By Grant McCorquodale
Heading into retirement and contemplating ending paid work, means you need to rethink the risks in your portfolio.
Your new career – Director of Income
Are you fearful of retirement? The term ‘Retirement’ is a misnomer in so many ways. Most of us are very anxious for what retirement means for our lives. The allure of time to spend with your family and freedom from the demanding schedule of work is matched with a new set of responsibilities – that of financial survival as a ‘sole business owner’ to your household. Retirement is a change of career, not an end of a career.
The wealthy call it “running the Family Office”, but even that understates the number one responsibility of this new career – producing enough income from your assets to meet your family’s cashflow commitments and ensuring it lasts for the rest of your life.
We’ve called your new role Director of Income, or DOI for short. DOIs are basically CEOs of a very specific type. A DOI is responsible for making sure they can source a portfolio of income producing investments to fund their commitments.
The importance of this profession cannot be overstated. In fact, the consequences of not excelling at this career are arguably the most impactful of any career you’ve had before. Unlike an employment environment, you are very much on your own because its so personal and to most, our financial affairs are confidential.
So, for those who say “retired”, we say “changed professions”!
Why Director of Income is the fastest growing profession in Australia
We all know Australians are living longer. But when you take a look at the impact this is having on the ratio of the years we work versus the years we are “retired”, the pace of change is quite extraordinary. In a single generation our life expectancies have increased by 14 years.
As shown below, only 40 years ago Australian’s worked nearly five times longer than they were in retirement – 42 years in the workplace followed by nine years of retirement. Now it’s only one and a half times longer – around 35 years working and 24 years retired.
Today the real challenge is that our average life expectancy has been pushed out to age 85. And, being the average, this means many of us will live well into our 90s. Our capital and income streams need to last over 30 years – almost as long as the term of our working careers.
To many these extra years are a good thing, but as DOI, you now have a major responsibility on your hands.
Managing your retirement is no different to managing a business – the golden rule is make sure you earn sustainable cash flows: don’t risk your capital and don’t run out of money.
Assuming you are already retired, you need to earn more income without blowing up the business (your capital), and try to cut costs without killing off the business (your lifestyle)!
Ensuring your capital and incomes are sustained for 30 years, in order to provide financial security, is a considerable challenge for any business owner.
You are responsible for bearing the risk and consequences on your employees and shareholders (your family members).
As they say, the buck stops here. And unlike many businesses, this business simply cannot afford to fail.
The three stage transitional shift in asset allocation through retirement
DOIs are addressing the need for long term secure income streams through greater asset allocation to the fixed income/bond investment sector and in the process, reducing the risk and volatility to their capital.
During our careers we take on many risks. We have to do so for two reasons:
- Because we do not have enough assets yet to be financially independent so we have to take risks to create a greater wealth base.
- If we make poor investment decisions and lose money we can always repair our losses with next year’s salary or free cashflow – and cover up our mistakes.
With retirement option 2 is lost.
A significant shift in investment risk appetite or asset allocation should begin approximately 10 years before retirement as, this is when you hit ‘peak wealth’ and you need to start taking some risk off the table and focus on protecting your accumulated financial assets.
Retirement is the pinnacle, but what happens before and for a few years afterwards, can very much affect the type of retirement you enjoy.
We would suggest preservation of capital becomes even more important once retired and a strategy to do so is to allocate more of your portfolio to fixed income investments. Including term deposits, bonds and perhaps some older style hybrids.
As you can see in the chart below, during your working career most investors allocate more capital to growth assets.
As you transition into retirement you need to protect your wealth by allocating more to fixed income and bonds, and in your last trimester you need to increase the security further.
Why Directors of Income are looking to the global pension funds for their SMSF insights
Back in the 1980s employers recognised the evolving longevity risk and its burdening financial consequences of funding defined benefits pension schemes for their staff. They could no longer absorb the expanding cost liability these extra years of life meant for pension payments and chose to transfer the responsibility of superannuation back to the individual. And so the SMSF path was laid.
Today when you look at the global pension fund asset allocations you see they invest over 50% of their assets to bonds and cash in order to both meet their liabilities and pay the income streams to their members for the durations of their lives and with the certainty the assets will last the distance. These funds adopt the ‘stage 2’ approach to asset allocation, balancing the diverse age groups stages of all their members.
This is a strategy that SMSFs are beginning to adopt where the direct bond market now is the fastest growing sector for SMSFs. SMSFs want access to direct assets – direct shares, direct property and now direct bonds and FIIG make direct bond access available from $10,000 per bond with a minimum $50,000 up front.
DOI is going to be the fastest growing profession in Australia over the next 20 years. Regardless, like in business, those that have a plan will succeed and those that don’t will not. Being a DOI is no different to being a CEO in that regard.
The key conclusion for the Director of Income is that it’s a lot more enjoyable in retirement with money than without it. So, make sure you reassess your asset allocation and ask yourself “Do I have enough defensive assets to protect me?”
If you would like to discuss further, please make an appointment to see John.
Source: FIIG, The Wire, 16 June 2015. Christopher.Mulenga@fiig.com.au is prepared to answer any questions about this article from MarketTiming clients.
CASE STUDY: Good news story
A couple recently retired and their previous accountant told them they did not have to pay capital gains tax on the sale of their rental property.
He was wrong.
The clients got hit with interest of $5,900. They are on the age pension and John was able to get the interest written off.
Here’s what they had to say:
On behalf of my wife and myself I wish to pass on to you and your staff our late but very sincere thanks to all of you regarding our problem with the ATO over our failure to pay capital gains tax. If it was not for your company’s expertise and experience in this matter, the end result for us would have been horrendous. The added bonus of the ATO refund following the appeal process by your company was really appreciated. Once again, thank you to yourself and your staff.
As we rapidly approach the end of the financial year, NOW is the time to focus on the best strategies to reduce your tax where possible, to streamline your accounting and bookkeeping procedures, and to forward plan for the new financial year.
Of course the best way to do this is to come in and have a chat with us, so we can discuss your situation and give you personalised advice.
However, to get you thinking, we’ve put together a few tips:
Tax planning strategies
- Top up your super contributions
- Delay invoicing or receipting your income until 1 July
- Realise capital losses to offset against capital gains made during the year
- Small businesses with a turnover under $2 million can claim an immediate deduction for the cost of depreciable assets costing less than $1,000 and certain prepayments (e.g. lease and rent expenses)
- Get rid of slow-moving stock and write-off obsolete stock before 30 June
- Write off bad debts and claim back the GST credits where the debt has been outstanding for more than 12 months
- Review PAYG instalment obligations and consider varying the instalment for the June quarter where the estimate of business income tax payable for the year is less than the instalments raised by the ATO
Accounting & bookkeeping
- Ensure that BAS lodgements and super guarantee contributions are up-to-date
- Behind on tax and BAS payments? Ensure that payment arrangements have been entered into with the ATO and are complied with
- Report salary sacrifice contributions and certain fringe benefits on employee’s PAYG Payment Summaries
- Back up the data file prior to rollover and ensure your records are in good shape
- Review GST codes for profit & loss and balance sheet accounts for correctness
- Have cut-off procedures to ensure matching of income and expenses. For example, ensure suppliers provide the relevant invoices for all purchases and expenses for the period up to the end of June. Also identify work in progress or sales not yet invoiced and raise the relevant invoices for the period up to 30 June.
- Complete stocktakes of inventory. Any unders/overs of stock quantities and spoilage identified from the stocktake process should then be adjusted in the stock module by 30 June and thereby reflected in the financial statements.
- Complete stocktakes of fixed assets. Any adjustments required to the assets register identified in the assets stock take for issues including description, location, quantity and damage/obsolescence needs to be made in the assets module by 30 June and thereby reflected in the financial statements.
- Review the balance sheet and profit & loss statement to confirm:
- Bank accounts and loans are reconciled.
- Receivables and Payables subsidiary ledgers are reconciled to the general ledger.
- GST accounts and PAYG withholding are reconciled to the business activity statements.
- Wages in the profit & loss is reconciled to the PAYG Payment Summaries.
- Capital items such as plant & equipment purchases have not been expensed as repairs.
- Amounts in suspense have been allocated to the appropriate account.
- Fringe benefits tax has been paid on deductions claimed for employees private expenses.
- Material differences to the prior year can be explained.
Planning for the new financial year
There are a few things you can do to improve on the performance of your business this year:
- Prepare/update your business plan to provide solid focus and direction
- Update the budgets for the next 12 months and compare actual to budget.
- Review your current accounting software and upgrade to the latest version to take advantage of new features, or talk to us about other options
- Review credit terms with suppliers and customers and make changes if required
- Review insurances to ensure adequate level of coverage
- Reduce costs in areas identified as excessive in the current year
- Implement new internal control systems to address weaknesses identified
If you need any help at all with your planning, please get in touch. We are here to support you and give you the right advice, whatever stage you’re at.