No one wants to run out of cash after they have retired but for the next generation to cross the workforce finish line stretching those dollars will be harder than ever.
A cocktail of unfavourable circumstances, such as low interest rates, poor returns on defensive investment classes and pension qualification changes, mean self-funded retirees will have to get savvy with their planning if they want to keep their pensions going.
Over the past few years we’ve become accustomed to super funds delivering stunning double-digit returns. But consultancy and financial management group Towers Watson predicts that trend won’t last, with long-term returns tipped to fall to about 5 per cent over the next decade.
With Australians living into their late 80s and early 90s and still retiring on average in their early 60s, it will mean we might have to get inventive.
Fortunately experts say there are several strategies you can put into place before you retire and early into your retirement to slim your chances of running down your pension fund too quickly.
“There are a lot of ways you can get ahead about having to worry about returns,” Olivia Maragna, co-founder of Aspire Retire, says.
Smart Investor has rounded up a few action plans to help you keep your longevity risk in check and cruise through the coming decades.
INCREASE YOUR WEALTH BY SPLITTING
If you’re coupled up and younger than your partner you might want to consider the splitting strategy, which allows you to put some of your super into their fund to build wealth in a tax-free manner.
You’re allowed to “split” up to 85 per cent of your super contributions with your spouse before you pay tax, including your super guarantee and salary sacrifices. This strategy works if one partner is working and the other is retired, so the contributor is paying no tax instead of at the marginal rate.
Maragna says a small proportion of retirees take advantage of splitting, which is surprising given how many would be eligible.
“Why would you pay tax on your earnings for another five years when you can split that across to your spouse and not pay tax on that for five years?” she says.
To take advantage of it, you’ll have to fill out an Australian Taxation Office form and contact your super fund. But there are a couple of conditions – if you’re splitting to your partner he or she must be either younger than 55 (the preservation age) or aged between 55 and 64 and still working.
CHOOSE INVESTMENTS WITH LONG-TERM POTENTIAL
How you invest in the lead-up to retirement can have a significant impact on how far your money goes.
Share investors are often obsessed with yield, when instead they should be targeting quality companies that offer steady growth and income over the longer term, says Chris Hogan, director of personal wealth management at HLB Mann Judd.
Hogan encourages pre-retirees not to shy away from stocks in the fear of a downturn, but instead go for those with lower yield upfront but the promise of dividend appreciation.
Ramsay Healthcare is an example of a stock that falls into that category, Hogan says. “It’s got a low dividend at the moment and it looks expensive, but it’s a quality company. The capital value and dividend should grow over time,” he says.
Hogan thinks bank hybrids are also a solid longer-term option for pre-retirees and says he favours the big four. “They get a fair bit of negative publicity but we think on a risk-return basis they look pretty good,” he says.
GET YOUR RISK AND DRAWDOWN MIX RIGHT
Pre-retirees are often advised to scale down risk in the last few years of work, but with cash and bond rates in the doldrums the traditional approach creates a bit of a predicament if the income needs to last 30 years.
Advisers are saying asset allocation strategies might need to be revisited, with a skew to either non-conventional diversifiers or approaches that rely on timed investments.
“Investors can no longer just rely on the term deposit. They have to have the term deposit and something else,” says Hogan, who recommends investigating fixed-income offerings at a local and global level.
Frank Mulcahy, a senior adviser at Stanford Brown, says investors moving into the retirement phase should be considering different
asset classes, such as hedge funds, private equity and infrastructure.
“The objective is not only to enhance return but to reduce the volatility of the portfolio returns,” he says.
And for Wade Matterson, senior consultant and leader of Milliman’s Australian risk management business, a conservative asset allocation mix in the years leading up to retirement no longer makes sense if planning for a 30-year horizon.
“The whole strategy that you de-risk your portfolio to the point of retirement is counter to what you should be doing if you’ve got a long-term focus,” he says.
“If you’re investing for a 30-year retirement you should still have a fair chunk in growth-style assets.”
To manage longevity risk – or the risk of running out of money in retirement – some use the bucket strategy, in which savings and investments are apportioned into various “buckets” to be spent over different time frames.
For example, your first bucket might be in cash-related assets and intended to last two to three years. Once that period has passed, and that bucket spent, you upgrade to the next bucket, which contains a higher proportion of fixed income, before moving into your growth assets bucket.
Matterson says there might be a benefit over time but warns it’s not a way to control market volatility. Instead, it’s a mechanism to work out a retirement income stream.
Milliman’s produced a research paper recently that suggests by maintaining a level of growth assets in a portfolio a sustainable withdrawal rate of 6 per cent could be maintained for retirees who want to make their investments last over the long term. It’s a revised version of the sustainable drawdown rate commonly used in the financial planning community of 4 per cent.
For retirees who like the idea of carefully controlling their drawdown and don’t want to be exposed to market fluctuations, an annuity could be the way to go.
Depending on the chosen product, annuities usually pay retirees at fixed monthly, quarterly or yearly intervals using money that has been invested through a super fund or life insurance company.
You might want to use your entire super savings pool to buy an annuity and in return receive a guaranteed income stream and potentially improved Centrelink benefits, Mulcahy says. But he warns the downside is the loss of investment control over the funds.
However, there’s also the option to break up super investments and apportion some to the purchase of an annuity, while the rest stays invested elsewhere, he says.
For example, you might wish to put 20 per cent of your super into a term certain annuity, which would offer fixed payments over the first 10 to 15 years, when you generally need more income, Mulcahy says.
Matterson says annuities are a great way to control income needs and risk but are often overlooked because their benefit is delayed.
“The problem from my perspective isn’t the availability of annuities. The bigger problem is getting people to buy them. It’s a behavioural problem. People are short term in nature and they struggle to make decisions today that won’t affect them for 20 years,” Matterson says.
While the government could mandate a solution, such as linking pension or tax benefits to product purchase, neither party has signalled an interest in doing so, he says.
MAKE THE MOST OF YOUR ASSETS
If you’re asset rich but cash poor, another avenue to ponder in the quest for a long and comfortable retirement is a reverse mortgage or equity release strategy.
If you own your home and aren’t holding on to it for beneficiaries, you might be able to borrow up to 15 to 20 per cent of the value of the property when you’re 60 as either a lump sum or income stream.
Mulcahy says the strategy acts as an alternative to having to downsize and makes sense in markets that have grown in value, like Sydney and Melbourne. There are restrictions on the loan, though.
The Australian Securities and Investments Commission makes the point that the debt can grow very quickly as the interest compounds.
If you don’t want to go down that path, Mulcahy says home owners can also consider renting out a section of their property or renting out the whole property and using the income to retire somewhere with a less-expensive cost of living.