SMSF trustees must consider cash flow needs when fund portfolios are adjusted going into pension mode, Mr Michael Hutton, head of wealth management at HLB Mann Judd Sydney says.
“Funds obviously need to have cash available to meet pension payments which are typically made monthly, but trustees often get it wrong,” he said.
“When people retire they tend to focus on returns and how long their savings will last, overlooking the need to have cash available throughout the year to make regular pension payments.
“By not planning ahead, it can cost the SMSF through unnecessary fees and brokerage in liquidating assets, as well as through lost opportunity.”
Mr Hutton said that trustees should understand the different levels of liquidity that exist – even of their various fixed interest investments and cash deposits – and timing of returns.
“Some fixed interest investments are more liquid than others, and even similar assets such as term deposits issued by different financial institutions, can pay interest at different times.
“It is why we advise trustees with a SMSF in pension mode to keep at least one year’s pension in cash – and that includes separating it from term deposits so that it is always accessible.
“Even with this reserve in place, trustees still need to know exactly how each investment works, how accessible they are, and how and when dividends, distributions and interest are paid, particularly those that they rely on to pay their pension.”
Mr Hutton said that term deposits make a good example to illustrate this. “Interest from term deposits is generally paid at maturity, or annually where the deposit term is greater than one year.
“Thus if a SMSF is relying on interest from various term deposits to make pension payments during the year, but they have cash tied up in deposits that do not pay interest until after the end of the financial year, the fund could have a cash shortfall.
“Recent research shows that many people are still putting money into term deposits – there is now $2.3 billion in term deposits compared to just under $1.8 billion in February 2009 – and this may not be the best approach for all SMSFs.
“If there is no cash available to make a pension payment, the fund may need to sell an asset it really didn’t want to and attract costs.”
Mr Hutton advises trustees to check when dividends, interest and distributions are made from all investments, how much is likely to be received, and the impact of this on regular pension payments.
“Dividends from direct equity investments are made twice a year, mostly in late March/early April and in late September/early October.
“Distributions from equity funds are usually also made twice a year – in January and July, while fixed interest funds mostly make distributions monthly or quarterly.
“By working out the cash flow from investments this way, trustees can see what cash needs to be kept to meet shortfalls, or they will need to be met from other asset sales.
“By taking cash flow into account, and having a reserve available to cover any extra payments or emergency needs that may be required – for instance, to buy a car – can also be met,” Mr Hutton said.
HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and part of the HLB Mann Judd Australasian Association.
For more information please contact:
Michael Hutton – 02 9020 4194