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Self Managed Super Fund (SMSF) Article
Providing for life's essentials - investment earnings

By Tony Negline.

This article may be out of date.

2nd March 2010

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Recent research by the US arm of Russell Investments suggests that 90 cents of every dollar paid out of a retirement pension comes from investment earnings.  Amazingly this research estimates that 60 cents of the investment proceeds is earned after the pension starts.

This means that only 10 cents of every pension payment comes from contributions made into a superannuation fund.

This research confirms the adage that a retiree's money must continue working hard when the retiree has stopped work and is trying to relax.

What is the best way to generate the 90 cents in the dollar?  ATO data shows that 20 percent of all SMSFs solve this problem by investing in one asset class and sixty percent of SMSFs have two asset classes – Australian equities and bank deposits.

This ATO research also shows that overall there are only small differences between the asset allocation of Self Managed Super Funds with pre-retiree members and SMSFs paying pensions.

Professional pension providers probably take a dim view of the relatively simple and uncomplicated approaches used by Australia's small super fund trustees.  They might also argue that SMSFs do not have an adequate spread of investments.

The Canadian arm of Russell Investments has developed the Bucket List which categorises the types of income retirees need into three different sub-headings – Essential, Lifestyle and Estate (or ELE for short).

Russell Investments argues that different investment strategies and asset allocation are needed for the different types of income.

Essential expenditure involves food, clothing and living expenses.  Russell Investments thinks that this type of expenditure should be met using conservative investments that provide tax beneficial income and possibly even some guarantee.

Lifestyle expenditure is money set aside for entertainment, travel, club memberships and so on.  This type of expenditure requires growth investments that also provide an income option.

Estate expenditures are assets set aside for inheritance or charities.  Russell Investments says that the investment strategy selected here will depend upon and investor's risk tolerance and capital growth requirement.

It is doubtful that many Self Managed Super Fund investors have bothered to look at their fund with this level of complexity.

So what is the right asset allocation for Self Managed Super Funds?

No one can answer with absolute certainty.  For many years, Self Managed Super Funds were criticised for having too much money in bank deposits.  This criticism has always been misplaced and failed to understand when this data is collected.

SMSFs only provide data to regulators once a year.  It is provided as at 30 June which is typically not long after a fund's members have made their annual super contributions.  The data is sent to the Tax Office when the new contributions are sitting in a bank account waiting for the trustee to decide how to invest the proceeds.

In any event from November 2007 until March 2009, having a great deal of money in equities generated large losses.  Those small fund investors who stayed out of the share market and invested in bank deposits during this period might still have reason to feel quite satisfied with themselves.

In reality is there a problem with investing in equities to generate pension income?  The answer is yes if the underlying assets are not generating any income.  To pay income you much earn income.

The above graph shows what returns look like in actual dollar terms after $100,000 was invested into the ASX 200 in March 1983.  The results are for each December year end.

The graph also shows the percentage annual return at three different tax rates – 0%, 15% and 46.5% for the same investment and over the same period.  These after tax returns assume that the dividends received were 70% franked over the whole investment period (please ignore the fact that dividend franking was not introduced until 1986).

As can be seen less dividend income was paid during 2009 in dollar terms than the four previous years.

However in percentage terms the 2009 returns are the second highest return since 1990.  The best return in this period was 2008.  Who could have predicted that the best income paying period, in percentage terms, for Australian equities would occur when the market was falling so heavily?

The ASX 200 has paid an average of 5.3 percent income for a pension paying super fund over 26 years.  Super funds do not have to pay pension income of more than 5% of assets until a retiree is aged over 75.  And remember that twhe required minimum income is reduced by 50% until 30 June 2010.

Finally a note about my article last week in which I dealt with a super fund that acquired a commercial property for $1 from its members:  in that article I raised a number of concerns about this transaction.  However I did not mention that when a super fund acquires any asset for less than market value, the Tax Office will assume that the difference between the actual purchase price and the market value will be deemed to be a Concessional Contribution and will be taxed accordingly.

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