OFFICE USE ONLY

Monash University
Semester One Examination 2008
Faculty of Business and Economics
Department of Accounting and Finance
EXAM CODES: AFC3440
TITLE OF PAPER: PENSION AND FINANCIAL PLANNING
EXAM DURATION: 3 hours
READING TIME: 10 minutes

THIS PAPER IS FOR STUDENTS STUDYING AT: (office use only - tick where applicable)

 Berwick  Clayton  Peninsula  Distance Education  Open Learning

 Caulfield  Gippsland  Malaysia  Enhancement Studies  Other (specify)

During an exam, you must not have in your possession, a book, notes, paper, calculator, pencil case, mobile
phone or any other material/item which has not been authorised for the exam or specifically permitted as noted
below. Any material or item on your desk, chair or person will be deemed to be in your possession. You are
reminded that possession of unauthorised materials in an exam is a disciplinable offence under Monash Statute
4.1.
THIS EXAMINATION PAPER MUST BE INSERTED INTO ANSWER BOOK AT THE
COMPLETION OF THE PAPER. NO EXAMINATION PAPERS SHOULD BE REMOVED FROM
THE EXAMINATION ROOM

AUTHORISED MATERIALS
CALCULATORS  YES  NO
(Permitted calculators: Citizen SRT-135, Casio FX82MS scientific calculator, the Casio FX82AU scientific
calculator, and Sharp EL-735 financial calculator, or calculators with an 'approved for use' Faculty label)
OPEN BOOK  YES  NO
SPECIFICALLY PERMITTED ITEMS  YES  NO
(i) The Australian Master Financial Planning Guide 2007/8 (10th edition) with ‘post-it’ labels.
Highlighting is permitted. This is denoted by AMFPG in the sequel.
(ii) Australian Government: Simplified Superannuation – Final Decisions Highlighting is permitted.
These items are permitted but will not be supplied.
Marks on the paper total 193. Marks allotted to each question part are provided as a guide to the amount of
detail required in answering the question. This consists of eleven (11) questions and one (1) page of formula
printed on a total of eleven (11) pages. All questions are to be attempted.
The 193 marks will represent 70% of assessment in this subject; 30% of assessment is for the Financial
Planning Assignment.
Students are expected to be familiar with abbreviations and acronyms in common usage in financial and
retirement industries; i.e. the ‘customs and usages’ of various markets.
PLEASE CHECK THE PAPER BEFORE COMMENCING. THIS IS A FINAL PAPER.

STUDENT ID: …………………………... DESK NUMBER: …………………….

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Answer all questions

Question 1

Superannuation Guarantee Scheme: regulation, contributions, pensions and taxation

In 1992 the Keating Labor Government introduced the Superannuation Guarantee Scheme
(SGS), Australia’s state-sponsored private pensions system.

(i) Contributions into SGS made on behalf of an employee by an employer are

concessionally taxed. What is the maximum total annual dollar amount that may be
contributed in this way?

(ii) At what rate is tax applied to such contributions?

(iii) How is the annual dollar limit indexed?

(iv) What transitional arrangements are in place for persons aged 50 years and over to obtain
concessional tax treatment on contributions?

(v) Working Australians can contribute after-tax money (‘undeducted contributions’ –

UDCs) to super. What is the annual maximum dollar amount that may be contributed to a
super fund in this way?

(vi) What rate of tax applies to fund earnings during the accumulation phase of SGS?

(vii) What rate of tax applies to realised capital gains during the accumulation phase?

(viii) A 60 - year - old retiree draws down as annual pension 7% of her SGS lump sum account
balance as pension in her first year of retirement. The lump sum was taxed throughout the
accumulation period. What rate of tax applies to her pension?

(ix) (Continuation of (viii)): What rate of tax applies to the earnings on the investments within
the fund during this year?

(x) What is the highest annual income for which the maximum ‘low income rebate’ of $750
applies?

(xi) A 65 year-old man dies in a year when he is drawing down an annual pension from a
super fund – a ‘New Pension’ - which is 5% of his invested account balance at the start of
the financial year. The invested lump sum was taxed during the accumulation phase.

The pension reverts to his spouse. What rate of tax applies to the spouse pension if the
spouse is aged 63?

(xii) (Continuation of (xi)): What rate of tax applies to the spouse pension if the spouse is aged
59?

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Question 1 (cont’d)

(xiii) During the accumulation phase of super, John (aged 58) dies with a superannuation
account balance of $400,000, which has been subject to tax throughout. He is survived by
his wife Joan (aged 56). Two years ago John had bound the trustee of his superfund to
pay his lump sum to Joan in event of his death.

What rate of tax applies to the lump sum death benefit to Joan?

(xiv) What was the main imperative for the Keating Government’s introduction of SGS?

(xv) What tax is levied on a lump sum withdrawal by a retiree over age 60 when the lump sum
was derived from a taxed source?

(xvi) For what proportion (approximately) of current retirees is Centrelink’s Age Pension the
principal source of retirement income?

(xvii) What is Centrelink’s assets test threshold for a single homeowner (what level of assets
may be held without penalty)?

(xviii) What is Centrelink’s assets test taper (what penalty attaches to each $1000 of excessive
assets above the threshold)?

(xix) Is the Age Pension entitlement subject to tax?

(xx) At what age (if any) must SGS entitlements be withdrawn?

(xxi) What is the principal legislation (Act) that governs the superannuation industry?

(xxii) Which body administers the act for self-managed funds?

(xxiii) Which body administers the act for all other funds?

(xxiv) What is meant by a regulated fund?

(xxv) Why is trust law important for superannuation funds?

(25 × 1 = 25 marks)

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Question 2
International overview of state-sponsored private pension schemes
Governments of countries around the world are faced with looking after their ageing populations.

(i) In Australia (as in most countries) a two-tiered system is used. Describe briefly the nature
of each of the two tiers.
(ii) Describe the type of benefit that usually accrues to members of state-sponsored private
pension systems.
(iii) What is the major shortcoming of such schemes from a retiree’s viewpoint?
(iv) Social security pensions may be means - tested or available to all.
(a) Discuss what ‘means - testing’ involves.
(b) Provide one argument for imposing a means test and one argument for making
such pensions freely available at Age Pension age.
(v) The two-tiered pension system must work in tandem indefinitely. Explain why this is so
and how it works. Your discussion should mention the length of time private pension
systems have been in place and the changing relationship between the two tiers as private
systems stabilise.
(vi) How does Centrelink adjust the extent to which retirees with some superannuation assets
can ‘top - up’ with Age Pension?
(2 + 2 + 2 + [2 + 2] + 6 + 4 = 20 marks)

Question 3

Topping up super with Age Pension; Centrelink’s asset and income test

Ann is 65 years old. She owns her own home, has $250,000 in super (all of it after-tax money,
invested in a New Pension) and $50,000 in lifestyle assets. In 2007-8 Ann takes $15,000 of
pension income.

(i) At what rate is tax levied on Ann’s retirement pension?

(ii) What tax applies to realised capital gains from investments supporting the New Pension?

(iii) Work out Ann’s age pension entitlement under Centrelink’s Assets Test. Use as
maximum age pension the fortnightly amount provided in Chapter 19 of AMFPG.

(iv) Work out Ann’s age pension entitlement under Centrelink’s income test and hence her
actual Age Pension entitlement.

(v) What is the tax charge on Ann’s total pension?

(1 + 1 + 4 + 6 + 3 = 15 marks)

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Question 4

Superannuation Guarantee Scheme accumulation and guaranteed indexed term pension cost

The Superannuation Guarantee Scheme aims to provide retirees with a lump sum benefit on
retirement. It is possible to estimate a ‘ballpark’ figure for this amount.
Most crucial are the estimated compound annual long-term earning rate of the accumulation
fund, and the estimated long-term compound annual rate of salary growth

(i) Suppose an employee has a starting gross salary of $55,000 per year. Her employer
compulsorily contributes 9% of this gross into a complying super fund at the end of each
quarter. Her salary is expected to grow at an average compound rate of 4.25% over the
next 40 years. What is her 40-year expected accumulation if contributions are taxed at
15% throughout the term and the fund averages 8.5% p.a. compound net yield over the
period?

(ii) Currently the ACTU (Australian Council of Trade Unions) is lobbying for an increase in
the contribution proportion from 9% to 15%. What effect would this have on the expected
accumulation calculated above (assume that the contribution rate of 15% is in place over
the entire 40 - year period)?

(iii) The employee retires after 40 years and (as part of an Optimal Retirement Income Stream
strategy - ORIS) purchases a 12-year term annuity indexed at 3% p.a. payable monthly
(12 times per year) in arrears with part of the accumulation. The annuity is purchased at a
yield of 6% p.a.

What is the cost per annual starting dollar of this indexed 12-year annuity?

Hence calculate the amount of annual annuity (payable monthly) that could be purchased
with $300,000.

Hint: You can use the price calculated in part (iii), the per-starting-annual-dollar annuity
cost in a subsequent question.

(6 + 2 + 8 = 16 marks)

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Question 5

The ORIS/ORARIS strategy

Jan is 62 years old and retires on 1 July 2008 with a $600,000 lump sum from a taxed source. Jan
decides to use the ORIS strategy to fund her retirement income.

(i) Briefly outline what is involved in the ORIS strategy for converting a lump sum to a
retirement income stream.

(ii) In what sense is this strategy ‘optimal’?

(iii) Jan decides to purchase a 12-year annuity starting at $24,000 p.a. payable monthly (12
times per year) and indexed at 3% p.a. after the first year. She can buy this annuity from a
commercial provider at a yield of 6% p.a. on her purchase price. Find the cost of the 12-
year indexed annuity starting at $24,000 in the first year.

(iv) Jan places the remainder of her $600,000 lump sum in an index fund (within her SMSF).
As her fund is paying a pension, there is no tax on these earnings. The fund is assumed to
earn 8.5% p.a. over the 12 years of the guaranteed income stream (according to Vanguard
Australia, the long-term average return of ASX is in excess of 12% p.a.).

Find the expected accumulation of the residual lump sum in Jan’s index fund at the end of
12 years if it accumulates at a rate of 8.5% p.a. compound over this term.

(v) Compare the expected accumulation in part (iv) with the indexed value (indexation is
assumed to be 3% p.a. compound over the 12-year term) of the entire original lump sum.

(vi) An alternative way of funding the annuity is by regular drawdown from a cash account
within the SMSF. How much money (approximately) should Jan place in the cash
account to run ORIS this way?

(vii) Discuss the pros and cons of the drawdown alternative as against the outright purchase of
a term certain indexed annuity from a commercial provider.

(4 + 3 + 3 + 2 + 2 + 2 + 4 = 20 marks)

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Question 6

Compliance in financial planning

(i) Financial planners have a fiduciary duty to clients. Explain what this means and why it is
necessary.

(ii) When constructing a financial plan (a Statement of Advice – SoA) two blocs of
information must be elicited from the client (then jointly signed and dated) in order to
proceed with the plan. Briefly describe this information.

(iii) Why is it necessary to obtain client confirmation of this information?

(iv) What are the two key elements of quality advice?

(v) What obligations of disclosure do financial planners have to their clients?

(vi) What is a FSG and when should it be supplied?

(2 + 2 + 1 + 2 + 2 + 4 = 13 marks)

Question 7

Superannuation lump sums and pensions derived from taxed and untaxed sources

(i) James is 65 years old, he has $600,000 from an untaxed source, all of it attributable to
post-1983 service. If James were to cash in the entire lump in the 2007 - 8 financial year,
how much lump sum tax would he have to pay?

(ii) James decides to roll over the $600,000 into a New Pension, drawing down a pension of
$25,000 in the 2007 - 8 financial year. What is the tax charge on James’ pension?
Comment on the effect of rolling over the lump sum rather than cashing it in.

(iii) Suppose James were to die in this financial year. The pension would then revert to his
widow Irene (aged 59). How would Irene’s pension be taxed?
(3 + 6 + 2 = 11 marks)

Question 8

Family court

(i) Describe briefly the Family Court’s approach to division of assets in the event of marital
breakdown (in the absence of a binding financial agreement – ‘BFA’).

(ii) ‘A BFA enables parties to contract out of rights and entitlements that are provided for
under the Family Law Act’. Write a short comment explaining why you think this
statement is true or false.
(7 + 4 = 11 marks)

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Question 9

Small DIY funds

(i) List three requirements for a SMSF to be a ‘complying fund’.

(ii) List three advantages of having a SMSF during your retirement phase as against leaving
your super in a public offer or industry fund.

(iii) List three disadvantages of using a SMSF during your retirement.

(iv) You retire with a substantial lump sum. Describe two ways in which a SMSF can be
utilised for conversion of the lump sum to a retirement income stream.

(v) Name two documents that the trustees must prepare each year and submit to the ATO.

(vi) What are two attractions of using a SMSF for disposal of assets?

(4 + 3 + 3 + 4 + 2 + 2 = 18 marks)

Question 10

Asset protection: general insurance, life insurance

(i) A basic part of asset protection is protecting your ownership of the asset. Explain the role
played by the following legal structures in protection of ownership:

• binding financial agreements

• common tenancies
• binding death nominations on superannuation fund trustees.

(ii) You can insure your income (or a proportion of it) against becoming totally or partially
disabled.

(1) How is ‘income’ established (and what proportion of it is insurable under a policy)?

(2) Three definitions of ‘disability’ are customarily used by insurers. Describe the nature
of:

(a) duty-based definitions

(b) time-based definitions
(c) income-based definitions.

(3) Benefits under such policies are of two types:

(a) agreed value

(b) indemnity type.

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Describe briefly the nature of the two types.

Question 10 (continued)

(4) Which definitions of ‘disability’ and ‘benefits’ are likely to be most serviceable to
clients (give brief reasons)?

(iii) A female life aged 30 takes out a 10-year endowment insurance policy for $1m. Describe
the benefit involved if:

(a) the life dies at age 35

(b) the life survives to age 40.

(iv) List three main types of motor vehicle insurance.

(6 + [2 + 6 + 2 + 2] + 2 + 3 = 23 marks)

Question 11

Estate planning

(i) A will is the most familiar instrument by which assets are transferred on death.

(a) List three main requirements for a valid will.

(b) What class of assets are disposed of by wills?

(c) List the three sorts of non-estate assets.

(ii) Describe how, on death, assets may be disposed of without use of a will in the following
cases:

- joint tenancies
- life insurance
- superannuation
- life insurance as part of superannuation
- trust distributions
- annuities, when they are ‘reversionary’
- assets treated by BFAs.

(iii) What is the function of an ‘executor’ of a will?

(iv) On testamentary capacity:

(a) What is meant by saying that the testator has ‘testamentary capacity’?
(b) By what tests is testamentary capacity established?
(7 + 7 + 2 + 5 = 21 marks)

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Appendix: Formulas
Annuity formulae

Present value of an ordinary annuity: an:i = (1-vn)/i = v+v2+ ⋅ ⋅ ⋅ vn

Present values of related annuities:

Annuity payable pthly a n( :pi ) = (i/i(p))× an:i, i(p) = p{(1+i)1/p-1}

Accumulation of Super Guarantee Scheme payments

Accumulation = SS×CP×(1-tc) × {r/r(p)}[(1+r)n – (1+g)n]/(r-g)

SS is starting annual salary

CP is annual contribution proportion of gross salary paid into fund
p is the number of times per year contributions are paid into the fund
tc is tax on contributions into the fund
r is average annual compound earnings rate over the n years net of tax and fees
g is the compound average annual rate of salary growth over the accumulation years

Purchase price of an indexed annuity payable pthly

Cost of each annual starting dollar payable p times per year (i.e. as $1/p each payment) for n
years indexed at rate g after the first year, assuming the fund to earn an effective rate r per annum
compound is:

n
1+ g 
a(p)n:r:g = {r/r(p)}[1-   ]/(r-g)
1+r 

New pension tax laws

Age % of account balance to be taken

55 - 64 4
65 - 74 5
75 - 84 6
85 - 94 10
95+ 14

Table 1 Minimum pensions as proportion of account balance that must be drawn to qualify as
tax-free income.

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