Retirement income: A moving target

Australians are living longer but retirement isn’t getting cheaper.

With both the length of time retirement income strategies need to provide for and costs of living increasing, it’s little wonder that Australians aren’t retiring with enough ongoing income secured.

State Street Global Advisors recently found only one in five Australians think all will be well when they retire, with close to 40 per cent of the workforce thinking they won’t have enough money in retirement.

So how much is needed to retire, why aren’t we hitting it, and what can we do to get there?

How much income is needed?

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While different figures are thrown around as to how much income is needed in retirement, consensus within the industry is that it’s really a case-by-case scenario.

“There’s no single answer, everyone is different,” senior partner at Mercer, David Knox, says.

“It can be impacted by whether you’re in a couple, single, the level of any other savings you have, your health, where your family is located and whether you are a home owner”

The Association of Superannuation Funds of Australia’s director of research, Ross Clare, says that your expectations of how you will live in retirement are also a factor.

In terms of putting a number on it as reliably as possible, the ASFA Retirement Standard puts the household budget per year for 65-year-olds at $42,764 for singles and $60,264 for couples for a comfortable lifestyle. For those prepared to live more modestly, the Standard is $15,396 and $20,911 less, respectively.

According to Clare, “for the great bulk of the population something around the ASFA comfortable [budget] makes sense”.

Of course, that changes the older you get.

“When we do our numbers in terms of the capital sums you need at retirement, we have people living through until 92 as part of the calculations, and after that we see the active lifestyle as a bit limited, people are off the road, they don’t have a car, but at the same time their healthcare and personal care costs can go up,” Clare says.

ASFA estimates that for those around 85 years old, $40,636 and $56,295 is needed for singles and couples respectively to have a comfortable lifestyle.

General estimations of retirement costs also often don’t factor in that many people want not just income but also capital for any big needs or emergencies.

“The other thing that is worth mentioning, even when looking at the ASFA retirement standard, is that it assumes that an amount of capital is run down through your retirement. But many retirees … want a rainy-day fund,” Knox says.

This could cover refurbishments, having aides built into the home, cars or health costs that aren’t otherwise covered.

“It’s this idea of wanting a buffer because there’s uncertainty. I’m not sure how long I’m going to live, I don’t know what health costs might arise that aren’t covered by the government or by private health, so I need a buffer. It’s not a bequest or an estate plan, but just a buffer,” Knox says.

“How big should the buffer be? Well it’s an unknown. Again, individual needs and situations impact this.”

Whatever the figure, Australians aren’t securing enough savings to have sufficient income in retirement as we all live longer.

People are also often retiring earlier than expected, meaning that regardless of longevity they may not have enough saved. Investment Trends found that half of retirees say they had to retire earlier than planned, with the top reason being health issues.

According to Clare, only about 20 per cent of people would currently hit the ASFA comfortable Retirement Standard (although that will get up to 50 per cent going forward).

People know they are not entering retirement with enough too. The Investment Trends 2017 Retirement Income Report reports that only 46 per cent of Australians feel prepared for retirement.

Worryingly, insecurity about retirement income is such that State Street Global Advisors recently found that almost 50 per cent of Australians anticipate getting a part-time job to make up any shortfall they might have in retirement. Which, of course, begs the question of where they will find these jobs in the current employment market.

So where does the industry go from here?

Advice and education

Superannuation funds, and professionals in the retirement income sector generally, can help by actively providing guidance to consumers.

“Part of the reason why people may feel unprepared for retirement is because many may not know how much they need to retire. Our data shows that there is a relationship between how informed people are about what they need to retire and whether they feel prepared for it,” Investment Trends senior analyst, King Loong Choi, says.

He believes that super funds can play a key role in addressing this. Indeed, Investment Trends found that only 33 per cent of Australians believe they can reach their retirement goals without any professional assistance.

Clare points to income calculators as one means of assisting, as they help people better understand what they will actually need in retirement.

Funds can also guide members in considering what investment approaches best suit them, and companies offering other retirement products such as annuities or income-focused funds can also help.

According to managing director of Optimum Pensions, David Orford, the biggest problem causing insufficient retirement income is that people simply aren’t saving enough.

State Street Global Advisors’ most recent survey backs this up, finding that the key to solving the problem of not having enough money in retirement is to start saving early.

Orford believes that while products geared toward assisting this weren’t good in the past, they’re improving now. This is especially true for products that specifically address annuity.

Orford says, however, that not enough people know about these options or the importance of saving. Recent legislative changes, for example, make annuities a much more varied and appealing means of securing income regardless of when you live until. Consumers are largely unaware of this, which is where quality advice and education from providers can assist.

Again, retirement needs’ individual nature comes into play.

“There’s a whole range of things that funds and financial institutions can do to help people, but it still comes down to some individual responsibility,” Clare says.

He points out that the super system has to service pretty much the entire Australian population, making it difficult to tailor it to individuals without them also taking an active role.

“So, you need to do a little bit of homework to ask, well what’s my lifestyle going to be, recognising too that during retirement over 20-30 years, things are not going to be constant. Even expenditure isn’t going to be constant, it’s probably going to reduce gradually,” Knox says.

Looking beyond superannuation

Australia, of course, already has two core structures in place to help with retirement income. The brunt is borne by the superannuation system, with the Aged Pension theoretically there to provide for those who need it.

The Aged Pension isn’t enough alone – as Clare observes, compared to overseas equivalents it’s pretty ordinary in terms of the retirement income it provides. As a percentage of GDP the Government contributes far less than some international counterparts and both Clare and Knox agree that it enables only a very modest lifestyle.

So it’s the super system then, that must bear the brunt of improving retirement income levels.

“The compulsory system will do quite a bit of the heavy lifting and that will be the base for improving retirement outcomes in the future, and already the more recently retired are retiring with a lot more than people ten or twenty years before, so the SG is a good start,” Clare says.

He also says the current SG level isn’t enough, joining the cries for it to be raised to 12 per cent. Acknowledging that “we won’t get there for some time”, he says in the meantime, people should make voluntary contributions.

He suggested salary sacrificing or making personal tax-deductible contributions, or even making non-concessional contributions if a person’s concessional cap is fully used, should their financial circumstances allow.

Then there are structures outside the compulsory ones that can help raise retirement income.

Knox points to the development of Comprehensive Income Products for Retirement (CIPR) as a possible remedy to the issues posed by longevity and the need for post-work income.

“They aren’t one-size-fits-all, but it’s a starting point for people to think about what suits them,” he says.

“My hunch is many individuals will say, okay the trustees have recommended this, I’ll just take that, and I can tweak it if I need to. So, I think it will be a nudge that will lead to further discussion.”

Again, in designing the CIPR, trustees will have to look at the average member.

“[The fund] may have a lot of members in the maritime industry, which is different to lots of members who are Qantas pilots, or members who work in the retail sector. Members will then have to work from there, recognising that this is not a one-size-fits-all [solution] and if you have poor health or a big mortgage debt or whatever, your conditions will be different,” Knox says.

Knox believes that having more longevity-focused products on the market will also improve retirement income prospects. It means that people will feel more comfortable using more of their retirement savings held through other means when they’re a bit earlier in their retirement, as they would be less concerned about longevity.

Orford points to annuities as one such product. While this is a market Challenger has traditionally dominated in Australia, legislative changes mean that new providers, such as Orford’s Optimum Pensions, can now make a play.

They have been used well in other countries, such as Canada and Switzerland, to provide steady income throughout retirement while mitigating the risk of unexpected longevity leaving you high and dry.

A benefit of the Australian retirement income system, Knox says, is that it can offer a blend of products that provide both access to capital and income. The issue with many European countries’ approaches comparatively is they may compel a product such as annuities but offer no flexibility.

“With a blend, we end up with a system that is better than most countries. It’s just about getting that blend right,” he says.

Improving underlying investments

Regardless of the product, understanding the risks to the underlying capital that generates the income is key to improving the quality of the income produced.

“The issue going forward [for retirement income] is lower total return ... While we’re still getting income technically in payouts, that’s not the return,” Wheelhouse Partners managing director, Alastair Macleod, says.

With shares very expensive at the moment, hitting a peak that is second only to during the tech bubble, Macleod warns that traditional investments mightn’t cut it for investors of retirement income-focused products.

“If you had a strategy that was generating consistently high income and the capital base wasn’t being eroded, then that’s a good, sustainable source of real return. But we’re still in a low interest rate world, so there aren’t many places that you can generate that,” he says.

“[Schroders] are expecting 1.6 per cent real returns the next seven years for the S&P 500. So if they’re right then, that makes [it] pretty hard to maintain your retirement nest egg if you also need to withdraw five per cent a year to live on. Hence the need for a source of real return, or real income, as opposed to hoping shares will go up.

“Investors need to look for different solutions than what they’ve been doing in the past.”

To improve the value and consistency of retirement income delivered going forward, Macleod says that those investing may need to look at alternative strategies such as private equities or real assets.

“I think that diversifying your source of income, whether it’s from Australian shares, which can benefit from franking credits, or strategies like [Wheelhouse Partners’], which are derivatives-based, or high dividend paying shares offshore, or even in having some annuities as part of the mix, it’s really spreading that risk of retirement income to a variety of sources so that you really get some diversification built into your portfolio.