Methodology and assumptions guide

Transcription

1 Methodology and assumptions guide Last updated 15 August The results produced by the Accurium retirement healthcheck are based on the methodology and assumptions detailed below. Suitable for retirees The retirement healthcheck is designed for households where all persons have retired or are about to retire. It is designed to be used by people between preservation age and 80 years old. It is not suitable for use by persons who have not yet met, or are not yet eligible to meet, a superannuation condition of release under superannuation legislation (such as persons still accumulating superannuation benefits while working full-time). Note: The needs of persons over the age of 80 often require a more detailed focus on factors such as aged care and estate planning so they are not considered in the retirement healthcheck. Also, forecasts of life expectancy for persons at these ages should consider health in more detail (rather than assuming the average life expectancy applies). The household The retirement healthcheck simulates a household of either a single person or a couple (being two persons). It models only the standard single and couple rules for taxation and Age Pension projections. For example, it assumes that all persons are Australian residents, not in gaol, not blind or illness separated and couples meet the requirements of a dependency relationship (e.g. spouse). For couples it is assumed that upon the first death all wealth is inherited by the spouse. The forecast The retirement healthcheck projects a retired household s finances to determine the likelihood of the household s spending plan being sustainable for life. The retirement healthcheck provides the user with a downloadable report and online outputs to help assess the household s retirement sustainability. A retirement healthcheck is obtained at the report date and all inputs are assumed to reflect the households current financial situation. There is no allowance for starting the forecast at a past or future date. Accurium Methodology and assumptions guide page 1

2 A single simulation A single simulation in the retirement healthcheck looks at one possible scenario for how a household s finances might play out in retirement. The results from the retirement healthcheck are generated by running different simulations through the model. The household is assumed to retire or already be retired at the start of the forecast. The household s spending plan and financial resources are then projected for the remainder of their life. At the end of each year of the simulation the retirement healthcheck assesses whether the household has sufficient income and wealth to fund their required spending in that year, and also whether the household has met any minimum balance requirements as entered by the user (see the user guide for more information on minimum total wealth inputs). In each year of the simulation the retirement healthcheck makes assumptions for the investment returns earned across all of the household s assets and allows for the minimum pension payments required, Age Pension entitlements, tax payable and whether a person passes away in the year. A simulation where the household has sufficient assets to achieve their desired spending up to when they are simulated to pass away is considered a success. Conversely, a failure occurs where the household has insufficient assets to support their desired spending level at some point in the projection. Once a failure occurs the simulation ceases. Baseline scenario - the deterministic forecast The baseline scenario is a single simulation from the retirement healthcheck which is based on fixed assumptions for investment returns and future inflation. This is known as a deterministic forecast and is provided to help the user understand what the household s total wealth and sources of spending might look like over their lifetime. The fixed assumptions for investment returns and future inflation used in the baseline scenario can be changed by the user. An explanation of the default assumptions can be found on page 11. Stress testing - the stochastic forecast A stochastic forecast considers a large number of different simulations to provide a distribution of possible outcomes. The retirement healthcheck s stochastic forecast completes 2,000 simulations of what the household s finances might look like in order to create a distribution of possible outcomes in retirement. This distribution is shown in two ways: the retirement sustainability result indicates the proportion of scenarios in which the household s spending plan was sustainable for life; and the range of future net worth chart illustrates the likely range of outcomes the house hold might expect in retirement, shown in terms of total wealth. The blue shaded area on the chart excludes the 10% worst and 10% best outcomes each year, meaning the household s wealth has an 80% chance of falling in this range. Accurium Methodology and assumptions guide page 2

3 Results are in today s dollars The retirement healthcheck results are shown in today s dollars. This means that future spending and Age Pension entitlements take into account changes in the cost of living. All figures for the household s future total wealth are also shown in today s dollars. Future changes in the cost of living are based on the following assumptions: Forecast CPI Baseline scenario (ignoring risk) User input (default value 2.5%) Stress testing (allowing for risk) Tower Watson inflation scenarios Taxation The retirement healthcheck calculates the tax payable on the household s projected income each year. The assets held by a household in superannuation can either be supporting accumulation interests or account-based pensions. Where assets are supporting a transition to retirement income stream (TRIS) in retirement phase this is treated like an account-based pension. If assets are supporting a non-retirement phase TRIS then the healthcheck does not currently support this income stream type. Income earned and net realised capital gains on assets supporting an account-based pension are exempt from tax. Income and net realised capital gains on assets supporting an accumulation interest in superannuation, or on assets held outside of superannuation, are subject to tax. The healthcheck allows for these differing levels of taxation. Tax on superannuation income Income and capital gains earned on assets supporting accumulation interests are assumed to be taxed at the Accumulation effective tax rate entered by the user. Earnings on assets supporting pensions are tax free. The retirement healthcheck does not distinguish between income and capital gains on superannuation assets for tax purposes. Therefore the user should allow for the following factors when determining the Accumulation effective tax rate : Capital gain discount on assets held within superannuation for over 12 months, Imputation credits, and Other tax deductions Taxation on superannuation earnings is allowed for in the healthcheck by reducing the overall superannuation rate of return (net of fees) in a year by the Accumulation effective tax rate in proportion to the average level of assets supporting accumulation interests in that year. Note that in years where investment returns are negative this will reduce the loss, effectively bringing forward the benefit of offsetting the losses again future gains. Income tax Income tax is determined separately for each person at the end of each year of the forecast and is paid in the following year. Tax payable is calculated based on current tax rates, bands and thresholds. It is assumed that tax rates remain constant over time, and tax bands and thresholds increase annually with inflation. Where appropriate, the retirement healthcheck assumes that a proportion of the total investment return on assets (held outside superannuation) is attributable to taxable income and the remainder to changes in the capital value of the asset. Accurium Methodology and assumptions guide page 3

4 Income Yields The retirement healthcheck tracks the following non-superannuation investment types: Personal assets Cash Property Financial investment portfolio The following table illustrates how tax is treated across the income yields of different asset classes in the retirement healthcheck. Investment income source Personal assets Bank interest (cash) Income yield from financial investment portfolio Rent on property Tax treatment n/a Taxable income Taxable income Taxable income Where the household comprises of a couple, the amount of taxable investment income allocated to each person in the household is half of the total taxable investment income earned on non-superannuation investments. Capital gains It is assumed that there are no taxable capital gains on personal assets or cash holdings. The entire return from cash is treated as taxable income. For property and the financial investment portfolio capital gains tax may apply in practice when assets are sold. The retirement healthcheck forecast does not explicitly track detailed capital gains events. However, an allowance for the impact of capital gains can be made by assuming a proportion of each year s capital gain is treated as taxable. The proportion of the gain that is treated as taxable is a default assumption which may be changed by the user. Setting an assumption for this is complex given that in reality capital gains events can be lumpy (i.e. large one-off events). Assuming a proportion of each year s gain is taxable potentially overstates taxable income in most years of the forecast, but then may understate tax in the year of the actual sale of the asset. The overall effect of this would be different for each case and care should be taken where capital gains tax is expected to have a material impact on the client s retirement. It is important to note that the primary focus of the retirement healthcheck is the sustainability result indicating in what proportion of simulated scenarios the household could afford their desired spending plan. Where a household runs out of assets this generally means that all assets would be sold and hence capital gains realised. Accurium Methodology and assumptions guide page 4

5 Tax offsets and levies In addition to income tax, the retirement healthcheck makes allowance for: Medicare levy Low income tax offsets (LITO) Australian superannuation income stream tax offset Senior and Pensioners Tax Offset (SAPTO) These tax offsets and levies are modelled based on the understanding of current legislation, including current rates, thresholds and duration. It makes no allowance for future changes in legislation. The retirement healthcheck does not allow for the introduction of the Low and middle income earners tax offset (LMITO) for financial years to , nor the future changes to LITO from 1 July The assumption that tax bands and thresholds increase annually with inflation extends to LITO as an approximation to actual future increases. Other taxable income In addition to investment income it is assumed that the following projected items are taxable income to the person: Age Pension entitlements Taxable components of pension payments from superannuation for people under age 60 Annual other income (user input) It is assumed that the following items do not form part of a person s taxable income: Insurance proceeds (user input) One-off income amount (user input) Superannuation lump sums (paid from Accumulation interests) Investment returns The investment returns used in the retirement healthcheck are not a guarantee or prediction of future investment returns. The stress testing investment return assumptions are provided by Willis Towers Watson and are generated using the Willis Towers Watson Global Asset Model (Model). This Model produces random future sequences of possible investment returns for each asset class (cash, fixed interest, equities, property etc). These are carefully generated so that as a whole the simulations represent a full distribution for how real world markets and inflation could perform in the future. The returns for each asset class are statistically calibrated in terms of average returns, volatilities and correlations with each other. Willis Towers Watson employ sophisticated methods for doing this including taking into account: an analysis of history, theory and academic research current market conditions such as interest rates and bond yield curves government target ranges for things like inflation forward looking economic indicators (such as market risk premiums) consensus forecasts the application of judgement and experience of their senior investment consultants Accurium Methodology and assumptions guide page 5

6 The retirement healthcheck uses the following asset classes: cash fixed interest property Australian shares overseas shares other growth defensive growth CPI (inflation) Defensive and growth asset classes are used to form the non-superannuation financial investment portfolio with a mix of defensive and growth assets specified by the user. In order to implement the taxation of non-superannuation assets as explained above, the retirement healthcheck splits the overall return on property, defensive and growth asset classes into income yields and capital gains. For the stress testing (stochastic) forecast: The model includes annual income yields for the defensive and growth asset classes in addition to the annual total return. Rental yields are assumed to be equal to the returns achieved on cash. For the baseline scenario (deterministic) forecast: The rental income yield and financial investment portfolio income yield are both assumed to be in line with the assumption made by the user for the return on cash. The default assumption for this is explained below. Asset allocation The retirement healthcheck assumes that a long term investment strategy for superannuation assets and for non-superannuation assets applies over the whole forecast. The asset allocation for superannuation assets and non-superannuation assets are specified by the user at the outset. Once investment returns and other cash flows have been allowed for, the retirement healthcheck assumes each portfolio is rebalanced each year in line with the relevant long term asset allocation. Any other income received (not investment income but items like Age Pension) in excess of the spending requirement for a given year is assumed to be invested as part of the household s non-superannuation assets. Fees and charges All investment returns are calculated net of investment management fees and an annual fixed superannuation administration fee is also deducted from the superannuation asset pool each year. The basis for the default assumptions used for these fees are explained on page 11 and can be changed by the user. Accurium Methodology and assumptions guide page 6

7 Superannuation assets Superannuation assets are assumed to be supporting pension and accumulation interests based on the detail of existing or new account-based pensions and accumulation interests as provided by the user. Pension interests The Government s Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 is now law. This superannuation reform package places a limit on the amount of superannuation a person can transfer into the tax free retirement phase. The healthcheck assumes that the pension values input by the user comply with the transfer balance cap and are assumed to be in the tax free retirement phase for the duration of the forecast. The pension interest could be an account-based pension or a TRIS in retirement phase. The healthcheck does not currently allow for the rules of a non-retirement phase TRIS, nor the pension payment factors for a market-linked pension. The minimum pension standards are applied against each pension interest in each year of the forecast. The minimum pension amounts are used to fund the required household spending each year, with any excess amount invested into the household s non-superannuation asset pool. The user can specify whether each pension interest is grandfathered for the purposes of the Centrelink income test (for use when determining the Age Pension entitlement of the household). For the purpose of the calculations we assume that the persons in a household are financial dependents. On death any pension interest held by the deceased is assumed to pass to the other person in the household up to the value of that person s remaining transfer balance as specified by the user. The healthcheck will convert the deceased person s superannuation interests to the surviving spouse in the following order: Reversionary pensions Non-reversionary (death benefit) pensions Accumulation balance (converted to a death benefit pension for the spouse) Where the spouse s remaining transfer balance is exhausted the total remaining pension and accumulation balances will be commuted and paid out of superannuation and will form part of the household s non-superannuation asset mix. If the pension is reversionary then the characteristics of the pension is retained (grandfathered status, tax free component). Any non-reversionary pensions are assumed to be combined and paid as a new account-based pension to the remaining person with the tax free component recalculated and the pension treated as deemed for the Age Pension. In line with current social security regulations, once a pensioner loses their entitlement to the Age Pension their pension interests will lose their grandfathering and will be treated as a deemed asset for Age Pension calculation purposes for the remainder of the forecast. Accumulation interests Any accumulation interest will remain in accumulation phase for the duration of the forecast. The after tax investment returns will be allocated to the accumulation interest. The accumulation interest can be used to fund any deficit in spending. For more information please see the Spending section below. The healthcheck assumes that an accumulation interest for a person entered by the user is in accumulation phase for the duration of the forecast (subject to withdrawals and the reversionary pension conditions noted above). Accurium Methodology and assumptions guide page 7

8 Age Pension The retirement healthcheck estimates the Age Pension entitlements of the household each year of the forecast based on current and legislated Centrelink rules. It is assumed that Age Pension thresholds generally increase each year in line with inflation. No other Centrelink entitlements are considered. On 1 January 2017 the Age Pension assets test thresholds and taper rate changed. Our projections allow for these new rules. In calculating Age Pension entitlements the retirement healthcheck assumes that a household consists of a couple or single person who fall under the standard rules for calculating couple or single Age Pension entitlements. Age Pension entitlements are calculated on an annual basis and more complex arrangements such as the work bonus, transitional rules, rental assistance, and couples separated by illness are not considered. The maximum entitlement for the Age Pension is assumed to be the sum of the maximum basic rate, the pension supplement and energy supplement and is assumed to increase each year in line with inflation. The retirement healthcheck assumes that 50% of a couple s Age Pension entitlement will count towards each person s taxable income. Where only one person in the couple is eligible for the Age Pension, they receive 50% of the couple entitlement and this amount is included in their taxable income. The deeming rates used in the means testing of the Age Pension are assumed to move each year in line with changes in the cash rate. Where a person is entitled to at least one cent of the Age Pension the retirement healthcheck allows for the minimum Age Pension amount in line with current rates. The Age Pension entitlement for the household is used to fund their required annual spending and any excess is invested in the household s non-superannuation asset pool. Centrelink treatment of superannuation interests All pensions held by a household within superannuation are treated as asset tested account-based type income streams and are assessable under the Assets Test. Income Test treatment will depend on the grandfathered status of the pension as entered by the user: Grandfathered pensions use the deduction amount to calculate the assessable income, otherwise income is deemed. Relevant numbers for grandfathered pensions are determined based on the life expectancy of the pensioner, or for reversionary pensions, the greater life expectancy of the pensioner and the spouse at the pension commencement. An accumulation interest held by a person who is of Age Pension age is treated as a financial asset under the Assets Test and is deemed under the Income Test for Age Pension purposes. Accurium Methodology and assumptions guide page 8

9 Centrelink treatment of non-superannuation assets All non-superannuation assets are assessable under the means tests for the Age Pension. The value of personal assets is assumed to change each year in line with inflation and is assessable. Non-superannuation financial investments (cash and financial investment portfolio, but excluding property) are treated as assessable under the asset test and as deemed under the income test. Property assets are assessable under the assets test and the rental yield is treated as the assessable income. Other income sources The following cashflow (based on user inputs) is treated as assessable for the Age Pension: annual other income The following cashflow items (based on user inputs) are not treated as assessable for the Age Pension: insurance proceeds received on death one-off income Life expectancy The life expectancy data used in the retirement healthcheck is based on the Australian Life Tables produced by the Australian Government Actuary. The mortality rates used in the retirement healthcheck are based on the ALT tables with 25 year improvement factors. The retirement healthcheck uses mortality rates to randomly simulate the age of death for each person in each of the 2,000 simulations. The life expectancy charts provided in the retirement healthcheck report demonstrate the assumed likelihood of being alive at each future age. The retirement healthcheck assumes that for each retired household mortality rates and wealth levels are independent random variables. Relevant numbers used in means testing calculations for the Age Pension are determined using: ALT for pensions commenced on or after 1 January ALT for pensions commenced prior to 1 January Pensions commenced on or after 1 January 2015 will be deemed and a relevant number is not required. Spending The user is provided with inputs to detail the household s desired spending plan in retirement. The user must specify an annual spend requirement, and in addition may allow for: a change in annual spend after a specified number of years a change in annual spend on first death Accurium Methodology and assumptions guide page 9

10 The one-off expense is assumed to have no impact on Age Pension entitlements, for example gifting rules are not considered. The desired spend in each year is funded firstly from income received in the year: Age Pension minimum pension payments annual other income one-off income Any shortfall is paid at year end by drawing down on the household s wealth. The model aims to meet the shortfall paid from the household s assets in the most tax effective order. The retirement healthcheck will calculate the tax paid in the previous financial year by the persons and in respect of accumulation interests in superannuation. The shortfall will be drawn from the vehicle with the highest effective tax rate in the previous year. Where the effective tax rate paid by the persons is higher than paid on the assumed rate of tax on accumulation interests, non-superannuation assets will be drawn on first to meet the desired annual spend. Where the tax rate on accumulation interests is higher, the shortfall in spending will first be met by lump sums from accumulation interests. Additional payments from pension accounts will only be made once all non-superannuation assets and accumulation interests are consumed. In the first year of a forecast, the shortfall is assumed to be met in the following order: 1. first paid from non-superannuation wealth (excluding personal assets which are assumed to never be consumed), then, if exhausted, 2. from accumulation interests in superannuation, then 3. finally the assets in tax free retirement phase using pension payments. Accurium Methodology and assumptions guide page 10

11 assumptions There are a number of assumptions used in the retirement heathcheck that can be changed by the user. The default assumptions used for these inputs and an explanation of why these are considered to be reasonable are detailed below: Investment returns used in baseline scenario: Superannuation growth rates value as at 15 August Cash 3.5% These default assumptions have been selected by Fixed interest 4.5% Accurium s actuaries and represent our view of the long-term expected return on each asset class Property 7.0% (gross of fees, taxes and inflation). Australian shares 8.5% Overseas shares 8.0% Other growth 8.0% The assumption for the return on other growth assets is based on the expected return on a diversified growth portfolio. Non-superannuation growth rates value as at 15 August Growth Defensive 8.0% 4.5% These default assumptions have been selected by Accurium s actuaries and represent our view of the long-term expected return on each asset class (gross of fees, taxes and inflation). Cash 3.5% Property 7.0% The assumption for the return on growth assets is based on the expected return on a diversified growth portfolio. The assumption for the return on defensive assets is based on the expected return on a diversified portfolio of defensive assets and the option for the return on growth assets is based on the expected return on a diversified growth portfolio. Inflation value at at 15 August CPI 2.5% The default assumption for the rate of future inflation used in the baseline scenario has been selected by Accurium s actuaries and represents our view of long-term inflation expectations. Accurium Methodology and assumptions guide page 11

12 Superannuation Annual superannuation administration fee value at at 15 August $2,500 The default assumption for the fees incurred and paid by the household s superannuation assets is based on our experience of likely fees for an average SMSF in retirement. The user should ensure this assumption reflects the actual fees and charges that the household s superannuation fund(s) will incur. Investment management fees on superannuation assets value as at 15 August Cash 0.0% The default assumptions for the investment management fees have been set by our Fixed interest 1.0% actuaries based on our view of the long-term costs and fees from investing in each asset class. Property 1.5% Australian shares 1.0% The level of fees may differ depending on the actual type and structure of investments held. The user should consider the appropriateness of these assumptions for the particular household s circumstances. Overseas shares 1.5% Other growth 1.5% Investment management fees on non-superannuation assets value as at 15 August Cash Investment portfolio 0.0% 1.0% The default assumptions for the investment management fees have been set by our actuaries based on our view of the long-term costs and fees from investing in each asset class. Property 1.5% The level of fees may differ depending on the actual type and structure of investments held. The user should consider the appropriateness of these assumptions for the particular household s circumstances. Accurium Methodology and assumptions guide page 12

13 Capital gains value as at 15 August Proportion of property capital gains taxable 50.0% The retirement healthcheck does not track detailed capital gains events, however a proportion of any capital gain earned each year is assumed to be taxable in that year. Proportion of financial investment portfolio capital gains taxable 50.0% Typically, assets held for more than 12 months are taxed on 50% of their gain. As such, the default assumption for the proportion of each year s capital gains that are taxable has been set to 50%. Accumulation in superannuation effective tax rate Households who already have significant unrealised gains on non-superannuation assets at the start of the forecast should consider this assumption carefully. Please contact Accurium for further information regarding this assumption. 12% This is the tax rate assumed to be paid on the earnings on assets supporting accumulation interests in superannuation. Earnings on superannuation savings in accumulation phase are generally taxable at 15%, however, the effective tax rate is often lower due to, for example, capital gains on assets held for more than 12 months attracting a 33.3% discount. The retirement healthcheck does not distinguish between income and capital gains on superannuation assets. Phone: act@accurium.com.au Disclaimer This information is current as at 15 August and is provided by Accurium Pty Limited ABN (Accurium). These assumptions are based on views held only at the date of publication and are not guarantees of future performance or events. The assumptions are subject to inherent risks, uncertainties and other factors, beyond the control Accurium and actual results may differ materially from those expressed or implied in such statements. The user should consider the appropriateness of any assumptions for the particular household s circumstances. Accurium gives no representation or warranty (express or implied) as to the completeness or reliability of the information. Accurium Methodology and assumptions guide page 13