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Self Managed Super Fund (SMSF) Article
The new Allocated Pension Pension Valuation Factors

By Tony Negline.

This article may be out of date.

16th November 2005

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Pension Valuation Factors determine the minimum and maximum income that can be paid from Allocated Pensions during a year.

These factors are determined by the government.  For about twelve years the PVFs have remain unchanged which is too long especially as we live in an age when retiree mortality (that is, in crude terms, the rate a group of people die) has been declining dramatically, and is expected to continue to decline.

A couple of months ago the government announced plans to release a new set of allocated pension factors which go some way to dealing with retirees living longer.

But the government also said that these new PVFs will only apply to allocated pensions that commence after December 2005. Allocated pensions which commence before January 2006 will continue to use the current set of PVFs.

Recently the Federal Treasury issued a draft set of the new PVFs for industry and those interested to comment upon.  So what are these new PVFs like and what impact will they have on pension payments?

It is perhaps best to look at an example.  Assume that an allocated pension has a purchase price of $100,000 and also assume that the total underlying investment return will be 10% throughout the whole investment period.  Assume that the minimum income is always taken.

For the sake of our example, we will ignore all costs in running the pension and the fund that pays it.  Also we will ignore pensioner income tax issues including Reasonable Benefit Limit  assessments.  We will also not look at any Centrelink benefit issues.

We will assume that the pensioner is 65 at commencement.  Figure One shows the pension amounts paid.

There are two issues that are immediately apparent.  Firstly, the new PVFs delay income.  For the first seventeen years of the product the investor will receive less income than what would have been received under the existing PVFs.  The net result is the second impact - the level of assets invested in allocated pensions will last for a longer period of time.

For active and healthy retirees, this is a good outcome because although they might receive less income during the early years of their retirement, there is less likelihood of running out of money before they die.

Under the pre-January 2006 PVFs just under $404,000 in income is paid over 35 years.  The new PVFs just over 448,000 in income paid – an 11% improvement.  If we assume a constant inflation rate of 3% and bring all income paid back to today's dollars then the new PVFs pay 6% more income than the old PVFs.

For the first sixteen years, the new PVFs pay a total of $8,840 less income than the old PVFs.  Another way to look at it is that over the first 16 years the new PVFs pay 94% of the income paid by the old PVFs.  From year 17 to year 35 the newPVFs pay over $53,000 more income than the old PVFs.  This is about 22% more income will be paid under the new PVFs during this period

Whilst the amount of income paid from an allocated pension is very important it is only one aspect of creating a retirement income stream that will satisfy long-term needs.

Anyone who already has an allocated pension must consider a wide do a much deeper analysis.  Should they reduce income now to make their net egg last a few more years?  How much would the transfer cost in total including tax?  This analysis is complex and often expert assistance should be sought to make sure nothing has been forgotten or misunderstood.

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