Australians will need to combine lower spending strategies and the right investment options to ensure their income lasts for an increasingly likely period of 25 years in retirement, according to analysis conducted by Towers Watson.
Andrew Boal, Managing Director for Towers Watson in Australia said lower levels of spending, particularly in the early years of retirement, must be implemented alongside an appropriate investment strategy to retain flexibility and reduce longevity risk. Using the Towers Watson Retirement Planner, a number of scenarios were modelled for a couple, both aged 65, retiring today with superannuation assets of $500,000.
“Towers Watson chose to model this scenario based on 2007 Census data that showed that more than 70% of Australians enter retirement as part of a couple,” Boal said. “When considering investing for financial success in retirement, there are several factors that come into play, including how much superannuation a saver has available at the start of retirement, their spending plans, the amount of any other savings they have, as well as their risk tolerance and preferences. An individual’s spending strategy, however, is one of the biggest factors that will determine whether or not they will achieve financial success in retirement.”
Based on the most recent published Australian life tables, a 65-year-old male is expected (on average) to live to 83.5 years and a female to 86.6 years. Boal added: “Mortality rates for the over 65s have been improving steadily since the early 1970s and, if you allow for these improvements to continue, then a 65-year-old man would be expected to live an additional 3.5 years to the age of 87.0 years, and a woman 2.9 more years to the age of 89.5 years. Using these improved life tables, there is a 72% chance that at least one of them will be alive at the age of 90.”
The Towers Watson Retirement Planner showed the impact of different investment strategies for the couple who want to make their savings last 25 years to age 90, varying their exposure to growth assets from 0% (cash) to 30% (conservative) to 50% (moderate) to 70% (balanced) to 85% (growth) to 100% (high growth).
Investing in a balanced portfolio, the couple is expected to be able to spend $57,705 a year (including Age Pension amounts available after applying means tests) up to age 90. After that, they would be expected to rely solely on the Age Pension. Boal continued: “It is important to recognise that this is only the expected outcome. There is only a 48% chance that their superannuation will last until age 90. But if we looked at this from the spending perspective, we can see a different impact.”
If the couple adopts a lower spending strategy (say, $50,000 or $52,000 a year), there is a much higher likelihood of success (more than 80%) for both the conservative and balanced options. Alternatively, if the couple spends at higher levels (such as $54,000 to $58,000 a year) then the investment option chosen has a more significant impact on the outcome. For example, under a balanced investment option, spending $54,000 a year has a 67% likelihood of success, compared to 56% under a conservative investment option.
Retirees are also likely to have variable spending patterns.
A number of academic research papers suggest that a retiree’s spending is likely to start reducing by around age 80. Taking the ASFA Retirement Standard as an example (which is based on budgets for a retiree aged 70), the “comfortable” index includes a range of leisure activities including overseas travel. Removing a lot, but not all, of these activities would reduce spending by up to 20%. On the other hand, later in life, spending may increase to cover the higher expected costs of health and aged care.
Boal said: “It is quite apparent that one of the biggest factors that will determine a person’s ability to achieve financial success in retirement is how much they spend each year. When combined with a lower spending strategy, there is little difference in the likelihood of their savings lasting to age 90 for a conservative versus a balanced investment portfolio. But the residual balance left over at age 90 is likely to be much higher for a balanced investment portfolio. For the sample couple, staying invested in growth assets produces a better outcome than de-risking, either gradually via a lifecyle or target date fund or more suddenly.
“Based on a recent study by ASFA, the level of spending for a 90-year-old is expected to be around 10% lower than for a 70-year-old. This provides a good opportunity for a retiree in their 70s to purchase some form of guaranteed annuity or other longevity risk pooling vehicle. An adaptive spending strategy, where people adjust their spending based on recent performance, is also likely to further improve the likelihood of financial success in retirement.”
When designing default retirement income solutions, superannuation funds first need to understand the demographics and expectations of the members they are targeting. The funds also need to help their members to understand more about their own expected retirement outcomes and the risks they face, by providing tools such as written retirement income estimates and online calculators. Only then will funds be able to guide their members more effectively into retirement income solutions that better suit their needs.
The full report: The path to retirement success.
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