disadvantage of superannuation fund is that highest penalty SIS is 45% which is very high. Moreover it is handled by trustees which may lead to risk of un-coordination of investment that may harm the fund.
f) Specific contribution types that would be suitable for Michael and Karen and the justifications for that.
In my view for the couple deemed covenant is the most suitable option due to its strict governance and regulation by SIS. Because the couple is retiring and there is no regular income flow after retirement therefore they need highly regulated and guaranteed and safe funds.
Question 3
Karen has heard from friends about the transition to retirement strategy and is wondering whether it would be suitable for her.
a) The transition to retirement strategy is vital in that
The transition to retirement scheme works best for those who are in the age of 55 years or above 55 years and still working. They should also have some super. The transition to retirement strategy makes you to transfer some or all your current super into non commutable income which gives regular income but does not allows to withdraw in a lump sum. It uses the income before tax resulting in tax saving and transferring more funds in super.
b) Retirement strategy that will be appropriate for Karen regard to the couple’s goals and objectives taxation calculations also illustrated to highlight the effectiveness of the strategy.
The transition to retirement rules need to start a non commutable allocated pension that will exit along with superannuation fund. In transition to retirement strategy he will save tax on the pension fund and superannuation fund’s capital gain.
On the capital gains and income they will have to pay higher tax after retirement, let’s assume it would be around 40%. But if they contribute the surplus income into non-commutable pension fund they will have to pay tax just 15%.
As we saw without tax their surplus is = $ 85,850
Now if they contribute this to non-commutable allocated pension they will have to pay only 15% tax that is $85,850*.15 = $12877.5 instead of $34,340 at 40% tax, hence saving tax up to 21462.5.
c) Advantages and disadvantages of the strategy assuming no superannuation benefits.
In the strategy of transmission to retirement Medicare levy will decrease by 13.66%. The tax of around 50% would be saved on taxable income. The pension with tax free component will increase. However, the client’s salary will decrease by 74% which will eventually result in increase of pension by this amount.
| % decrease | |||
| Salary: | $100,000 | $36,325 | 74% |
| Before tax income | $100,000 | $86,325 | 14% |
| Tax on taxable income | $27,100 | $13,630 | 50% |
| Plus Medicare levy | $1,500 | $1,295 | 14% |
| Net tax payable | $28,600 | $14,925 | 48% |
Question 4
Michael has made no nomination of beneficiary for his superannuation benefit, while Karen has nominated Michael and her daughters equally as her beneficiaries.
In your own words:
a) Briefly explain who is able to receive superannuation benefits upon the death of a member during the accumulation phase and the methods by which benefits can be paid.
In case the death of the member occurs then financial advisor gives information to the client’s beneficiaries that by who, when and how benefits will be received. In the given case if Michael’s death occurs, his wife Karen will be the beneficiary if she is alive otherwise his daughters will receive the benefits. In Karen’s case his husband Michael will be the beneficiary or he can choose his daughters if he wants so.
For instance, the employer sponsored superannuation fund’s benefits are paid including insurance proceed, pension or tax laws. The benefits of superannuation after death is paid generally according to SIS act.
b) Identify the two methods of nominating a beneficiary for superannuation members and the advantages and disadvantages of each.
The two methods of nomination of a beneficiary for superannuation are binding and non binding death benefit nomination. The main benefit is of binding death benefit is that trustees are bound to accept the nomination and instructions of the members. While in non-binding the trustees are not compiled or bound by members’ instructions.
c) Tax treatment of superannuation death benefits.
If the superannuation death benefits are paid to the dependant that all the benefits will be tax free. Whereas, if the death benefits are paid to non dependant the lump sum paid will be taxed at 15 per cent.
If the death benefits are paid as reversionary pension then taxation would depend on the age of the primary and reversionary beneficiary. If the primary beneficiary was of 60 years or above then the benefits to reversionary will be tax exempted. Whereas, if the primary beneficiary was below 60 years then the death benefits will be taxed until the reversionary beneficiary becomes of 60 years above 60 years.
The death benefits will be paid as pension to the dependant if the member’s death occurs before pension commencement. The tax treatment of these benefits will be same as reversionary pension.
Death benefits are paid as pension to the dependent child as pension till the child turns 25 then balance will be paid as tax free lump sum.
d) Effect of Karen and Michael’s beneficiary nominations with reference to above issues.
In case of Michael’s death Karen will receive the death benefits if she is live . She is above 60 and dependant therefore she will receive benefits as pension and tax exempted. If she dies before Michael’s death the benefits will not be available to their daughters because he has not made any nomination for it.
Similarly, if Karen dies his husband will receive tax free pension because he is above 60 years. If Michael dies before Karen’s death her daughters’ will receive taxed lump sum.
Question 5
Michael and Karen would like to access social security payments if possible.
a) Will the couple be entitled to any Centrelink Age Pension or any other Commonwealth Government benefits based on their current investment portfolio structure at the time Michaels plans to retire.
The couple is entitled to a centrelink age pension because the couple’s expenditure is more than the income and they are not able to receive the exact amount. They both are in the age of pension ,hence the calculation will be as
Pension p.f= Basic rate + pension supplement-((Income-Threshold test) * 0.5)
b) Legally acceptable strategies that could be employed to enable the couple maximize their Centrelink benefits.
One of the legally acceptable strategies is the work bonus. When the pensioners are above 60 years and earning they can earn work bonus which will increase the centrelink benefits. The aged care also can maximize their centrelink benefits.
c) Advantages and Disadvantages associated with adopting the above strategies.
The advantage of the above strategy is that work bonus and aged care can maximize the couple’s centrelink benefits and can reduce the burden after retirement. The aged care will count the couple’s family home as an asset while assessing accommodation benefits. The disadvantage is that there are some qualification criteria need to me met for applying for the work bonus and aged care strategy. The qualifications such as whether spouse and dependent child is is living with the couple and also the couple has been living in the house for at least 2 years.
Question 6
For achieving their goal of preferred lifestyle and objectives they need to have the funds covering expenses for at least next 10 years without liquidating their shares which they want to give their grand children as inheritance. The couple wants to have cash in hand for liquidity purpose but rather than having cash in hand they can go for some liquid investment plan which can provide them some decent returns. Thus they can earn some returns on the funds while maintaining liquidity and safety. Similarly they want to buy the car which either they should buy little cheaper or should postponed the car buying decision until it is required.
As calculated earlier they require at least $ 5, 55,000 total income for achieving their retirement goals. For achieving this they need to maximize the income and reduce some expense. For maximizing their income Michael can get a job after retirement for next three years till his wife gets retired. In this way they can maximize their income.
For the couple being in old age and at the age of retirement they need a good risk management planning. They should invest in lesser risk assets and should have guaranteed returns. They should also invest in legally accepted strategies to maximize the benefits and get maximum tax exemption. After certain risk free return only they should go for pursuing high return and riskier schemes.
References
http://www.supermatters.com.au/death_and_taxes.htm
http://simplersuper.treasury.gov.au/documents/decision/html/final_decision-01.asp
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