Retirement: Susan Hely Keep the cash flowing

Buffeted by low returns and volatile sharemarkets, retirees need new strategies to secure a comfortable lifestyle

Could this be the worst time to retire? Retirees are in a bad place. The official cash rate is at a record low of 1.5%, term deposits are paying around 2.5% and long bond yields are 2.8%. Australian equity markets continue to move sideways, although dividend yields are still healthy at around 5.7%, including franking credits, as are rent-collecting property trusts. Lower-yielding global sharemarkets have been very strong over the past year but there are concerns about the expensive US market.

“We are going through a period of low yield and it is going on for much longer than what people thought,” says Andrew Boal, regional head of Australasia at Willis Towers Watson and convenor of the Actuaries Institute’s superannuation practice committee.

All this means that if retirees want the same return on their savings they were getting 10 years ago, they need a different investment mix. A decade ago retirees could comfortably invest 40% of their portfolio in fixed income and double what they get today from bond yields. “Future returns [from fixed income] are likely to be lower and more volatile,” says Sam Morris, investment specialist at Fidante Partners.

These days retirees need to take on more investment risk for a decent return. Healthy, repeatable investment income is available but the values of these high-yielding assets are volatile.

Certainly leaving your money in cash means you are going backwards. With the Reserve Bank expecting inflation of around 2% over the next year, the after-tax return from your cash isn’t keeping up with the cost of living. If you have a large slab in term deposits paying 2.5%, the net return is 1.3% if you are on the top marginal tax rate. But this is below expected inflation. If you are investing through your super fund you are marginally ahead in real terms, but only just.

If you invest conservatively and leave 40% of your retirement savings in term deposits you will run out of money more quickly than you would if investments were working harder for you. Because the income generated

is low, you will need to eat into your capital to maintain your standard of living. Retirees don’t want to go broke and certainly don’t want to be poor when they are old and facing high healthcare and aged-care accommodation costs. The age pension is a social safety net in case you run out of money but at about $880 (including supplements) a fortnight for a single person ($1350 for a couple), it is only around 28% of male total average weekly earnings.

The prospect of outliving their retirement savings, known as longevity risk, is troubling retirees. The number of retirees who say they won’t have enough money to last them until the end of their life has jumped over the past three years to 51% in 2016, from 33% in 2013, according to the latest research from Investment Trends.

“There are a lot of external factors eroding superannuation, such as poor market performance and changing interest rates. As well, many more people – some 25% – are worried about regulatory changes to superannuation,” says Recep Peker, research director at Investment Trends.

And pre-retirees need to watch out for unforseen events such as retrenchment or ill health during the last years of their working life, says Peker. They will have to dip into their retirement savings earlier and the nest egg will have less time to benefit from compounding returns.

Retirees need their money to last on average 20 to 30 years. If they draw on their capital because they are not getting enough income it won’t last long. Less capital results in less income, leading to more capital drawdown and even lower income generation.

Another important feature of income from shares and property is that while not without risk, over the long term the growth rate has been close to the inflation rate. The income they derive today is less likely to go backwards in real terms so their lifestyle is more durable.

Retirees need to work harder at diversifying investment risk, says Boal. “Diversifying the portfolio will help to buffer the investments.”

One of the biggest risks to retirement savings is turning your back on the sharemarket, particularly dividend-rich Australian stocks.

The Australian market is unique because it pays healthy dividends that also enjoy franking credits. Pension-phase super investors get a full refund of the credits, so for them it represents extra income, says Don Hamson, managing director of Plato Investment Management, which is launching a listed investment company, Plato Income Maximiser (ASX: PL8). He calculates that dividends have provided a total return of 6.1%pa over the 10 years to December 31, 2016, including 1.6%pa franking, for tax-exempt investors such as pension-phase superannuants. This is based on the S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt).

Another important feature of income from shares and property is that while not without risk, over the long term the growth rate has been close to the inflation rate.

Also the dividend income generated by the market is around half as volatile as the value of the market itself. For example, with the index level at 5700 you might expect that in two out of three years it would range between 1000 points more or 1000 points less – almost 20% either way.

But the dividend yield, including franking, for the ASX 200 index in two out of three years might be only 0.5% more or less in a well-diversified portfolio.

If you invest narrowly in only a handful of companies, the dividend income is likely to be much more volatile. And, of course, there is scope to diversify into commercial property trusts as well, with an income yield of twice that of expensive residential property.

If you can live off your investment income, dominated by dividends and distributions, you won’t need to draw on your capital. Fluctuations in value will be less of a concern, although hard to ignore altogether. It’s only when you are forced to sell your assets, due to insufficient income generation, that volatility in value becomes a pressing problem.

But even if a couple have only $200,000 in their superannuation, an income-oriented strategy could generate $11,000-$12,000 a year without having to consume capital. The $200,000 might bounce around in value over time, both up and down, but the trajectory

won’t be steadily downhill, and maybe it will be a little positive. Your dividends and income are likely to buy the same in 10 years as they do today. At that level of assets, the age pension is not reduced.

So you will have to take on more risk to get the income generation of 10 years ago but that risk may not be as worrisome as the alternative: running out of money early.

Boal says how you invest depends on how much you have in savings. He says there are three groups of retirees: people with not much super, those with $600,000 to $1 million and those with over $1 million.

If you have less than $100,000 in super you will depend on the age pension. This will deliver a modest retirement, which the Association of Superannuation Funds of Australia (ASFA) retirement standard for December 2016 estimates to be $23,603pa for a single homeowning female ($36,851 for renters) and $34,992 ($51,760) for a couple.

The second group will be able to have a comfortable retirement if they own their home and have $640,000 as a couple (about $1.07 million renting) and $545,000 ($917,000) as a single. Both groups will have to draw on their capital and not just live on their income, says Boal. They have to make their money last 25 to 30 years.

He recommends that they invest their savings in an account-based pension set up in their super fund or self-managed fund. He suggests they combine the account-based pension with a deferred lifetime annuity for old age, perhaps when they reach 85, as an insurance strategy for five years until they are 90. They can buy it at any stage.

He says most people don’t want to spend all their retirement savings because they want to leave money to their children or relatives. For this reason they prefer investing in an account-based pension that allows them to leave money to their children if they die early. “If you

Most retirees don’t want to spend all their money – they want to leave some for their children

live to 90, then your children are in their 60s and the bequest motive is not quite as important,” says Boal.

He says that buying a deferred lifetime annuity to provide a guaranteed income in the later part of life, say age 85 to 90, can give people some peace of mind that they will not run out of money when they could be frail and have high health costs.

Boal says the question for them is what is the best way to invest their money to get them up to 85. He recommends a balanced portfolio that is diversified and aggressive because of longevity risk. But to be better off over the whole investment period, people need to be more agile with their spending. If sharemarkets go down, they need to cut back; if markets go up they can spend a bit more.

If a couple are spending $59,808pa (or $43,538 for a single) to have a comfortable retirement (according to the ASFA standard for December 2016) and the markets fall, they don’t travel that year and cut their spending back to $50,000. “This will help the money to last,” says Boal. “Be aware that the age pension will be a buffer.”

When Investment Trends surveyed pre-retirees about how much income they would need for their retirement, the average amount was $3600 a month. But when it asked retirees how much they spent in retirement, the average was $2000. “People can spend more and this shows that they need more advice,” says Peker.