Ultra-low interest rates are really hurting retirees who are trying to make their nest egg go the distance.
Spooked by the GFC, they are investing conservatively but this means that their returns are very low, with bond yields at around only 2%.
It is not surprising that almost half of all retirees draw down the regulated minimum amount on their super pension account, according to two research reports – one by the Actuaries Institute, based on data from Plan for Life, and another that uses tax office data provided to the CSIRO-Monash superannuation research centre.
Even at the minimum prescribed drawdown level for account-based pensions, retirees are well aware that they are eating into their capital because their withdrawals (starting at around 4% for the early retirement years and rising as they age) exceed their investment returns.
It is psychologically uncomfortable to watch retirement wealth diminish, however slowly, because it raises the question, “What happens when the money runs out?”
No matter how much money retirees have in their nest egg, the research found that the drawdown behaviour of people in their 60s and 70s (there are few older people with superannuation) is universally similar.
In fact, it found that retirees with larger balances are most likely to withdraw the minimum amounts. The pattern is similar across all sorts of funds, whether industry, retail or self-managed.
It is no surprise that retirees elect to take the minimum amount given the uncertainties that overhang retirement years: the inflation rate, how long they will live, what investments markets will do and what their healthcare expenses will be.
The complexities of the aged care system, and the desire to provide a roof overhead for their children, mean capital is precious.
A consequence of the high cost of property is that retirees are less inclined to consume the capital tied up in the family home for fear that their children and grandchildren will never own their own place. If the equity in the family home is off limits, superannuation must serve two roles: providing retirement income and paying for aged care.
The CSIRO-Monash report makes the point that most people are generally risk averse. “It is perhaps not surprising that the minimum withdrawal rates have come to act as an anchor for uncertain decision makers,” it says.
But not all retirees are frugal. Around a quarter draw down more than twice the minimum amount, according to the CSIRO-Monash researchers. Men withdraw amounts at a faster amount, perhaps reflecting the fact that they have shorter lives than women.
Decisions about how much to spend each year in retirement (particularly how to pay for the essentials) and how to adjust the asset allocation so that it can produce an income (particularly in a low-income environment) are the most important part of a retirement plan, according to Doug McBirnie, the senior actuary at Accurium, a retirement group that does actuarial reports for 65,000 self-managed super funds (SMSFs) in the retirement phase.
Just as you don’t want to be overly frugal, you don’t want to put all your savings into risk-free investments such as cash or term deposits because rates are so low.
The sharemarket has rewarded investors over time and if you have sold out you will miss out on the gains when it goes up.
One obvious way to ensure you won’t run down your portfolio is to live off the interest, dividends and perhaps the capital gains on your investments and preserve the principal.
At current interest rates, you would need a hefty amount to generate a reasonable income: $1 million in a balanced fund or a balanced portfolio with a 3% annual payout would produce $30,000.
Accurium, which launched the findings with the SMSF Association, found that the investment return for self-managed funds bounces around each year, varying from 4.2% in 2015, 8.2% in 2014, 9.4% in 2013 and 0.6% in 2012.
McBirnie says the current lower-return environment means retirees need more in savings to achieve their retirement goals.
Accurium’s estimate is that a 65-year-old couple will need $702,000 to afford a comfortable retirement. The group’s research found that around 30% of SMSF couples have insufficient balances in their SMSFs to afford this lifestyle, up from 25% last year.
McBirnie says a 65-year-old couple who want more than a comfortable standard of living will need $1.8 million in savings to be reasonably confident of affording $100,000 a year in retirement. The proportion of 65-year-old couples with sufficient assets in their SMSF to support this lifestyle has fallen from 34% to 29%.
The federal government has warned that superannuation is not to be used as an estate planning tool and McBirnie says Accurium’s research shows that less than one in five SMSF households plan to leave a bequest.
If conscientious retirees don’t spend their retirement savings while they are alive, they will die with substantial amounts of their savings unspent. Going without in old age could well mean the assets will end up going to the next generation via the estate.
The big challenge: saving v spending
Retirees typically retain most of their savings in the superannuation system in an account-based pension. Most large funds offer an account-based pension with the range of investment options that exist in the accumulation phase.
An account-based pension, which is easy to set up, pays an income stream. There are mandated minimum and maximum amounts that retirees have to draw down each year.
The minimum amount depends on your age. It is 4% for 55- to 64-year-olds, 5% for 65 to 74, 6% for 75 to 79, 7% for 80 to 84, 9% for 85 to 89 and 11% for 90 to 94.
Account-based pensions are not guaranteed to last for a set period of time. A small number of retirees have bought annuity products that do guarantee an income.
How long an account-based pension lasts depends on how much it holds, how much you withdraw each year, the investment return and the fees.
To get an indication you can punch your numbers into the account-based pension calculator on the MoneySmart website, run by the Australian Securities and Investments Commission.
When returns get stronger, retirees are likely to see their super balance increase. But as they age, point out the CSIRO-Monash researchers, the minimum drawdown increases.
Instead of thinking about super as being about saving and investing, it is important to frame it differently and focus on consumption and spending, suggest the researchers. But they admit that “drawing down on a non-replenishing resource may also represent a psychological challenge”.
Make the most of your super pension
• Put your figures into the MoneySmart account-based pension calculator.
• Look at the fees you are paying for your pension. How do they compare with other pension fees?
• Once you have set up your pension, you can vary your drawdown amounts, as most retirees don’t need the same amount each year.
• As you age, you spend less as your mental and physical condition deteriorate.
• Cut your spending when markets don’t do well.
• Spend more when markets perform strongly.