As published in The Australian Saturday 7 May 2016
Retirees and income investors are in shock after the surprise triple whammy of tighter super rules, an official interest rate cut and drop in bank dividends as ANZ bit the bullet and cut its payout
The measures will leave many investors confused and wondering how best to rearrange their affairs.
No matter how much money you have — inside or outside the superannuation system — lower interest rates mean lower returns and lower overall balances for everyone with a savings account.
Retirees are worse off as they’ve stopped working and have a set amount to live on for an unknown period. The cash rate cut, and predictions of further cuts, will make them even more conservative consumers.
The general consensus now seems to be a further cash rate cut of 25 basis points in September after inflation figures are released in August.
So what do you do? If you also think interest rates are moving lower, it’s best to lock in a fixed rate of return that will provide certain income for as long as you need it or to cover the time that you think interest rates will stay low.
This is where long dated indicators and forecasts would be really helpful to retirees but we generally don’t see any long term predictions. A benchmark that is commonly used is the 10 year government bond rate and as of May 5 this was 2.376 per cent.
For some years now I’ve said interest rates would be lower for longer; the issue now is that the scenario is playing out as the government creates a two tiered pension system with a maximum amount allowed to fund tax free income of $1.6m and any excess being taxed at 15 per cent.
The combination of these issues means income seeking investors must make big decisions as rates move lower and taxes move higher.
In a global context our interest rates are high and a number of developed countries have near zero or negative interest rates. Central banks are desperately trying to stimulate economies and get banks to lend but it hasn’t worked.
I wonder what it will take to stop the global economy going down the same path as Japan? That is very low rates for a very long time.
Are we collectively missing the harsher, longer term picture?
While I desperately hope the scenario of very low rates for a very long time doesn’t eventuate, my training is in identifying and assessing risk. At this stage a significant risk, especially for retirees, is that interest rates go much lower for longer than expected.
Under such a scenario, deposits and bonds are choice assets. Long dated fixed returns will provide certainty and protection. Deposits are generally limited to five years while bonds can have much longer maturity dates of 20 years or more.
Critically bonds are tradeable, so that if your view of the market changed you could sell the bond and reinvest elsewhere.
Our insight into the deposit market suggests the highest term deposit rates over the next few weeks are likely to be in three to six months, but longer dated investments of a year might provide better value if you expect another cash rate cut this year.
Late last week, 3.1 per cent per annum was still available on a five year term deposit but we expect rates to be lowered this week. This rate is low and not for that long. Bonds can offer higher returns for higher risk and longer terms.
The ultimate defence is a government bond. Queensland Treasury Corporation has a bond maturing after 17 years in 2033. It pays 3.15 per cent per annum until maturity. Not that attractive in this market but imagine the excitement in Japan!
Two investment grade long dated corporate bonds from Rabobank and freight logistics company Asciano offer attractive risk and reward propositions. The Rabobank bond matures in 2024 and has a yield to maturity of 3.64 per cent per annum. The Asciano bond matures in May 2025 and higher risk but has a yield to maturity of 4.71 per cent per annum.
If you are looking to lock in higher returns for four or five years, there are some well known mid sized companies with high yield, fixed rate returns approaching 8 per cent per annum. The proposed changes to super this week were disturbing.
While some measures such as extending the age for contributions were applauded, others, such as the cut in concessional contributions to $25,000 and the lifetime cap for non concessional contributions (retrospective from 1 July 2007), confounded industry participants.
Lawyer Shane Ellis, a SMSF and estate planning specialist, commented: “We will have to revisit just about all of our SMSF and estate planning clients to ensure that their funds have a proper mix of complying pension and accumulations balances, as well as having the best result from their out of superannuation savings in structures such as investment family trusts.”
With two months of the financial year remaining it’s important to maximise this year’s concessional contributions of $30,000 for those under 50 and $35,000 for those over. Existing allowances will continue next year, with the new cap due to start the following year, assuming the changes are legislated.
It has never been more important to get good quality advice from a range of professionals. Proper planning and sound portfolio allocation strategies will help you achieve your objectives.