Ensuring your SMSF can meet your cash flow needs in retirement
Cash is king in every context, and none more so than in the superannuation environment when it’s the lifeblood of every retiree’s post-work income.
Working out the right cash management strategy for your fund is a critical component of its success. Pete Pennicott, a principal and financial adviser with financial advice firm Pekada says everyone’s cash flow needs in retirement will be different.
“A good approach is to look to arrive at a percentage of your pre-retirement expenses, rather than go for an average figure based on figures over a number of years,” Pennicott says.
“Clients generally spend at a higher rate in the first few years of retirement because they are doing all the things that they couldn't while they were still working. Then we find expenses generally settle down. The best way to determine cash flow needs is usually to run a budget for 12 months, either after the fact or as you go, to find out what they are really spending,” he adds.
Pennicott then takes a more granular view, breaking down the budget into fixed and discretionary expenses. That gives him a benchmark from which to work. From that point, it’s possible to build an investment strategy that will produce the desired level of cash.
“Once we know how much cash the fund needs to generate, the next stage is to apportion the capital appropriately within the portfolio. This is especially important when you're navigating the transition from the accumulation to pension phase,” he says.
As a buffer, Pennicott ensures there is at least 12 months in income payments held in defensive assets like cash and term deposits.
“Let’s say a client has annual expenses of around $65,000 dollars a year, and want to spend $20,000 on travel each year. We make sure we've got $85,000 in cash and term deposits in the portfolio. Then we want to understand what level of volatility the portfolio can withstand.”
He says given that many people will need to have sufficient income for 30 years after they stop working, generally an allocation to growth assets is essential to ensure the money won’t run out before the members die.
“It’s important growth assets have reliable, sustainable income to help top up the cash account, so we're not having to sell growth assets regularly. A big part of our strategy is we never want to be a forced seller of a growth asset. We're happy to sell assets on our own terms, but we never want to be in a position of having to sell to generate income.”
While many SMSF members set their investment strategy so that it is aligned to achieve the same returns as a particular benchmark, for instance the All ordinaries Index, Pennicott says the risk of using this approach is that the fund may not produce the type and timing of returns in line with the client’s unique income needs in retirement.
“We believe an income strategy should focus on achieving the client's objectives. If that's for the fund to produce a certain amount of money, that's the most important thing, rather than whether the fund produces a return that is tied to a benchmark,” says Pennicott.
“It's all about having the right amount of money available at the right time for the client, then aligning the portfolio to those specific cash flow needs. If you get that right, you’ve got very happy clients.”
In terms of Pennicott’s other advice for ensuring the fund can meet its cash flow requirements, he says the main thing is to ensure there’s some flexibility around the retirement planning process.
“Life can be unpredictable, even in retirement, so you need a portfolio that can respond to life events. That's the advantage of an SMSF over a retail fund. You can structure the assets with a lot more purpose and a lot more predictability and certainty,” says Pennicott.
“It's all about making sure you've got that liquidity to fund lifestyle and pension payments, and also beyond that, to make sure the fund can absorb any surprise income requirements members have as they reach the retirement phase. We want to make all our clients have a healthy weighting of liquid and accessible assets within their portfolio,” he says.