Superannuation in a challenging market

There is really nothing good to say about investment markets right now – nor, of course, the existential challenge that COVID-19 poses to society. 

But apart from frightening falls in the value of retirement savings, what do the recent stock market gyrations mean for those with superannuation and in particular superannuation pensions?

New rules allow you to draw less money

One question we are commonly asked by clients with pensions in their SMSF is about the pension payments their fund has to make before 30 June 2020. In most cases these were set back on 1 July 2019 based on the value of the pension account at that time. Chances are that was much higher than it is today. 

Normally, pension payments are only worked out once a year even if the markets change dramatically in the meantime. 

That means someone who is 70 and had $1m in their pension on 1 July 2019 normally has to take at least $50,000 from their superannuation pension before the end of this financial year even if their pension account falls to $800,000 during the year. 

However, as part of the latest stimulus package (22 March 2020), the Government announced that these minimum requirements would be halved for 2019/20.

This is great news for those who were worried about having to sell assets to make the normal level of payments in 2019/20. Pension payments must be made in cash - they can’t be made by giving some of the fund’s assets to the pensioner. At the time of writing the change had not yet been formally legislated but it is expected to pass into law before 30 June 2020.

Of course, pensioners who are already drawing more than the minimum can scale back their regular payments at any time.

What about next year?

Next financial year, the compulsory minimum pension payments will be based on the value in the pension account at 1 July 2020. That means that any falls in value will automatically be reflected in the amount that has to be paid next year (2020/21). In addition, the Government has announced that payment rates will be halved again for 2020/21. That means those who are looking to take as little as they possibly can from their pensions will benefit from both having their pension calculated on a smaller base and also having a lower compulsory draw down rate than normal. Of course it is worth bearing in mind that it is also possible to stop a pension – in an SMSF this requires some relatively straightforward paperwork. Those who expect to have little or no cash available to make pension payments in 2020/21 might be well advised to consider this closer to 30 June 2020.

Finally, don’t forget that none of these changes stop people drawing more from their pension if they need to. It just means that they don’t have to if they don’t want to.

Will your SMSF be able to make the required payments?

Don’t forget that the size of the pension account at 1 July 2019 will dictate how much must be paid during 2019/20 but it’s the fund’s cash flow that determines how easy or hard it is to do so. This is exactly why pension funds often stockpile two to three years’ worth of pension payments in cash – just to make sure that they have enough on hand to make pension payments without selling assets at a time when their value is really low. Even those who don’t have large cash reserves should remember a few points.

Firstly, the fact that a company’s share price goes down doesn’t automatically mean any change to its dividends. During the Global Financial Crisis in 2008/09, a lot of companies were still able to pay dividends and these provided the cash flow to meet pension payments even when markets were in freefall. The real challenge of 2020 is that unfortunately the causes of the market falls are also likely to have a negative impact on business profitability and therefore dividends.

Remember also that SMSFs can usually use the cash from all of the fund’s investments to meet pension payments. This means that if (say) only one member’s superannuation has been converted to a pension and the other member’s superannuation is still in the build up phase (often referred to as “accumulating” or “in accumulation phase”), the fund may still generate plenty of cash and be well able to make the required pension payments.

SMSFs can even use new contributions from the pensioner (assuming they are still eligible to contribute) or other members to finance pension payments.

(In both cases, the accounting records behind the scenes will make sure this is all fair. In other words, if cash from my contributions is used to pay my husband’s pension, the accountant will make sure the fund’s records show that I now own a bit more of all the other assets of the fund).

Are there any silver linings?

Not really. But something to bear in mind is how falls in superannuation values interact with the rules that came in back in 2017 capping the amount anyone could put into what’s called a “retirement phase pension”.  (For most people, this is a superannuation pension they have once they have retired or turned 65.)

These rules put an upper limit (initially $1.6m) on the amount that could be used to start a pension. They don’t limit the amount a pension account can grow to once it starts. Hence in many ways, the best time to start a pension is when markets are at their worst.  For example, consider someone whose superannuation was worth $1.8m at 1 July 2019. Today it’s worth $1.5m. If they start a pension today with their entire balance, the starting value is comfortably within the $1.6m limit. If markets recover back to $1.8m over time, they won’t have to take extra amounts out of their pension to get back down below $1.6m. All the government cares about is how much it was worth at the start.

In contrast, had that person started a pension back on 1 July 2019, only $1.6m of their super could have gone into their pension. The other $200k would have had to remain in accumulation phase. The market falls would again see their balances today at $1.5m (say $1.33m in the pension account, $167k in the accumulation account). Unfortunately they are stuck with that set up. They can’t start an extra pension with their accumulation account or add it to their existing pension even though their pension account is now well below $1.6m.

So the silver lining only benefits a few people – those who were about to start pensions but haven’t done so yet. All in all, market falls are a frightening time for all of us but particularly those who are watching their impact on more personal capital than ever before in their lifetime – recent retirees. 

But don’t forget that at times like this, cash flow or the amount available in cash reserves is almost more important in protecting the retirement savings in your SMSF. 

These will allow your fund to keep making the payments it needs to without selling assets.