All our lives lead up to our golden years, when we finally get to relax and enjoy the fruits of many decades of working and saving. Yet a ground-breaking report currently being prepared by the CSIRO reveals many senior Australians are too worried and uncertain about their financial position to make the most of their retirement.
This is true even for those who have no good reason to fear for their financial futures, provided they get good professional advice and plan for the future properly.
CSIRO behavioural economist Dr Andrew Reeson says fear of running out of money during retirement is obviously a major driver of retirees’ investment and spending decisions.
Dr Reeson is studying how retirees draw down on their superannuation.
By law, retirees must withdraw a minimum amount from their super as a pension each year to qualify for the tax exemption on super investment earnings.
Dr Reeson’s research has found most people in their 60s and 70s withdraw at close to the minimum rate. And surprisingly, this is just as true for the very wealthy as for anyone else.
“It seems people are choosing to self-insure for longevity risk,’’ he says.
One obvious explanation for this is the desire to leave a bequest, but he says another major factor is the fear of running out of savings.
John Piggott, director of the ARC Centre of Excellence in Population Ageing Research, agrees fear is a key factor in retirees’ decision-making.
“People are terrified of coming to the end of their lives and having no money for health and aged care,” he says.
To counter this problem, Piggott has called for more focus on financial investments such as annuities, which deliver regular, guaranteed income streams into the future and effectively insure people against outliving their savings.
Annuities are financial products that pay a guaranteed, regular income that can keep pace with inflation. The income is generally tax free if you’re over 60 and investing your superannuation money. Some annuities can interact efficiently with Age Pension benefits, social security and aged care rules.
The CSIRO’s Dr Reeson also believes guaranteed income streams have a key role to play in giving retirees peace of mind.
“We need more annuity-type products and a better understanding of how to best encourage more people to make use of them,’’ he says.
Dr Reeson also points to the huge psychological challenge of retiring, and the upheaval and difficult decisions it brings, as another issue causing retirees to feel stressed.
Many retirees, he says, find the complexity of the financial decisions they face overwhelming.
Whether to take any lump sum out to cover debts or one-off expenses at retirement, at what rate to draw down at, how to factor in the Age Pension, what financial products to buy, how much to invest in equities, whether to downsize the home, whose advice to take … the list is endless.
And then there are the assumptions required, such as what one’s health (and that of one’s spouse) is likely to be like in the future, how share markets and interest rates may perform in the years ahead, and what legislative changes the government may introduce.
However, the Association of Financial Advisers estimates only one in five Australians have an ongoing relationship with a professional financial adviser, leaving most to muddle through this minefield alone.
“Retirees face impossibly complicated decisions that require them to factor in life expectancy, their future spending, and so many other variables,’’ Dr Reeson says.
“Behavioural economics shows that when people face complex decisions, they either defer them or fall back on default options.’’
Search for answers
So if the superannuation system, despite its $2 trillion in assets, is failing to deliver peace of mind for retirees, what possible solutions are there?
David Reed of The Retirement Advice Centre says the issue goes much deeper than finances.
Reed was named Australian Financial Adviser of the Year for 2015, but he prefers to call himself a retirement specialist – not because financial advice isn’t critical, but because he believes it is simply one important aspect of retirement planning.
Only a holistic approach to the huge lifestyle change that is retirement can deliver the levels of happiness and financial confidence we would all hope to enjoy in our later years, Reed believes.
He points to recent findings by top US financial research firm DALBAR – which concluded investors’ results were more dependent on investor behaviour than on fund performance – as evidence that all aspects of retirement planning will have an impact on financial outcomes.
“The problem is, we spend too much time focusing on what we are retiring from and not enough on what we are retiring to,’’ says Reed.
Without a clear vision of what their goals are, and a plan for how to achieve them, it’s no wonder so many retirees make poor decisions about their finances, he says.
Reed is particularly focused on what is termed the retirement risk zone – the years immediately preceding and after retirement.
“The first five years after retirement are fraught with danger,’’ says Reed. “An adviser’s role is to put their clients onto a good glide path into this zone.”
Those who successfully transition through this critical period with their finances in good shape are much more likely to go on to enjoy a successful retirement.
“Retiring is not easy,’’ he says.
For one thing, there’s the psychological adjustment to being at home all day after a lifetime of work. This can put a great strain on the newly retired – and on relationships, as spouses suddenly find themselves spending more time together.
Then there are new expectations to be met.
“There is pent-up demand for holidays and toys, and all too often the budget goes out the window,’’ Reed says.
Another key danger of the risk zone is sequencing risk – this risk is when unfavourable investment returns occur when your capital is highest in the early years of retirement. If returns are negative early in your retirement, a larger portion of your investments will need to be sold to pay for ongoing living expenses. This reduces the potential for recovery and future growth, meaning your money may run out sooner.
“In some ways, retiring is a lottery,’’ says Reed. “People retiring at the worst part in the cycle who do not adjust their plans accordingly stand an 85 per cent chance of running out of money within their lifetimes.’’
But despite all the challenges, Reed says that with professional guidance, retirees should be able to draw down on their super and other assets comfortably in the knowledge that they have a road map for the future and won’t be left penniless.
One example of the tools financial advisers can use to give retirees confidence that they will never run out of money is a guaranteed income such as an annuity.
“Lifetime income streams such as annuities are important, and very popular in the US compared to Australia,’’ says Reed.
He agrees with Piggott of the ARC Centre of Excellence in Population Ageing Research and the CSIRO’s Reeson that not nearly enough attention is paid to these products in Australia, and he recommends retirees ask their financial advisers to explain how useful they can be.
With professional advice on how to make the best use of all the strategies and tools available to them, there is no reason for retirees to be too conservative when it comes to enjoying spending their savings.