The retirement balancing act

nyone who is planning to retire in the next few years has plenty of things to keep them up at night.

But there are two specific risks that should be front of mind for your average baby boomer: One, do they have enough money to retire on comfortably, and two, what are the chances they will outlive their savings?

The superannuation industry refers to the first issue as ‘adequacy’, and to the second as ‘longevity risk’.

Longevity risk was a popular topic at the recent Actuaries Institute Summit held in Sydney. Speaker after speaker warned of the impending ‘mortality improvements’ that could see life expectancies blow out in the coming decades.

Cures for cancer, human genome mapping and even the 3D printing of replacement organs were some of the possible medical advancements under discussion.

Leaving the ‘technological singularity’ aside (you’ll have to Google that one!) there is plenty of evidence that the bulk of Australians are underestimating their life expectancies.

According to Actuaries Institute chief executive Melinda Howes, most people make the mistake of looking at the ‘at birth’ life expectancies in the life tables produced by the Australian Bureau of Statistics (ABS).

As a result, financial planners and their clients alike tend to plan on the basis that men are likely to live until 79 and women until 84.

But as Ms Howes points out, the ABS numbers fail to take into account future improvements in mortality.

“What people don’t realise is that today’s healthy 65 year-old – and by ‘healthy’ I mean ‘not obese’ – has a 50 per cent chance of living to 100,” she says.

And if you can hang in there until your eighties, your chances of receiving a letter from Buckingham Palace shoot up even further.

“So what we have is a not-quite-mature pension system that doesn’t have guaranteed pensions, and we’re going to live a lot longer than we thought. So we do have a real problem,” says Ms Howes.

For the Actuaries Institute, part of the solution to longevity risk lies in products that guarantee a stable income for life, such as lifetime annuities.

But for Colonial First State general manager for advocacy and retirement Nicolette Rubinsztein, the current generation entering retirement does not have the luxury of worrying about longevity risk.

Instead, the current crop of baby boomers will have a hard enough time funding their retirement to 80 – let alone until 100, she says.

Ms Rubinsztein pointed to the most recent Association of Superannuation Funds of Australia (ASFA) retirement standards, which indicate that a single person needs an annual income of $41,169 to have a ‘comfortable lifestyle’.

The ASFA figures are based on the costs of various household and living expenses as of the March 2013 quarter, and were compiled in collaboration with retiree focus groups. The retirement standards also assume the retirees own their own home.

To fund an income of $41,169 until their late eighties, a retiree will need a lump sum of about $450,000 at age 65, says Ms Rubinsztein.

“A very small proportion of people would have that kind of money today. And even at a 12 per cent [superannuation guarantee for an entire working life] you only get to about $350,000,” she adds.

In order to make up the shortfall between what they have at retirement and what they need, retirees need an exposure to growth assets in their portfolio.

“The predominance of account-based pensions is a way of meeting the needs of retirees, who have much more of an adequacy issue than a longevity issue,” says Ms Rubinsztein.

In fact, allocated pensions were doing a pretty good job of providing that growth – but then the global financial crisis (GFC) hit.
However, the market volatility experienced in the wake of the GFC has caused many retirees to rethink their strategy completely.

A whole new ball game

Against this backdrop, one thing is clear: asset allocations that are appropriate in the accumulation phase are not appropriate in the drawdown phase.

Lonsec general manager, investment consulting, Lukasz de Pourbaix, says many of the retirement portfolios in the market have simply been “accumulation portfolios with slight tweaks”.

The way Mr de Pourbaix frames it, when retirees make the transition from the accumulation to the drawdown phase, they move from a single objective – wealth accumulation – to a multi-objective environment.

Firstly, retirees need to meet an income requirement for their everyday living expenses. Above those expenses, however, sits an additional level of income needed to meet lifestyle requirements – which will vary from person to person.

“Then there are other goals above that, which are more aspirational. Things like inter-generational wealth transfer and leaving a bequest,” Mr de Pourbaix says.

One popular strategy in the retirement area is ‘layering’ – that is, using an appropriate product to provide a guaranteed level of income for retirement, and then building additional layers of riskier assets on top of it.

According to AMP director, platforms, Steve Burgess, layering also frees up the adviser to focus on growth by removing one of the deep-seated fears of retirees: running out of money.

Mr Burgess says that in all the research he has overseen, the comment of one particular retiree has stuck in his mind: ‘When I’m in retirement, I’m not that keen on becoming rich – I just don’t want to be poor’.

By taking care of everyday expenses first, planners can get around clients’ psychological resistance to growth assets, Mr Burgess says.

When planners sit down with their clients to come up with an appropriate retirement income, they should also be conscious of the fact that the income needs of retirees are not static.

According to a recent ASFA white paper, there are three distinct periods during retirement.

The early years of retirement form the ‘active’ period, which is similar to the last years of work. The ‘passive’ period covers the time during which health declines
and expenditure is reduced. Finally, during the ‘frail’ period, health deteriorates and aged care costs become significant.

Guaranteed for life

Products that guarantee an income for life are often touted as part of the answer to longevity risk.

Lifetime annuities, in particular, can be purchased by retirees to ‘lock in’ an income for life.
Australia’s annuity market, however, is relatively small compared with overseas markets – particularly those in the UK and United States.

According to DEXX&R statistics for the first quarter of 2013, the Australian annuities market is currently worth $10 billion, whereas retirees currently have $124 billion invested in account-based pensions.

According to Ms Rubinsztein, the difference between account-based pensions and annuities in Australia is the “polar opposite” of, say, the UK market.

In the UK it was compulsory to take a retirement benefit as an annuitised income stream until 2011 – and there are still big tax incentives in place today.

Annuities also form a large part of the post-retirement market in the United States.

However, according to Financial Services Council (FSC) senior policy manager for superannuation, Blake Briggs, innovation in the

Australian annuities market is being stifled by regulatory and taxation barriers.

As a result of these barriers, it is not currently viable to manufacture deferred lifetime annuities (DLAs) in Australia.
DLAs allow a retiree to purchase an income stream when they retire (say, at 65) and then have the income stream commence when they turn 80.

Under the current tax regime, however, the money used to purchase the annuity is taxed – whereas it would be untaxed if it were placed in an allocated pension.

The government responded to industry lobbying in the federal Budget, announcing its intention to give DLAs the same concessional tax treatment that applies to investment earnings from other superannuation assets from 1 July 2014.

The FSC expects to see a discussion paper outlining further changes to the regulations affecting annuity products “in the near term”, Mr Briggs says.

“But it’s critical that the government doesn’t change the regulations in a way that is a ‘one-size-fits-all’ approach. The reform needs to allow [a range of] different tailored products to come to market,” he says.

Financial planners have been less than enthusiastic about recommending annuities to their clients.
According to Investment Trends’ December 2012 Retirement Planner Report, 27 per cent of planners used annuities in 2012 – and 43 per cent said they planned on doing so in 2013.

The income-guaranteed products most widely used by planners in 2012 were the Challenger range of annuities (60 per cent), followed by the North Protected Retirement Guarantee (28 per cent).

According to Challenger Life chief executive Richard Howes, lifetime annuities can guard against the risk of living too frugally – something the ‘silent generation’, which came before the baby boomers, was famous for.

“One of the really powerful advantages of lifetime annuities and deferred lifetime annuities is that they enable an appropriate level of consumption,” Mr Howes says.

When they purchase an annuity, investors generally have the choice to index their ongoing income payments to inflation – although doing so can be quite expensive.

Along with annuities, there are other income-guaranteed products available to investors in the Australian market.

These products generally involve a managed fund – or list of managed funds – with an insurance overlay that guarantees the capital and/or the income stream.

Overseas, such products are often referred to as ‘variable annuities’, although as the general manager for retirement solutions at

MLC/NAB Wealth Andrew Barnett points out, they are neither variable nor annuities.

Examples of these products include MLC’s Protected Capital and Protected Income; AMP’s North Protected Retirement Guarantee; and BT’s Wrap Capital Protection.

OnePath MoneyForLife – formerly ING MoneyForLife – is now closed to new investors.

According to Mr Barnett, the products available in the Australian market are either term-based or lifetime products.

‘Variable annuities’ sit somewhere between a fixed annuity and an allocated pension, he says. They provide a certainty of income, but the underlying capital which is invested in growth assets can be accessed at any time.
But the cost of the protection can be prohibitive – as high as two basis points for some products.

The North Guarantee fee depends on the client’s age and the term chosen, according to Mr Burgess.

“It can be quite high – up to 2 or 2.5 per cent on top of your administration fee. So it’s really important that advisers and clients take that into account when they’re thinking of how they might engage with the guarantee,” says Mr Burgess.

To keep costs down, planners often choose to apply the North Guarantee to a ‘core’ part of a client’s portfolio, he adds.

Meanwhile, NAB recently made a low-cost annuity deposit available through its retail banking arm, NAB general manager of income and investment solutions, John McClusky says.

The annuity deposit pays out its principal and interest either monthly or quarterly over a term of one to 10 years, as chosen by the investor.

“Some of the other products [in the market] have fee burdens and other assets that support the cash flow payments, whereas this is a simple, low-cost and transparent investor solution being a direct obligation of a major Australian bank,” says Mr McClusky.
NAB is looking to get the product onto platforms so it can be made available to the advised market, he adds.

Living within your means

The age pension can play a vital role in retirement planning – even for relatively wealthy clients.

Russell Investments director for superannuation Tim Furlan says the means test for the age pension effectively gives investors downside protection against the market.

“When markets go down, your pension goes up. It’s not a one-for-one trade – a perfect ‘put’ on the market – but it does provide some protection,” says Mr Furlan.

And surprisingly, modelling conducted by Russell has shown that even people with account balances of up to $2 million can find themselves eligible for a part pension.

“Even if you’re well above the means testing early on in retirement, you’re going to find yourself in that means testing zone at some point,” says Mr Furlan.

Russell Investments’ modelling has shown that the downside of the protection offered by the age pension means that Australian retirees can afford to take slightly more risk than their American counterparts.

Financial planners can add value in this area by recommending various Centrelink strategies to maximise the amount of aged pension their clients can receive.

Eluvia director and financial planner Mark O’Leary says that one strategy involves holding money in a superannuation fund in the name of the younger member of a couple, who has yet to convert their savings to an allocated pension.

This strategy is, of course, completely dependent on the age of the clients, but for a couple who are 65 and 62 years-old, the strategy could give them access to the pension for a few years, Mr O’Leary says.

Other strategies that can allow retirees to reduce their asset base and qualify for some pension include giving gifts of money to children, purchasing funeral bonds, and spending money on the family home (property is a non-assessable asset under the means test), he adds.

Tapping into the family home

For a majority of baby boomers entering retirement, the family home is their most significant asset.

With relatively low superannuation balances, it makes sense for retirees to use the family home to provide for their retirement incomes, says Domacom general manager, business and professional development, Kevin Conlon.

Equity release products such as reverse mortgages allow retirees to tap into the equity of their home, says Mr Conlon.

Since the GFC, however, the reverse mortgage market has been drastically reduced to a few major players, according to Mr Conlon, with a number of non-bank providers struggling to access funding during the ‘credit crunch’.

Bendigo Bank offers one of the few equity release products left in the market, but it is only available to homeowners in a selection of inner-city suburbs in Sydney and Melbourne.

DomaCom is in the process of rolling out its fractional property interest (FPI) offering, which proposes to create a market between SMSF investors who want to diversify into residential property and homeowners who want to release some equity.

“DomaCom will be like a RealEstate.com.au or an eTrade,” says Mr Conlon. “There will be a portfolio of properties that have FPIs for sale. Investors go online and choose which properties they want to have an interest in.”

Opportunity knocks

According to Investment Trends, retirees currently make up 34 per cent of the average planner’s client base – and 41 per cent of planners expect retirees to take up a greater proportion of their client base by 2014.

A huge wave of baby boomers is set to enter the drawdown phase in coming years, and they will need plenty of advice when it comes to weighing their growth needs with the longevity risks.
Financial planners who choose to specialise in the retirement space face plenty of challenges over the next decade – but they won’t be short of work. «