Do kids have a right to parents’ cash?
One of the biggest challenges for retirees is how to plan the use of their retirement nest egg. Accumulating savings and investments during your working life is hard work. It requires discipline and sacrifice to set aside funds for later in life, and there is a sense of immense relief in getting to retirement with a decent lump sum set aside.
However, the hardest part is yet to come. Because retirement money is so hard won, it can be nerve-wracking trying to decide what to do with it.
A key issue to be decided is whether to gradually run down the retirement capital over time or just live off the income from it, so the capital is still intact at the end of life.
These days, most people are not concerned at all about leaving money for family. The general approach is that the kids can have the house and whatever is left in the bank or investments. After all, isn’t it up to each generation to make their own way in life?
Choosing to retain investment capital has a significant impact on the amount of capital required to produce the required amount of retirement income.
For example, assuming an investment return of 2 per cent after inflation and tax, you would need investment capital of $500,000 to produce an annual income of $10,000 while leaving your capital intact.
However, if we assume capital is run down over a period of 30 years, only around $228,000 is needed.
Retired investors often overlook the fact that investment return comprises both income and capital gain. Both can and should be used to supplement income.
Investing in assets which produce income but no capital gain, such as term deposits and bonds, inevitably means lower returns and more tax. Capital gain comes from growth assets such as shares and is accessed for income by selling part of a holding or portfolio.
It is important to track the total return (income and capital gain) on an investment portfolio so you can make informed decisions about how much to take from the portfolio.
The impact of inflation on the purchasing power of both capital and income over the long term needs to be taken into account when planning a retirement portfolio.
Maintaining a constant dollar value of a portfolio does not maintain the purchasing power of the portfolio or the income it generates. An allowance for inflation needs to be made in calculations for how much to draw down from the portfolio.
There are two approaches to taking cash from your portfolio. One approach is to have a single, diversified portfolio from which cash is taken from across the portfolio to maintain the diversification. Taking regular drawings from a KiwiSaver fund is an example of this.
Another approach is divide your investment amount into three buckets; one to purchase an annuity which will provide additional income for life, one to invest for the short and medium term in income-producing investments such as term deposits and bonds, and one to invest in growth assets such as shares for the longer term.
The idea is to use up the capital in term deposits and bonds over a period of time and then top up that bucket from the long-term growth portfolio.
Annuities are scarce in New Zealand. Members of the old Government Superannuation Fund and some other private superannuation schemes have annuity options available to them on retirement.
The only actively marketed annuity product available for purchase is the Lifetime Income Fund, which has builtin longevity insurance to ensure continuity of income to the end of life.
Purchasing an annuity gives greater certainty of retirement income in the face of uncertainties about investment rates of return or length of life.
Running down assets over a lifetime can extend to the family home through home equity release. This is generally treated as a last resort option when all other funds are exhausted, however just knowing that such an option exists gives some comfort to those who are worried about running out of money.
The more thought is given to all these issues and options prior to or at retirement, the better the outcome is likely to be. Liz Koh is an authorised financial adviser and author of
Awa Press. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847.