Safety First

Story by Ron Giles

Establishing your nest egg is only your first step in making sure you have everything in place for worry-free management of your affairs. Protective strategies you can use range from making sure your financial advisors are well qualified to putting effective trusts, wills and powers of attorney in place.

Perhaps the most reassuring move you can make is to ensure that any financial adviser you have is well equipped to help you grow, maintain and manage your assets. Investment advice is available from a diverse range of people such as accountants, share brokers, lawyers, mortgage brokers, qualified and unqualified financial planners and insurance salespeople. The best strategy, always, is to look for those with the best qualifications.

In the past, anyone has been able to set themselves up as a financial adviser, so it is vital to check credentials. You are looking for experience, credibility and impartiality. A good investment adviser should act as a filter, weeding out unsuitable investments from the myriad on offer, and presenting only those that suit your investment plan and are compatible with your risk profile.

The government is currently moving to establish more rigorous controls on the financial industry in order to boost investors’ confidence in the professionalism of advisers. Meanwhile, it’s wise to check whether any prospective adviser has CFP (Certified Financial Planner) after their name. This means that the planner will have at least two years of mentoring on their CV, and is subject to a code of ethics, practice standards and a formal complaints and disciplinary process. Many CFPs will be members of the Institute of Financial Advisers (IFA), which has more than 1400 members, or the Society of Independent Financial Advisers (SIFA) – but many will not.

Before appointing such a professional, you have the right to request a written disclosure statement.

This must be provided within five working days of your request and should include information on these questions:

• What is the adviser’s experience and qualifications? If advisers lack experience, they may not have experienced downturns in the market and so may not be alert to signals indicating a reversal.

• Is the advice limited to the investment offered by only one or two financial organisations? You need to determine if the adviser has an investment strategy they can explain and tailor to your risk profile, or if they are really just a salesperson for a couple of investment funds or insurance products.

• Does the adviser give advice only on a particular type of investment? In this case, they are not qualified to give advice across your whole portfolio. In reality, they are sales-driven and only interested in promoting one product.

• How will the adviser handle money received from you for investment? Is your money protected in the event of misappropriation? What records will be kept and what access will you have to this information?

• How does the adviser receive their income? Is it via brokerage from financial organisations that provide the investment products they recommend, or is it via a fee that you pay? Most financial products have a brokerage and this is disclosed in the product prospectus. Typically advisers who charge fees will rebate to the client the brokerage paid.

You should also seek client references so you can contact them about the adviser’s service and professionalism. You need to establish clearly what the adviser’s services will cost you. Just as with managed funds, high fees will seriously affect your net wealth over the long term.

It is important that a financial adviser can address your changing needs as you age. A long retirement generally has three phases:

• The go-for-it phase – potentially the best time of your life, when you get to do all those things you never had time for previously

• The slowing down phase – when you are not so active and prefer to spend more time relaxing and ‘taking life easy’.

• The final stage – when you need medical and nursing or hospital care

Your adviser should be aware of these stages and adjust your investments to suit the different cash flow you will need at various times.

A major oversight of many clients is a failure to monitor the performance of the planner. You need to know what your investment should have returned. If it has not met the average for that type of investment, you should be asking why. It is relatively easy to ascertain average returns for New Zealand, US or Australian share markets. If yours are substantially less, you will want to know what your adviser is going to do about it.

Whether using an adviser or handling your affairs yourself, you’ll need to decide how much of your capital you’ll draw down each year. That depends on how long you expect to live. If you follow comedian Steven Wright’s line of thought (‘I intend to live forever – so far, so good!’) then you need to have a long-term strategy. Given current life expectancies, if you draw down the capital at 10% each year you are likely to have exhausted it before you die.

One study says that UK people average nearly 20 years in retirement and it is a costly time – retired people are spending over £400,000 between 65 and their year of death. This equates to more than a million NZ dollars, or about $NZ53, 000 per year. Such a spending rate would exhaust most New Zealanders’ savings long before 20 years were up.

To allow for such a long retirement, a prudent drawdown rate is vital. In determining when you will run out of money, how much you take out in the early years of your retirement is more important than factors like your asset allocation. The safe rate may be less than you think. Those expecting a 20- to 25-year retirement should keep initial withdrawal in the 4% to 5% range. Those who retire early (thus facing 30 years or more in retirement) may need to reduce that to a 3% to 4% drawdown of their capital.

This can be increased by the rate of inflation, so that a withdrawal of $12,000 p.a. from a $300,000 portfolio could be increased to $12,360 the following year (assuming 3% inflation). This might have to be cut back if a portfolio drops drastically in value. A big drop early in retirement is especially dangerous, as drawing from a smaller pool of assets makes it more likely you will run out of cash.

Those who take out just 3% a year can be pretty conservative with investments, with most of their money in cash and bonds. Having most of your savings in equities will be a greater risk, but a higher withdrawal rate is then possible. It has been calculated that with a 4% withdrawal rate, a $500,000 initial nest egg would probably still be worth around $400,000 after 30 years if the portfolio was invested 60% in equities, 30% in bonds and 10% in cash.

When the stock investments are reduced to 20% of the portfolio, the likely value is just $180,000. Many advisers recommend retirees should have at least 50% of their portfolio in stocks to generate returns that are substantial enough to offset the corrosive power of inflation.

However you invest, there are a range of safeguards you can put in place to protect your assets. Establishing a family trust could be a smart move. If you own a business, a trust can protect personal assets from creditors in the event that it collapses. A trust may also:

• Avoid assets being included if at some future date you need to apply for rest home subsidies

• Protect you against any future means testing for universal superannuation or a ‘super’ surcharge

• Help you pass on property to offspring without death duties or capital gains taxes

• Protect your assets from falling into perceived ‘wrong’ hands, such as children’s ex-partners

• Enable income distribution to family members to achieve tax savings

You should put into the trust appreciating assets like the family home, other property shares and quality art or jewellery. After an independent valuation, the assets are bought by the trust. The trust then owes the person who has sold the assets and this debt is forgiven at a rate of $27,000 per year. Higher amounts will attract gift duty, so if you intend to set up a family trust, do it soon. It takes time to get all your assets shifted over. Once you are in your sixties you may not have time to complete the necessary gifting programme before your death.

Consider, also, the challenge of selecting a neutral trustee. If this is someone in your immediate family, there is the distinct risk of disputes with other family members. Lack of control is the main disadvantage of establishing a trust. Once it’s in place you are handing over ownership of its assets. You may still have some influence over their use but you will not have total control. Also, the rules around keeping accurate records of trust dealings and completing IRD returns all have to be followed to avoid any future legal challenges to the trust’s integrity.

It’s also important to have an up-to-date will, with no contradiction between it and any trust deeds. Dying without a will leaves you ‘intestate’, with your assets divided up by law, as the court sees fit. Your assets may be frozen meantime, causing possible big headaches for your dependants. You need to decide who will be your executor and trustee and what instructions, if any, you might want to leave for them. You will also choose how your estate will be divided and, if you have children under 20, who will become guardians. Remember, too, that if you marry, have children or get divorced, you will need to update your will as the previous one will no longer be valid.

It’s also a good idea to set up an enduring power of attorney (EPA). This legal document gives someone you trust the power to look after your interests if you can no longer do it yourself. An EPA is much cheaper to draw up than a family trust. A lawyer can do it for around $200, the Public Trust for $100, or you can do it yourself. Without an EPA, the court decides who your lawyer will be. This might result in decisions in conflict with your original intentions and costs you had not envisaged. It can also take time to put this structure in place, and your estate might suffer from lack of action in the meantime.

As with a family trust, make very sure the person you choose to look after your affairs is ultra-trustworthy. Many are the horror stories of people being ripped off by children or friends who take advantage of a trusted position to reward themselves. Because government may soon enact legislation in this area, lawyers setting up an EPA must act for the donor and be independent of the attorney receiving the power of attorney – a move which should be a starting point if you set up an EPA.

All of the above may sound like a lot to consider, but you’ll feel much more secure once you’ve given these things your attention. There is nothing as satisfying in life as being prepared.

Ron Giles is the author of Reed’s All the F Words for Babyboomers, from which this article was sourced.

MORE INFORMATION

For more information on choosing a financial advisor, go to: www.ifa.org.nz (the website of the Institute of Financial Advisors) or www.sifa.org (the Society of Independent Financial Advisers). There’s also good advice on financial planning at www.consumer.org.nz, though some of its articles can only be accessed by Consumer Society members. An annual online subscription is $63. The Retirement Commission’s website, www.sorted.org.nz , provides information on all sorts of money-management topics along with useful calculators and planning tools.

Reprinted by permission. Copyright 2008 Plenty magazine Summer 2008 published for Hanover Group. Subscribe to Plenty today.