In retirement you’ll need to find a new way to cover your living costs.
Investing your money is one way to make the most of your savings and provide an income in retirement. But if you’re expecting savings and investment earnings to help cover your expenses, it’s important to get your strategy right.
Why timing matters
When accumulating super for retirement, you can afford to be patient. With years ahead to top up your super, you can stay invested during falls in the share market and wait for markets – and your assets – to bounce back. For the few years just before and after retirement, it’s a different story. This period, known as the ‘retirement risk zone’, is the time when you have most to lose from a fall in the value of investments. Your super has likely reached its peak in value and you want to make the most of these savings for your future retirement income.
In order to protect your savings and provide you with income throughout your retirement, it’s important to be aware of three key risks.
1. Living longer
Australians are living longer than ever before. Life expectancy has grown by more than 30 years in the last century. Living off retirement savings for 20 to 30 years or more introduces the very real risk of running out of money. It’s no wonder then that 38 per cent of Australians aged 50-plus are very worried about outliving their savings and another 33 per cent are concerned, according to YourLifeChoices’ 2019 Ensuring Financial Security in Retirement survey.
We’re lucky that we live in a country where if your retirement savings run out, the Age Pension is there as a safety net. But those regular payments may not be enough to maintain the lifestyle you’ve been enjoying in retirement. You could also be left with limited funds and options for aged care, should you need it. That’s why it’s so important to make a financial plan early in your retirement so that you can work to protect your income now and in the future.
Inflation is the increasing cost of living over time and represents an important and often underestimated risk to your financial security in retirement.
Given your retirement could last 20-plus years, there's a good chance your savings and income will be affected by inflation.
At an average annual inflation rate of 2.5 per cent, a dollar today is worth roughly half what it was 25 years ago. Even this modest year-on-year rise in the price of goods and services can put you at risk of having an income that no longer covers your living expenses from year to year.
3. Market volatility
Market volatility is a risk for investors with exposure to investments such as shares, bonds and commodities.
If you’re worried about another potential market collapse similar to the Global Financial Crisis (GFC) in 2008, you’re not alone. A 2018 survey found that seven out of 10 older Australians share your concerns.
Falls in the value of investments are impossible to predict and can make a big difference to income and financial security throughout your retirement.
When investments earn negative returns, your retirement savings are falling in value. Crucially, if you also need to make regular withdrawals to pay for living expenses, it’s a twofold blow to your overall financial position in retirement.
Fewer savings now means more potential for outliving those savings later in life.
What is sequencing risk?
Another part of market volatility risk is sequencing risk. Sequencing risk is the risk that the order and timing of your investment returns are unfavourable, resulting in less money for retirement.
For example, two people about to retire might have made identical super contributions and experienced average returns of eight per cent per annum over a 20-year period and yet have significantly different balances to retire on, all due to sequencing risk. Investment returns, good and bad, have more impact at some points in the superannuation life cycle than at others.
The consequences of sequencing risk are potentially strongest around the point of retirement. If you have a run of poor market results close to retirement, it can really affect your retirement plan. Before you retire, you might be able to extend your working years to save a bit more. It is much harder to go back to work after you have retired.
The good news is that there are ways to protect against the effects of sequencing risk. It can be a good idea to structure your cash flow needs around the time of your retirement to limit the risk that a poor sequence of investment returns impacts on your retirement goals.
Protecting your income and future in retirement
Diversifying your investments – balancing growth and defensive assets for example – can limit the impact of market risks and inflation on your retirement savings. However, even with a well-diversified portfolio, your super and Age Pension may not provide you with enough income for your entire retirement.
If you’d like the peace of mind that comes with a guaranteed income for life, a lifetime annuity might be right for you.
Using a portion of your savings or super, you can invest in a lifetime annuity and receive regular, guaranteed income payments for life. An annuity can act as a safety net ensuring that you will receive income for life, regardless of how long you live or how investment markets perform.
To find out more about the benefits of a lifetime annuity, and whether it might be right for you, talk to your financial adviser, visit www.challenger.com.au, or call Challenger on 13 35 66.
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.
Before making a decision about whether to acquire or continue to hold a financial product, you should obtain and consider the Product Disclosure Statement (PDS) for the relevant product. A copy of the relevant PDS for a Challenger product can be obtained from your financial adviser, by calling 13 35 66, or at www.challenger.com.au.
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