The case studies presented here describe possible scenarios that would be typical to many of today’s retirees. But it’s important to understand that all Australians, and particularly retirees, live with uncertainty.
For retirees, the main issues are the state of their health, whether or not their children need assistance, and the rate of return they can achieve on their assets given interest rates, inflation and changes to the superannuation and pension rules.
My responses are indicative of what may happen in the future and a guide to possible strategies. Retirees should closely examine their affairs at least once a year to ensure that their investment strategies are on track and their estate planning is up to date.
Retirees also face the juggling act of having part of their assets in growth, where volatility is the norm, while keeping enough cash on hand for at least three or four years of planned expenditure.
I am happy with assuming returns of around seven per cent for superannuation, but members must understand that this is a long-term average. For example, a fund may return 12 per cent one year and two per cent the next.
YourLifeChoices members should make themselves familiar with the calculators on my website, www.noelwhittaker.com.au They are simple to use and great for modelling possible outcomes.
The Stock Market Calculator allows users to enter a notional sum, invested on a starting date of their choice, and find out what they would have had on a given closing date if the investment they chose matches the All Ordinaries Accumulation Index that includes income and growth.
Many retirees are concerned about low rates on term deposits, but it’s important to understand that if the term is short, the rate does not have a big impact. For example, Constrained Couple Joan and Brian have $80,000 in a term deposit earning 1.5 per cent interest. I recommended drawing down on that at the rate of $17,000 a year. At an earning rate of 1.5 per cent, the money would be gone in 4.5 years. If a rate of three per cent could be achieved, the money would last just six months longer.
Case study 1
Affluent Couple (homeowners with private income)
Ages: 64 and 66
RAI estimated expenditure: $76,208
Couple’s estimated expenditure: $70,000
Superannuation: $600,000 (combined)
Cash: $45,000 term deposit (1.5 per cent interest)
Wages: Sally $15,000pa
Age Pension: Not eligible
Q. Sally and Andrew
We are spending nearly $70,000 a year (slightly less than our retirement tribe but still a lot) and are worried that, given such low interest rates, we will burn through our capital. How long do you think our savings will last before we become fully reliant on an Age Pension? Sally earns about $15,000 a year as a part-time teacher’s aide and hopes to fully retire when she is 66. Can we organise our retirement savings better? What else should we consider?
Noel says: We don’t know what the repayments are on the mortgage, but at their age I would expect a five-year term maximum, which would take a big chunk of their money in repayments. Therefore, I believe it’s a no-brainer that they withdraw $100,000 from their superannuation to pay out the mortgage. This would reduce the balance to $500,000. If we put $30,000 as the value of their personal effects, their total assets for Centrelink purposes become $880,000.
This is just a shade over the assets test disqualifying limit of $863,500 for a couple.
I don’t think they should be adopting strategies to get a part Age Pension, because the shares should be growing by at least six per cent a year, which would equate to $18,000 a year. Therefore, it could be an ‘on-again off-again’ process for the Age Pension, depending on what the share market does.
Furthermore, a person who just scrapes in for the Age Pension is basically doing it for the Health Care Card. If we put the value of that at $5000 a year, I reckon it’s pointless to spend $30,000 to get under the cut-off limit for the Age Pension assets test. It would take at least six years to get your money back.
To allow for contingencies, it may be simpler long term to ignore Sally’s income and treat that as a bonus. Therefore, we could run the numbers based on living off their superannuation at the rate of $70,000 a year.
The next step is to make assumptions about inflation, the rate of return from the superannuation and the rate of return from the shares. For this exercise, I will assume that inflation is one per cent, the shares achieve eight per cent income and growth combined, and the super fund returns seven per cent.
If we run their superannuation through my Retirement Drawdown Calculator, we can see that on the assumption of an earning rate of seven per cent, annual drawdowns of $70,000 indexed one per cent, their superannuation balance should be down to $287,000 after five years.
But their shares are compounding, so after five years the share portfolio should be worth around $470,000. This would mean that their total assets then would be around $800,000, which should be under the pension cut-off point in five years. This, of course, assumes that there won’t be any major changes to the Age Pension asset limits or to treatment of the family home.
I don’t recommend any big changes, but they should watch their asset values and, if there is a market fall, get straight on to Centrelink, because they might become eligible for a part pension.
They should also keep at least three years of anticipated expenditure in cash to give themselves a buffer if there is a big market correction. Of course, any kind of casual work that either could do would be a big help to their finances, as would any savings they could make to their expenditure.
Case study 2
Constrained Couple (homeowners on an Age Pension)
Ages: 72 and 74
RAI estimated expenditure: $43,818
Couple’s estimated expenditure: $48,500
Superannuation: $322,000 (combined)
Cash: $80,000 term deposit (1.5 per cent interest)
Age Pension: $33,500 (combined)
Q. Joan and Brian
We thought we were living within our means, but we are spending about $48,500 per year. We are earning very little on our term deposit and are worried that we can’t sustain this for much longer. How do we better arrange our affairs? Would an annuity work as we think it is now part of the assets test? Can you help us to understand how long before we will consume all our capital? Is there anything we should be doing to maximise our income and stretch our savings?
Noel says: Joan and Brian are currently assessed under the assets test because their total assets are $434,000 if we add $20,000 as the value of assets such as cars and furniture.
Pensioners should note carefully that for assets test purposes, items such as furniture and cars are not valued at replacement value but at garage sale value. This puts a limit of around $5000 on most people’s furniture, while cars should be valued as if they were being sold for cash to the local car dealer.
I assume Joan and Brian’s superannuation will be in pension mode, which means they are required to make minimum annual withdrawals. The requirement is currently five per cent of the balance, but this will rise to six per cent of the balance when they are aged between 75 and 79. This makes the annual drawings from super $16,100 a year. Add in the $33,500 Age Pension and the total income should be about $49,600 a year. This means that they should not need to draw from their savings to balance the budget.
If we then run the numbers on their superannuation, using an earning rate of seven per cent per annum, we can see that at the end of five years, the balance should be about $354,000.
At the end of five years, their shares should be worth around $19,000 if they have left them untouched and have reinvested all dividends. They will also receive a small cash bonus from the refund of franking credits.
I don’t believe an annuity is an appropriate choice because they would be locking in today’s low rates of return for the rest of their lives. In any event, they can create their own annuity by simply drawing down on their superannuation.
It’s important they ensure that this superannuation is in one of the better-performing funds. The rate of return, and the fees, are the two major factors that determine how long their superannuation will last.
It is important that they take good advice to ensure they are optimising the returns from investments, and advising Centrelink if and when their balances reduce, because every $10,000 reduction in assets is worth an extra $15 a week in Age Pension. They should also make sure that they have non-financial assets such as furniture and motor vehicles valued as low as possible.
Case study 3
Cash-Strapped Single (renter on an Age Pension)
RAI estimated expenditure: $23,145
Jenny’s estimated expenditure: $27,000
Wages: $3500 pa
Age Pension: $24,258 pa
With more than one third of my full Age Pension of $933 a fortnight going on rent, I have very little discretionary spending – and not much to back me up if something goes wrong. I am worried that I’m going to have to give up my private health insurance – it seems simply unaffordable now. Is there anything I can do to make the sums work? I do part-time babysitting and earn about $3500 per annum from this.
Noel says: This is an example of the challenges faced by single people who arrive at retirement without a house. And, sadly, their numbers appear to be growing. Jenny should make sure she takes advantage of every concession that governments at all levels offer, and also visit websites such as Simple Savings that give thousands of ideas on ways to save money. Even saving one dollar a day is worth close to $400 a year.
It’s great that Jenny has some money from employment – because employment does not just provide that extra income, which is so critical, but also contributes to health and wellbeing. A job provides a reason to get out of bed in the morning.
I also believe that people at every level should develop some kind of a buddy system – a person or persons with similar values and goals, with whom they can meet regularly, preferably weekly, to encourage each other and think about ways to improve their financial situation. It’s a great source of motivation, and will almost guarantee ongoing support when those inevitable situations arrive and Jenny feels down and out of her depth.
My initial thoughts were that Jenny should cash in her super. That way she could save ongoing fees and be free of the death tax that might be incurred by her beneficiaries when she dies. But that begs the question as to what she might do with the money. She would be lucky to get one per cent in a bank account, and the type of superannuation fund she is in should have been paying her between six and eight per cent per annum. The only way for her to get better returns would be to invest in a range of managed funds that are heavily invested in the share market.
But the problem here is that if she is inexperienced in do-it-yourself investing, she would need to get advice. The challenge is that the financial advice industry is so heavily regulated she would need a full financial analysis, which involves a long consultation and would cost at least $3000. That’s money she can’t afford.
On reflection, I think she is better off leaving her superannuation alone. She could relax and enjoy the monthly income, and the fact that her money is being professionally managed. She could still make withdrawals at call whenever she needs money.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance.
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Disclaimer: All content in the Retirement Affordability Index™ is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.