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Australia is now witnessing some of the lowest interest rates on record and there is an expectation that low interest rates will be with us for quite some time. While good news for borrowers; for self funded retirees who are relying on bank deposit interest for income, this can be a very worrying time.

Many self-funded retirees will be forced to use their saved up capital to make ends meet.

Australia is not on its own. Low interest rates are now the ‘norm’ for the major industrialised countries around the world. In fact, the interest rates in Australia are still higher than most comparable countries.

How do low interest rates affect the self funded retiree?

If you are relying on traditional bank deposits for all your income, you will be in for a shock.

Monthly Income received at different interest rates

Investment

4%

5%

6%

7%

$400,000

1,333

1,667

2000

2,333

$600,000

2,000

2,500

3,000

3,500

$800,000

2,667

3,333

4,000

4,667

$1,000,000

3,333

4,167

5,000

5,833

 

A small change in the interest rates can mean a big difference in your income.  For example, the difference between a 4% and a 6% interest rate on $600,000 investment is $1,000 per month. Or to put it another way, your income has been slashed by 33.33%

Alternative investment options to cash in the bank

The good news is that there are plenty of alternative investments to cash. However, as with every investment each one will carry its own investment risk. The two most popular alternatives are shown below.

1.     A selection of good dividend paying stocks (shares)

The Australian stock market has a large number of stocks that pay strong dividends. For example, the major banks have been paying dividends in the region of 6%. However, the real return is greater than 8.5% as you receive a tax credit.

Important – Dividends in the hands of the shareholder (the investor), are generally received as ‘tax paid’. The tax paid will be at the company tax rate of 30%.  The government will treat this tax paid amount as a tax credit against your personal tax.

There are of course risks with share investing, including the shares of the Australian banks. Share prices will rise and fall and you need to comfortable knowing the investment value will fluctuate.

2.     Fixed Interest Securities (bonds)

Many major institutions, including the big four banks, will raise money for their businesses by issuing Fixed Income Securities to the open market.

Fixed Income Securities including bonds, come in all shapes and sizes these days. A popular investment is to purchase a bond that will pay a defined interest rate (referred to as a coupon rate) for a fixed period of time. The bonds can be traded on the open market.

Investors who hold bonds will normally benefit from a higher investment return compared to what they would typically receive from a bank term deposit.

As a general rule, the investment risk with Fixed Income Securities including bonds is greater than bank deposits but less volatile than investing in shares.

Review your investment strategy

There are different strategies available to maximise your net (after tax) investment return. Some popular options are highlighted below.

Self Managed Superannuation Fund (SMSF)

Funds held in a SMSF do not pay any tax, not even capital gains tax once they become pension funds. You will also receive the full benefit of any tax paid dividends (imputation tax credits) that flow through by owning shares in your SMSF.

Annuities

A fixed term annuity could be a favourable investment as part of your portfolio. Annuities pay a regular income which includes both interest and a return of your invested capital.

There is no tax payable on the capital that is returned and this benefit may provide additional tax savings across your portfolio. And knowing that you have secured your income, you can seek to invest a larger proportion of your portfolio into growth investments.

Are you eligible for other benefits?

Government pensions, allowances and utility discounts may not be out of your reach. The rules can be complex but for many people they are worth investigating. Additional pension and allowances may be gained from restructuring your investments.

Spend a little less – look at your budgets

As the old saying goes ‘A penny saved is a penny earned’. Working through a budget with a financial adviser to find some savings is a great place to start.

Start shopping around! Not so many years ago shopping around was expensive, but with the Internet it is now significantly easier and cheaper. There are plenty of websites that can help you find some real bargains.

And one last tip, when you are out shopping don’t be afraid to ask for a discount. Think of it this way – The major stores will price their goods knowing that some customers will get a discount. If you are not getting your discount, you are paying more for the goods so others can enjoy their discount.

 

This is a  Professional Adviser Post from Neil Heriot, an experienced financial adviser specialising at pre and post retirement planning. Neil and his team can be contacted at Boston Private Wealth 

 General Advice Warning 

Any advice given is general only and has not taken into account your objectives, financial situation or needs. Because of this, before acting on any advice, you should consult a financial planner to consider how appropriate the advice is to your objectives, financial situation and needs.

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