Maximise the value of client relationships and your expertise.

The value of financial advice isn’t always easy to measure. While helping clients grow their wealth is certainly important, the true value extends beyond financial returns. This article, sponsored by Russell Investments, explores the value of financial advice.

Financial advisers provide essential support to their clients. They help them to assess and reassess their evolving goals, needs and circumstances. Their role becomes even more critical during periods of transition and uncertainty. In today’s environment, which is characterised by geopolitical instability, market volatility, interest rate uncertainty and the rising cost of living, clients face challenges at both personal and broader economic levels.

Effective wealth management requires a comprehensive approach. This includes an in-depth discovery process, ongoing strategic planning and continuous coordination. This can be especially difficult when emotions run high and uncertainty dominates the conversation.

Advisers who guided their clients through recent periods of market volatility and worked with them to reassess their goals in the face of a myriad of uncertainties can take pride in knowing they delivered real value. To help you articulate that value, a recent paper^[1] detailed five factors that measure and quantify the value advisers bring to the table. These factors are:

• appropriate asset allocation
• behavioural coaching
• helping clients through choices and trade offs
• expertise
• tax savvy planning and investing.

Part one and part two of this series examined the importance of appropriate asset allocation and understanding investor behaviour – and your important role as a behavioural coach – as key inputs into the measurement of adviser value.

Asset allocation can have a significant impact on whether a client achieves their investment goals; analysis has found that it drives more than 85 percent^[2] of the investment outcome for an individual.

Understanding investor behaviour and related coaching will help you to keep your clients focused on the big picture and to avoid falling prey to common investor emotions during periods of market volatility and general uncertainty. In this article, which is part three of the series, the remaining three factors will be unpacked: helping clients through choices and trade-offs, demonstrating your expertise and tax savvy planning and investment. 

Choices and trade-offs

Not everyone understands the extent to which advisers act as financial coaches for clients, guiding them to the best decisions as regulation, social security and their own situations change over time.

Advisers are there for clients from early adulthood, when they are accumulating assets, to late middle age when they are planning retirement. Advice flows through to older age, when care requirements and funding may be significant. The number of people entering the latter category dominates headlines with the number of Australians aged 65 and over forecast to more than double over the next 40 years^[3].

However, it’s not just older Australians who must juggle difficult life decisions. Younger generations are increasingly faced with trade-offs that may be necessary to achieve their long-term goals, given the rising cost of living and housing and for many, HECs debts to service.

Quarterly increases in living costs for employee households – those whose primary source of income is salary or wages – have been higher than the Consumer Price Index since September 2022. Rising mortgage interest rates hit this group hardest, jumping by seven percent in the March quarter as more people rolled over from fixed to variable mortgages and following a Reserve Bank of Australia rate hike in November last year^[4].

In such a difficult environment, advisers can reinforce the benefits of implementing financial plans early in life and then identify opportunities or compromises to achieve the desired outcome.

In 2024, this might include advice to invest tax cuts, in superannuation or elsewhere, or to use cash freed up by the Federal government’s energy bill relief to maintain dollar cost averaging into investments.

Such decisions are indicative of the choices and trade-offs that a broad cross section of the community faces. For example:

• Single retirees, particularly women, can be significantly underfunded for retirement and at risk of losing their homes at a later age.
• Younger generations have the advantage of higher compulsory super payments than their parents but must grapple with the increased difficulty of buying a home and other costs such as HECS repayments.
• The so-called sandwich generation must juggle the needs of elderly parents with those of their own children – including sometimes paying for a parent’s aged care costs or forgoing an inheritance to do so.
• Older parents can be faced with ‘impatient inheritors’ – adult children or grandchildren who want a bequest early.
• The so-called ‘bank of mum and dad’ has grown rapidly, as adult children ask parents to fund mortgage deposits. Some estimates suggest ‘the bank’ has seen the transfer of $2.7 billion over the past year^[5]. Alternatively, parents are allowing their offspring to live at home longer to save more or to help them meet living expenses.
• Grandparents are more often pitching in to support grandchildren, by providing childcare or funding private education.
• Second marriages can cause family disputes unless there is an extra layer of estate planning that caters for two sets of children.
• Downsizers, whether couples or singles, have a range of options to consider – including downsizer contributions to super.

Each of these scenarios can require detailed arrangements to achieve an optimal outcome and ensure family relationships aren’t fractured.

Couples, for example, can be encouraged to adopt strategies that give them a degree of financial independence within a relationship – so that neither is left without assets if their partnership ultimately breaks down.

Advisers can assist in striking loan agreements for parents providing mortgage deposits to adult children. By working closely with other specialists such as lawyers and accountants, they can develop solutions that protect the interests of clients. This process includes explaining implications which a lay person may not contemplate, helping to avoid situations in which important decisions are put aside or made incorrectly.

Even if the above scenarios are not applicable, each client has their own unique circumstances, preferences and considerations, all of which require countless decisions over a lifetime.

Things to consider include:

Personal circumstances

When young and accumulating assets, people tend to focus on the big picture by establishing a career, buying a home and in many cases, raising a family. As they move through life, there may be school fees to factor in and new priorities that arise.

As clients near retirement and enter the preservation stage, building their retirement savings, as well as their own health and that of their parents, increase in importance. It’s also the time that lifestyle goals come to the fore. Finally, the distribution phase can involve decisions related to estate planning and funding for health and long-term aged care.

Personal preferences

Each individual has personal preferences that must be reflected in a financial plan. These may include an appetite for exchange traded funds, an interest in alternative assets or a desire to invest in ESG products.

Advisers can suggest appropriate options and explain any trade-offs required to implement those decisions. For example, they can explain the risks of alternative investments or help price-conscious investors understand that passive investments may be in conflict with ESG principles – and, of course, suggest other ways to achieve their objectives.

When it comes to retirement planning, clients will have a range of preferences. Some might have lifestyle aspirations that include extensive travel, while others may have health concerns and want to ensure they are financially able to meet those costs as they arise.

External considerations

External considerations can have as much impact on financial affairs as personal preference. In 2024, this is clearly seen in the higher interest rates and high inflation that is forcing people to reconsider their financial situations.

It is also evident in the ageing population – in terms of both social security for the elderly and in bequests made to the younger generations. For the former, advisers can ensure elderly clients take advantage of available benefits such as the Commonwealth Seniors Health Card, which provides cheaper prescriptions and medical appointments to those who pass an income test but are not receiving Centrelink benefits. Clients can also check eligibility for lower cost banking and state based seniors’ cards.

A recent report^[6] estimates the potential intergenerational wealth transfer in Australia to be close to $5 trillion, significantly more than the $3.5 trillion estimated by the Productivity Commission. For those who inherit assets, an adviser’s role is to craft a strategy that considers both short-term tax impacts and long-term wealth goals.

Articulate and demonstrate expertise

Advisers’ expertise extends beyond financial matters to human behaviour. This latter skill allows them to forge the trusted client relationships that are necessary to deliver on their recommendations. In good times, this is an easier task. Advisers help clients attain the goals that matter most and celebrate their successes with them. But they support clients in difficult times too – providing counsel as people negotiate challenges such as job loss, relationship breakdowns, ill-health and death. This unique combination of technical skill and emotional expertise provides a priceless form of value to clients.

In terms of technical expertise, advisers are at the frontline of the regulatory changes and product innovations that are a constant in the Australian market. They interpret changes to ensure clients both meet their regulatory requirements and seize opportunities as they arise.

The complex superannuation system is an obvious example where professional advice can make a real difference. The 1 July 2024 increase in compulsory super to 11.5% and another hike in concessional and non-concessional super caps are compelling reasons for people still working to revisit their retirement strategies.

Advisers can also reinforce the benefits of super to people who remain sceptical about its benefits by explaining other forms of contributions, such as catch-up contributions, spouse contributions and small business sale contributions.

Additionally, the Melbourne Institute has found that only approximately half of all Australians think their superannuation works well for them. Those most likely to think it worked well were married and outright homeowners. Renters were more likely to think the system doesn’t work well for them^[1].

Pre-and post-retirement planning is another example where professional advice can add considerable value and comfort to clients. The impending retirement of most of the Baby Boomer generation – some 5.6 million individuals – means more people than ever need help to establish retirement income streams, make aged care decisions and undertake robust estate planning.

All this requires much more active decision-making than many people ever applied to their default superannuation while working. The decisions involved are not always technical in nature either – each involves a multitude of emotions as people leave the workforce and plan their final decades.

The same applies to Australia’s complex social security system. The available benefits are not just financial as they also offer the emotional security of a government safety net. Advisers can ensure their clients access legitimate entitlements such as childcare rebates or the Age Pension and related entitlements, thereby helping people when they are most vulnerable.

Technical skills only get part of an adviser’s job done – the ability to gain the trust of a client is critical to establishing a successful relationship and achieving the best outcomes for the client. This is where advisers draw on their essential interpersonal skills: empathy, caring and genuine curiosity.

As illustrated in figure two, there’s a large number of Australians who do not expect to reach their retirement savings goals. Financial advisers can play a crucial role to help such individuals with personalised strategies and expert guidance. By offering insights into tax-effective strategies, superannuation options and portfolio diversification, advisers can help their clients make informed decisions that align with – and help them to meet – their long-term objectives.

Elsewhere, understanding financial markets and portfolio construction is key to advisers’ training and experience. Advice teams are consistently researching investment solutions by decoding technical terminology to determine what is appropriate for different clients.

The value of working with an experienced adviser is about tapping into the accumulated expertise they’ve developed over their career. Together with ongoing education, this insight grants them problem-solving skills that can be leveraged by clients at all stages of their lives.

The adviser’s role

Through good times and bad, as clients’ needs evolve an adviser can play a different role when providing expert advice.

Guide

Advisers can shoulder the practical and emotional burden of decision-making for clients in different ways, depending on individual needs. Clients who are overwhelmed by their financial affairs may rely almost entirely on their advisers. Others may opt for more control and instead use advisers as a coach or sounding board.

One example may be a situation in which a couple with $1.2 million in superannuation wanted to gift $100,000 each to their three children on retirement. The gesture, while generous, would reduce their own capital to $900,000 – or even lower if it coincided with a market downturn. An adviser can brainstorm the implications of such a move, balancing the parents’ intentions with the impact on their own standard of living.

Guru

In some situations, advisers stand tall as both an expert and voice of reason. This includes imparting technical knowledge that can sway clients’ decisions or simply using their judgement built over a career to foresee potential consequences of certain actions.

This is perhaps most evident in tax planning and structuring of financial affairs to reach the most optimal outcomes. Alternative retirement savings vehicles to superannuation such as investment bonds and company structures, for example, are worth considering as the proposed implementation of an additional tax on earnings on super balances above $3 million draws closer.

Gladiator

Advisers are well equipped to advocate on a client’s behalf if the need arises. This could mean challenging a refused insurance claim, solving social security hiccups, or managing administration of finances. In all instances, it allows a client and their family to focus on themselves during periods of stress.

Elder financial abuse is an example where advisers can stand up for their clients, preventing the most difficult ‘impatient inheritors’ or others from controlling an aged person’s money and assets. Six in 10 Australians are worried that someone they know will fall victim to this abuse, and in absolute numbers the figure could grow significantly as the population ages^[8].

Advisers can maximise the value of their expertise in three key ways:

1. Have a clear value proposition, advice philosophy and service model that helps illustrate the service you provide.
2. Have existing client case studies that highlight how elements of your expertise helped the client and the outcome you delivered. Share these with new clients so they can better understand the intangible value you deliver.
3. Understand the different motivations for seeking advice and have examples to use with new clients that describe how you deliver sometimes intangible, yet highly valued, advice.

Tax savvy planning and investing

Tax expertise sits alongside market knowledge and estate planning as among the central pillars of financial advice. It is required to deliver on all aspects of the services that advisers offer – from superannuation advice to investment strategies and social security assistance. In fact, the importance of tax know-how becomes more critical every year as changes to tax matters and how they intersect with super, social security and other investments is subject to constant change.

Super power

Salary sacrifice is one of the most potent tax-effective investment strategies advisers can implement across a majority of their working-age client base.

A hypothetical investor, Rashmi, provides a good example of its benefits. Her salary is $120,000 and if she sacrifices $16,200 to super^[9], she will pay $2,430 in contributions tax instead of $5,184 in income tax^[10] . This means an additional $2,754 is invested in her superannuation fund, providing an initial boost that will also increase the power of compounding over time.

Voluntary contributions to super appear to have increased over time but a survey in advance of the Federal Government’s 2020 Retirement Income Review showed there was still mixed awareness of these benefits. Roughly similar proportions of the self-employed (52 percent) and employees (43 percent) stated they were aware of the tax concessions and understood them (figure three).

Transition to retirement strategies can deliver similar benefits when clients get older. These popular – but sometimes misunderstood strategies – allow people to add extra to super without reducing their take-home pay. This is not just beneficial for anyone who wants to work part-time but can also help people to boost their savings while the cost of living remains high.

But such strategies can prove complicated to arrange without the help of an adviser who can explain the pros and cons – and then implement a chosen course of action.

Advisers can walk clients through a range of sometimes complicated alternatives – explaining both the upsides and downsides – and undertake any implementation on their behalf to ensure the agreed strategy is implemented in an optimal fashion.

Beyond super

Advisers can provide expert guidance on many tax issues outside superannuation. Examples include:

• Investment solutions that optimise results for clients, such as low turnover strategies that minimise capital gains tax, tax minimisation overlays or centralised portfolio management that mitigates inefficient after-tax outcomes.
• Insurance strategies that allow clients to hold policies in superannuation, generating tax benefits that can be reinvested into super or elsewhere.
• Entitlement to social security payments such as childcare rebates, family tax benefits and other concessions that can make a real difference to a household balance sheet.
• Eligibility for small business grants and incentive payments that time-poor proprietors might miss.

The high cost of error

Individuals can easily be caught out by tax rules. It may be because they misinterpret requirements or push boundaries without properly understanding the consequences. There can be onerous penalties in both cases – penalties that astute advisers would foresee and prevent.

The potential for such errors is evident in research for the Australian Taxation Office that found most people recognised the benefits of the tax system – but it was “not top of mind and did not prevent them from being inactive, avoiding or leaving it all with the ‘experts’.”^[11].

The fact that only 12 percent of people consider overall tax effectiveness as among the top three considerations when making investments^[12] further highlights a lack of understanding, and the important role advisers play in helping to resolve this.

By no means is tax just the realm of the accounting profession. Neither is it limited to the typical items included in an individual’s tax return. Actions advisers can take to maximise value when it comes to tax matters include:

• know each client’s marginal tax rate, tax sensitivities and opportunities
• provide access to solutions that have tax-savvy strategies for your clients
• explain the different tax-smart decisions you include in your advice and ongoing implementation.

By showcasing their expertise, financial advisers can truly solidify their reputation as invaluable partners in managing their clients’ financial affairs. From retirement planning to investment management and beyond, an adviser’s ability to provide tailored solutions not only helps clients meet their financial goals, but also enhances the adviser’s role as a trusted, long-term guide in all aspects of financial wellbeing.

Read the full series:

Asset allocation – the value of advice (part one)

Understanding investor behaviour – the value of advice (part two)

Adviser expertise – the value of advice (part three)

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References:
[1] Russell Investments, Value of an Adviser, 2024
[2] Russell Investments, Making Super Personal White Paper, 2020
[3] Intergenerational Report Factsheet
[4] Living cost increase highest for Employee households | Australian Bureau of Statistics
[5] https://thenightly.com.au/opinion/david-koch-beware-the-risks-of-bank-of-mum-dad-c-14273059
[6] https://www.morningstar.com.au/insights/personal-finance/250250/the-biggest-beneficiaries-of-the-generational-wealth-transfer
[7] Melbourne Institute, Critical gaps in household attitudes and support for superannuation
[8] https://www.ausbanking.org.au/wp-content/uploads/2019/07/Elder-Abuse-Fact-Sheet.pdf
[9] Assume $0 administration costs and insurance premiums, maximum concessional contribution $30,000 for FY24-25
[10] Example for illustrative purposes only
[11] ATO, Shaping community beliefs, attitudes and norms
[12] ASX Australian Investor Study 2023

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Understanding the importance of investor behaviour and decision making can assist in translating behaviours into value-adding client management.

Investor behaviour, positive and negative, cannot always be anticipated and can have a marked impact on client outcomes. This article, proudly sponsored by Russell Investments, examines the value of advice and within that, the importance of understanding investor behaviour.

Advisers are much more than investment experts – they have an equal role to play in helping clients navigate the emotions that can cloud financial decision-making.

Today, these emotional challenges are the reverse of just a few years ago.

Early this decade, COVID-19, global conflict and surging interest rates all triggered bouts of volatility that tested peoples’ fortitude as markets fell temporarily lower. Advisers played a crucial role in ensuring clients understood that a properly constructed portfolio could weather such extreme swings in the value of investments.

The challenge in 2024 has been curbing investors’ enthusiasm as the AI boom and anticipated interest rate cuts pushed markets to record highs. There is always a risk of investors falling into the trap of buying while markets are bullish and selling when sentiment turns bearish, as history shows it does.

This is where the adviser’s expertise in reweighting portfolios at regular intervals to maintain long-term financial plans is vital. Investors are more likely to grasp the benefits of that process when presented with the historical advantages of maintaining a steady investment strategy instead of chasing quick wins, then bailing when markets turn sour.

Successful investors recognise that the risk of loss is highest when markets are driven by euphoria – and, conversely, that market capitulation may present an opportunity.

What is behavioural finance?

Behavioural finance is a field of study that combines psychology and economics to understand how individuals make financial decisions. It challenges the traditional assumption that people always act rationally and in their own best financial interests. Instead, behavioural finance focuses on how psychological biases, emotions and cognitive errors can influence financial behaviour.

Much of traditional finance theory is predicated on rational investor behaviour that advocate the notion that financial markets are efficient. The efficient market hypothesis argues that current stock prices reflect all existing available information, making them fairly valued. It also suggests that people are free from emotion and make rational decisions based on fact.

However, behavioural finance would suggest this is not the case; instead it asserts that financial decisions around investments, income, risk and debt are influenced by human emotions, biases and cognitive limitations of the mind in processing and responding to information.

Key concepts in behavioural finance

There are a number of key aspects of behavioural conditioning that advisers would benefit from understanding. Each of these, and how they relate to investment decision making, are described as follows:

Cognitive biases – systematic patterns of deviation from rationality in judgment, such as:

• Overconfidence – where investors overestimate their knowledge or ability, leading to risky decisions.
• Anchoring –  or relying too heavily on the first piece of information encountered when making decisions.
• Loss aversion – which describes why the pain of losing is psychologically twice as powerful as the pleasure of gaining. The loss felt from money, or any other valuable object, can feel worse than gaining that same thing^[1]. People are more likely to avoid risks when thinking about potential gains and take risks when thinking about potential losses; for a client experiencing loss aversion, it’s better not to lose $50 than it is to find $50.
• Herd mentality – the tendency to follow what others are doing in the market. Defined by the Oxford Dictionary as “the tendency for people’s behaviour or beliefs to conform to those of the group to which they belong”, herd mentality manifests in finance when investors follow the crowd instead of their own analysis. It has a history of starting large, unfounded market rallies and sell-offs that are often based on a lack of fundamental support to justify either^[2].
• Confirmation bias – describes the tendency for individuals to seek out and prefer information that supports their own pre-existing beliefs and ignore any information that contradicts those beliefs. Confirmation bias is often unintentional but can still lead to poor decision-making in real-life contexts^[3].
• Recency bias – is considered to be a cognitive error identified in behavioural economics whereby the individual incorrectly believes that recent events will recur in the near future. This tendency is irrational, as it obscures the true or objective probabilities of events occurring, leading the individual to make poor decisions.

Emotions – feelings such as fear, greed, and excitement often influence financial decisions, particularly during periods of market volatility. This is explored more in the following section.

Mental accounting – individuals can sometimes categorise money into different “buckets” – for example, treading a bonus differently from regular income. This can sometimes lead the individual to make irrational financial decisions.

Cycle of investor emotions

A discussion of behavioural finance provides a good opportunity to revisit the Cycle of Investor Emotions (figure one). The AI propelled market highs would have many investors in the blue zone, experiencing the thrill – and sometimes euphoria – of markets reaching new highs. Although rate cuts have yet to meet market expectations, the prospect them have buoyed bourses around the world.

While unadvised investors may make rash decisions in this environment, advisers can manage clients’ emotions by explaining market cycles and how they might feel and respond at different points of the cycle. By educating clients, advisers can provide this ‘behavioural coaching’ to best position clients to ride out the vagaries of financial markets^[4] and prevent them from ‘buying high, selling low’.

Investors typically start with optimism, which sits at the inflection point on the emotional upswing. At this point, investors expect things to go their way, or they expect to receive a return for the risk of investing. Investors enter markets because they believe they will be able to grow their wealth through their investment choices.

When markets move in the direction the investor had hoped to see, they start to get excited about the possibility of even greater gains. This is when investors start hearing positive news stories in the media, coupled with tips from friends, colleagues and even Uber drivers…stories about how well their investments have done can spur investors into further action. This can be an attractive comfort zone because in such a scenario, investors are running with the herd.

When the momentum continues, investors can find the experience thrilling and begin to anticipate even higher returns – and sometimes start sharing their own tips!

As markets reach the top of the cycle, investors may experience euphoria.

At this point, the uneducated investor starts to believe that they made a smart move to invest when they did and believe that the good times will continue unchecked. In some cases, investors fool themselves into believing they can tolerate higher levels of risk and may begin to trade more frequently or invest in riskier asset classes.

The second phase of the cycle occurs when the market starts to turn. At first, investors watch anxiously to see if the downturn is just a blip. They may believe that things will improve shortly and therefore hang on to their investments. They often try to shield themselves psychologically from the bad news and move into denial.

As the market continues to fall, denial gives way to fear. Investment values decline and perhaps investors begin to see losses. Bad news stories proliferate in the media and online. When market losses accelerate, real fear kicks in. Some investors may then turn defensive and switch out of riskier equities to more defensive equities or other asset classes, such as bonds or cash.

In the third phase of the cycle, the realities of a bear market come to the fore and an investor may become depressed and desperate. Those investors who missed their chance to take profits may try to get their portfolio back into the black by either selling their worst-performing investments or moving into securities that don’t fit their risk profile. When that doesn’t work, panic may set in.

At this point, some investors feel at the mercy of the market and capitulate, pulling out altogether, abandoning investments at precisely the wrong time.

Those who remain invested may become despondent and wonder whether they should ever have invested their hard-earned money in the markets…yet this is the part of the cycle identified as the point of maximum financial opportunity.

In the fourth phase of the cycle, investors may experience some scepticism when markets start to rise. They often have a sense of caution or worry, wondering if market growth will last.

Though investors are hopeful about continued market increases, they may be reluctant to invest money – even at a point when prices are still relatively low, and opportunities are attractive.

Eventually investors come to realise the market is recovering. For those investors who let their emotions rule their investment decisions, the market cycle can begin all over again – unless of course they have good financial advice and understand the cyclicality of the market and the importance of staying the course in the asset allocation recommended by their adviser.

Time in the market

The journey of four hypothetical investors who each invested $100 in January 2020 may help sway their behaviour^[5]. Each reacted differently to the market downturn in March that year, recording different outcomes as result.

With reference to figure two:

• Mandy remained in the market and witnessed her $100 investment rise to $140 by June 2024 (blue line)
• Naizar instead moved to cash in March 2020 after his $100 fell to $87, re-entering the market three months later. His ultimate investment was worth $125 in June 2024 (orange line).
• Bhupinder also moved to cash in March 2020 but waited until the following New Year to re-enter the market. Her investment was worth $113 in June 2024 (grey line).
• Finn was worse off still – he also bailed into cash in March 2020 and has never re-entered it. The $87 he initially moved to cash is now worth just $74 in real terms due to the impact of inflation (red line).

The experience of these hypothetical investors highlights the fact that those investors who jump in and out of markets can mistime their entry and exit points. As figure three illustrates, missing out on even a small number of the market’s best days can have a real impact on the amount of capital that someone can accumulate over time. This counterintuitive result occurs because markets, while unpredictable, have a history of rising over the long term^[6].

Those individuals who remained invested in the S&P/ASX300 Total Return Index throughout the past 10 years built significantly more capital than those who missed just the 10 best days’ performance of the index in that period. Those who missed the best 20 days wound up more than 50% worse off than if they had remained invested for the full decade.

Without the guidance of advisers, investors can fall into the trap of buying when markets are rising and selling when sentiment drives prices down. There is real value in the ability of advisers to help clients maintain their long-term strategies in the face of unnerving volatility across all asset classes.

In another example, calculations show that regularly increasing or decreasing exposure to the US S&P500 Index by trying to time the market may have cost investors as much as 3.28% per annum in returns in the 21 years to May 2024, as shown in figure four.

Advisers who forge solid relationships with clients are best placed to convince them of the merits of maintaining the positions that underpin the financial strategies they formulate on their behalf. These conversations can be more difficult to instigate in good years – but prepare investors for the inevitable cyclical nature of markets.

Why understanding investor behaviour is important

There are several reasons an adviser and their clients will benefit from a good understanding of investor behaviour. These include:

• Customised communications – understanding behavioural biases can help advisers communicate more effectively with clients by addressing emotional reactions to market movements. For example, during a market downturn, recognising loss aversion allows advisers to calm clients who might want to sell prematurely out of fear.
• Tailored recommendations – while we know all clients have different risk tolerances, financial goals and objectives and preferences, each client also has different biases and emotional tendencies. Understanding these helps advisers tailor strategies that fit their clients’ risk tolerance and decision-making styles. For example, a client prone to overconfidence might need more conservative investment advice to mitigate risky behaviour.
• Risk management – investor behaviour can be influenced by emotions such as fear, greed and overconfidence. By understanding these tendencies, advisers can help their clients to avoid impulsive or emotionally driven decisions that may lead to poor outcomes.
• Long-term success – an understanding of investor behaviour helps advisers to guide their clients towards strategies that are more likely to lead to long-term success; this includes remaining committed to their investment plan through periods of market volatility.
• Avoiding common pitfalls – being aware of common behavioural biases such as herd mentality, confirmation bias, loss aversion and recency bias allows an adviser to recognise when a client might be making decisions based on flawed thinking. They can then provide guidance to alleviate these biases.
• Communication and trust – understanding how clients perceive and react to financial information and market events is critical for effective communication. An adviser who truly understands investor behaviour and its drivers can explain complex concepts in a way that resonates with the client, building trust in the process.
• Managing expectations – investor behaviour often includes unrealistic expectations about returns or the ability to time the market; an adviser can help set realistic expectations and educate clients.
• Emotional support – investing can be an emotional journey, especially during times of market volatility. An adviser who understands investor behaviour and the cycle of investor emotions can provide emotional support and act as a steadying influence for the client. That way, rash decisions driven by exuberance, fear or panic can be avoided.
• Helping clients stick to long-term plans – behavioural finance equips advisers to guide their clients to stay with their long-term financial plans, even when emotions (like fear during a crash or greed during a rally) threaten to derail them. They can also educate clients on the potential pitfalls of biases like herding, preventing clients from following the crowd in a volatile market.
• Building trust and deeper relationships – clients appreciate advisers who understand and focus on more than simply the technical aspects of finance. They appreciate an understanding of the emotional and psychological dimensions of decision-making. By addressing biases and fears, advisers build a deeper trust, positioning themselves as partners who not only manage money but also help navigate complex emotions tied to wealth.

By integrating the principles of behavioural finance into their practices, financial advisers can help clients make more informed, balanced decisions, particularly during periods of market uncertainty. The adviser who understands investor behaviour is better equipped to provide holistic financial advice that considers not only the financial aspects of advice, but also the emotional and psychological dimensions of investing. This leads to better long-term financial outcomes and a successful and truly valuable client-adviser relationship.

Read: Asset allocation – the value of advice (part one)

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References:
[1] Kahneman, D., & Tversky, A. (1977). Prospect Theory. An Analysis of Decision Making Under Risk. doi:10.21236/ada045771
[2] Investopedia https://www.investopedia.com/terms/h/herdinstinct.asp
[3] Scribbr https://www.scribbr.com/research-bias/confirmation-bias/
[4] Investopedia https://www.investopedia.com/recency-availability-bias-5206686
[5] Examples shown for illustrative purposes only.
[6] Russell Investments https://russellinvestments.com/us/blog/bulls-vs-bears-2

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What is the role of asset allocation when it comes to adding value to clients?

While financial advice is always important, it’s especially critical during periods of market volatility in a world with a plethora of geopolitical uncertainty. This article, proudly sponsored by Russell Investments, examines the value of financial advice and within that, the importance of appropriate asset allocation.

Advisers continue to provide clients with advice that enables them to achieve long-term financial goals in a constantly changing and complex world.

In 2024, that has meant balancing the competing emotions triggered by strong investment returns and a cost-of-living crisis. While we’ve seemingly avoided the global recession that was predicted this time last year, pervasive sticky inflation, an uncertain interest rate environment and periods of market volatility amid the positive returns have made investors nervous. Advisers have played an important role, to encourage clients to stick to their long-term goals in this environment by providing both practical and emotional guidance that allows them to navigate the highs and lows of wealth generation.

Advisers’ counsel helped their clients adhere to principles such as asset allocation by reweighting portfolios as stock markets reached new highs. Equally, it has encouraged clients to retain dollar cost averaging even as household budgets are squeezed by rising prices.

For younger generations, advice has helped them make the multitude of decisions required to enter the housing market, start families and pay off HECS debts. Older people have been better able to plan for retirement and their own parents’ aged care by engaging advisers.

Of course, financial advice encompasses so much more than investing. It requires in-depth knowledge of taxation, superannuation and social security, plus the understanding of human behaviour required to support people making life decisions.

Holistic financial advice requires a deep discovery process, planning and ongoing coordination. This is particularly challenging when uncertainty prevails and clients’ anxiety runs high. Clients’ priorities, goals and outlooks may have changed during this time, making the adviser-client relationship more important than ever.

Those advisers who help their clients prepare for an uncertain outlook and remain invested through periods of market uncertainty, who work with closely with their clients to ensure they can achieve their goals – or important milestones towards those goals – can look back with a real sense of having provided true value.

How then, can advisers best articulate that value? A recent paper^[1] examined the five factors that measure and provide true adviser value to clients:

• asset allocation
• behavioural coaching
• choices and trade offs
• expertise
• tax savvy planning and investment.

This article will examine the first of these factors, asset allocation.

Asset allocation examined

Asset allocation is a core principle of investing and plays a critical role in enabling clients to achieve their short and long-term financial goals. It refers to the strategic division of an investor’s capital across various asset classes, such as equities, fixed income, alternatives, real assets and cash. The key importance of asset allocation lies in its ability to balance risk and return; this optimises the likelihood that each client will achieve their specific investment objectives.

A well-planned asset allocation strategy is essential for a comprehensive investment approach; it focuses not only on maximising returns but also on managing risk. In this context, risk refers to volatility, which signifies potential fluctuations in the value of investments. Volatility can be unsettling and can often lead investors to question their strategies and make impulsive decisions.

Because each asset class carries a different risk profile, diversification across multiple asset types helps mitigate the impact of severe downturns in any one sector. A portfolio heavily concentrated in a single asset class is vulnerable to large swings in value, which could result in significant losses. In contrast, a well-diversified portfolio is better equipped to handle market volatility.

Asset allocation plays a vital role in aligning investments with each clients’ risk tolerance and financial goals. For example, a younger client with a long time horizon and higher risk tolerance might allocate a larger portion of their portfolio to growth assets, which tend to deliver higher long-term returns. Conversely, a client nearing retirement may prefer a more conservative allocation, focusing on assets that preserve capital and provide income.

Advisers can also use asset allocation to take advantage of different economic cycles, adding further value to clients’ portfolios. Since asset classes often perform differently under varying economic conditions, adjusting the portfolio’s composition in response to these changes can enhance returns and reduce overall risk.

Another important aspect of asset allocation is rebalancing. Over time, as market conditions shift, a portfolio’s original allocation may change. Regular rebalancing ensures that the portfolio stays aligned with the client’s objectives and risk tolerance, maintaining the desired balance between risk and return. This is a key element of the value advisers provide, helping clients remain on track toward their financial goals.

Asset allocation also allows advisers to set realistic expectations for investment outcomes. By understanding the historical performance and risks of different asset classes, advisers can help clients establish achievable financial goals. This knowledge is critical for managing expectations during periods of market volatility and promotes a disciplined investment approach.

Managing client expectations also helps reduce emotional, short-term decision-making. During market downturns, impulsive reactions can lead to costly mistakes, often at the worst possible time. A thoughtful allocation strategy provides a framework for making informed decisions based on long-term objectives, rather than reacting to market noise.

It’s not only during volatile times that investors face challenges. In prolonged market upswings, complacency can set in, leading self-directed investors to drift from their original allocation and expose themselves to higher risks than they intended. Regular reviews and adjustments to the asset allocation help maintain the right balance and ensures the portfolio remains aligned with the investor’s long-term goals. This disciplined approach, combined with periodic rebalancing, is essential for managing risk and achieving financial success.

Appropriate asset allocation

How an individual is invested has a huge impact on their ability to achieve their investment goals. Many non-advised investors believe market timing or investment selection are the greatest determinants of portfolio success…but they would be wrong. Instead it is asset allocation that’s the biggest weapon in an investor’s arsenal, as it accounts for more than 85% of their ultimate outcome. It far outweighs the impact of individual security selection^[2].

This is becoming increasingly apparent as the number and types of investment opportunities increase, encompassing asset classes that weren’t previously available to retail investors. This includes rejuvenated cryptocurrencies, which are now more accessible through spot exchange traded funds, and the growing private debt market.

The latter’s recent boom has driven a proliferation of providers with sophisticated marketing, though the average investor’s understanding of private debt remains limited and good advice is critical to achieving desired outcomes.

Nonetheless, the importance of asset allocation is underestimated by the general public. Retail investors are more inclined to remember the returns of individual securities than how asset allocation laid the foundation for overall risk-adjusted returns.

The thrill of stocks reaching new peaks in 2024 – including AI giants like Nvidia and local stalwarts like Commonwealth Bank – may have proved sufficient for many investors to abandon caution in the belief that “it’s different this time” and resist moves to rebalance their portfolio.

But these are the very investors most likely to panic in rapid market retreats. It may seem counterintuitive, but the guidance of an experienced adviser is just as critical in rising markets as down times.

Asset allocation in action

There are generally two types of non-advised superannuation investor who can benefit from professional asset allocation advice.

The first is the disengaged investor, one who consciously or unconsciously opts for the one-size-fits-all default option offered by their super fund for simplicity’s sake. By definition, these default options take limited – if any – account of the personal circumstances or needs of an individual.

The second category is comprised of engaged investors who build their own portfolios but sometimes fail to consider all the potential risks – or even all of the opportunities available to them.

The following case studies examine both categories of investor. In each case, professional advice could help prevent the investors from generating lower gains that place them behind others in their retirement planning.

Case study one: The disengaged investor

The majority of Australians hold their super in default options. These options take no account of their age, super balance or retirement goals. More than 62% of the $1 trillion in MySuper investments is allocated to these single strategy options^[3].

This high level of disengagement means investors often miss out on the opportunity to improve their financial position with personalised strategies. This case study considers Maryanne, who – until recently – had been a disengaged investor. Her retirement plans received a boost after she sought advice, and her adviser recommended that she allocate 80 percent of her super to growth assets. This recommendation was based on an analysis that considered her age, investment goals, risk tolerance, superannuation balance and other preferences.

Maryanne’s new portfolio could deliver an annualised return of 7.4 percent over a 10-year period. By contrast, her previous default super option, which had 60 percent in growth assets, might return a lower gain of 6 percent. Maryanne’s potential extra gain of 1.4 percent could translate into $204,956 after 10 years – nearly $26,000 more than if she stayed in the default portfolio.

Case study two: The DIY asset allocator

A DIY approach to asset allocation has potential pitfalls if an investor lacks the know-how or discipline to keep their strategy on track over the long term. This includes rebalancing the portfolio, particularly during a bull market when returns might seem too good to be true.

This is especially pertinent in a world in which market complexity is amplified by geopolitics and economic uncertainty. Advisers can fill any gap in clients’ knowledge by sharing both market insights and an in-depth understanding of the different assets that can be included in portfolios.

Self-managed super fund (SMSF) investors are one group that may benefit from such advice. The lack of diversity in their portfolios is reflected in Australian Taxation Office statistics that consistently show SMSFs have a relatively high allocation to cash and shares. As of the end of June 2024, ATO data show the average SMSF has invested 16.4 percent of their capital in cash and 27.9 percent in listed shares^[4].

A too conservative asset allocation may prevent individuals from reaching their retirement goals because it may limit their ability to generate significant capital gains over the long term. Those portfolios overweight in shares might encounter issues if their drawdown phase coincides with a market downturn.

In this case study, Levi has an SMSF he manages without professional guidance. He is a conservative investor and over 70 percent of his capital is held in cash and other defensive assets, with just 30 percent in growth assets.

An adviser would instead be likely to recommend that over half his portfolio should be in growth assets given his age, circumstances and objectives. The potential difference in outcomes from the DIY versus advised strategies could make a real difference to Levi’s retirement.

His hypothetical DIY portfolio might return just 4.1 percent over 10 years due to its defensive make-up. A portfolio split equally between growth and defensive investments could generate 5.5 percent and set him up for a better lifestyle.

The significant difference of 1.4 percent is a real indication of the benefits that financial advice and appropriate asset allocation can deliver to investors.

Based on an initial $100,000 balance, after 10 years Levi might have $149,310 in the more conservative portfolio versus a balance of $171,463 for the advised portfolio. In other words, Levi’s DIY strategy could leave him $22,000 worse off after a decade.

Of course, asset allocation isn’t just a set and forget strategy. In periods of steadily rising markets, it can be easy for people to ignore the need to reweight a portfolio and instead let it drift from its initial position. By ensuring portfolios are regularly rebalanced, advisers help clients remain close to their original asset allocations and within their risk comfort zone.

In both case studies, professional advice could help prevent the investors from failing to meet their investment objectives and being in a position to enjoy a comfortable retirement. Actions advisers can take to convey the value of good asset allocation to their clients include:

• Spend time articulating why getting the right asset allocation can be a key driver of achieving goals and the consequences of getting it wrong.
• Remind clients of the art and science of understanding true risk preferences.
• Use your investment philosophy to demonstrate how you select and implement an appropriate asset allocation to achieve clients’ goals.

Appropriate asset allocation is not simply about pursuing the highest possible returns. It involves creating a balanced strategy that effectively manages risk while aligning with your clients’ specific financial goals and time horizons. This approach ensures that investments are tailored to meet the unique needs of each client, whether they are focused on growth, income generation, or capital preservation.

Diversification across various asset classes helps to mitigate the impact of market volatility and reduce exposure to any single risk factor. This diversification not only safeguards against unnecessary risk but also allows portfolios to perform more consistently across different market conditions.

Regular portfolio management and rebalancing play a critical role in maintaining this alignment. Over time, market fluctuations can cause a portfolio’s asset mix to drift from its intended allocation, increasing exposure to risk or diminishing potential returns. By routinely reviewing and rebalancing the portfolio, advisers can restore the desired asset allocation, ensuring the investment strategy remains aligned with the client’s long-term objectives.

Ultimately, a disciplined approach to asset allocation enhances the likelihood of achieving short, medium and longer-term financial goals. It helps clients to navigate the market’s ups and downs with greater confidence, knowing their investments are positioned to maximise returns while staying within acceptable risk parameters. Through a well-executed asset allocation strategy, advisers can deliver a more stable and sustainable path toward financial success and thereby add value to their client relationships.

Read the full series:

Asset allocation – the value of advice (part one)

Understanding investor behaviour – the value of advice (part two)

CPD: Adviser expertise – the value of advice (part three)

———–

References:
[1] Russell Investments, Value of an Adviser, September 2024
[2] Russell Investments, Making Super Personal, 2020
[3] APRA, Quarterly MySuper Statistics Report, 31 March 2024
[4] ATO, Self-managed super funds statistical report, June 2024

The post Asset allocation – the value of advice (part one) appeared first on AdviserVoice.

Harness your expertise to add value to the client relationship.

The value of advice cannot always be readily quantified. It’s so much more than simply making money for clients, although that is a key factor. Being able to articulate value is important for advisers, particularly during periods of uncertainty and the expertise advisers bring to the table is an integral element of this value. This article, proudly sponsored by Russell Investments, examines the value of financial advisers.

Financial advisers play a crucial role in supporting their clients by assisting them to assess their changing goals, needs and circumstances. Their significance becomes even more pronounced during times of transition and uncertainty. Consider the current environment: geopolitical unrest in different corners of the world, volatility in financial markets, increasing interest rates and spiralling inflation in developed economies. This scenario provides challenges at both the individual and macroeconomic levels.

A comprehensive wealth management approach involves a thorough discovery process, ongoing strategic planning and continuous coordination; this can be particularly challenging when emotions are heightened, and uncertainty prevails.

Those advisers who helped their clients remain invested through the turbulence of the pandemic, who helped them understand and deal with market volatility, who worked with them to re-evaluate goals and objectives through rising rates and inflation, can look back with a real sense of having provided true value.

To help you articulate that value, a recent paper^[1] detailed the five factors that measure and quantify the value advisers bring to the table. These factors are:

• asset allocation
• behavioural coaching
• helping clients through choices and trade-offs
• expertise
• tax savvy planning.

Parts one and two of this series examined the importance of asset allocation and understanding investor behaviour as key inputs into the measurement of adviser value. Asset allocation can have a significant impact on whether a client achieves their investment goals; analysis has found that it drives more than 85%^[2] of the investment outcome for an individual.

Understanding investor behaviour and related coaching will help keep clients focused on the big picture and to avoid falling prey to common investor emotions during periods of market volatility. In part three of this series, the remaining three factors will be unpacked: helping clients through choices and trade-offs, demonstrating your expertise and tax savvy planning and investment.

Choices and trade-offs

Advisers provide a holistic wealth management approach throughout a client’s financial life, acting as a financial coach whose work extends far beyond investment selection. While the adviser’s role in each client’s journey will start at a different point in life, the value an adviser can add from the beginning of the relationship is crucial. As you will have experienced, most people’s lives invariably become more complex over time; the growing complexity of the regulatory environment, family situations and social security are just some of the intricacies to be navigated. To help achieve an individual’s goals, an adviser will incorporate many inputs into the design of a personalised strategy.

Inputs into holistic advice will change as clients age and go through typical life stages; from early adulthood when they are accumulating assets to late middle age when preservation becomes a focus and, finally, to older age when their accumulated assets are drawn down and planning for aged care and the intergenerational transfer of wealth take precedence (figure one).

An increasing number of people will fall into the latter category over next 40 years. The 2023 Intergenerational Report forecasts the number of Australians aged 65 and over will more than double during this period, and those aged at 85 and older are forecast to more than triple. The number of centenarians in line to receive a letter from this King or next is expected to increase six-fold.

It’s not just that Australians are ageing as an overall population, average longevity has increased significantly. In fact, life expectancies in Australia are among the highest in the world and are expected to increase by an average of four to five years over the next 40 years for both men and women^[3].

Implications

The ageing population, alongside increased longevity, means the financial affairs of a broad cross section of the community incorporate many choices and trade-offs that previous generations didn’t always face. For example:

• The so-called “bank of mum and dad” has grown rapidly with adult children asking parents to fund mortgage deposits, as longevity delays inheritance and house prices continue to climb.
• Grandparents are often asked to fund school fees as the cost of private education extends beyond the reach of parents.
• Second marriages can add an extra layer to estate planning, particularly to provide for two sets of children.
• The so-called sandwich generation must juggle the financial and emotional needs of ageing parents with those of their own children.
• Divorce in later life can sometimes leave one or both partners with financial challenges, particularly in relation to retirement funding.
• Older parents are sometimes asked to provide an early inheritance to adult children or grandchildren to supplement their income.
• Older Australians have a broader range of retirement funding options to consider, including downsizer contributions to superannuation.

Each scenario generally requires detailed preparations and careful implementation of the selected approach to ensure no party is at a disadvantage that could derail their financial future or fracture family relationships. Advisers are an important link in this planning by offering, for example, assistance in striking loan agreements for parents providing mortgage deposits to adult children. By working closely with other experts such as lawyers and accountants, advisers can draw on their knowledge – and those of other specialists –   to develop solutions that protect the interests of their clients.

This process will include explaining any implications that a lay person may not contemplate and helping to avoid situations in which important decisions are made incorrectly or not considered at all. Irrespective of the scenario, each client has their own unique circumstances, preferences and objectives that require innumerable decisions over a lifetime. In many cases, these decisions require an adviser to draw on their expertise to recalibrate a holistic plan.

Things to consider

Personal circumstances

In the accumulation phase, individuals tend to plan for major life events; these might include establishing a career, buying a home or raising a family. These priorities change as individuals enter the preservation stage before retirement. Often, their health or that of elderly parents becomes a more important consideration. Finally, the distribution phase can involve decisions related to long-term care or managing the intergenerational transfer of wealth.

Personal preferences

Each individual has personal preferences that must be integrated into financial decision making. These may include a preference for lower or higher investment risk, for low-cost investments or for investing in ethical financial products.

Advisers can suggest appropriate options and also explain any trade-offs that may be required to implement those decisions. For example, they can help price-conscious investors understand that passive investments may be in conflict with ethical principles as a result of the composition of an underlying index – and, of course, suggest alternative strategies that may achieve their underlying objectives.

External considerations

External considerations can impact a wealth strategy as much as personal preferences or personal circumstances. In 2023, this is clearly illustrated by rising interest rates and high inflation, both of which are compelling many people to reconsider their financial situation.

It is also evident in the ageing population in terms of social security needs for older Australians and inheritance events and wealth transfer for younger generations. For the former, advisers can ensure older clients take advantage of available benefits such as the Commonwealth Seniors Health Card. And for those who inherit assets, an adviser’s role is to help manage those assets and minimise any tax impacts that arise.

Articulate and demonstrate expertise

Advisers are more than financial technicians and do far more than recommend investments. They are also specialists in human behaviour who build trusted relationships with clients that allow them to deliver on their recommendations.

In the best of times, advisers help clients achieve life-long goals and celebrate personal milestones along the way. But they also support people in challenging times – through trauma, illness, financial crises, job loss and death. This unique combination of technical skill and emotional expertise that is regularly demonstrated by advisers provides a priceless form of value to their clients.

In terms of technical expertise, regulatory change and product innovation are constants in the Australian financial system. Advisers are at the frontline of interpreting change to determine both the impact and, of course, opportunities for clients.

This is a real responsibility due to the poor level of financial literacy among Australians. A 2021 survey conducted as part of the federal government’s Financial Capability Strategy found Australians scored 68 out of 100 in terms of financial literacy^[4]. There is an obvious need for improvement and advisers can help bridge the gap.

Retirement planning

Retirement planning is one of many examples where professional financial advice adds considerable value to the client. Legislative change and product innovation are quickly broadening the decisions both pre-retirees and retirees must consider as they age. The impending retirement of the majority of the Baby Boomer generation means more people than ever must establish income streams, make aged care decisions, and undertake robust estate planning.

But each of these decisions is not just financial – it involves a multitude of emotions as people leave the workforce and plan their final decades.

The empathetic adviser

The same applies to Australia’s complex social security system. The benefits available provide not just financial support but also the emotional security drawn from a government safety net. By ensuring clients access legitimate entitlements such as childcare rebates, family tax benefits or the Age Pension, advisers are helping people when they are most vulnerable.

When providing financial advice, technical proficiency plays a significant role; however, its efficacy is only part of the equation. The true hallmark of a successful relationship between adviser and client lies in the adviser’s capacity to establish a connection and cultivate trust. Beyond the numbers and strategies, the human element is essential to achieve optimal outcomes.

To deliver holistic advice, advisers must draw on essential interpersonal skills. Foremost among these is empathy, a quality that enables advisers to understand and resonate with their clients’ emotions and perspectives. Empathy allows advisers to fully understand each client’s unique circumstances and concerns and fosters a deeper connection.

Care is another indispensable element. Clients want to feel not only understood but also genuinely cared for. This goes well beyond the transactional aspects of financial advice and creates a sincere concern for the well-being and financial success of the client. Demonstrating care creates a sense of security and reassurance, reinforcing the foundation of trust in the relationship.

Finally, genuine curiosity is important to create successful client-adviser dynamics. Advisers who approach their clients with an authentic desire to understand their goals, aspirations and challenges create an environment of open communication. This curiosity not only aids the adviser to tailor financial strategies to align with the client’s unique circumstances, but also reinforces the client’s confidence in the adviser’s commitment to their financial wellbeing.

Problem-solving practitioners

Understanding financial markets and portfolio construction is key to advisers’ training and experience. Advice teams are consistently researching investment solutions by decoding technical terminology to determine what is appropriate for different clients.

The value of working with an experienced adviser is about tapping into the accumulated expertise they’ve developed over their career. Together with ongoing education, this insight grants them problem-solving skills that can be leveraged by clients at all stages of their lives.

The adviser’s role

Through good times and bad, as clients’ needs evolve, an adviser can play different roles.

Guide

A trusted adviser can help manage both the practical and emotional burden of decision making with clients who may be overwhelmed by their financial affairs. For other clients who opt for control, advisers can act as a coach, or sounding board, who provides support to the person and their family.

Guru

In many circumstances, an adviser is both an expert and voice of reason. This includes disseminating knowledge that can improve a client’s understanding as well as imparting the objective wisdom gathered during a career.

Gladiator

If needed, an adviser can be an advocate on a client’s behalf. This could mean challenging a refused insurance claim, chasing beneficiary payments or managing the administration of finances. This allows a client and their family to focus on what is important to them at that point in time.

Tax savvy planning and investing

Tax knowledge is as much part of an adviser’s role as a grasp of markets or estate planning. In fact, the importance of tax know-how becomes more critical every year. This is perhaps most obvious in superannuation due to the continued introduction of caps designed to limit the amount of capital that people can hold in tax-effective retirement funds. it is, however, equally important outside superannuation, in both investing and social security related matters.

Super-charged retirement

Salary sacrifice is one of the most potent tax-effective investment strategies advisers can implement across a majority of their working-age client base.

For older clients, transition to retirement strategies can deliver real benefits by allowing people to add extra to super without reducing their take-home pay. But such strategies can prove complicated for individuals to arrange without the help of an adviser who has a working knowledge of all the requirements.

And, for those with a higher super balance, alternative vehicles such as investment bonds and company structures are an option worth considering as the proposed implementation of an additional tax on earnings on super balances above $3 million draws closer.

Advisers can walk clients through these sometimes complicated alternatives – explaining both the pros and cons – and undertake any implementation on their behalf to ensure it is completed in an optimal fashion.

Beyond super

Outside this planning, advisers can provide expert guidance on a range of tax-related matters such as:

• Investment solutions that use low turnover strategies, tax minimisation overlays or centralised portfolio management
• Insurance strategies that allow clients to hold polices in super, thereby providing tax benefits that can be reinvested
• Entitlement to social security payments such as the Childcare Subsidy, Family Tax Benefit and Parental Leave Pay
• Eligibility for seniors’ benefits such as the Age Pension, Commonwealth Seniors Health Card and Home Equity Access Scheme
• Small business grants and incentive payments.

Getting it right

Individuals can easily be wrong-footed by tax rules and face penalties for decisions that advisers would foresee and prevent. The fact that only 12 percent of people consider overall tax effectiveness as among the top three considerations when making investments^[5] highlights the crucial role advisers can play in guiding clients to better wealth outcomes.

It’s important to note that tax is not just the realm of the accounting profession and not limited to the items included in an individual’s tax return. By reinforcing these key points to clients, advisers have a significant opportunity to establish their credentials as invaluable service providers over each client’s entire life.

Continued economic uncertainty and geopolitical tension provide an ideal time for advisers to reassess the full value they offer to their clients – and to articulate it to them clearly.

Many advisers have worked with clients during recent market volatility to help them stick to planned investment strategies and navigate other areas of their financial affairs. By helping clients avoid the behavioural mistakes that many investors made in the market turbulence, you’ve likely already provided value far above and beyond your fee.

Add to that your other services – appropriate asset allocation, customised client experience and the expertise you provide, as well as the savings from a tax-effective approach – it seems clear that the total value advisers deliver to their clients is significant. Focus on the value you provide, and your clients will more readily recognise and appreciate it.

Notes:
[1] Russell Investments, Value of an Adviser, 2023
[2] Russell Investments, Making Super Personal White Paper, 2020
[3] Australian Treasury, Intergenerational Report 2023, August 2023
[4] Australian government national financial capability survey 2021
[5] ASX Australian Investor Study 2023

The post The value of advice – harness your expertise appeared first on AdviserVoice.

Understanding asset allocation is vital, when it comes to advising clients and articulating the value of your advice.

Advisers are never more important than during periods of significant change. As the macro backdrop continues to evolve and volatility reigns, the need for advice and reassurance of clients is as imperative as ever. This article, proudly sponsored by Russell Investments, examines the value of advice and within that, the importance of appropriate asset allocation.

In a complex world that keeps posing challenges to investors, advisers continue to add value that enables their clients to attain their long-term financial goals. The spectre of a global recession, along with rising interest rates and inflation have created an environment of extreme caution in 2023, just three years after a global pandemic swept through markets to test investors’ fortitude.

In this environment, Australians have relied on their financial advisers heavily to navigate both the practical and emotional aspects of investing. Advisers have provided invaluable assistance, helping their clients to review their evolving goals, needs and circumstances in an uncertain environment.

This holistic wealth management requires a deep discovery process, planning and ongoing coordination, not always easy when clients’ anxiety runs high. As priorities and outlooks may have changed over the course of the pandemic and beyond, the adviser-client relationship has proved fruitful not just in periods when markets fell, but also when assets rose to buoy portfolio gains.

Those advisers who helped their clients remain invested through the turbulence, who helped them prepare for an uncertain future, who worked with them to determine their post pandemic goals, can look back with a real sense of having provided true value.

How then, can you best articulate that value? A recent paper^[1] detailed the five factors that measure and provide true adviser value to clients:

• asset allocation
• coaching
• helping clients through choices and trade offs
• expertise
• tax savvy planning and investment.

This article will examine the first of these factors, asset allocation.

Under the spotlight: asset allocation

Asset allocation is a fundamental investment principle and serves as the cornerstone for achieving long-term financial objectives. It can be described as the strategic distribution of investor capital across various asset classes, which may include shares, fixed income, alternatives, real assets such as property and infrastructure, and cash. The significance of asset allocation lies in its ability to balance risk and return, thereby optimising the potential for each client to achieve their specific investment goals.

Appropriate asset allocation is a crucial aspect of a well-rounded investment strategy; it’s not just about maximising returns, but also managing risk. In this context, risk means volatility and the potential for fluctuations in the value of your clients’ investments.

Volatility can be unsettling for many investors, leading them to question their investment decisions and make impulsive decisions. Different asset classes have distinct risk profiles and, by spreading investments across multiple asset classes, an adviser can mitigate the impact of a severe downturn in any one area. If a portfolio is heavily concentrated in a single asset class, it becomes susceptible to extreme swings in value, potentially leading to significant losses. In contrast, a well-diversified portfolio is better positioned to weather market fluctuations.

Asset allocation is an important tool to align investments with an individual’s risk tolerance and their financial goals. A younger investor with a long investment horizon and a higher risk tolerance might allocate a larger portion of their portfolio to growth assets, which historically offer higher potential returns over the longer term. Conversely, an investor closer to retirement may opt for a more defensive allocation, with a greater emphasis on securities more likely to preserve capital and generate income.

Asset allocation enables advisers to capitalise on the benefits of different economic cycles, further adding value to their clients. Because asset classes often perform differently in varied economic environments, advisers can modify portfolios accordingly. By strategically adjusting the weighting of assets in response to economic conditions, advisers can potentially enhance the returns and reduce overall portfolio risk experienced by their clients.

Importantly, following a designated asset allocation approach allows for advisers to rebalance portfolio as required; this is crucial for maintaining each clients’ desired risk-return profile. Over time, original asset allocation can drift due to market movements. Being able to ensure a client’s portfolio stays aligned with clients’ objectives and risk tolerance is an important component of the value advice can add.

Asset allocation can also help advisers set realistic expectations. Different asset classes have historically delivered varying levels of returns. By understanding the historical performance of each asset class and the potential risks involved, advisers can establish realistic expectations for their clients’ investment outcomes. This knowledge forms the basis for setting achievable financial goals and helps to manage expectations during periods of market volatility.

Realistic expectations help advisers promote disciplined investing, so their clients avoid impulsive decisions driven by short-term market fluctuations or emotions. These reactions often occur at precisely the wrong times, typically when the market is experiencing a downturn. Instead of reacting to market noise, an allocation strategy can provide a framework for making informed investment decisions. This disciplined approach fosters patience and reduces the likelihood of clients making costly mistakes.

It’s not just volatile times that can prove challenging. During periods of prolonged market upswings, investors may become complacent and underestimate the significance of a professionally managed portfolio. In these times, self-directed investment portfolios can gradually deviate from their initial asset allocation. This deviation can be perilous, as it may expose the investor to higher levels of risk than they initially intended.

This is where disciplined asset allocation and rebalancing come into play. By regularly reviewing and adjusting the asset allocation, a well-managed portfolio can maintain its original balance of assets. This is crucial because it ensures that the portfolio remains aligned with the investor’s stated financial objectives.

Appropriate asset allocation

In bull markets, it can be easy to underestimate the value of a professionally managed portfolio. During these periods, self-directed investment portfolios often drift away from the initial asset allocation. A disciplined approach to portfolio management and rebalancing can ensure a portfolio retains its original asset allocation – and therefore remains appropriate for an investor’s stated goals – while also potentially reducing risk.

How an individual is invested has a huge impact on achieving their investment goals. Many non-advised investors believe market timing or investment selection are the greatest determinants of portfolio success…but they would be wrong. Rather, it is asset allocation that’s at the heart of every investment strategy, determining more than 85% of the outcome for an individual ahead of the selection of the actual assets within a portfolio^[2].

This known investment truth is becoming even more apparent as the range of investment opportunities increases, encompassing asset classes that didn’t exist until recently and remain difficult for retail investors to access.

It is also, though, perhaps the most underestimated element of financial advice by the general public. Retail investors are more inclined to remember the returns of individual stocks – such as this year’s gains from the so-called magnificent seven AI stocks – than how asset allocation laid the foundation for overall risk-adjusted returns.

Analysis shows that carefully considered asset allocation, which takes into account the needs of an individual, can add value of up to 1.2% per annum^[3].

Asset allocation: who benefits most?

There are generally two types of non-advised superannuation investor. The first category (case study one) is the disengaged investor, who either consciously or unconsciously opt for the one-sized-fits-many default options offered by their funds. By definition, these default options take limited – if any – account of personal circumstance or needs.

The second category are those engaged investors who build their own portfolios (case study two) but can sometimes find themselves falling foul of risks that they have not considered when allocating capital to different assets.

Case study one: The disengaged investor

More than 63% of the $996 billion in MySuper investments is allocated to single strategy options^[4]. This means members, irrespective of age, super balance or retirement goals, are invested in the same way as everyone else.

This case study uses Jane as an example. Her adviser recommended an allocation of 80% to growth assets after conducting an analysis that considered her age, investment goals, superannuation balance and other preferences.

Her hypothetical portfolio could deliver an annualised return of 7.8% over a 10-year period, versus the 6.6% gain from a default superannuation fund with a 70% allocation to growth assets.

Her potential extra gain of 1.2% means her retirement savings could be worth $210,947 after 10 years – or $21,818 more than if she invested in a default portfolio.

Case study two: The self-directed asset allocator

There are inherent risks in a DIY approach to asset allocation that can limit investment returns, ranging from a lack of investment know-how to ill-discipline that prevents an individual from implementing a strategy and reweighting it as required.

The increasingly complex world of investing requires an in-depth knowledge of markets, economics and geopolitics that is difficult for individuals to both attain and maintain. Advisers can fill this gap by offering an insight into alternative assets which make up a larger part of institutional-grade portfolios than previously, such as private debt and infrastructure.

The above factors are reflected in Australian Taxation Office statistics which consistently show self-managed super funds (SMSFs) have a relatively high allocation to cash. The latest figures show SMSFs had a 16% allocation to cash at March 2023^[5]. Such conservative asset allocations can hold investors back if they require capital growth to meet their retirement goals.

For example, Lee has a SMSF he manages on his own. It holds over 70% in cash and other defensive assets, even though an adviser may recommend that over half his portfolio should be in growth assets given his circumstances and objectives.

Indeed, Lee’s portfolio could deliver a hypothetical return of 4.3% over 10 years versus a return of 5.7% from a portfolio split equally between growth and investment assets. The significant difference of 1.4% could be reduced if Lee sought assistance from a financial adviser to determine the asset allocation best suited to his needs.

Based on an initial $100,000 balance, after 10 years Lee might have $152,936 in the more conservative portfolio versus a balance of $174,575 for the advised portfolio.

By investing in a DIY portfolio, Lee could be $22,000 worse off after a decade. In periods of steadily rising markets, it can be easy for people to underestimate the value of a professionally run portfolio. The danger, however, is that a DIY allocation will drift away from its initial position.

A more disciplined approach to portfolio management by advisers can ensure the original intent is maintained and the asset allocation remains appropriate for an investor’s stated needs.

In both case studies, professional advice could help prevent the investors from falling behind in their retirement planning.

Appropriate asset allocation is about far more than simply chasing high returns. It’s about crafting a strategy that safeguards against unnecessary risk and aligns with your clients’ financial goals. Through diligent portfolio management and regular rebalancing, advisers can maintain this alignment, potentially reducing risk and increasing the likelihood of achieving their clients’ long-term financial objectives.]

Notes:
[1] Russell Investments, Value of an Adviser, September 2023
[2] Russell Investments, Making Super Personal, White Paper 2020
[3] Russell Investments, Value of an Adviser, September 2023
[4] APRA, Quarterly MySuper Statistics Report, 30 June 2023
[5] ATO, SMSF quarterly statistical report March 2023

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There are strategies to optimise client meetings when dealing with challenging client conversations.

A financial adviser’s job is to guide and advise their clients on managing and maximising their finances in a way that meets the client’s objectives…it’s therefore crucial for them to have effective client meetings. This article, sponsored by Russell Investments, provides strategies for effective client meetings and the sometimes challenging conversations that can arise.

Client meetings provide an opportunity for advisers to truly engage with their clients, listen to their concerns, understand their lifestyle and financial goals, and develop a plan that suits their needs. It also builds trust between the adviser and client, as the client recognises that their adviser genuinely cares about their financial well-being.

The 3 P’s of effective meetings

Effective client meetings between financial advisers and their clients are underpinned by three essential components: Perspective, Process, and Poise (figure one). These elements collectively contribute to fostering meaningful interactions and ensuring the success of these meetings.

Perspective

One of the fundamental goals of financial adviser-client meetings is to provide clients with a broader perspective on various fundamental aspects of their finances. In a world inundated with news, market trends and economic updates, clients often find it challenging to decipher the information’s true significance. The recent period of market volatility, largely in response to rising inflation and interest rates, has made perspective all that more important.

This reinforces the importance of the financial adviser’s role in offering context and clarity. By distilling complex financial concepts into understandable terms, advisers enable clients to navigate the sea of information – and misinformation – with confidence. This not only enhances the client’s comprehension of world events and market fluctuations, but it also showcases the value of having a knowledgeable guide. The ability to provide perspective instils a sense of trust in the relationship, reinforcing the understanding that expertise extends well beyond the numbers.

Any good meeting requires advance preparation. Advisers should gather and reflect on a range of materials to help the conversation with their client go smoothly. For example, market insights keep advisers abreast of what’s happening in investment markets globally. Resources are widely available from research providers, fund managers and dealer groups, and could include:

• latest market news and insights
• gblobal market outlook
• weekly market updates
• expert video commentary
• podcasts.

Poise

The significance of effective communication during client meetings cannot be overstated. The term ‘poise’ encapsulates the art of conducting conversations with intention, empathy and authenticity.

Financial advisers should be mindful of the words they choose, ensuring that their communication is clear and relevant. Equally important is the skill of active listening, where advisers genuinely engage with their clients’ concerns and objectives. By asking probing questions and showing genuine interest, advisers create an environment where clients feel valued and understood. It also helps you truly understand your client, their needs and objectives over the near and long term.

Empathy, a cornerstone of effective poise, enables advisers to appreciate the emotional aspects of financial decisions and provide tailored solutions that resonate with the client’s individual circumstances. Ultimately, poise in communication sets the stage for a productive exchange that addresses financial goals, emotional well-being and a sound understanding of the journey.

Process

A structured and transparent process is pivotal in guiding financial adviser-client meetings towards successful outcomes. A process-driven approach underscores the professionalism and expertise of the adviser.

During these meetings, advisers should plan to walk clients through a carefully constructed process, designed to align with each client’s unique financial situation, aspirations, and risk tolerance. By detailing the client-centred approach, advisers demystify the complexities of financial planning.

Transparency builds confidence in the adviser’s capabilities and fosters a deeper understanding of how decisions are made. In addition, discussing specific aspects such as the client’s financial plan and portfolio adjustments within the context of a defined process enhances the client’s appreciation of the long-term journey towards meeting their financial goals.

It’s important that advisers prepare their talking points in advance of the meeting and send an agenda to the client at least three business days prior to the meeting. A sample agenda is provided in figure two.

Steps to optimise the client’s experience

Be personable

Interacting effectively with clients is a cornerstone of successful financial advice and imperative for a successful client meeting. To ensure a strong and enduring relationship with their clients, financial advisers should prioritise being personable and empathetic.

Rather than immediately jumping into the formal agenda, an interaction that begins with genuine interest in the client’s well-being is more likely to optimise the client experience. Taking a moment for personal conversation not only establishes and builds rapport but also provides an opportunity to gauge the client’s emotional state. By understanding the client’s current feelings and concerns, advisers can tailor their approach to suit the client’s needs, both financial and emotional. This fosters an environment of trust and comfort.

Speak the client’s language

In addition to being personable, speaking the client’s language is paramount. Financial jargon can sometimes be overwhelming and confusing to those in the industry, doubly so for those not well-versed in the field.

A skilled adviser takes the time to explain concepts and strategies in a clear and understandable manner and avoids unnecessary complexity. Speaking in plain English not only demonstrates expertise but also empowers clients to make informed decisions about their financial future.

By bridging the communication gap, advisers show that they genuinely care about their clients’ comprehension and are committed to guiding them through the complexities of financial planning.

Stay focused

Maintaining focus during client interactions is a critical aspect of effective client meetings. Once the personal connection is established and the emotional landscape is understood, advisers should transition to the meeting’s agenda.

A well-structured meeting agenda provides a roadmap for discussions and ensures that both parties stay on track. Walking the client through the agenda not only gives them a clear sense of what to expect but also encourages transparency and collaboration.

Advisers should also actively invite their clients to share any topics they’d like to add to the agenda; this demonstrates a commitment to addressing the client’s unique concerns, interests and needs.

Challenging client conversations

When navigating uncertain environments, many clients want to have calming, effective conversations with their financial adviser. Clients want reassurance that their adviser understands their priorities and fears, can relate to their perspective and clearly explain how their financial goals will be met, whatever is happening in the external environment.

To deal with potentially challenging client conversations, advisers can draw on the ALEC framework to reframe the challenge as a coaching opportunity. ALEC encompasses a range of communication and personal skills that are crucial for effective client interactions. These skills include posing open-ended questions, displaying genuine attentiveness while listening, demonstrating empathy and being able to educate the client.

Ask

Asking open-ended questions can prove invaluable when trying to extract the rationale that underpins a client’s concerns. All advisers will have encountered situations where clients inadvertently channel their grievances towards unrelated matters. Addressing these misplaced grievances merely treats the symptoms but does not provide a cure. In fact, providing only temporary relief generally results in the underlying issue resurfacing with even greater intensity in the future.

For example, when a client questions underperformance, the adviser should consider employing open-ended questions instead of resorting to pre-prepared charts and tables.

For example:

“I understand your apprehension. Could you specify the timeframe you’re focusing on?”

“I appreciate your concerns. What were your expectations regarding the returns on this portfolio?”

“I acknowledge your worries. How do you define success?”

Open ended questions enable the adviser to delve more deeply into the challenge and provide clearer guidance for providing the appropriate information and education.

Listen

Being an active listener is one of an adviser’s most effective tools – resisting the impulse to interrupt is vital!

Beyond the client’s spoken words, it’s also important to observe non-verbal cues during the discussion; this enables the listener to garner additional insights into the client’s emotional state. This can include gestures and facial expressions, as well as instances where the client averts their gaze, pauses or makes postural shifts. It’s also important to pay attention to shifts in the client’s tone.

Paying attention and responding to these cues enables the adviser to better deliver empathy and coaching.

Empathise

When clients interact with their adviser, they seek validation that their priorities and concerns are understood. There are ways the adviser can convey that they are genuinely empathising with their circumstances and respect their perspective. For example, using phrases such as:

“Thank you so much for sharing that perspective with me, I see it’s an issue that’s worrying you.”

“I appreciate your viewpoint – it’s evident this matter is of concern to you.”

“Before making any investment decisions, I always go back to principles first, just to make sure I’m not getting caught up in emotions that might feel right but are unlikely to add up mathematically.”

“While we can’t control or predict performance, we can prepare and strategise for any changing market conditions by adjusting asset allocation, a factor within our control.”

Demonstrating empathy validates the challenge, confirms and acknowledges its existence, which then paves the way for productive coaching to overcome the challenge and improve client understanding.

Coach

Recent market volatility has likely created anxiety among investors, which can lead clients to question some of the basic tenets of investing and the potential impact on their financial success. Financial advisers who coach clients on the timeless concepts – such as maintaining a long-term investment horizon and understanding the realities of market cycles – are better placed to demonstrate the value they bring to the relationship. This, in turn, can convert challenging conversations into relationships built on trust and respect.

Guiding clients through these challenging conversations requires advisers to leverage their experience and insights to redirect the client’s emotions. Asking questions, actively listening and being empathetic will help guide the conversation and facilitate coaching.

In essence, the ALEC framework encompasses a spectrum of skills that, when applied adeptly, empower advisers to foster constructive client interactions, address concerns effectively, and provide valuable guidance to their clients.

The art of interacting with clients requires the financial adviser to be personable and empathetic, through which a strong foundation of trust and understanding can be established. Speaking the client’s language and listening to them ensures effective communication and comprehension of complex financial concepts. These elements, combined with the ALEC framework, will contribute to a positive and meaningful client-adviser relationship, driving successful financial outcomes and long-term satisfaction.

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What are the changes to superannuation that came into effect on 1 July 2023 and how these changes might impact their clients?

In the ever-evolving world of finance, few sectors experience transformations as regularly as superannuation. Each year, as the calendar ticks over to 1 July, the superannuation landscape witnesses a series of changes, ranging from subtle adjustments to profound overhauls. This article, proudly sponsored by Russell Investments, outlines this year’s changes and how they can impact your clients.

With every passing year, the governments and related bodies implement changes to the superannuation sector with varied objectives in mind. Some of these changes may be driven by economic factors, others by policy adjustments or the need to address societal challenges. Financial year 2024 is no different.

As superannuation becomes an increasingly large component of retirement savings, the importance of staying informed about all changes, large and small, cannot be overstated. Superannuation holds the potential to shape retirement plans and financial security for the estimated five million retired Australians – and the wave of baby boomers approaching this next phase of life.

A number of changes were made to superannuation rules, effective from 1 July 2023. These include rules to increase the ATO’s visibility over unpaid super and changes to the transfer balance caps. From this date, superannuation guarantee contributions rose to 11% and minimum pension withdrawals reverted to normal levels.

Let’s explore some of these changes in greater detail.

Annual drawdown requirements

Each tax year, super fund members in retirement phase are required to be paid at least the minimum legislated pension from their pension account. This annual minimum amount is based on each client’s age and expressed as a percentage of the balance of their pension account as at 1 July or when they commence their pension (whichever occurs later).

In response to Covid-19, the federal government temporarily reduced superannuation minimum drawdown requirements for Account Based Pensions and similar products by 50%. From 1 July 2023, minimum drawdown rates revert to prior levels (figure one); as this affects the year ahead, you or your clients may need to revisit any reoccurring pension amounts that were established or adjusted in the 2019–20, 2020–21, 2021–22 or 2022–23 financial years.

Drawdowns and SMSFs

SMSF trustees who plan to receive income from more than one pension account must ensure they have clear documentation to demonstrate that they’re meeting the minimum pension payment requirements for all pensions involved. A failure to do so may make them ineligible for exempt (tax free) pension income on the pension that does not meet the minimum pension requirement.

Increasing the ATO’s visibility

The ATO’s visibility across unpaid super entitlements will be enhanced under the ‘Securing Australians’ Superannuation Package’. The federal government has allocated $27 million to the ATO to improve its data capabilities, which includes matching employer and super fund data to readily identify instances of underpayment of the superannuation guarantee by employers.

In addition, the ATO has been allocated a further $13.2 million to co-design a new compliance system to proactively identify occurrences where the superannuation guarantee contribution is underpaid.

To further demonstrate the government’s commitment to ensuring payment of superannuation guarantee entitlements, it has set targets to assess the ATO on the recovery of unpaid superannuation.

Those of your clients who run businesses and have employees should be aware that the ATO has increased its resources to detect non-compliance with the superannuation guarantee regime and ensure they have established schedules to ensure inadvertent non-payment.

Transfer caps

The Total Super Balance (TSB) Cap, which determines eligibility to make non-concessional contributions in any given year for individuals up to the age of 75, increased from $1.7m to $1.9m. Those of your clients with balances less than $1.9m have the opportunity to contribute further to their superannuation fund.

The Transfer Balance Cap (TBC), a lifetime limit on the total amount of super that can be transferred into tax-free retirement phase income streams, also increased from $1.7m to $1.9m. Clients with super funds in retirement phase that have utilised the full transfer balance amount in prior years are not entitled to this indexation increase. However, those clients yet to enter retirement phase have the opportunity to transfer up to the new cap limit.

All transfer balance events, such the commencement of a pension, must be reported to the ATO on a quarterly basis from 1 July 2023.

Transfer caps and SMSF reporting

SMSFs that have members in the retirement phase will be required to report certain events that affect their members’ Transfer Balance Accounts (TBA) on a quarterly basis from 1 July 2023.

This requires SMSF trustees to lodge a Transfer Balance Account Reporting (TBAR) form 28 days after the end of the quarter in which a reportable event has occurred. Events that occurred in the 2023 financial year are also captured; all reportable events that occur from 1 July 2022-30 September 2023 will have a reporting date of 28 October 2023.

Reportable events include those that affect a member’s transfer balance account^[1]:

• Details of when a member starts a retirement phase income stream, including death benefit income streams.
• Details of limited recourse borrowing arrangement (LRBA) payments if the arrangement was entered into, on, or after 1 July 2017 or a pre-existing LRBA was re-financed on or after 1 July 2017 and the payment results in an increase in the value of the member’s interest supporting their retirement phase income stream.
• Compliance with a commutation authority issued by the ATO.
• The details, including value, of personal injury (structured settlement) contributions.

If there is no event, your client has nothing to report.

Non-reportable events include^[2]:

• Pension payments
• Investment earnings and losses
• When an income stream ceases because the interest has been exhausted
• Death of a member
• Family law payment splits
• Debit events including fraud, dishonesty, or bankruptcy.

Any client who acts as a trustee of an SMSF needs understand these obligations and ensure their TBAR reporting is accurate and timely. An SMSF may be subject to compliance action and penalties from the ATO if they do not make TBAR lodgements on time or respond to an ATO commissioner commutation authority.

Non-compliance with a commutation authority may result in denying exempt pension income claims, which can impact the tax position of your client or another member of the SMSF in retirement phase.

The ATO describes this change as one intended to provide members and the ATO with more timely and accurate information in managing transfer balance accounts and caps and warns of adverse consequences that may be costly to the SMSF trustee if timely reporting is not complete.

Contribution caps

Both the concessional and non-concessional contribution caps remain unchanged for the 2024 financial year.

Concessional contribution cap at $27,000

It’s important to remind clients that concessional contributions include employer superannuation guarantee contributions (now at 11 percent), salary sacrifice contributions and other voluntary contributions. If a client’s employer subsidises administration costs or pays insurance premiums on the client’s behalf, these amounts also count towards their concessional contribution limit.

Carry-forward concessional contributions allow clients to carry forward their unused contributions caps from prior years, as long as their super balance did not exceed $500,000 at the prior 30 June. Unused amounts are available for a maximum of five years.

Non-concessional contribution cap at $110,000

These contributions are those made by your client from their after tax earnings. The work test no longer applies to non-concessional contributions, meaning eligible clients can make such contributions until they turn 75.

However, the work test must still be met for personal deductible contributions. So, if a client aged 67 and above wants to claim a tax deduction for a personal contribution made to their super this financial year, work test requirements remain in place.

Government co-contribution income thresholds

The government co-contribution scheme is an incentive for individuals to make personal contributions to their super account. In the situation where a client has a non-working or low income spouse, it’s a good way to build up that individual’s super fund.

The government co-contributes up to 50c for every $1 that the individual contributes, capped at $500 and paid when the individual lodges their tax return. The co-contribution decreases progressively as the income increases.

For the 2024 financial year, the lowest income threshold has increased to $43,445 p.a. and highest income threshold has increased to $58,445 p.a.

Reduced tax concessions

Although it does not come into effect until 1 July 2025, the ‘Better Targeted Superannuation Concessions’ measures need to factor into client plans for those with a high super balance. From this date, any clients with a super balance exceeding $3 million will be subject to an additional 15 percent tax on investment earnings on that portion of their super balance which exceeds $3 million. This takes the tax rate on those earnings to 30 percent.

Investment earnings on assets below $3 million will continue to be taxed at 15 percent if held in an accumulation or defined benefit account, and 0 if held in a retirement pension account.

Downsizer contribution

Introduced on 1 July 2018, the federal government’s downsizer contribution allows older Australians to top up their super with some of the proceeds of selling their main residence. The contribution does not count toward their annual non-concessional cap.

From 1 January 2023, eligibility age was lowered from age 60 to 55. Proceeds from the sale of a client’s main residence can be contributed to super – up to $300,000 for singles or $600,000 for couples. No work test or upper age limits apply to downsizer contributions.

By lowering the qualification age, the government had two aims: to enable more pre-retirees to use the downsizer contribution to get a greater amount of savings into super earlier, thereby benefiting from investing in the tax effective environment offered by super, and to increase available ‘family sized’ housing stock.

Eligibility requirements for the downsizer contribution include^[3]:

• Your client/s are 55 years or older at the time they make a downsizer contribution.
• The home was owned by your client and/or their spouse for 10 years or more prior to the sale.
• The home is in Australia and is not a caravan, houseboat or other mobile home.
• The proceeds (capital gain or loss) from the sale of the home are either exempt or partially exempt from capital gains tax (CGT) under the main residence exemption, or would be entitled to such an exemption if the home was a CGT rather than a pre-CGT (acquired before 20 September 1985) asset.
• The client has provided their super fund with the ‘downsizer contribution into super’ form either before or at the time of making their downsizer contribution.
• The downsizer contribution is made within 90 days of receiving the proceeds of sale, usually at the date of settlement.
• Your client has not previously made a downsizer contribution from the sale of another home.

The changes to the superannuation landscape as of 1 July 2023 were not as significant as some previous years. However, it’s important to understand the key amendments because superannuation plays an increasingly pivotal role in shaping retirement plans and financial security for millions of Australians.

As financial advisers, it is imperative to communicate these changes effectively to clients and guide them in navigating the evolving superannuation landscape. By understanding the impact of these changes, advisers can assist their clients to make informed decisions to secure their financial future and achieve their retirement goals. Staying ahead of the curve in the ever-changing world of superannuation is key to providing clients with sound financial advice and ensuring their long term financial wellbeing.

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Notes:
[1] Source: ATO
[2] Ibid.
[3] Ibid.

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Understanding of the benefits of managed accounts can help navigate and protect your clients through periods of market volatility.

Australia’s burgeoning managed accounts industry has transformed the ease and efficiency with which advisers can both run a business and best serve their clients. This has been particularly evident during the bouts of market volatility that have impacted investors over the past three years, since the Covid-19 pandemic first upset world markets in March 2020.

Despite this volatility, the managed accounts landscape has continued to evolve and grow. In the six months to 31 December 2022, managed accounts reached another new peak, with funds under management registering a high of $144.5 billion, an increase of nearly 10 percent on December 2021^[1].

This funds under management figure equates to inflows in excess of $10 billion over the last six months of 2022. This, according to the Institute of Managed Account Professionals, demonstrates the important role managed accounts hold as a core service for financial advisers and their clients^[2]. This is borne out by the annual managed accounts report from Investment Trends^[3] that surveyed 632 advisers and found that 56 percent use managed accounts today, a significant increase from 17 percent a decade ago.

There’s no doubt that managed accounts are gaining in popularity and for good reason. If you want to read more about managed accounts and how they work, this earlier article provides an overview.

Market driven evolution

The market-driven evolution of managed accounts has revolutionised the financial advisory landscape, offering a powerful combination of business efficiencies, lower fees, and transparent investment outcomes. This is a transformative change, one which highlights the potential to generate better outcomes for both financial advisers and their clients over time. There are several reasons behind this paradigm shift.

In the first instance, managed accounts introduce significant business efficiencies for financial advisers. Traditional investment management often involves manual processes, paperwork and time-consuming administrative tasks. With managed accounts, these processes are streamlined through automation and technology. As researcher Investment Trends found, managed accounts can deliver real time savings to advisory practices, with advisers saving an average of 15.7 hours per week^[4].

By leveraging digital platforms and robust portfolio management systems, advisers can efficiently create, manage and rebalance portfolios on behalf of their clients. This automation frees up valuable time for advisers to focus on more strategic aspects of their business, such as client relationship building, client education and providing personalised financial advice.

Managed accounts also enable financial advisers to scale their business effectively. With more traditional approaches to financial advice, servicing a growing number of clients can be challenging due to the labour-intensive and compliance heavy nature of the process.

Managed accounts, however, offer the ability to handle a larger client base without compromising the quality of service. The streamlined processes, combined with automation, allow advisers to efficiently manage a larger number of clients. This means advisers can expand their business and increase their revenue potential.

Importantly, managed accounts provide transparent investment outcomes, important for both financial advisers and their clients. Traditional investment management often lacks transparency; clients often have limited visibility into the underlying investments and trading activities. For example, most clients – unless they have a self-managed superannuation fund – are unlikely to know what investments are held by their super fund, despite it being, in most cases, a significant component of their retirement savings.

This concern is ably addressed by managed accounts, through the comprehensive reporting and transparency provided. Clients can access real-time information about portfolio holdings, performance and transactions. This transparency builds trust between advisers and clients because clients can clearly understand how their investments are being managed and track progress towards their financial goals. Trust is an essential component of long-term business relationships.

Transparency of managed accounts also enables advisers to have more meaningful conversations with their clients. By having access to detailed portfolio information, advisers can provide personalised advice tailored to each client’s circumstances and in many cases, client values. The increased propensity for investors to be cognisant of environmental, social and governance factors has led to many wanting to specially include or exclude specific funds, industries or stocks from their portfolio.

A high level of customisation also enhances the overall client experience and fosters stronger adviser-client relationships. Advisers are supported and well informed with respect to client conversations about risk management, tax implications and investment strategies. In turn, this can lead to better investment decisions and improved client outcomes.

Comprehensive reporting and transparency mean that managed accounts provide enhanced oversight of a consolidated portfolio. This, combined with the enhanced functionality of managed accounts, means advisers – and their clients – are better positioned when it comes to periods of market volatility.

Managed accounts and volatility

Consider the recent market volatility first triggered by the collapse of Silicon Valley Bank in March. Managed account providers with multi-manager options that each tap into upwards of 75 global asset managers could tilt in and out of markets at different points of time to provide active management without the need for a planner to provide a statement of advice to clients when underlying funds are swapped. This provides advisers not just with best-of-breed investment prowess in a period when it’s most needed, but also with the ability to concentrate on providing counsel to clients whose nerves may be rattled by market turbulence.

Managed accounts provide valuable tools and features that can help financial advisers and investors weather market volatility more effectively. Managed accounts offer several advantages in this regard.

Diversification and risk management

Managed accounts typically employ a diversified investment approach, spreading investments across different asset classes, sectors, and geographies. This diversification helps reduce concentration risk and provides a buffer against market volatility.

In fact, well-constructed managed accounts can provide several additional layers of diversification in their asset mix to provide a welcome cushion to clients in down markets and access to the best investment ideas throughout the cycle. This could include passive exchange-traded funds which work to achieve both cost and benchmark-tracking targets, or a factor-based portfolio of select direct equities that is rebalanced on a semi-regular basis, in addition to active funds.

By spreading investments, managed accounts can potentially mitigate the impact of a downturn in a specific asset class or market segment. Additionally, professional portfolio managers monitor and adjust the allocations within managed accounts to align with changing market conditions and risk profiles, helping to manage risk and adapt to market volatility.

Active portfolio management

Active portfolio management helps ensure that portfolios are aligned with clients’ goals and risk tolerance, increasing the potential for better outcomes in volatile market environments. Managed accounts often employ active portfolio management strategies, which involve ongoing monitoring and adjustments to portfolios based on market conditions.

Advisers, of their own volition, can also use managed account infrastructure to alter portfolios across an entire client book in a single step. This enables financial advisers to respond swiftly to market volatility by making necessary changes to asset allocations, to rebalance portfolios and take advantage of potential opportunities that arise during periods of volatility.

In periods of heightened volatility, this capability ensures the holdings of each client can be adjusted in a measured way and appropriate timeframe to address their personal objectives. The keys to this process include the enhanced functionality of managed accounts together with the capability to transfer assets in specie without triggering capital gains tax.

Transparent and timely communication

Managed accounts provide transparent and timely communication to both financial advisers and investors. During times of market volatility, clear communication becomes crucial to assuage investor concerns and maintain confidence.

Transparency gives clients the ability to look-through to their holdings. This is an important feature that gives managed accounts a significant advantage over more costly legacy platforms because it provides investors with a greater sense of control.

Managed account platforms typically offer regular reporting, such as trade notes that explain the logic underpinning each transaction; such reporting can provide clients with confidence that their capital is being managed in the most professional manner. Other reporting often includes updates on portfolio performance and holdings, to keep investors apprised of the most up-to-date information.

Financial advisers can leverage this transparency to communicate effectively with their clients and use it to explain market conditions, the rationale behind investment decisions and clarify the strategies they’re implementing to navigate or mitigate volatility.

This communication helps foster trust and understanding and allows investors to stay focused on their long-term goals, rather than being fearful of short-term market fluctuations and potentially making rash decisions based on loss aversion.

Customisation and flexibility

Managed accounts offer a high degree of customisation and flexibility, which allows financial advisers to tailor investment strategies to meet their clients’ specific needs, objects and risk tolerance. During market volatility, different investors may have varying risk appetites and objectives – and those might differ from the ‘good times’ in the market.

Managed accounts can be adjusted to reflect individual preferences and ensure portfolios are aligned with clients’ comfort levels and long-term goals. This customisation and flexibility enable financial advisers to make portfolio adjustments as required, thereby reducing the likelihood of knee-jerk reactions to market volatility.

While managed accounts are structured so that the individual investor has beneficial ownership of the assets in the account, the management of the account can be outsourced to the financial adviser. This means the adviser can make instant changes to their client’s investments without having to prepare a statement of advice and attain the client’s consent.

This process can delay portfolio changes by days or even weeks, not ideal during periods when nimble trading will be advantageous to the client. Being able to respond so quickly means the adviser can flexibly update each client’s portfolio – individually or as a batch – to protect the portfolio or take advantage of opportunities that arise from volatile markets.

Once you add in the capacity of advisers to maximise a client’s tax position by using franking credits and the refund of excess credits, the case for using managed accounts as the primary vehicle for portfolios becomes even stronger.

Emphasis on long-term investing

Managed accounts typically have a long-term investment horizon and focus on achieving clients’ objectives over time. This emphasis on long-term investing helps investors weather market volatility by shifting the focus away from short-term fluctuations.

Financial advisers can educate their clients about the importance of staying invested and maintaining a disciplined approach during market downturns. Managed accounts support this long-term perspective by providing investors with a comprehensive view of their investment journey, demonstrating that volatility is a normal part of the market cycle and that maintaining a well-diversified, actively managed portfolio can lead to better outcomes over time.

There is good reason that Australia’s managed account industry has grown so significantly over the last few years. It has matured into an investment solution that allows advisers to deliver a transparent and cost-effective service to their clients, without compromising the quality of investments on offer or the returns that are generated.

This market-driven evolution has revolutionised the financial advice industry in several fundamental ways: by offering a powerful combination of business efficiencies, lower fees, flexibility and transparent investment outcomes. These factors work together to generate better outcomes for both financial advisers and their clients over time.

The transparency of managed accounts provides clients with a clear understanding of their investments, fosters trust and facilitates personalised advice. Importantly, managed accounts equip financial advisers and investors with valuable tools to effectively navigate market volatility. By leveraging the attributes and advantages of managed accounts, financial advisers can guide their clients through challenging market environments, instill confidence, and foster a disciplined investment approach that leads to better long-term outcomes.

In volatile markets, this enables advisers to manage risks quickly on behalf of clients to alleviate their anxieties and protect their capital. But it is equally advantageous in more steady markets as it gives advisers the critical tools that are necessary to capitalise on opportunities, while also running their own business in the most efficient manner possible.

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Notes:
[1] https://imap.asn.au/publications/perspectives/114-perspectives-autumn-2023/1117-imap-fumcensus-dec-2022.html
[2] Ibid.
[3] SPDR ETFS/Investment Trends Managed Accounts Report 2023
[4] Ibid.

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Know the rules and regulations around superannuation caps, tax, contributions and other related facts pertinent to the current financial year.

By the end of 2022, Australians had amassed $3.4 trillion in superannuation assets^[1]. As a greater number of Australians join funds, the rules that govern contributions, tax, super caps and access to those retirement savings continue to evolve. This article, sponsored by Russell Investments, provides a snapshot of superannuation in 2023.

Mark Twain is often credited with the pithy declaration “The only two certainties in life are death and taxes”; while numerous luminaries used these words before and after Mark Twain, a modern wordsmith could add “and change to Australia’s superannuation system” as a third certainty. We know that advisers – and your clients – are besieged with changes to the system: changes to contributions, both the quantum and how they are taxed, at what thresholds different taxes are applied, how and when super can be accessed, changing caps…the list is long and onerous.

However, the importance of superannuation as a retirement savings vehicle remains undiminished. There are tax advantages to saving inside superannuation, as well as a range of strategies to help your clients amass retirement savings, make the most of tax efficient savings and eventually enjoy a comfortable retirement.

Contributions

There are limits applied to both concessional and non-concessional contributions that restrict the amount your clients can contribute to superannuation each year before incurring additional tax.

Concessional contributions are those made before tax and include super guarantee (SG) contributions made by employers, personal contributions for which your client can claim a tax deduction and salary sacrifice contributions.

If your client’s employer subsidises any administration costs or pays insurance premiums on their behalf, these amounts also count towards the concessional contribution limit. There are special rules to calculate concessional contributions for Defined Benefit (DB) members. The tax rate for concessional contributions remains at 15%.

Non-concessional contributions are after tax contributions. To make a non-concessional contributions, your client must be less than 75. If your client is between 67 and 74 and wishes to claim a deduction from their personal super contribution, they will need to meet a ‘work test’ of 40 hours gainful employment within a 30-day period in the financial year in which they contribute.

Clients over the age of 75 may not make voluntary contributions to their super.

Importantly, if your client has $1.7 million or more in the super system on 30 June in the previous financial year, they can no longer make non-concessional contributions. This limit will increase to $1.9 million from 1 July 2023.

What happens if a client exceeds their contributions limit?

If your client’s contributions pushes them over their limit, they’ll be liable to pay more tax. However, only the amount above the relevant limit is subject to this additional tax. For example, if your client contributed $5,000 over their limit, extra tax would be charged only on this $5,000.

Any concessional contributions that exceed the limit will be taxed at the client’s marginal tax rate (including the Medicare Levy).

Excess concessional contributions count towards the client’s non-concessional contribution limit. Any non-concessional contributions that exceed the limit will be taxed at 47% (including the Medicare Levy).

Importantly, for those clients contributing to more than one super account, the contribution limit is a total combined limit.

Limits for the 2022/23 financial year

Concessional contributions are limited to $27,500 for the year.

Clients have been able to carry forward any unused concessional contributions cap amounts from 1 July 2018. If they have not used all of their concessional cap in a particular financial year, they’re able to carry forward their unused concessional cap amounts to future years.

This is only available where the client’s total superannuation balance less is than $500,000 on 30 June in the previous year. Unused amounts are available for a maximum of five years.

Non-concessional contributions are limited to $110,000 for the year.

Depending on your client’s total superannuation balance, those aged under 75 may be able to bring forward two years of contributions, providing a total non-concessional cap of $330,000 for the three years. Where a bring-forward has been triggered, the two future years’ entitlement are not indexed.

Since 1 July 2017, the bring-forward amount and period has been dependent on the client’s total superannuation balance and the financial year in which the bring-forward was triggered.

Any contributions made in excess of this limit will be taxed at 47% (including the Medicare Levy). If a client is over their limit, they can choose to have the excess non-concessional contributions (along with associated earnings) returned. These can be invested outside of the super environment.

Importantly, those clients with $1.7 million or more in the super system on 30 June in the previous financial year cannot make non-concessional contributions. This limit will increase to $1.9 million from 1 July 2023.

Salary sacrifice v after tax contributions

There are two benefits that arise from clients making salary sacrifice contributions. One, it can help grow your client’s super savings to meet their retirement goals and two, it can reduce their taxable income. Only 15% tax is deducted from a salary sacrifice contribution, small when compared to the client’s generally much higher marginal tax rate.

The tax rate on the investment growth inside super is also a maximum of 15%, again which is typically lower than tax paid on investments returns outside superannuation. The Federal Government is proposing that from 1 July 2025, earnings on super balances over $3 million will be taxed at 30% instead of 15%.

Sally’s salary is $85,000. If she sacrifices $5,000 to super, she will pay $750 in contributions tax instead of $1,725 in income tax, giving her $975 more to invest.

In the case of after tax contributions, if a client’s total assessable income is lower than the relevant income threshold, making after-tax contributions may qualify them for a co-contribution from the government of up to $500.

No contributions tax is deducted from after-tax contributions, provided the contribution limits are not exceeded. For those with a low income or who receive franked dividends from share investments, their income tax rate may be lower than the 15% contributions tax deducted for salary sacrifice. In such cases, the client could pay less tax by making after tax contributions rather than through salary sacrifice.

Spousal contribution splitting

In the case where one partner of a couple is a low-income earner, works part-time, or is unemployed, the higher income earner could add to their partner’s super, something that can benefit both parties.

Clients can transfer contributions to their spouse’s account once per financial year and these must be concessional (before tax) contributions. These are generally the client’s salary sacrifice, personal tax deductible contributions and employer’s contributions.

The client can then transfer up to 85% of the gross concessional contributions made to their account to their spouse. This is the same as the net contribution after 15% contribution tax has been deducted. If the client has a Defined Benefit account, they generally can only split the voluntary contributions they have made.

There are two possible benefits of splitting contributions with a spouse. It may allow earlier access to their super and can save on tax.

Earlier access

If the spouse receiving the contribution is older, they will reach their ‘preservation age’ (figure two) sooner. The non-working spouse will then be able to start a super income stream or, if they have retired from the workforce, take a lump sum payment.

If the contributions had remained in your client’s account, they would not have been able to access them until they reached preservation age.

It’s important to note that the spouse receiving the contributions must be under age 65, and if aged between 55 and 65, must not be retired to be eligible to receive split contributions.

Tax savings

If your client or their spouse intend to access a lump sum from super before reaching age 60, contribution splitting could save on tax. When a lump sum is taken, a tax-free threshold (‘low rate cap’) is applied to the taxable component.

The threshold is $230,000 for 2022/23. This means an individual may access up to $230,000 from their taxable super without paying tax between their preservation age and age 60. Splitting contributions could allow your client to access two full tax-free thresholds.

Case study – Spousal contribution splitting

Jody and Mark were both born between 1 July 1963 and 30 June 1964, so they both have a preservation age of 59. Mark intends to retire at 59 and take some of his super as a lump sum.

Jody’s super balance is $40,000 and Mark’s is $350,000. Jody has not accumulated much super, because she has primarily worked part time and left work to take care of their children.

Scenario 1

Mark does nothing and the couple access $390,000 as a lump sum when they reach age 59. The tax situation is as follows:

Jody’s balance is $40,000, and she takes the whole balance tax-free.

Mark accesses $350,000 from his account to make up the total of $390,000 and pays $20,400 tax.

This is based on tax of 17% including the Medicare Levy on the amount above the tax free threshold of $230,000 and assumes the total balance is made up of the taxable component.

Scenario 2

Mark transfers some of his super contributions to Jody’s account each year, and as a result when they reach age 59, Jody has a balance of $195,000.

Mark and Jody each access $195,000 from $390,000 and pay no tax, because of the tax-free threshold.

This strategy is only applicable when accessing super before age 60. After 60, all payments from super are tax-free, regardless of the amount. From 1 July 2023, everyone will have a preservation age of 60 and so this strategy will not be able to be used to save tax.

Transfer balance caps

The transfer balance cap (TBC) limits the total amount of superannuation that can be transferred into a tax-free super pension account. First introduced on 1 July 2016 at $1.6 million, from 1 July 2021 the transfer balance cap increased to $1.7 million, and will increase again to $1.9 million from 1 July 2023.

The ATO will create a transfer balance account for clients who commence a pension account. For those clients with a transfer balance account before 1 July 2023, the ATO will calculate their TBC, which will be between $1.6 million and $1.9 million.

The transfer balance account:

• includes the total amount transferred from super to one or more pension accounts and includes any death benefits taken as a pension
• does not include transition to retirement accounts
• assuming the TBC is not exceeded, does not apply to investment earnings made in the retirement phase.. so if your client’s pension account balance grows over $1.9 million, no action is required. If the TBC is exceeded the investment earnings on the excess amount is included in the transfer balance account.

Clients can leave any amount over $1.7 million ($1.9 million from 1 July 2023) in their superannuation account.

If a client transfers more than $1.7 million ($1.9 million from 1 July 2023) into their retirement phase account, they will be liable to pay 15% tax – or in the event they have previously gone over their TBC, 30% tax. This is calculated from the day they exceed the TBC.

Super and tax

Super contributions made before tax are taxed within your client’s super fund at a concessional rate of 15% up to the concessional contribution limit. An additional 15% tax – known as Division 293 tax – was introduced in 2012. It reduces the tax concessions on superannuation contributions for individuals with income greater than $250,000^[2] a year. The Division 293 tax is payable in addition to the standard 15% contributions tax.

If your client is a high income earner with an income in excess of $250,000 a year, the total tax on their before-tax contributions below the concessional contribution limit is 30%.

Concessional contributions in excess of the concessional contribution limit will be taxed at the client’s marginal tax rate, therefore Division 293 tax does not apply on this portion.

The concessional contributions limit is currently $27,500 per annum, indexed to increases in Average Weekly Ordinary Time Earnings (AWOTE) in increments of $2,500. If your client has carry-forward concessional contributions and their total superannuation balance was less than $500,000 at the end of the previous year, then their concessional contributions limit is increased by the amount of these carry-forward contributions.

If the client’s income is less than $250,000 a year, but by including before tax contributions (that are below the concessional contribution limit) the total is more than $250,000, the 30% tax rate will apply to the part of the before-tax contributions that are over the $250,000 total (but below the concessional contribution limit).

For example, if your client’s income is $230,000 and their before-tax contributions are $25,000, they only pay the 30% tax rate on $5,000.

Income for surcharge purposes (also known as adjusted taxable income)

The ‘income’ that is used to calculate the Division 293 tax is similar to the income used for determining whether a client is liable to pay the Medicare levy surcharge. It excludes reportable superannuation contributions (that are instead included in the low tax contributions).

This income includes the following amounts, if applicable:

• taxable income (assessable income less deductions)
• reportable fringe benefits
• net financial investment loss
• net rental property loss
• the net amount on which family trust distribution tax has been paid.

It excludes the taxed element of a superannuation lump sum benefit (other than a death benefit) up to the low rate cap amount, relevant only to those aged between 55 and 59. 

Low tax contributions

If your client is an accumulation member, low tax contributions are generally the concessional contributions made in a financial year, excluding any excess concessional contributions. For most individuals, this will be employer contributions, salary sacrifice contributions and any deductible personal contributions.

For those clients in a defined benefit scheme, their low tax contributions will be the total of any concessional contributions (by the employer or as salary sacrifice) to an accumulation account plus the defined benefit contributions, calculated in accordance with a formula specified by the government, less any excess concessional contributions.

In the case of defined benefits, those contributions are regarded as the ‘notional taxed contributions’. This is the same formula that is used to determine concessional contributions for the purposes of the excess contributions tax. For some defined benefit members ‘notional taxed contributions’ are capped at the prevailing concessional contribution limit.

The defined benefit contributions for the purpose of calculating the low tax contributions are equal to the client’s ‘notional taxed contributions’, but without any cap applying. For example, if the defined benefit notional taxed contributions calculated without the concessional contribution cap applying are $40,000, and the concessional contribution limit is $27,500 and a cap applies, then the defined benefit concessional contributions are $27,500, but the defined benefit low tax contributions are $40,000.

Does Division 293 tax apply?

If the total of your client’s income for surcharge purposes and low tax contributions is above $250,000, the Division 293 tax will apply to the lesser of the following two amounts:

• the amount by which the client’s total income for surcharge purposes and low tax contributions exceeds $250,000; or
• the total of their low tax contributions.

The additional 15% tax is applied to the lesser of these two amounts.

Case study – Accumulation member

Will has an income of $243,000 and low tax contributions of $25,000.

The sum of these two amounts is $268,000. He exceeded the $250,000 threshold by $18,000. This means the Division 293 tax will be applied to $18,000, as it is lower than his low tax contributions of $25,000. He will pay Division 293 tax of 15% x $18,000 = $2,700.

Case study – Defined benefits member

Anna is a defined benefit member. Her income is $245,000. She makes voluntary salary sacrifice contributions of $15,000 to an accumulation account. Anna’s notional taxed contributions for her defined benefit are $10,000 and her low tax contributions are $25,000 ($10,000 + $15,000).

Anna’s combined income and low tax contributions is $270,000 ($245,000 +$25,000). She has exceeded the $250,000 threshold by $20,000. This means she will pay Division 293 tax of $20,000 x 15% = $3,000.

In this example, the tax is apportioned between her accumulation account and defined benefit; meaning she will need to pay $2,250 attributed to her accumulation account within 21 days of the notice of assessment from the ATO and the remaining $750 may be deferred to a debt account.

Financial advice plays a pivotal role in navigating the complex superannuation landscape. With retirement planning becoming increasingly important in an uncertain economic climate, providing your clients with the knowledge and tools necessary to maximise their superannuation benefits is critical. Your invaluable advice empowers clients to make informed decisions, enabling clients to optimise their superannuation outcomes, confidently plan for retirement, and enjoy a comfortable and prosperous post-work life.

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Notes:
[1] https://www.apra.gov.au/news-and-publications/apra-releases-superannuation-statistics-for-december-2022
[2] From 1 July 2017, the Australian Government lowered the Division 293 income threshold from $300,000 to $250,000.

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Transition to retirement strategies can help clients achieve their financial and lifestyle objectives in retirement.

Over the coming years, 5.5 million people born between 1946 and 1964 will retire, increasing the demand for retirement advice. This article, sponsored by Russell Investments, discusses the importance of pre-retirement planning and the benefits of a smooth transition to retirement.

As individuals approach retirement age, it is essential to plan for a smooth transition into this new phase of life. While retirement is a significant milestone that usually marks the end of a long and fruitful career, it can also be a source of stress and uncertainty. Pre-retirement planning is critical to ensure that your clients can enjoy a comfortable and financially secure retirement. Detailed pre-retirement financial planning can help them prepare not just financially, but mentally and emotionally for the changes that come with retirement.

The ageing cohort of Australia’s baby boomers represents a significant challenge and opportunity for financial advisers. As wave after wave of this demographic reach retirement age, they will have unique financial needs and considerations that will require specialised guidance and planning.

For financial advisers, this means that they will need to cater to the specific needs of baby boomers; help them to navigate the complexities of superannuation, create appropriate retirement income streams, and estate planning. This may involve developing new strategies and investigating investment products tailored to the changing needs of this demographic, as well as offering personalised advice and support.

Increased longevity means that retirees today can expect to live for 25 plus years and an important element underpins their ability to achieve this – a sound financial plan, one which needs to commence before they hit retirement. By doing so, financial advisers can help their clients to navigate the complexities of retirement planning and ensure that they are able to enjoy a secure and comfortable retirement.

Pre-retirement planning

In 2020, 65 percent of Australians had balances below $250,000 at retirement; while this proportion is expected to decrease to 30 per cent by 2060^[1], it’s little solace for clients retiring in the coming years. Even when considered in conjunction with the Age Pension, a superannuation balance of this quantum is unlikely to provide the retirement lifestyle many baby boomers expect. This reinforces the need for pre-retirement planning.

The Investment Trends 2022 Retirement Income Report is an in-depth study of Australians’ attitudes towards retirement and post-retirement issues. The report highlights that confidence levels have plummeted to a ten year low among pre-retirees when it comes to their feelings of preparedness for the next stage of their life. Year on year there was a significant decrease, with confidence levels dropping a whopping 25 percent between 2021 and 2022.

This lack of confidence is driven by a number of factors cited in the report: inflation and the spiralling cost of living, increases in cost of medical services, fear of outliving retirement savings, and income expectations not being met. According to Investment Trends, non-retirees expect their retirement income to be around $3,200 per month but perceive $4,300 per month as the desired level, roughly on par with ASFA’s^[2] budget for a comfortable lifestyle for a single person ($49,462), but below that required for a couple ($69,691).

Interestingly, Investment Trends’ study found that the fear of not having enough money in retirement is driving non-retirees to seek retirement related information and wanting to be better prepared. This presents advisers with an opportunity to educate and prepare clients for retirement, to explain the retirement income products available and prepare a retirement strategy appropriate for each client.

The transition to retirement

When working with pre-retirement clients, a Transition to Retirement (TTR) strategy can be useful for those clients aged 58 plus, who have reached their preservation age (figure one) and are still working.

A TTR strategy generally involves restructuring the way your client receives income by enabling them to top up the income received from their employment with a regular income stream from their super through a transition to retirement pension. This means your client receives income from two sources: their employer and their super fund. You can also take advantage of certain tax rules to boost your clients’ retirement income.

It’s important to note that there’s a minimum and maximum amount clients may withdraw from a transition to retirement pension each year; until retirement or age 65, the maximum income your client may draw in any year is 10 percent of the account balance.

This approach is flexible. If a client starts a transition to retirement pension but no longer needs the income, the pension can be stopped at any time and the client can return their focus to accumulating super.

TTR strategies

1. Lifestyle booster: subsidise a move into part-time work

Clients approaching retirement may want to reduce their working hours, but not their income. They may still have debts to service, renovations scheduled or travel plans. Clients can ease into retirement and boost their lifestyle by working fewer hours and supplementing the reduced income with a regular income from their super fund, via a transition to retirement pension.

Case study one: Stepping into retirement

Mark was born on 27 March 1961 and decided to move from full time to part time employment. He wants to not only ease his way into retirement, but to take advantage of his good health to do as much travelling as possible.

Following advice from his financial planner, Mark and his employer agree to reduce his employment to part time; however instead of working fewer days per week, Mark continues a five day week but is able to take additional annual leave each year to fulfil his travel plans.

As Mark has reached preservation age, his adviser facilitates the transfer of a portion of his super savings into a TTR pension account that his superannuation fund has established for him. Each month, a regular sum is transferred from the TTR account to his savings account.

Mark receives his regular salary from his employer, but it’s lowered in line with his reduced hours. The extra income from the transition to retirement pension tops up his overall income. The combined income means that Mark can continue to maintain his lifestyle while ticking off some bucket list items as he makes the transition to retirement.

2. Income booster: provide an increased level of income

Some clients might wish to increase their income in their pre-retirement years. This might be to pay down debt before retirement or to meet other financial or lifestyle objectives. This can be achieved by your client maintaining their existing work arrangements and drawing from a transition to retirement pension.

At the same time, the client can take advantage of paying a reduced level of income tax by electing to salary sacrifice into their super fund, which can then be drawn as a transition to retirement pension. For those clients aged 60 or over, pension income is tax free. For those under 60 (but have met their preservation age), pension income is taxed at their marginal tax rate, however a 15% tax offset is received.

Case study: Discharging debt before retirement

Paul was born on the 22 May 1960. He and his wife Julie, born later in 1960, have a lot of plans for retirement – first and foremost, a year or two as ‘grey nomads’ taking to the open roads in their caravan. However, projections show they will take an outstanding mortgage of around $150,000 into retirement. The impact of this on their retirement income is of particular concern, particularly given recent rate rises and increasing repayments.

In consultation with their financial adviser, they decided that rather drawing a lump sum from the super fund upon retirement, they would use a transition to retirement pension to increase their pre-retirement income and focus on paying the mortgage as quickly as possible. While they may need to use a small amount of capital to pay it out when they do retire, this strategy should meaningfully reduce it. This strategy enables the couple to retain as much capital as possible in their super fund to generate income to support their eventual retirement.

3. Super booster: increase a super balance

It’s no surprise that a significant proportion of people retiring today may not have a sufficient level of retirement savings to get them through 25 plus years of retirement. For many, compulsory super only came in toward the end of their working lives, too late for many to amass a significant nestegg. Women, who are more likely to have held part time roles and taken career breaks, are typically worse off.

A commonly used TTR strategy is for clients to contribute a greater portion of their earned income into super via a salary sacrifice arrangement. At the same time, the client draws a transition to retirement pension from their super fund, to maintain their level of income.

As the client continues to work, they continue receiving super guarantee contributions from their employer. They can also make salary sacrifice contributions and rollover balances from other super accounts they hold to boost their primary super account. This is an effective way to grow a superannuation balance.

As described earlier, clients who choose to salary sacrifice into super could pay less income tax. Using this strategy to top up super rather than other investments is also tax effective; investment earnings on the investments that fund the pension are taxed at the concessional rate of up to 15%, whereas tax on any investment earnings outside super is generally higher.

Case study: Adding to super savings

Michael, 60, is still working full time, earning $70,000 plus his super guarantee contribution. He plans to retire when he is 65. With five years to go, he wants to bolster his retirement savings. While he will be limited by his concessional contributions cap of $27,500 a year, his adviser looks into taking out a transition to retirement pension so he can commence a TTR strategy and salary sacrifice more into his super.

Michael salary sacrifices as much of his salary as possible into his existing super account, and draws down an amount from his pension account, so that he still has the same amount of money on which to live. The maximum he may draw down is 10% of his pension account.

In one year, Michael can save over $4,000 in tax and contribute this to his super by putting it straight into his existing super fund. Over the five years between age 60 and 65, Michael can boost his super by over $20,000 while maintaining the same take home pay. This strategy is tax effective, because income payments from a pension account are tax free for people aged 60 and over.

Things to consider with a TTR

There are a number of issues to consider when discussing a TTR with your clients.

Contribution limits

The government imposes limits as to how much an individual can contribute to super each year. For the 2022/23 and 2023/2024 financial years, an individual can make concessional (or before-tax) contributions to super of up to $27,500.

Concessional contributions include superannuation guarantee contributions made by employers, personal contributions (for which the client has claimed a tax deduction), and any voluntary salary sacrifice contributions made. Contributions above the limit will be taxed at the client’s individual marginal tax rate plus an Excess Concessional Contributions charge.

Some strategies can reduce a client’s overall super balance

Removing money from an accumulation superannuation account could impact its potential earnings over time, which in turn can reduce the account’s balance at retirement and its ability to generate an income stream in the future.

Drawing down an income

How much income your client draws down will depend on how much they need and the other sources of income they may have. As clients get closer to retirement, their income needs tend to reduce, and they can afford to salary sacrifice into super without having to replace the lost income. The maximum income they may draw down in any year is 10% of the account balance until they reach the age of 65.

Defined benefit members

If your client is in a defined benefit scheme, the amount they can transfer from their existing account into a pension may be limited to the accumulation portion of their benefit. However, there may be the option to transfer out of the defined benefit plan and commence a pension with the whole balance. This will vary between defined benefit schemes.

Centrelink benefits

The income received from a transition to retirement pension may impact the client’s taxation status and eligibility for Centrelink benefits. Income from financial assets such as superannuation form part of Centrelink’s income test for pension eligibility.

SMSFs

As long as the SMSF member meets the TTR preservation age requirements and has a nil cashing restriction, they can generally access their superannuation benefits in other ways and don’t need a transition to retirement pension. In these circumstances, the trustees can start paying the member a normal account-based pension, or the member’s benefits can be paid as a lump sum without having to go through the process and cost of setting up a pension.

Income stream

Clients can only access their super benefits as a ‘non-commutable’ income stream, one that cannot be converted into a lump sum. This generally means clients are not able to take super benefits as a lump sum payment while they are still working.

Transitioning from a working life to retirement can be challenging and overwhelming for many. With the right support and guidance, pre-retirees can prepare themselves financially and mentally for the next chapter of their lives.

Financial advisers can play a crucial role in assisting pre-retirees with the complex financial decisions and planning required to achieve their retirement goals. By offering tailored advice and solutions, potentially including a transition to retirement strategy, financial advisers can help clients gain confidence and peace of mind, ultimately enabling them to enjoy a fulfilling and financially secure retirement.

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Notes:
[1] Superannuation Balances at Retirement, Australian Treasury, 2021
[2] ASFA Retirement Standard, December 2022

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