Last week’s Cuffelinks contained three interesting articles on life expectancy, lifecycle funds and investment strategies. Amongst other things, these articles discussed the following concepts:
- the ability of the state to pay the age pension due to the decreasing number of workers versus the increasing number of retirees
- the appropriateness of having a more conservative investment allocation as we grow older, and whether superannuation funds should be structured so this happens automatically.
Here are some comments based on my observations as a financial planner, and many years discussing retirement and superannuation with clients.
Although the raising of the superannuation guarantee charge to 12% of salary will assist many to accumulate enough money for their retirement, for most this comes too late as they have not had enough time to benefit from the government initiative. Treasury’s 2010 Intergenerational Report projects that by 2050, 75% of the population will still be receiving some age pension.
I have come across many people in their late 50s who have relatively small amounts of super but live in a home that is debt free. One challenge for them is to fund the gap between the time they finish work and the time they can access the age pension.
An ABS study, the 2010-11 Multipurpose Household Survey, revealed a significant gap between the average retirement age and the age pension age. According to the survey, the average age at retirement from the labour force for people aged 45 years and over in 2010-11 was 53.3 years (57.9 years for men and 49.6 years for women). Of the 1.4 million men who had retired from the labour force:
- 27% had retired aged less than 55 years
- 53% had retired aged 55-64 years
- 20% had retired aged 65 years and over.
Although many people in their late 50s and early 60s would like to continue working, a high percentage of them are not able to do this. According to the ABS study, 36% were made redundant or got sick. In my experience, relatively few finish work because they have enough money. Many are forced into lower income jobs, perhaps because they are considered to be more expensive or less innovative than younger people. Perhaps they no longer ‘fit in’ with younger colleagues.
I suspect that in future years this problem will become more significant. The high cost of housing and the associated debt repayments, plus the inclination to pay for private schooling means that many Generation X families are spending their entire incomes and saving nothing beyond the minimum superannuation requirements. In many cases, affordability of their current lifestyle and preferences is only possible because both parents work and interest rates are low.
Annuities or endowment funds have been mentioned as a potential solution to the longevity problem. This might seem a reasonable idea if these products are CPI-linked, but if they aren’t, unforeseen rises in interest rates and inflation will be disastrous for people who lock into annuities at today’s low rates.
The two most important messages I give to clients about superannuation are:
- during your working life you must build up sufficient money to create an income stream that will last for the 25 years or more you will spend not working
- once you have finished work, your super must grow faster than tax and inflation, and if it doesn’t, then you may run out of money.
I suspect ‘lifecycle’ funds fail these tests in two ways. Firstly, they move members’ money from ‘risky’ assets to ‘secure’ assets too soon. Secondly, in the current environment, ‘secure’ assets are not delivering returns that exceed tax and inflation.
In essence there are four parties that can help super fund members with their investment decisions – the government, the super fund manager, a financial adviser and the member themselves. The government has a duty to incentivise people to secure their own retirement because the government knows they will not have the money to pay for health and pensions over coming decades. Based on demographics and the ageing of our population, there will only be 3.5 workers for every retiree in 2025. If the government ignores this statistic and introduces policies that assume that the average retirement age will rise to 73, there will be negative ramifications if it does not come to pass.
Wealth managers also have a duty of care as they are the trustees of super funds. They appear to have two choices when it comes to default design under the MySuper regulations – a lifecycle approach or a balanced fund approach (where asset allocation is not linked to age). Members can of course opt out and choose from a number of asset allocations based on risk profile (defensive, conservative, balanced, growth, etc). This relies on the member choosing the right profile. Whether a member remains in the default option or makes an active choice, neither solution is perfect.
Into this imperfect world steps the financial planner. He or she should have the experience, ability, desire and tools to guide a member into the most appropriate investment option. The advice is based on individual circumstances and should involve the following steps:
- establish how long the member has between now and retirement
- find out how much super they have already and what they are contributing
- help the person assess how much income they will need in retirement
- calculate the shortfall or surplus based on some assumptions about future employment income and fund performance
- if there is a shortfall, will non super investments or the age pension cover it?
- if not, the member either has to save more money, accept a lower retirement income or try and achieve better performance.
An individual can follow these steps themselves but I question whether most have the time or the expertise.
The actions of governments and super fund managers are based on actuarial statistics focussed on averages. But the average investor does not exist. The true value of a financial planner is the ability to blend a super fund member’s personal situation, objectives, time frame and risk profile with the generalist policies of governments, super fund managers and administrators.
Rick Cosier runs an independently-owned financial planning business, Healthy Finances Pty Ltd.