The main concerns most Australians face when entering retirement is whether they have saved enough and, how long this money will last. But when faced with the questions ‘how much is enough?’ and ‘how long will you live?’ finding the right answer isn’t straightforward. And to compound the issue, there are other key risks that need to be considered when planning for retirement.
Here are three retirement risks all Australians need to address.
Risk 1: How long will you live?
Australians are living longer than ever, ranking seventh in the world for life expectancy. Taking into account improved mortality rates, a 65 year old male today can expect to live an additional 22 years, to the age of 87, according to the Australian Government Actuary. Women typically live longer with the average age of death of 89 years for a 65 year old female today. With many over-60s expecting to live well into their late 80s in a retirement lasting over 25 years, the question being asked is ‘how do you make your retirement savings last the distance?’ Living longer is highly desirable if you’re fit and healthy, but if you’re not prepared financially, those extra years could actually become a burden and there’s a real risk you could outlive your savings.
Life expectancy for retirees in 2017
Source: Australian life tables with 25-year mortality improvement factors from the Australian Government Actuary. Calculation by Challenger, 2017.
Risk 2: How the market can influence how long your money lasts
While successfully saving for retirement is best done over several decades, making assumptions based on long-term average returns is a risk. There is no certainty that average returns calculated over a set period of time will be reflected in the actual returns that your investments receive. A period of lower-than-average returns can negatively affect your superannuation savings; diminishing the income you have at your disposal to fund your retirement.
Volatility in the market, especially just before, or in the first few years of retirement, when your nest egg is at its greatest, can have an extremely negative effect on your retirement plans. This is often referred to as sequencing risk, the risk that the order and timing of your investment returns is unfavourable. This sequence of investment returns is a concern for retirees who will be relying upon both their capital and income from investments to cover their living expenses. Just ask anyone who had planned to retire around the time of the Global Financial Crisis in 2007/08 about the effect a market drop at the wrong time can have on retirement investments in the long run.
Risk 3: How inflation can diminish your spending power
Most people can expect to spend 20 years or more in retirement. Not only is that a long time for your savings to last, but the inflationary pressure on prices can, over time, also have a significant effect.
Simply put, the purchasing power of a dollar when you start your retirement will be significantly different to when you’re approaching the end. In fact, with an annual rate of inflation at 2.5 per cent, the purchasing power of a dollar will almost halve over the course of a 25 year retirement span meaning that the loaf of bread that today costs $3.43, could cost $6.36 in 25 years’ time.
What, if anything, can you do to counteract these risks?
The good news is that you don’t necessarily need to work longer or limit your spending to negate the effect these risks may have on your cash flow in retirement.
Your first step should be to speak to a qualified financial planner. They can help you assess your exposure to these risks and put in place the correct mix of investments to ensure that you can cover your retirement needs. Some of the investment options you may wish to discuss could include:
- secure investments, such as lifetime or fixed-term annuities, which deliver guaranteed, regular income (over a fixed term or for the rest of your life)
- market-linked investments, such as shares and managed funds which can grow over time but carry some risk
- other retirement income products, such as account based pensions, term deposits and investment property
Don’t forget the Age Pension
Despite tightening of eligibility criteria, the Age Pension remains one of the three pillars of Australia’s retirement income system, along with superannuation and private savings. As this payment is subject to means testing through assets and income, structuring your finances to ensure you receive even a part Age Pension may help minimise the above retirement risks.
If you don’t have a financial planner, visit your bank or call your super fund. Alternately, you can search for a financial planner in your area by visiting the Financial Planning Association of Australia’s website: fpa.com.au