Case study: Self-employed single seeking a comfortable and secure retirement income for life

Transcript

Meet Justine. Justine is 45 and happily single, with no plans to partner in the future. She’s self-employed, earning $140,000 per year, but she only has a relatively small super balance of $100,000. This is money that accumulated when she was younger and working in a traditional job, and she hasn’t contributed to super for many years since she’s been self-employed. She is on track to own her own home by age 60, and she also has $60,000 invested in an exchange-traded fund that she’s planning to use towards her retirement.

Her goals are to reduce to part-time hours at 60 and retire completely at 70. She’s not keen to stop work any earlier than that because she really enjoys her business. She’d like a retirement income of $65,000 a year that she feels would be very comfortable. And she also wants to have the confidence that she’ll have sustainable retirement income for life. As a single person, she doesn’t have anyone else to fall back on, and that confidence is very important to her. The first step for Justine in retirement planning is to run a model to see what her retirement income will look like if she does nothing at all.

For that I’m going to use Mercer’s Retirement Income Simulator. So let’s get started. I’m going to skip the tutorial and tailor the calculator to Justine’s scenario. So we know she’s 45 and she has an income of $140,000 plus 100,000 in super, and she’s female. That will change the life expectancy information, which does differ by gender.

Moving on, we can say she is self-employed, and that means she’s not receiving any contributions from from her employer. She’s also currently not making any super contributions herself. Justine is planning a career change. She wants to go part-time at age 60, and the calculator can take that into account. So I’ll put in her career change at 60 and her expected salary of half what she’s earning now because she’d like to go to half-time hours. Now, she has no spouse or partner, but she would like to allow for the Age Pension in her calculations. She is repaying her home, so we can insert that as well. She has $370,000 remaining at 6.1% interest rate and is repaying $3,000 a month. She also has that exchange-traded fund of $60,000, so we can put that into the tool, too. It will include that in her retirement income and also use it to estimate her Age Pension.

Moving on again, we can set her desired retirement retirement income of $65,000 a year and her retirement age of 70. She’s not planning to make any lump sum withdrawals, and I’m going to leave it as the default investment option that this tool uses, which is a lifecycle option at Justine’s current age that will be made up of 89% growth assets and 11% defensive assets, so quite an aggressive option. It will wind down to have a smaller proportion of growth assets automatically as Justine ages. And of course, this is something that you can change if that’s not the option that your super is in.

We can move on again and see the final results of the tool. There is an option here to do a stress test, which I’m not going to do right now, but I will show you later when we’re modelling Justine’s modified scenario. Here we can look at the summary of the results. She is now 45 and has $104,000 in net income, so that’s after tax. At retirement, the tool expects she’ll retire with just under $200,000 and live on $65,000 a year, which is the goal that she inserted.

But her super is only predicted to last until age 76, so only six years beyond retirement because she has that quite modest balance and isn’t making any contributions. Based on her age and sex, there’s a 92% chance at the moment that she will outlive her super and then just be living on a combination of Age Pension and whatever income she’s receiving from her exchange-traded fund investment. That is not something that Justine is happy with, of course. So she’s looking to significantly improve her outcomes, and she can, from here, model the different things that she is prepared to do to try and improve her outcome.

The first change that Justine wants to consider is making a significant tax deductible contribution to super. She’s interested in reducing her income taxes and also wants to move her exchange traded fund investment into the super system where the future earnings will be taxed at the low super tax rate of 15% instead of her income tax rate, giving her investment a greater opportunity to grow. She’s happy to put it into the superannuation system because she’s planning to save that money for retirement in any case and doesn’t need access to it right now.

Justine’s current scenario without making any contribution is that she earns $140,000 in taxable income and pays just under $36,000 in tax on that money, leaving her with just a little more than $104,000 a year to take home. If she sells her ETF and contributes to super, her taxable income from work will remain the same, but she will also have an additional capital gain that she needs to declare of $7,500. So we’ll add that on. Of that total income now of $147,500, she plans to contribute the $60,000 proceeds from selling the ETF into super and claim a tax deduction for that.

So you can see that $60,000 contribution reduces her taxable income significantly. That contribution is more than the current concessional contribution cap, but Justine has significant unused cap space available from the previous five financial years, more than $130,000 worth because she hasn’t been contributing to super at all during that period of time. So that contribution is well within the maximum that she’s permitted for the year, thanks to her ability to carry forward those unused concessional contributions from previous years. After her super contribution, her tax is reduced to $18,788, leaving her with $121,212 to take home for the year.

If she’s already paid her income taxes by instalments during the year, as is common for self-employed people, she’ll receive a significant tax refund to account for the change in her taxable income at the end of the financial year. To compare the two situations side by side, you can see how much difference that tax deductible contribution has made. Justine has reduced her income tax by just a little more than $17,000. We do have to remember that the contribution to super will attract contribution tax, and that is at an amount of $9,000, which is 15% of her contribution. That will leave her with $51,000 remaining that’s invested in her super, but she’s still $8,150 better off for the year tax-wise once all the income tax and super contribution tax is accounted for. She can also use that additional $17,000 of take home pay that she’s received in the form of a tax refund to make another tax deductible contribution to super in the following financial year.

Justine is also prepared to consider making some regular tax deductible contributions to her super on top of the lump sums from the sale of her ETF. She knows that if she tightened her belt, she could afford $1,100 a month from her take home pay, but she doesn’t know what that would equate to as a tax deductible super contribution because of the reduction in her income tax that it would also generate.

The Money Smart Contributions Optimiser can help her to work that out. We can put in Justine’s situation with her current income from work that she’s receiving annually. She’s not receiving any employer contributions, and she can afford $1,100 on a monthly basis from her take home pay. The calculator will do the work. It estimates her current take home pay is $8,672 a month, so she can afford to contribute $1,661 a month as a before-tax contribution. And this tool is calling this salary sacrifice. But because Justine doesn’t receive a salary from an employer, her contributions will be personal contributions for which she’ll claim a tax deduction, which has the same effect on her super and her income tax.

If you scroll down further, you can see the details of how that contribution will work and that the total tax deductible contribution for the year will be just under $20,000 on an annual basis. That won’t reduce her take home pay by $20,000, though, because of the benefit of the tax deduction. So her net pay will only decrease from $104,000 to just under $91,000, which is the level that’s affordable for her. And she can go in to her instalments with the tax office to reduce what her expected taxable income will be for the year Since she knows she’ll be contributing roughly $20,000 to super and claiming a tax deduction for that, she can reduce the ongoing tax instalments that she pays to account for the difference in her taxable income.

Now, Justine can come back to her retirement projection and make her plan changes to see what impact that will have on her retirement income. In this tool, we can save the scenario to compare to her new one. So let’s do that by clicking, scenarios and creating that new one. We’ll go back to the very beginning and change the super balance to $151,000 because after that $60,000 contribution, $51,000 will remain after contribution tax to be added on to her old balance of $100,000. Next, we can add in the regular contributions that Justine is planning to make of approximately $20,000 per year. Again, this calls it salary sacrifice, but we know a personal tax deductible contribution will achieve the same thing.

She’s also still planning to make a one-off super contribution because she has that $17,000 or so left over from her tax refund that she received for making her tax deductible contribution, and she’d like to put that into her super as well. So if we add one more year on so she has time to wait for her tax refund, the contribution Contribution amount will be approximately $14,500 after the contribution tax has come out. This tool will assume that a one-off contribution is a after-tax amount, so we need to take that contribution tax out for it.

Moving on, she’s not planning any difference to her career or her spouse or partner. She does have to remove the $60,000 of investment assets, though, because she sold that exchange-traded fund, so that won’t be generating income in retirement any longer. Moving on, we can now see the comparison. Here we’re in the Summary section, and we’ve got this new tab pop up that tells us we can compare our old scenario to the new one. You can see here the summary of the changes that we made. It says that the super could now last 28 years longer and the risk of our living savings decrease by 90%.

So Justine is spectacularly happy to see that, but she’s still concerned that she could potentially outlive her super if the investment markets don’t go well. So If we look at her Income page, you can see here that the current projection is showing that her income will last beyond the age of 100, which is not particularly concerning. But if we use this stress test function, we can see how a different pattern of investment returns might affect the outcome. If we go to the next item and go past these lump sum withdrawals and the investment strategy, which we’re going to leave the same, we come to the stress test.

If we enable that, you can see how the graph has changed. So it’s changed the pattern of investment returns. And in this first scenario that it’s modelling, that’s had a really positive impact. The pattern of returns has been generous to Justine, and she’s going to have some years where she’s receiving significantly more income than she really needs. But a different pattern of returns can give a different outcome. So if we scroll down here, we can press this refresh button, and it will change that pattern for us. You see now her super is predicted to run out much earlier, at the age of 99. And we can refresh again to model a different pattern of returns. Now the super is predicted to run out at 93.

Now this is a concern for Justine because she doesn’t have any family or partner to fall back on in her retirement, and she needs to be fully self-sufficient. She doesn’t want to run the risk of running out of savings and having to live on the Age Pension alone in her old age. So the very last calculation that we can look into is the possibility that she could use some of her super to purchase a lifetime income product in her retirement that would guarantee her income for life, no matter how long she lives.

So our last stop brings us to the QSuper Retirement Calculator. QSuper is part of Australian Retirement Trust, and they’re one of the providers in the Australian market that offer retirement income products that guarantee an income for life.

Justine is going to use this calculator as if she was retiring right now because that’s the simplest way that it works. We’ll say, yes, I’m retired and I’m 70, so she’s gone forward in time. She’s female, and the super balance that she’s inserted is $970,000, which is about a midpoint of what the Mercer calculator estimated that her final super balance would be in the different stress test scenarios that she ran using that tool. So it’s just a guesstimate, but it’s better than nothing to give her an idea of what she might be looking at in retirement. She will be a homeowner and not have any other assets. So now we can click to get started and see the results.

Now, initially, it’s showing a combination of 40% of the money being invested in a lifetime pension and the other 60% in a more traditional account-based pension. In an account-based pension, you can generally make make lump sum withdrawals if you wish, and you can change the amount of income that you’d like to receive each financial year.

With a lifetime product, the provider sets the income level, and in this particular product, it varies based on the investment returns of the pool of assets that are supporting the pension. So they expect that pension income will go up each year, although it can go down if investment returns are not favourable. The calculation here is showing the outcome. So I’ve put in Justine’s income goal of $65,000 per year, which is this green line, and we can see that the tool expects she’ll be able to generate that. And even in her very late retirement, a lot of income is expected to be coming from her Age Pension and her pooled lifetime pension in combination, nearly enough alone to bring her to her income goal. That’s excellent news for Justine because she can have that confidence that she’s not going to run out of income. Even if these dark blue bars of her other super pension have run out because of unfavourable investment returns or lump sum withdrawals, she knows she can fall back on her pooled lifetime pension and Age Pension in combination.

She can also use this slider to change the amount that is invested in a lifetime pension versus an account-based pension. So if she’d prefer to do 50/50, go right down the middle, she can move that slider and the graph will adjust where her income is coming from. Justine is really pleased with this and knows that she doesn’t have to make a decision right now, but is happy to have the confidence that when she does retire, she’ll have significant assets in super and enough to consider both a lifetime product to give her that peace of mind and also a more flexible pension that will give her access to lump sums as and when she needs them.