Financial advice and retirement: a change in climate

Market volatility is changing the way financial advisers structure their clients’ retirement income and the advice they are offering around it. Benjamin Levy reports on the latest trends in retirement incomes.

The current share market is full of pitfalls for retiree investors. It now looks as though Greece will default on its debt while the Europeans sit near-idle.

The United States economy, and its unemployment level, is as bad as ever. Closer to home, there are indications that China’s demand for resources, which saved Australia during the global financial crisis (GFC), is slowing. The retail sector is in the doldrums.

Australia may have avoided the worst of the global financial crisis, but it is now clear that the country can no longer stave off the cumulative effects of a global economy in turmoil.

It is no surprise then that older investors are turning to their superannuation account balances in alarm and making frantic calls about their retirement plans.

But is it really time to panic? Despite negative returns on superannuation accounts, many financial planners believe their clients are better off than they think.

Financial planners need to help their clients reassess their retirement goals and make stronger retirement plans. For that, open and frank conversations are needed.

Market volatility is also driving advisers away from relying on single retirement income products towards offering long-term strategic retirement investment advice.

Coupled with the creation of a double portfolio approach to retirement, the assets that investors are relying on for income generation are changing, while using growth assets such as shares for wealth creation has assumed much greater importance.

But annuities are not finished yet, with super funds and the government planning to reinvigorate the sector.

Investors need reassurance

As overseas tremors become more pronounced here in Australia and shares continue to plunge, the need for financial advice in retirement planning is more critical than ever.

“Engaging with clients is really to understand what retirement actually is for them, and this is critical particularly at the moment with people being a bit disillusioned with returns,” says Mark O’Leary, director of AMP Financial Planning practice Eluvia.

Pre-retirees have continued to flock to advisers for retirement income advice since the GFC, and that trend has only strengthened as investors have become more concerned over problems in Europe and the United States reaching Australian shores.

“What we’ve seen over the last couple of years is this huge appetite for advice in relation to the provision of income, and obviously a lot of that is driven off the back of the GFC. I guess what we’re seeing these days is a lot more focus on cash flow management and generation, and income generation, rather than these massive investments that we saw previous to the GFC,” says senior executive of advice at Count Financial, Dean Borner.

Superannuation is the primary source of retirement income for most clients, and the volatility in global and domestic markets is fuelling the perception that super is suffering by an inordinate amount.

Super contribution caps have also remained low, adding to clients’ frustrations that during the last 10 or 15 years leading up to retirement they cannot maximise the amount they are contributing to their future retirement income.

The government will increase the concessional contribution cap to $50,000 for those with under $500,000 in superannuation from July next year. While that will go some way towards alleviating the disappointment, it won’t satisfy everyone.

The effect on retirement savings has been severe. Research jointly commissioned by the Self Managed Super Fund Professional’s Association of Australia (SPAA) and Russell Investments this year found that there was $15.1 billion less going into superannuation as a result of the contribution caps.

SPAA chief executive Andrea Slattery slammed the contribution caps as restrictive, prohibitive and counter to the intent of the Government to make super the main retirement vehicle for Australians.

Together with the reduction of super contribution caps, market volatility is pushing clients to forgo salary sacrificing and place their funds in assets like cash accounts, which may not generate the same level of returns. It also means they will miss out on the tax reductions generated through placing money into super.

“Many clients are under the perception that their portfolios have suffered significantly, but that might not be the reality, because many clients have their money invested in a moderately conservative or balanced portfolio, which is well diversified,” O’Leary says.

It is up to planners to convince their clients that their superannuation may not be suffering as much as they think and get them to recommit to the long-term accumulation of their super balance. 

That will involve a reassessment of where they are in terms of retirement savings, benchmarking that against their long-term objective.

Count Financial is developing a more advanced interactive retirement income tool for advisers to use with clients which will demonstrate the volatility of capital markets and help them better plan retirement funding.

Count will educate advisers on how to use the tool with their clients when planning retirement, Borner says.

Despite all the talk from advisers about getting clients ready for retirement, CoreData’s Retirement Report earlier this year found that pre-retirees over the age of 55 are being overwhelmed by the planning needed for retirement.

Out of 1690 participants in the survey, 69 per cent of respondents felt overwhelmed by their superannuation and retirement finances. One in three said they did not believe they would be able to choose when they retired and would be forced to work for as long as possible, and 39 per cent said they were unlikely to meet their retirement needs.

CoreData head of advice, wealth and superannuation Kristen Turnbull said the findings showed that super funds and advisers needed to do more to engage pre-retirees about the products and services available to them when they retire.

Providing financial advice on retirement planning is even more urgent in light of the imminent retirement of the baby boomer generation.

In the two decades leading up to the GFC, including the introduction of the superannuation guarantee, there was a strong bull market run, in which investors and super fund members were focused on the accumulation of assets, not the protection of assets. Even with some years of negative returns, there was time enough for assets to recover.

Now that there is a wave of baby boomers entering retirement, there is suddenly an overwhelming focus on wealth protection and longevity risk  –  and financial planners must cater accordingly.

“The catchcry of a retiree when they sit in front of a financial planner is ‘I don’t want you to make me rich, I just want you to ensure I’m never poor’,” says AMP director of sales Barry Wyatt.

ipac chief investment officer Jeff Rogers also warns that advisers must ready themselves for the upcoming shift among older clients to a wealth protection situation. 

“The whole demographic of the baby boomer beginning to retire means there is just going to be this acceleration of people hitting that retirement mark where the major issue will be that there’s no salary stream,” Rogers says.

How market volatility is altering the make-up of retirement portfolios

Market volatility isn’t only driving investors to seek out financial advice about their retirement planning. It is also changing how advisers structure their client’s retirement income and the advice they are offering around it.

Advisers are shifting away from relying on a single type of retirement product such as an annuity or longevity risk product to an approach of a long-term investment strategy.

“A lot of the advice has been more around strategy management of the whole retirement income stream, not so much a flight to certain types of products,” says Borner.

Count Financial has seen only a small increase in annuity business recently.

A lot of their clients are instead sitting on cash to finance pension payments for a couple of years, Borner adds.

As part of that investment strategy, advisers are building two or more portfolios per client: one a more growth-oriented portfolio to build their assets, the other a sustainable income generating portfolio.

The income portfolio would include a typical combination of defensive assets such as fixed income, cash, infrastructure, property, and blue chip shares, enough to provide a steady ongoing income for a few years.

The rest of the money not needed for that income would be placed in a growth portfolio to continue accumulating assets.

This strategy of splitting retirement funds into a defensive and growth portfolio is largely to make their clients feel more comfortable about the volatility of the share market.

Even if there may be some volatility in the unit price of their fund, seeing sustainable, predictable income coming through every month will make clients feel more comfortable with where their retirement savings are, Rogers says.

The two-buckets approach of ‘safe for the short term’ and ‘risky for the longer term’ is also an effective attempt to calm the wild investor behaviour of previous years which saw falls in investor confidence, massive dives in shares both in Australia and overseas, and unnecessary sell-offs that ate into investor’s funds.

The approach of placing everything that your client won’t need into a growth portfolio may run against the conventional wisdom of making retirement income long-lasting and safe, but with their income needs provided for, the benefits of such an approach are becoming clear.

Fund managers have been promoting the change in approach to retirement income for some time.

In an article in Money Management at the beginning of the year, chief investment officer at Select Asset Management Dominick McCormick pushed advisers to create simple ‘low stress’ retirement income portfolios that would more closely resemble what worked for retirees, rather than the financial services industry.

By placing half of their funds in cash accounts, and the other half in a do-it-yourself super fund with a growth-oriented mix and wide diversification and flexible asset allocations, McCormick’s clients suffered far fewer stresses of retirement and yet weren’t inhibited from meeting their long-term objectives, he said.

“The primary role of a good financial planner should be to arrange their client’s financial affairs in ways that reduce that client’s financial pressures and stresses,” McCormick said.

PIMCO global head of wealth management Peter Dorrian approves of the new approach to retirement income investment.

“It’s not a bad idea, because it’s all very well for all of us who work in the financial markets to say ‘You can buy on the dip, and things will get sorted out over time’ but we also have [a salary] coming in every month,” he says.

“If you’re in a situation where your working career is over, and you’re looking for that pool of savings to give you your income, the last thing you want to do is be continually stressed about whether or not it’s going to be there.”

That approach reduces stress for the adviser as well. Many advisers feel they have to be investment gurus for their clients, always being on top of portfolios and constantly issuing reports.

That only leads to unnecessary scrutiny, spending more and more time worrying about a particular poorly performing investment and considering substituting it with another every time an asset drops in value. 

However, creating an adequate double portfolio approach needs many elements to work. McCormick warned that in order to work across a range of client situations, advisers must utilise a generalist approach, with broad knowledge of investments, insurance, social security, tax and estate planning, including access to appropriate experts when needed. Few dealer groups are structured this way.

For some, the number of portfolios you can create is only limited by the number of needs that you can identify. ipac has pinpointed three needs that investors have in retirement – essential needs, discretionary spending needs, and estate planning needs – and built three different portfolios for each.

“Instead of bucketing the portfolio into parts, start at the needs of someone in retirement and then go and build a portfolio that is best at meeting all of those needs,” Rogers says.

Typically, a financial adviser works on essential needs with retired clients first, calculated to go up with inflation, and whatever is left over can be split between discretionary needs and leaving money for their descendents.

How is market volatility changing which products are used in a portfolio

Building a solid income-generating portfolio needs to have some careful thought behind it.

When it comes to income generation, market capitalisation doesn’t matter so much as dividend payouts. Only companies that will pay out the bulk of their free cash flow in dividends should be part of that side of a retiree’s portfolio.

And of those companies, only the stronger dividend yield companies, which are less affected by market volatility, should be used.

That means that small resource companies, for example, while incredibly attractive for their share growth, are useless for income because they don’t pay out for investors.

Borner suggests that advisers consider whether investing in shares through direct equities or managed funds would provide a more consistent income stream in retirement. 

Advisers and investors need to be aware of future downturns in the economy, which could force companies to cut dividends, Dorrian warns.

Even stronger companies could suffer in that environment.

“If this is all people have got in their retirement in terms of their pool of savings, they really do need to ensure they have some level of predictability in terms of what that income is going to be,” Dorrian says.

Count Financial’s research department constantly investigates the types of retirement income products available.

Advisers shouldn’t restrict themselves to annuities and longevity products, but should explore alternate arrangements such as Investment Management Accounts that can also meet retirement needs, according to Borner. 

Capital protected solutions also have some part to play in retirement income. Geoff Watkins, managing director of financial investment consultant company Path Independent, noted earlier this year that super funds and platforms have been considering implementing some form of capital protection over the last six months of the current market downturn.

The prospect of low earnings for fund managers may prove the benefits of spending money to build a safer way of investing in equity, Watkins said.

The shock to investors from falling account balances will also increase their scepticism about shares and drive them to capital-protected solutions, he added.

Annuities

Longevity risk products and new variable annuities still feature in some people’s conversations.

PIMCO, which counts a large number of super funds among its clients, expects enormous growth in the annuity product space. 

Annuity products are a regular feature of their dialogues.

“They are all looking at getting into the product space that will allow them to provide some sort of post-retirement income stream to their investors,” Dorrian says.

Traditional annuities have normally been quite expensive, and dependent on the insurance companies to survive for the next 30 years to pay out the annuity. The money also went back into the insurance company when the beneficiary died, rather than to his or her relatives.

But now that super funds and wealth managers are developing their own products with a different mix of fees and assets, there is a chance that more investors may become interested.

PIMCO has also been pushing for the introduction of hybrid longevity risk products. In a recent Retirement Income Forum convened by the company, PIMCO head of retirement solutions Tony Hildyard said longevity risk remained the major unsolved problem of marrying growth-based investment solutions with the risk aversion common to many retirees.

The development of more retirement income products has the support of the Government, with former minister for Financial Services Chris Bowen acknowledging it needed to examine the regulatory and tax burdens preventing more attractive solutions being offered.

However, the Government also warned that it would not take on the responsibility of mandating compulsory products.

The Institute of Actuaries of Australia (IAA) has warned there can be no innovation in the annuities space unless there are tax law changes.

In a Federal Budget submission early this year, the IAA called for the Government to reverse the unfavourable treatment of annuities under aged care and Centrelink rules. Annuities should also be able to be issued as a component of an account-based pension.

The product should also be regarded as a pension for tax purposes if taken out in the drawdown phase, the IAA said. 

Financial Planning Association chief Mark Rantall also encouraged the Government to make tax law changes. In an address to the two-day Tax Forum in Canberra, Rantall said the current superannuation and tax legislation overly restricted the definition of an income stream.

Providers should be allowed to develop deferred annuities and other longevity protection-style products, he said.

However, while lifetime annuities can work can work as part of an asset mix as long as they are competitively priced, and even replace the cash component of a portfolio, McCormick warned that alternative arrangements such as the ones his clients use showed that there are alternatives to annuities that provide greater flexibility and better returns.

Time to talk

It is has historically been difficult to get clients to engage in a retirement planning process early in their working lives. The concept of retirement for many people is synonymous with a sudden lack of purpose and consequently a loss of joie de vivre. 

“I think it’s a discussion you have which is a bit of a confronting discussion in many ways,” says O’Leary.

“A lot of people are disengaged with the retirement planning process, because the word is like a full stop, you just stop work and then exist for a few years before you turn your toes up.” 

However, funding income in retirement takes many years of planning and therefore getting clients to engage with the concept early on in their working lives is crucial, O’Leary says. 

Financial planners should at least open a conversation about retirement when their clients are working and have a strong monthly commitment to superannuation, even if later in life that commitment becomes diluted by other financial responsibilities such as a mortgage and educating children.

But more needs to be done. Clients also need to be made more financially literate and engaged if they are going to fully appreciate the importance of planning for retirement.

In an address to a Money Management Retirement Incomes Seminar, Parliamentary Secretary to the Treasurer David Bradbury said consumers could be encouraged to engage more in making decisions around retirement – but it demanded a more financially literate consumer.

As workers pass middle age and start to approach their pre-retiree years, advisers need to move beyond a conversation and establish a solid retirement planning process. Clients in the 55 year age group, with the objective of retiring in 10 years, should start reviewing their situation and corresponding investment strategies every five months and increase the pace of those reviews as they get closer to retirement, according to O’Leary.

Investment strategies should be reviewed regularly just to keep on top of market volatility, Dorrian warns.

The outlook for the global economy is not good. The low growth environment that investors are suffering through is likely to continue until at least the end of 2013, according to some, making it imperative that retiree portfolios stay under the spotlight.