Planning for retirement in a world where nobody’s average
Getting retirees to cut back spending in the middle of retirement will be seen as more of a failure of advice than a useful strategy, Aaron Minney writes.
Australians are living longer than ever. This is both a blessing and a problem. The experience of living longer and healthier lives is great news, but is a real challenge for many Australians to have the money to enjoy their longer life.
Many of these Australians will turn to an adviser, either in the lead up to their retirement, or just after. It is essential that advisers are equipped to help their clients manage the great uncertainty of life.
The 2015 Intergenerational Report highlighted the problem to the public purse of people living longer. It projects that Australians born today can expect to live past 90, where males have a life expectancy of 91.5 and females 93.6.
These are average life expectancy figures so about 50 per cent can expect to live longer. This highlights the need for adequate savings to provide for our longer lives, but it is only half the longevity problem.
The other half is that no one knows exactly how long they will live, which makes it difficult to build a financial plan for retirement to ensure that money lasts.
Like many problems in investing, knowing the average outcome does not always provide you with the solution because few people are actually "average".
In fact, only one in 20 people live exactly to the "average age". As such, it is very hard to reach the target when you do not know what the target actually is. The wide range of ages that people over 65 lived to in 2014 is shown in the chart below.
This is the uncertainty of individual lifespans and it can have a big impact on planning for retirement.
A lucky few are wealthy enough that they can spend what they want and still not eat into their capital.
For most retirees, particularly the quarter of the population who start as self-funded retirees, their solution is often to spend less.
This can lead to a diminished lifestyle as many older retirees cut back in order to allay their fears about their money lasting.
Telling clients to spend less and save more when they are younger is sound advice, but getting them to cut back spending in the middle of retirement will be seen more as a failure of advice than a useful strategy.
It is here that an annuity can provide a benefit to retirees. An annuity will help manage the financial consequences of an uncertain length of life by continuing to pay the retiree for as long as they live.
For many, this will bring the peace of mind of having in place a guaranteed stream of income to help cover the necessities in retirement.
An annuity can also have the immediate impact that retirees can spend their money to sustain the lifestyle that they want after a lifetime of working and saving, knowing that, essential income requirements can be met for life.
The key to using the annuity is ensuring that there is the right balance between it and growth investments.
The role of the annuity is to make sure that income lasts as long as you. Many retirees that are self-sufficient at retirement will eventually receive some or all of the Age Pension.
Their aim is to ensure that their lifestyle in retirement is maintained. The annuity provides uplift from the Age Pension to the minimum level of retirement that can be sustained by the retiree for life.
This will not be enough for all of a retiree's desired spending, but by providing a secure layer of income for life, retirees can enjoy "peace of mind".
Confidence that they will have income for life allows them to spend more now and attain the lifestyle in retirement that they desire, while they can enjoy it.
There are two alternatives to taking an approach that insures a retiree gets some income for life.
One approach is for the retiree to spend as much as they want, knowing that it might not last long and they will have to survive on the Age Pension once the money runs out.
The other approach is to spend only a little to conserve wealth and have some left in case the retiree lives a long time. This means that the lifestyle a retiree enjoys will, except for a small number of retirees, be less than what they could have enjoyed.
Their sacrifice means more for the next generation, but that probably is not what they imagined for their retirement.
The vast majority of new retirees can expect to live a long time in retirement. However, as retirees enter the middle of retirement, the length of future time in retirement becomes more uncertain.
This increased uncertainty comes at a time when the average retiree will be less inclined, and possibly less able, to manage their own financial affairs.
There are many more 65-year-olds happy to spend the time managing their financial affairs than there are 80-year-olds doing the same.
A lifetime annuity can really add value here by helping manage the increasing uncertainty around longevity.
The pooling properties, just like insurance, mean that the risks are managed for the retiree. This plan will not need constant adjustment, so the focus can be on enjoying the lifestyle that they want.
Aaron Minney is the head of retirement income research at Challenger.
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