During their working years, people leverage time to build savings, enjoy the benefits of compounding interest, and perhaps, if there is time, plan for far away things like retirement.
Then, upon reaching retirement, most individuals will be asking themselves many questions for the very first time. Such as, how should I draw down my super balance, should I downsize my house, and how do I want to spend my newly found free time?
But “time” itself, may actually be the most important question as in, “how much time will I have to enjoy retirement?” As it turns out, the answer to this question impacts the answer to nearly every other question people might ask in retirement.
While governments, actuaries, and other institutions can rely on average life expectancy information and be fairly certain on the length of time in retirement for a group as a whole; for your clients, as individuals, the length of retirement is actually very uncertain. To help think through how time impacts your clients in retirement, we consider three key factors:
- Age at retirement;
- Life expectancy; and
- Retirement goals.
The age at retirement is the variable that individuals likely control the most. While health and employment circumstances do impact retirement age, for individuals considering how best to ensure they have enough money to fund their retirement, delaying retirement is the best approach. Delaying actually has a dual benefit - one more year of saving and one less year of drawing on their super balance. In fact, we can see many people are taking this approach today.
After dropping over a nearly 30-year period to about age 60, the retirement age has begun to increase since the late 1990s and is now between 64 and 66 (figure one). This is in part a reflection of the change in preservation age (the age retirees can access their super balance), but it is also a reflection of people being in better health later in life and working longer both for life fulfillment and to meet savings needs.
For clients that have yet to retire, being very strategic about retirement timing, considering age pension eligibility, superannuation preservation age, health, and employment prospects will go a long way to ensuring the length of time in retirement is manageable.
Figure 1: Average age at retirement
Source: Vanguard, using OECD Average Effective Age at Retirement
If retirement age is the most controllable variable, then life expectancy is the greatest unknown variable and likely the one your clients will be thinking about most. Often cited statistics from the Australian Bureau of Statistics (ABS) note that life expectancy in Australia is 80.5 for men and 84.6 for women, but this is “at birth”. By the time Australians reach age 65 today, life expectancy is 84.7 for men and 87.3 for women; three to four years longer.
Planning for retirement to be even longer than life expectancy however likely makes sense. For example, for those retiring at 65, the age men and women are most likely to die at is actually 87 and 90 respectively (figure two). And for couples planning not only for one life span, but two, should plan for retirement to last past age 90. So a client entering retirement at 65 perhaps expecting an average a 15 to 20 year retirement, should more realistically expect a 20-25 year retirement.
This is of course just an “average” expectation, and again, as individuals, the risk of living beyond the average is high. In fact, over 25 per cent of men, over 40 per cent of women, and nearly 60 per cent of couples (at least one person) will live past age 90 and experience a retirement well beyond 25 years in length if retiring at 65.
Figure 2: Age at death for workers retiring at 65
Source: Vanguard, using ABS Australia Life Table 2015 – 2017
Note: 2.8% of females, 1.4% of males, and 4.1% of couples survive to age 101 or later based on the current Australian Bureau of Statistics Life Table
This gets to the final point about aligning retirement goals with the time horizon you’re planning for your client. While planning for a 30+ year retirement is highly prudent, it may leave a lot of money on the table for those that don’t live as long. For example, nearly half of men and over a third of women will experience a retirement of less than 20 years.
How do you strike the right balance of, on the one hand, ensuring there is money able to last a very long time while on the other hand, not sacrificing too much lifestyle spending today given retirement may not be as long as planned?
In this case, aligning the objective to the time horizon is key, and helping clients understand the differences in basic living expenses versus discretionary, lifestyle expenses goes a long way.
We like to think of these outcomes in distributions and probabilities. For example, in the case of basic living expenses, we may be looking for a high degree of certainty, say 95+ per cent, that basic living expenses can be met for a 30+ year horizon through superannuation, age pension, and other assets. However, depending on a client’s circumstances, they may be more comfortable that lifestyle spending only has a 75 per cent probability of going beyond 20 years.
This information can then be used to establish appropriate spending policies and asset allocation given the resources available to your clients at retirement. As we can see in figure three, the amount of annual spending one can reasonably expect for a given portfolio value is highly dependent on the time horizon and desired probability of success. Understanding the objectives for that portfolio will help set the appropriate time horizon to use and risk level to take.
Figure 3: Annual spending from a $500,000 super balance + age pension for given time horizon and probabilities of success
Source: Vanguard, December 2018 VCMM Simulation
Note: The analysis assumed 0.5% annual investment fees, the retirees are homeowners and a balanced (50% equity/50% bond) portfolio. The model incorporates the age pension as at 31 December 2018 and only considers financial wealth.
As investment professionals, we may often think of market volatility and returns as the most important dimension to manage for our clients, but time may be even more impactful, and is likely equally misunderstood. Helping your clients understand this risk, manage it, and plan for an appropriate amount of time given their goals in retirement, will go a long way in bringing them retirement success.
Nathan Zahm is a senior investment strategist at Vanguard Investment Strategy Group.