Topic Five: Investments Outside Super

Some people prefer to hold some or all of their money outside super either because they like to have their money spread around, or they weren’t able to get all their money in super, or they want an early retirement and to be able to access funds before 60, and/or they have a legacy investment or income products that have different options available to them. In this session I talk at a very high level about alternative financial products that are available and their pros and cons.

Action plan:

1) Seek advice from an independent financial adviser to assist with understanding and strategy for the right types of financial products to suit your circumstances and retirement income needs.

Transcript

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SPEAKER_00 0:00

Hello and welcome everyone to our fifth topic, and today we are going to talk about investments that you might make or hold outside of superannuation. Now, in our last topic, we talked about those retirement income accounts that you can hold within superannuation, and I said at the time that I really feel that superannuation is a cornerstone of retirement income funding, and I still think that's very much the case. However, I also understand that there are times when people either want to or need to hold money outside of super, and that might be because people like to spread their money around, or they weren't able to get all of their money into super, and perhaps that's over a staged period where you had a large asset sale and you haven't been able to fully utilize the caps that prevented you from putting all your money into super, or there are those people that want an early retirement, potentially before age 60, when there's when there is that access age to superannuation. So, where do you put your funds to have some access before then? And then for others, there are just legacy products or investments that have been held for some time that give them concerns about selling either due to capital gains or because they can't sell them, and we'll talk about those as well. I am going to talk at a very high level about these products because I can't determine which one is the right one for you without knowing your circumstances, and that's where it's really important to get financial advice, particularly if it's a product that you may get locked into, and we're going to talk about some of those later, and that it might be either at a significant penalty or very difficult to break out of. So because it is so individual when it comes to these products, please have a listen so that you understand some of the alternatives. But working out which one is the right one for you really does take some specialist financial advice. The first financial product that I'm going to talk about, and arguably the most popular for retirees outside of Super, is simply to hold excess funds in cash and/or a fixed interest type investment, such as a term deposit. Now, the advantages of these products is firstly that feeling that people understand them and know where they are. So there's nothing complicated about cash and a term deposit. Generally, there's easy and quick as quick access, particularly on cash accounts. Term deposits a little bit different, but you've you've got a known date that you can access funds, and there's security. So a lot of the savings accounts that are helped with major banks in particular may have a government-backed guarantee with a limit, but that's a great comfort to retirees. And obviously, there are low, even sometimes zero fees associated with cash and fixed interest products. So a great consideration with cash and fixed interest is that it will keep your capital stable and it focuses on paying interest from that money you've got invested. And so, what I mean by that is often if you put say $100,000 in, you will then receive $100,000 when that product matures, like a term deposit. The problem with it is that there's no capital growth in many of these products, and $100,000 today is not going to buy you as much in a year or two's time due to inflation. And even at the lower end of inflation, the Reserve Bank of Australia's target band of two to three percent a year, it means that if you are not reinvesting your income and you're drawing it down, even if you are reinvesting your income but it's taxable, it's going to be hard work to keep ahead of that two to three percent inflation. And when we get inflation as we have recently in the four to five percent band, it's even harder. So effectively, the true value of your money will decline in cash and fixed interest over time. And look, some people are comfortable with that because they want that security, like I said, of something they can understand and they know has got a government backing, but having too much in cash and fixed interest is going to affect your retirement funding. And then the last thing on fixed interest, I would absolutely suggest that you understand who the backer who's issuing that fixed interest product. And for those of you that remember back in the 80s and 90s when there were mortgage-backed securities, they were being marketed very much to mums and dads and retirees as being like a term deposit. History showed us they weren't. The assets that were behind them failed and those people lost money in them. I would say that at the time they were advertising interest returns of about 8% on a fixed interest product when the bank rate was more like 5%. If there is a difference in the interest rate that you're being offered, you need to understand why. It's likely because there's higher risk, which may not mean that they are then the low-risk products that you thought you were getting into. Now, the next uh investment type I'm going to talk about is shares. It's really hard to just say shares as one product type because shares are so varied in nature and they can really range from very long-term sort of blue chip shares right through to quite short-term speculative ones. So just saying shares as an investment is really hard to do, and that is one of the issues you need to understand the company shares that you hold and what the likelihood of them being riskier than others is, and that's where getting advice and particularly some research on those companies is very helpful because holding shares can be at the higher risk end of the scale, but because they're so very transparent in terms of you can see that share price every day, unlike a lot of other assets. Um, this is great for people who want to understand what's the value of my money doing, but it can also bring a fair bit of anxiety watching share prices move up and down, and also you can't explain sometimes why those share prices are moving up and down, and it is and it is that transparency I think that um that really inflates that and makes it feel like a risky access and risky asset to hold. Now, many people hold shares directly as a kind of a legacy situation and can enjoy the tax-effective income they get from them if they pay dividends that are fully franked. A lot of people also worry about the capital gains that would result from selling their shares if they have held them for a long time, and particularly after the recent budget, maybe more so. But there is a drawback to holding shares, and that's what I want you to think about on when you're holding these type of investments directly in retirement. So, apart from that volatility of share prices moving up and down and creating potentially some anxiety, there's actually quite a bit of paperwork in administration that goes into holding direct shares these days. You will need to do that regular monitoring of the share price, there's the record keeping, depending on how often they pay dividends and reporting that for tax, there's responding to various corporate actions, and a real issue for retirees with all of these investment types is that unless you have that active interest and you see investing as a hobby and don't mind doing the paperwork, there are many others who just want a simple life and less administration. And many shares aren't a set and forget investment if they're held directly. So people find that uh we find that people start using an administration service for shares, which brings into question the next financial product group and whether or not this is an alternative, and that is managed investments. So people who want that ease of having no active involvement in the management of a share portfolio, there are alternatives in managed investments, such as the exchange traded funds that we talked about in topic one in investments, and managed funds. Now, simply the difference between these two can come down to a lot of the exchange traded funds are listed on the Australian Stock Exchange, so they're easier to trade, they're transparent in value, they're very easy to transact with. A lot of the managed funds will be unlisted, so you're dealing directly with a manager or through a financial advisor to access them. Now that's not always the case. Another key difference can be passive and active management. Now, both of these can have that style. We talked about this in topic one, so I won't go over again what the difference is in the approach, but definitely whether they are active or passive is going to have an impact on fees and potentially performance. Now, many ETFs or managed funds have a similar tax advantage to owning shares directly if they their objective is to receive fully franked dividends from those shareholdings that they own, and they'll be passed through to you as the investor. And as I said, they're fairly easy to access funds from, usually in a very short time frame, and some, particularly the unlisted ones, make it easy to add monies to them via something like a saving plan. So if you know that you've got more money coming in and want to be able to contribute. And understanding their performance, you can use, as we talked about in understanding how your superannuation is performing in a previous topic, and there's a super ratings guide you can use. There are independent rating agencies for things like ETFs and managed funds in Morningstar and CanStar. So being able to access this performance and understanding what it is, net of fees, and over a reasonable time frame will help you with that. Most financial advisors have their own research tools as well to guide you through this process. So that's got to be your biggest issue. It's it's choice and knowing which ones to invest in. Now, another class of financial product that is incredibly popular in Australia is owning an investment property. And Australians just love investing in property, and for many, completely understand it's because you can physically see and understand this asset. You can you can drive by and say or walk into that's my house, that's that that's a building I own a part of. And there's a number of ways to invest in property. Um, by far the most popular is making a direct a direct investment in a residential, commercial, or industrial property, but you can also make an investment in a portfolio of properties by combining with other investors. So let's talk about owning a property directly first. It has a lot of appeal for people that want to be hands-on with decision making, they want to control ongoing maintenance and improvements, and obviously, negative gearing has been a really popular reason for people to invest in property directly, and that's why there's been such a reaction to the changes in the federal budget. I want to talk about when you're retired, your primary need is for ongoing and regular income. So there are two issues potentially with holding direct property. The first is that if you own a single property or even a number of properties, they do tie up a large part of your capital, and you may be really dependent on their ability to produce rental income for you to be able to draw retirement income from. And any interruption to that rent can be a problem if you don't have other assets to support the cash flow that you need to draw down retirement income. And those problems can be from things that you just have no control of, natural disasters, meaning that there's damage to your property, um, tenants moving out, damaging your property, not moving out, but not paying rent. Um, you know, there's a whole list of things that can go wrong with um with properties in terms of affecting your ability to draw rent from them. And if your income exceeds your your income needs, sorry, exceed the rent that you're receiving, the difficulty with property is that you just can't sell a part of it. You can't sell the toilet, unlike a parcel of shares or cashing in some um, you know, some money from the bank, you know, or any other sort of diversified investment, it's really hard to sell a part of a property. So you get to the point where you have to sell the whole property, and the timing of that may not be great, and the tax management of it may not be great. So it's something to really think about as you head into retirement if you're intending on holding properties directly, that side of it. The other thing I think you need to revisit pre-retirement is your costs and returns after tax. So, negative gearing is hugely popular as a wealth creation strategy, particularly for people who are paying income tax at the highest marginal tax rate as a way to reduce that. But what happens when you go into retirement is you might find that your marginal tax rate drops significantly. So isn't it's having a property that's negatively geared, and that is where you have debt on it and debt repayments that are higher than the rent you receive or costs as well as debt repayments. So if come retirement, the properties you own aren't positively geared, that is that you're receiving more rent than costs, the tax effectiveness of a negative gearing strategy really might need a rethink. And that's where it's worth you know talking to a financial advisor or even your accountant to understand what the after-tax return is now going to be like from your properties. Um, and I I sort of dwell on this for a moment because a lot of retirees I talk to who own properties in retirement, and that is the greatest Australian dream, and I think you know all of us have aspired to do that for past generations, so it's not a criticism, but it can put you in a situation where you become asset rich but income poor. And agonizing over selling a property is just really real in the lead up to retirement, so it's great to start thinking about it sooner rather than later. Now, owning a part share in a portfolio of properties is another option. If you love property and you want that diversification of being in property, it's definitely a less hands-on way to access this type of investment. Some of the vehicles that do this are listed on the stock exchange, um, they're usually called listed property trusts, and they're very transparent with the value which people like, but it also makes it easier to buy and sell units in them. Others are unlisted property syndicates or trusts which might require more investigation. Now, these portfolios can hold commercial, industrial, residential, tourism, or even specific property types such as retirement villages. So you need to investigate what is the main objective from the portfolio. Is it to produce regular and reliable income? Is it to generate capital growth or is it a mix of both? And because this will influence the consistency and type of returns you receive. And these vehicles could be taxed internally or they may distribute income and returns untaxed. So you need to also understand this when you're comparing returns that are tax-free or have already been taxed, it's not apples for apples, and using one of those ratings agencies, you know, accessed through a financial advisor can help with understanding what the real returns are versus ones that are before tax. The other thing I would say about the unlisted ones is they really do require a lot more investigation into the manager or the administrator's credentials and track record. Um, what has happened to some retirees in the past is that where a property trust fails or or a property syndicate fails or freezes their assets for different reasons, usually you know, delays or concerns with construction, lending, or other you know, economic situations, it can be hard to have an exit mechanism for these funds. So you really need to understand that before you go into them. Okay, let's move into some more specific retirement type products that people may either want to have their money in or already do. So, annuities are one of those that are very common in terms of marketing to retirees, and an annuity is basically investing a lump sum in exchange for an income stream. Now, that income stream could be paid for life or a guaranteed period of say 10 years. It could be paid to the holder as well as the holder's spouse if they nominated one and use that option after death. The amount of income you receive is really dependent on the size of the lump sum invested, and it's likely to be calculated with both longevity, so um you know how long you've got to go until the average life expectancy, and interest rate or income return expectations. So, given these two factors, it's not uncommon to see annuities are cheaper when you have a shorter investment time frame, so the older you are, and um, and also when interest rates are higher, so the returns that the manager expects to get from receiving your lump sum until the time that they have to pay it out is higher as well. Annuities can be attractive to people who want certainty that they will receive a minimum level of income required to meet living costs. So, for example, if they know they're going to be eligible to the age pension and they just want to have enough to top it up to meet that comfortable living standard, an annuity might be of interest then to have that certainty that that minimum income will be met. The annuities might also be offered with an option to index with inflation to keep ahead of that inflation we talked about with cash and fixed interest in terms of its impact on cost of living and retirement. Now, lifetime pensions are a newer class of product but similar to annuities. They are designed to pay income for life to the holder and may also include that option to extend to the life of a spouse. But they may not pay a guaranteed income account, income amount, and annuities may not either. You really need to understand what you'll be receiving in return for your lump sum. But a lifetime pension is more likely to have a variable return based on the portfolio's income returns in each payment period, so whether that's annually, quarterly, whatever it may be, at net of any investment and administration fees. So what that might mean is that your income from a lifetime pension could go up, but it also could come down. So if that is the way that the product is structured and you're looking for that certainty, you need to understand the differences. Now, choosing to invest in these products is a really individual decision because you'll have to have a view on life expectancy, whether you're happy to trade off your lump sum for certainty of income, but also for some people it's just that ease of administration. Again, it's a simple product that their financers are looked after, they know they've got um income locked in, including for spouses who may or may not have been involved in financial decision making before. Now, both um annuities and um uh life um lifetime pensions may get and and usually do get an advantageous treatment by Centrelink when it comes to calculating what could be both asset and income values in terms of determining your eligibility for the age pension and this is one of the key reasons people will look at them and that is because you know the government's really trying to encourage you to self-fund part of your retirement so locking into a product like an annuity or a lifetime pension is is good for them because they know you're funding that portion of your retirement. One of the major downsides of this type of product is the ability to exit. So there may be an ability if you're in the early stages of the investment to draw the capital that hasn't been used yet but it gets to a point where you're locked in and none of that capital can be returned and that's where you start having to think about estate planning and if you know do you want your lump sums to be available to beneficiaries if something was to happen to you. So the last class of financial product I want to touch on briefly is life insurance investment bonds. Once again some of these are legacy products so some of the features are different to what I talk about if you were to purchase them now. But basically life insurance companies issue these investment bonds in a structure that can be both tax effective advantageous for centering calculations and provide estate planning benefits. The bonds themselves can be invested in a number of different asset classes similar to what we talked about in the investment topic so there'll be a menu where you can choose what your risk tolerance is and what type of investment you'd like to be exposed to. The bonds are purchased with a lump sum. Some of them may allow additional contributions over the life of the bond that might have an annual limit something to think about but they'll be similar in nature in terms of a savings plan for a managed investment or being able to do regular contributions into super. Now the life of the bond is generally set at 10 years it can differ and the bonds are taxed internally at 30% that rate however can be reduced if the investment option you choose is shares and those shares pay those fully frank dividends so that could bring down the tax rate from 30% to an effectively lower one. There is generally a penalty if you try to withdraw funds during the life of the bond and that penalty sort of goes down over the life of the 10 years. But after the 10 year period has you you've invested for 10 years in these bonds any capital gain you may have made becomes exempt from capital gains tax and this might make it more attractive after the recent federal budget changes. So if you have a time frame of 10 years and you know you're concerned about taxation that's what these products are designed to address. They can also be used for estate planning purposes as you need to nominate a beneficiary for the bond and we'll talk about this later in the estate planning topic how that's different from other investments and what happens on passing but the beneficiary would receive the value of the bond capital gains exempt regardless how about how long it has been held so if you weren't alive for the full 10 years the beneficiary would get capital gains tax free anyway. So like annuities they can be useful for centrelink eligibility as they have a reduced asset value. It can also in some cases draw income down from them so you really need to do your homework on these investment bonds with the help of a financial advisor to understand if they would be good for your circumstances. There are so many other assets out there that I could cover and it just is so broad. Each product has its own advantages and disadvantages some of them are quite complex I hope I've given you a high level overview so that you can understand what kind of alternatives there are and what are the some of the things that you need to think about as you're heading into retirement if indeed you already hold these products. So your action plan from this topic really is as simple as take this one to your financial advisor to assist with the understanding and strategy of each product and whether it's the right one for you. And I look forward to seeing you in our next topic which is one I know you've all been waiting for which is centre link payments including the age pension.