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Mortgages, personal debt and retirement

 

Ideally, we would enter retirement with our home mortgages paid off and completely free of any other kind of debt.

           

That would give us the capability to use our retirement savings to finance (or help) finance our standard of living in retirement.

Yet many retirees are, of course, reaching traditional retirement ages with outstanding mortgages and other debts. And often these retirees may decide to use at least part of their super to fully pay off their debts, reduce debt or to direct part of their super pensions to keep making repayments.

Other debt-reduction options include remaining in the workforce for longer than perhaps intended or “downsizing” to a less-expensive home if possible (keeping in mind the possible impacts on the age pension).

It may be worthwhile seeking advice from a financial planner before taking a new mortgage or extending an existing mortgage if it is unlikely that the debt can be repaid by your intended retirement age. Perhaps you need advice about how to deal with a longstanding mortgage as your retirement nears.

With the ageing of the population and rising house prices in recent years – Sydney and Melbourne being at the forefront – outstanding debt near retirement is apparently becoming more of a mainstream personal finance issue. A large proportion of the debt is accumulated using home equity loans, enabling home owners to increase the size of their mortgages, according to comprehensive research by the Australian Housing and Urban Research Institute at Curtin and RMIT Universities.

Another research paper shows that home mortgages, excluding investment properties, made up almost 30 per cent of debt in 2013-14 of households headed by a person aged 65 or older. This is up from under 20 per cent in 2004.

Further, this paper – Buy now, spend later – Household debt in Australia, published in December by the National Centre for Social and Economic Modelling (NATSEM) at the University of Canberra – reports that home mortgages made up 46 per cent of debt in 2013-14 of households headed by a person aged 50 to 64.

In an examination of median household debt, NATSEM found that 44 per cent of households in 2013-14 headed by a person aged 65 plus had some kind of debt (this figure includes non-mortgage debt) against 38 per cent a decade earlier.

However, it is critical to keep in perspective any concerns about retirees using their super lump sums to repay pre-retirement debt.

Rice Warner Actuaries has found that almost 87 per cent of retirement super accounts in 2013-14 with balances of more than $300,000 were being taken as pensions rather than lump sums. And for retirees with super account balances between $50,000 and $100,000, the split was almost even between lump sums and pensions.

And of the super retirement benefits taken as lump sums, at least a third of the money was transferred into bank deposits with most of the remainder being used to reduce debt.

Perhaps the bottom-line is that retirees with little or no debt upon retirement can direct their retirement savings to financing their retirement lifestyles – not to repaying or simply servicing pre-retirement debt. It is something to think carefully about before taking on a new loan.

 

By Robin Bowerman
Smart Investing 
Principal & Head of Retail, Vanguard Investments Australia
09 February 2016

Cost of retirement continues to climb

 

The Association of Superannuation Funds of Australia (ASFA) retirement standard for the December quarter shows living costs for retirees have risen once again.

           

The ASFA retirement standard estimates that couples need to spend about $59,236 per year, while singles will need to spend $43,184.

Both categories increased from the previous quarter. The total budgets for older retirees increased by 0.5 per cent at both the comfortable and modest levels.

While there was a modest rise, ASFA CEO Pauline Vamos said the cost of living had not increased substantially, which is positive for current retirees.

“However, many Australians are still retiring with an inadequate amount of superannuation. In order to achieve a comfortable standard of living in retirement, an individual requires a minimum of around $545,000 and a couple around $645,000,” said Ms Vamos.

According to ASFA, the most significant price rises in the December quarter contributing to the increase in the annual budgets were domestic holiday travel and accommodation up 5.9 per cent, and international holiday travel and accommodation up 2.4 per cent.

The most significant offsetting price falls were automotive fuel down 5.7 per cent, fruit which was down 2.6 per cent and communications down 2.4 per cent.

Written by Miranda Brownlee
Thursday, 25 February 2016
SMSFadviser.com.au

Personal finance goes ‘viral’

 

Home videos of animals or babies often seem to go viral on the internet. But have you heard about a list of personal finance tips going viral on the net?

             

Your response is probably: “No way”.

Well, it did happen two years ago. Harold Pollack, a professor in social service administration at the University of Chicago, jotted down on a small index card a straightforward list of things that had personally helped him straighten out his own finances.

Pollack then posted a photo of his handwritten note online; it went viral. And Money Magazine in the US named the listing of his points distilled on a single card as one of the best new money ideas of 2013.

Now fast forward to 2016. His simple index card has evolved to become the basis of a recently-released 245-page book, The Index Card: Why Personal Finance doesn't have to be complicated. Forbes magazine, among other publications, has given the book, co-written with personal finance writer Helaine Olen, a favourable review.

It should be emphasised that Pollack is not, nor does he claim to be, a personal finance expert but someone who carried out extensive research because of his own candidly-discussed financial challenges. That perhaps adds to the appeal of what he is saying.

In broad terms at least, his key points – which have been revised to a degree for his book – make much commonsense:

  • Try to save a proportion of your income for an emergency fund and to at least partly finance your retirement. (Although Pollack suggests actual percentages, a person's ability to save much depends, of course, on personal circumstances.)
  • Invest in a diversified portfolio of low cost index funds rather than trying to beat the market. (A Vanguard diversified fund was mentioned as an example).
  • Maximise savings in a concessionally-taxed retirement (super) fund.
  • Hold adequate insurance.
  • Buy an affordable home if and when you can.
  • Pay off your credit card in full each month.

With the release of Pollack's index card book, New York Times personal finance writer Ron Lieber has had a look at the handful of current publications featuring simple, should-do personal finance lists.

Lieber says the authors – who include Jonathan Clements, writer of the book Money Guide 2016, which carries a list of 18 personal finance steps – agree on at least four things. These are: create an emergency fund, invest most of your portfolio in index funds, buy your own affordable home if you can, and hold adequate life insurance.

In his article, How should you manage your money? And keep it short, Lieber writes that the “biggest takeaway” from these various simple financial pointers is: “Managing your money should be pretty straightforward but that doesn't make the task all that easy.”

He asked the authors of the personal finance lists why people keep on breaking these four seemingly straightforward rules given that not one is new. However, as their responses indicate, this is no simple answer.

As behavioural economists tell us, we often seem naturally drawn to acting against our own best interests – such as trying to pick winning individual stocks and trying to time the markets. That is why some of the most fundamental and sometimes seemingly obvious principles of sound personal finance management are worth repeating again and again.

Hopefully such published lists will prompt more of us to write down or revise our own list of financial goals given our personal circumstances. (One of Vanguard's Principles for Investing Success is to set clear and appropriate investment goals.)

By Robin Bowerman
Smart Investing 
Principal & Head of Retail, Vanguard Investments Australia
11 February 2016

ATO warns on poor asset records causing SMSF breaches

 

The ATO has stressed the importance of clearly distinguishing SMSF assets, with some funds losing assets to lenders following personal debts because they were not recorded correctly.

         

Speaking at the SMSF Association’s national conference in Adelaide last week, ATO assistant commissioner Kasey Macfarlane said it is important fund assets are clearly distinguished as such, and that legal ownership of those assets is correctly recorded in the fund’s name.

We have seen real-life cases where that hasn’t occurred, and legal ownership of shares, for example, hasn’t been correctly recorded in the fund’s name, and there’s been personal debts,” said Ms Macfarlane.

“A lender has taken action to recover those personal debts and because the fund assets haven’t been recorded properly, the trustee has been required to sell those fund assets to satisfy the personal debts.”

This not only has an impact on the member’s retirement savings, she explained, but also means a breach of superannuation laws, which also potentially brings with it further financial issues in terms of administrative penalties and other compliance actions.

Ms Macfarlane said while poor records of assets on its own isn’t something the ATO would typically look to take compliance action against, it is important practitioners and their clients think about the broader context and purpose of those particular rules and why they are actually there.

“They are rules that are there not just regulation for the sake of regulation, but they are actually designed to protect the fund’s assets, and effectively protect member’s retirement savings,” she said.

She also cautioned that there are different state and territory laws around recording titles or assets.

“There are also different laws around lenders protecting their security interests and then enforcing those security interests,” she said.

“You need to make sure that you’re comfortable within the context of those broader laws that the way that the asset is actually recorded is going to be sufficient to protect the fund’s assets, because the last thing we want to see is assets being lost out of the fund [because] of something that could have been taken care of relatively easily.”

Miranda Brownlee
Thursday, 25 February 2016
accountantsdaily.com.au

When is an unallocated contribution account a reserve?

 

The ATO interpretative decisions and tax determinations on this issue refer to contributions being allocated to an “unallocated contribution account”.

           

But what are these accounts and do they represent reserves? 

Over the past several years the ATO has released multiple interpretative decisions, tax determinations and public statements that confirm the use of contribution reserving strategies in SMSFs. However, when using this strategy, a question arises as to the status of the contributed amount between the time of contribution and allocation: Is it a reserve or some other type of unallocated account?

This is important as where the amount is considered a reserve, a trustee will need to ensure the governing rules of the fund do not prohibit the trustee from maintaining reserves. In addition, the trustee will have an obligation to formulate, regularly review and implement a strategy for the reserve in accordance with the superannuation covenants in section 52B of the Superannuation Industry Supervision Act 1993 (SIS Act).

Strategy background

Contribution reserving strategies involve a trustee allocating contributions received for a member to a reserve or other unallocated contribution account prior to allocating them to the member’s account within:

  • 28 days after the end of the month in which the contribution was made, or
  • within a longer period as is reasonable in the circumstances.

In this situation, the ATO has confirmed that where a contribution is made in June of one financial year (Year 1) but not allocated to the member until the next financial year (Year 2), the contribution counts towards the member’s concessional cap in the year it is allocated (Year 2). In addition, the ATO also confirmed that where the contribution is a personal tax deductible contribution, the contribution is deductible to the member in Year 1.

In this situation, a question arises as to the status of the contributed amount pending allocation. The ATO interpretative decisions and tax determinations on this issue refer to contributions being allocated to an ‘unallocated contribution account’. But what are these accounts and do they represent reserves?

What are reserves?

Unfortunately, the meaning of reserves is not defined in the SIS Act. However, the ATO defined the meaning of a reserve in ATO Interpretative Decision 2015–213 as: ‘An amount set aside from the amounts allocated to particular members to be used for a certain purpose or on the happening of a certain event’.

In addition, the APRA published Prudential Practice Guide SPG 222 – Management of Reserves, which defines reserves as: ‘Monies forming part of the net assets of a registrable superannuation entity (RSE) that have been set aside for a clearly stated purpose’.

Both these definitions imply that reserves are amounts that have been set aside for a future purpose or as a contingency for future events rather than as a means of accounting for past events.

This is supported by SPG 222, which confirms that not all unallocated monies constitute reserves and that unallocated monies that are not reserves include:

  • accrued expenses
  • provisions for tax and administration liabilities
  • accounting constructs, such as suspense accounts, used to record contributions pending their allocation to specific member accounts.

Finally, the wording from the Explanatory Statement (ES)4 to the SIS regulation that introduced the requirement for contributions to be allocated within a specified period also supports the notion that accounting constructs, such as unallocated contribution accounts, are not reserves for superannuation purposes. For example, the ES suggests that the amendments were intended to prevent members avoiding the superannuation surcharge by allocating contributions to reserves or through the use of other types of arrangements that don’t involve reserves, such as by deferring the allocation of contributions.
Therefore, it appears that unallocated contribution accounts that are used to account for contributions pending their deferred allocation may not be reserves for superannuation purposes. However, in the absence of any specific clarification from the ATO or the courts in regard to this issue, trustees may also need to be mindful of their fund’s own governing rules.

For example, many SMSF trust deeds often contain specific provisions that give trustees the power to establish and maintain ‘contributions reserves’ to ensure members can implement a contribution reserving strategy. In this case, if the fund’s own governing rules clarify the issue by defining these amounts as ‘reserves’, it would be prudent to treat these amounts as reserves for superannuation purposes.

Why is it important?

Under the SIS covenants where a fund has reserves the trustee is required to formulate, review regularly and give effect to a strategy for the prudential management of the reserves that is consistent with the fund’s investment strategy and that takes into account the fund’s capacity to discharge its liabilities (actual and contingent) when they are due.

While the ATO as regulator of SMSFs has not provided any clarification on what it expects to be included in a reserve strategy, APRA SPG 222 provides some useful guidance on what a reserve strategy should cover, including:

  • the purposes of the reserve
  • the appropriate size for the reserve given its purpose
  • how the reserve is to be funded or built up
  • when amounts can be allocated to and from the reserve and
  • how the reserve should be would up when it’s no longer required.

Therefore, where a fund’s governing rules allow for the use of contribution reserves, the trustees may wish to consider formulating a reserve strategy to ensure compliance with their statutory obligations.
In this case, the reserve strategy could specify that given the short-term nature of the reserve it will be invested in bank deposits in accordance with the cash allocation as specified in the fund’s investment strategy.

Conclusion

While an unallocated contribution account may not constitute a reserve for superannuation purposes, trustees need to take care to consider the wording of the fund’s trust deed. Where an SMSF’s deed defines these amounts as reserves; the trustees should consider formulating a reserve strategy to ensure compliance with their statutory obligations.

 

Columnist: Craig Day 
Wednesday 10 February 2016
smsfadviseronline.com.au

Market Update – 31st January 2016

A snapshot of the key points for January 2016

         

  • There was no RBA Monetary Policy meeting in January and the cash rate was kept at 2.00% following the February meeting. 
  • In fixed income, the 3 Month Bank Bill Swap Rate and the 10 Year Australian Bond Rate fell by -0.03% and -0.26%, respectively, in January.
  • Corporate debt spreads, as measured by the iTraxx Australian Index, rose to 139.54 in January from the previous reading of 126.23.
  • Shares fell both domestically and overseas, with the Hong Kong Hang Seng Index declining by -10.18% to be the worst performer.
  • In Australia, the All Ordinaries Index and the S&P/ASX 200 Index fell by -5.39% and -5.48%, respectively. Listed property continued to outperform the broader domestic share market, gaining 0.93% for the month.
  • Global commodity prices recovered slightly in January, gaining 2.33%, as measured by the US$ CRB Spot Commodity Index. Gold prices had the largest gain, 5.16% in US Dollar terms. Notwithstanding this, over the past year gold has declined by -12.26%.
  • Oil and Iron Ore prices continued to suffer, falling by -9.23% and -2.28% over the month, taking the past year loss to -30.31% and -34.15%, respectively. 
  • The Australian Dollar depreciated against most currencies in January, falling by -2.82% versus the US Dollar, -2.78% against the Euro and -3.15% versus the Japanese Yen. The Dollar rose slightly comparing to the British Pound, by 0.26% for the month.
  • The Australian Trade Weighted Index (TWI) fell by -1.91% over the month, ending January at 61.50.
  • The share market volatility rose both domestically (+4.37%) and in the US (+1.99%).

 

Please click on the following link to gain access to this resource.

Click here for a Market Report – 31st January 2016

 Source:       Zenith Investment Partner

 

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