Rethinking the role of cash in your retirement income

In an era of low returns, many retirees are questioning the value of cash investments.

couple assessing retirement income

In an era of low returns, many retirees are questioning the value of cash investments. Jon Kalkman of the Australian Investors Association (AIA) considers the options.

Retirees are traditionally very attached to holding their retirement savings in cash. The reasons are simple. The value of a cash holding does not fluctuate with market prices, it is government guaranteed up to $250,000 per account * and there is no risk of loss.

Bonds are similarly attractive for retires because they have a guaranteed income payment like interest, called a coupon. If held to maturity, the risk of the bond not returning your capital depends on the creditworthiness of the issuer. With government bonds there is low risk because governments can always levy more taxes to repay bondholders, but government bonds also have the lowest yield.

This demonstrates that risk and return are directly linked; it is difficult to achieve high returns with low risk. If sold before maturity, the bond price is set by the market and depends on many variables.

Accordingly, the change in market price provides scope for capital gains and losses. Traditionally, many retirees have been encouraged to invest their savings conservatively in cash and bonds to ensure they do not risk their capital. People who invest aggressively in growth assets, such as shares or property, must accept the risk of volatile market prices and the risk that the asset’s sale price will be lower than its purchase price. In accepting this risk, these investors have been rewarded, at least in the long term, with higher returns.

The problem for today’s retirees is that we no longer live in a traditional world. Central banks have pushed interest rates very low to zero or below, in an attempt to stimulate economies smashed by the GFC. In the process savers including retirees have been squeezed. In 2007, a term deposit of $800,000 would have generated about $64,000 per year in interest, or eight per cent. Today that same term deposit will generate about $24,000, or three per cent.

At the same time, the Australian Government has made it more difficult for retirees. Rather than using actual income to determine eligibility for the Age Pension it uses “deemed” income. Any investment, including superannuation, is deemed to be earning a level of income whether it does so or not. Income in excess of the deeming rate it is not counted and that is a bonus to you. If your investment earns less, your pension is calculated as earning the deeming rate even though you don’t receive it. Using the present deeming rate, a term deposit of $800,000 is deemed to earn $24,791, which is higher than the $24,000 from our term deposit above.

It gets worse. Assume a retired couple own their family home and hold $800,000 in a term deposit – their only other asset. At present they receive a part Age Pension of $567.15 per fortnight, or $14,750 per annum, in addition to the interest on their term deposit, which at three per cent is $24,000. This gives them a modest retirement income of $38,750 pa. Changes to the Age Pension assets test that take effect from 1 January 2017, mean that this couple will have their Age Pension reduced to $47.40 per fortnight, or $1,234.40 pa. From this date the couple will see their income fall by more than $13,500 pa. Compare their situation with the couple whose assets are below the test threshold.

From 1 January 2017 they can hold $375,000 and still receive the full Age Pension, plus whatever income their assets can earn. The search for yield is now a global phenomenon. This has led many to consider shares as a source of income. This is not a recommendation, but consider Telstra shares. At present they cost about $5.10 each (depending on the day of purchase).

The dividend in 2015-16, which is the shareholder’s share of the profits, was 31 cents per share. That is a yield of six per cent. Under Australia’s unique imputation system, Australian dividends have a tax credit for the company tax already paid. That tax credit can be used to pay other income tax and any unused credits are refunded as cash. Many retirees pay little or no tax because they hold their investments inside a superannuation fund or they benefit from the Senior Australian and Pensioners Tax Offset (SAPTO). That means they can benefit from the cash refund of these tax credits. In that case, the Telstra dividend represents a yield of about 8.6 per cent. This compares very favourably with both a term deposit rate and the deeming rate.

The global search for yield has driven some share prices to unsustainable heights and when interest rates return to normal, the attractiveness of these shares and their market prices will likely fall. Considerable care and advice is needed in selecting suitable shares for income.

Retiree’s discomfort with shares stems from market volatility. The media’s hysterical fascination with falling prices doesn’t help. Remember market volatility relates to an uncertain sale price. If you are prepared to hold a share for the long-term for income, as you would a bond, the sale price may be less relevant.

Low interest rates mean that retirees need to accept more risk. How much, depends on your individual appetite for such risk. One thing is certain; dependence upon income from cash will erode your capital very quickly, because the income will not even keep pace with inflation.

In summary, retirees may find it helpful to remember:

  • Depending on term deposits for income in retirement is very expensive. With a return of three per cent, your capital needs to be 33 times your annual income if you want to live on the income and not eat your capital – and that ignores tax and inflation.
  • Bonds are similarly expensive but they have the added risk that their market prices are likely to fall if interest rates rise.
  • Some shares provide a viable alternative for income but you must be prepared to tolerate the market volatility of prices. The unsavoury choice is between accepting some market risk or longevity risk – the risk that you outlive your money.

* per person per Authorised Deposit-taking Institution

Jon Kalkman trained as a teacher before qualifying as a psychologist. He has held various positions in schools, including spending 10 years as principal of special schools, and has also worked within the Department of Education. Jon joined the Australian Investors Association (AIA) in 2005. He is currently Vice President of the AIA and Chair of the Brisbane Committee. This is not investment advice. The views of the author may not represent the views of the AIA Board or members.





    COMMENTS

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    MICK
    13th Jan 2017
    10:49am
    The claim that share dividend yield across all shares is 6% is not true. You'd be doing well if you could buy a share that offered that these days.
    What many people do not realise is that Central Banks have been driving down returns on cash because they are trying to get investors to put their hard earned cash into assets which are already over priced and primed for falls when interest rates are again driven up. Whilst nobody has any idea of when that is going to happen it will because the rich need to have cheap assets and will buy up everything at an ensuing fire sale as they always do.
    There is a lot brewing at present:

    1. the end of cash and replacement with digital currency. I read recently that this is already under way.
    2. the crash of currencies due to debt which can never be repaid due to the sheer size of it.

    Whilst all investors have a mix of investments shares and property, which have been driven up since the GFC, are not real good. I read that many rich people are stockpiling gold and this indicates where we are heading. These people rarely get it wrong because they are connected at the hip with governments and their Central Banks and they get out at a time when small people are being urged to get in. Sound familiar?
    Rae
    13th Jan 2017
    1:26pm
    The advantage of digital currency for government is huge.

    They can impose negative interest rates and therefore increase revenue. For example each $1000 in will only be worth $980 going out.

    More importantly they will then control your spending. Smoking, alcohol, gambling, unhealthy or excessive food purchases, prostitution etc can all be forbidden or taxed very highly.

    There cannot be a run on the bank.

    Fines and charges can be set on a whim and taken without any problems.

    The end of currency in our hands is really an end to freedom as we know it.
    MICK
    13th Jan 2017
    2:30pm
    As with all things there are always pluses and minuses.
    My concern about governments and their Central Banks is that digital currency will be about total control and hence about manipulating the system for the big end of town.
    We only need to cast our minds back to what happened to Greece and Cyprus during the GFC. Only 50 euros permitted to be withdrawn per day.......and then the Cypriot government decided the would steal any deposits over 100,000 euros.
    We have to be careful what we wish for Rae. Whilst the cash economy will die we will get a whole pile of other consequences we are unable to stop. Sounds a lot like biblical prophesy to me!
    Rae
    13th Jan 2017
    3:58pm
    I think you mis understand MICK. I am absolutely against cashless society.

    In fact after being caught in Athens when we thought the whole global money system was about to collapse I now keep 6 months worth of income in actual notes. Half in a bank safe deposit parcel and half in my solicitors safe.

    I never travel without a money belt, a separate account card and two thousand US dollars in it.Plus a plane ticket home and my passport.

    There isn't a solvent bank anywhere now and this cashless idea is because they know we are teetering on the brink.

    Apparently we are three days from chaos at any point and lucky so far.

    I shop at farmer's markets and little country stores and always use cash. In some cases I prefer my purchases to remain private. It is not the governments role to be my keeper.
    Farside
    13th Jan 2017
    4:21pm
    Never underestimate the ingenuity of people to work around rules. Although less convenient than cash it will only be a matter of time before services emerge enabling people to remain anonymous from the government. It will be increasingly difficult to remain off-grid.
    Rae
    13th Jan 2017
    6:33pm
    Yes Farside. It has been suggested that good whiskey keeps indefinitely and can be swapped for a lot of things.

    I remember watching Soylent Green and thinking I'd rather be eating the rat burger way before the shocking end. No way do I want to live in a perfect society controlled by a bunch of computers.

    As for Centrelink I'm surprised a good hacker or two hasn't brought it down yet.
    MICK
    13th Jan 2017
    9:04pm
    Sorben Green?? Don't quote me on that one.
    Yeah...I agree with the banks. It pains me to have money in them but then what asset other than gold is worth buying at present?
    Rae
    14th Jan 2017
    9:12am
    Soylent Green was a Sci Fi future book converted into a cult movie. The problem of population control and growth was dealt with ruthlessly. In the midst of this perfect world were those that lived underground in the sewers living a freer existence away from the imposed perfections, rules and regulations.
    LiveItUp
    17th Jan 2017
    7:05am
    If you want 6% yield from shares buy those with hig dividend yields. Using derivates you can double your dividends. If you want to make money from shares learn a bit of charting and follow the smart money.

    13th Jan 2017
    10:50am
    The "Innovation Generator" is certainly trying to make Age Pensioners the "cashless society" by being the "politicians' providers".
    MICK
    13th Jan 2017
    11:48am
    The cashless society is here. Plans already in place to bring it on, hence the removal of big notes in India and talk of same in US and South Africa. Hold on to your hat.
    Anonymous
    13th Jan 2017
    11:52am
    and your wallet.
    Old Geezer
    13th Jan 2017
    5:19pm
    $100 bills are about to be taken out of circulation here too. A country should change it's currency regularly so that the old notes have to be replaced with new ones to be legal tender.
    Rae
    13th Jan 2017
    6:35pm
    That is fine Old Geezer I have no illegal money at all and can justify the lot. But to give total control to the government and banks is a step way to far.
    MICK
    13th Jan 2017
    9:07pm
    Nothing to do with changing old notes Geezer. They just want to gradually remove the ability to pay with anything other than digital transactions. First the 100s then the 50s and finally they say 'ohhh...we can't go on like this so let's do away with cash altogether'. Trust me that this is the way this is being orchestrated...run by Central Banks and their governments wanting total control over YOUR MONEY.
    Circum
    15th Jan 2017
    2:36pm
    The government doesn't like people big noteing themselves.
    Anonymous
    17th Jan 2017
    9:12am
    Having stupidly offered a 7.8%+++ return to retirees who saved for retirement but can't get better than 3-4% on their investments, the government now has to find ways to stop people putting their money under the bed - where many will get far better returns than they can get anywhere else!
    Anonymous
    17th Jan 2017
    9:12am
    Having stupidly offered a 7.8%+++ return to retirees who saved for retirement but can't get better than 3-4% on their investments, the government now has to find ways to stop people putting their money under the bed - where many will get far better returns than they can get anywhere else!
    The pom
    13th Jan 2017
    11:19am
    If you buy shares sensibly with the view to mid to long term holding there is no reason to leave your savings in cash accounts which will just melt away over the years, as the interest will never take care of inflation and your need to spend some of the income. I retired over 16 years ago and due to a very conservative investment policy over the last years of my working life I find I am better off than I was on retirement. Had I listened to the man who tried to sign me up as one of his stable I would now be not much better than having a basic pension
    MICK
    13th Jan 2017
    11:50am
    "Past performance is no indication of future performance"?
    When has the world had the level of debt we now have and when have we had the mass unemployment and underemployment we currently have in the first world....with robotics to arrive and halve the workforce again?
    Be careful of spruikers. Little people are always burnt!
    maelcolium
    13th Jan 2017
    11:39am
    A psychologist and ex teacher now a honcho in Australian Investment Industry - says it all really. Thanks but I'll speak with my accountant.
    Rae
    13th Jan 2017
    1:32pm
    I would think those qualifications allow a good insight into human failings in investment. People are usually more fearful of failure than of winning so they do nothing.

    I liked the article and thought it good advice.

    I'm happy to take the falls with the gains. In fact I have had my best buys during major corrections when the punters panic and sell at discounts to value.

    The market can be over valued.

    Investing is hard work really as you have to be informed and act even in fearful situations.
    Anonymous
    17th Jan 2017
    9:13am
    Accountants are seldom good financial advisers, maelcolium!
    Farside
    13th Jan 2017
    1:29pm
    "The unsavoury choice is between accepting some market risk or longevity risk – the risk that you outlive your money." This is a poor excuse for not using capital to fund retirement. Longevity risk is capped and much less than market risk/volatility. Few can expect to live beyond 105 regardless of health and genes. Indeed for most people, life expectancy is lower by 20 years of more so further reducing longevity risk.
    Hasbeen
    13th Jan 2017
    2:41pm
    The government was forced into the deeming system when thousands of wealthy oldies were stashing their money into non-productive "investments", reducing their income, so they could draw the pension.

    It is yet another example of the smarties stuffing it up for genuine people.
    MICK
    13th Jan 2017
    3:01pm
    The thousands of wealthy oldies you are referring to have very expensive homes where much of their money is squirrelled away. and never to be touched by greedy governments. Then there are Trust arrangements. Then there are gifts, precious metals and collectables, etc.
    Wealthy people are more savvy than you give them credit for. That is at least 90% of why they are wealthy.
    Rae
    13th Jan 2017
    4:06pm
    Yes it is quite bizarre. A bit like purposely losing money by negative gearing to save a bit of tax.

    Funny how some would rather go without income than pay tax.

    Living in huge mansions with all the costs and work involved and hoping the market doesn't fail while collecting a government pittance makes no sense to me.
    Old Geezer
    13th Jan 2017
    5:15pm
    I see it as madness to tie up all your capital for the meagre amount of the OAP. Maybe it's the status that goes with it instead. It certainly has me shaking my head in disbelief.
    Rae
    13th Jan 2017
    6:42pm
    Not sure about any status attached to welfare OG. If like me you are self funded then you can suit yourself. I keep working at income production. It has become a hobby actually. When the new legislation took away the promised part pension, I never got to the age to claim it just came close, I simply replaced the income by investing. My local service people who got sacked and businesses I stopped spending with took the fall.

    This is what the LNP want though isn't it? All those billions taken out of our economy and given to the internationals.
    Bugger the local small businesses, the lawnmower men, the window cleaners, the hairdressers.

    The IPA think they will be rewarded. Fat chance of that happening.
    MICK
    13th Jan 2017
    9:01pm
    That is the way this bunch of misfits is playing the game. Just like America this bunch want to give the 1% exactly 90% of everything.
    One day the idiots who keep voting for their football team will wake up with no job and no hope....and then want to find somebody to blame.
    Anonymous
    17th Jan 2017
    9:35am
    Maybe its the financial and emotional security, OG? Did it ever enter your arrogant head that people do what they feel they have to do to survive in a cruel and unjust world where choices for some are limited?

    I know people who have $820,000 in assets aside from their home and are getting $22,500 a year income and paying extra for everything due to not having a pension card. Now they have a choice. They can live on their savings until they run down substantially and they qualify for a pension ((benefiting the taxpayer and less responsible pensioners, but denying them ALL benefit from their hard work). When they are down to $375,000, their income will have doubled and their expenses been slashed!), OR they can find a way to tie up their capital (maybe gift to offspring or hide cash under the bed?) so that they actually have a chance to BENEFIT from their savings.

    Sure, it's easy for arrogant pigs to say ''invest more intelligently''. You have no idea what challenges people face. One I know simply cannot deal with the risk of investment because he has PTSD and anxiety syndrome after being robbed of his savings. He NEEDS the security of seeing bank statements every month. He tried investing in shares but was physically ill every time the market fell. Now you won't have the empathy to appreciate how tough life is for someone like that. Being arrogant and self-opinionated, you will say ''that's just an excuse'', because you've never walked in his shoes and you are too vile and nasty to even try to appreciate his challenges.

    The bottom line is that Australian seniors are being treated with vile disrespect and lack of compassion, and they DESERVE A BETTER DEAL. 'Whatever the OAP is or isn't, it SHOULD NOT EVER BE WELFARE. It should be paid to all as a right. Put taxes up to pay for it. Save on administration costs. But treat Aussie seniors with the same respect afforded to seniors in far less affluent nations.
    Old Geezer
    13th Jan 2017
    4:01pm
    A teacher and now a psychologist...well that explains it all.
    PIXAPD
    13th Jan 2017
    5:11pm
    psychologist?<<< would not trust any of them......most are insane
    Aussie
    13th Jan 2017
    7:29pm
    So how we pensioners that live on a day by day basis with cash to survive ???? how is that going to affect us with the digital currency ????? will be very hard specially if you are overseas on holidays ,,,,,how you get the cash ?????
    I just wonder how the gov. will implement all this ?????
    Rae
    14th Jan 2017
    9:19am
    You won't get any cash. You will have to use a card. There will be restrictions on what you can and can't buy.

    Banks will charge as they see fit. Negative interest rates will be entirely possible and probable.

    Look at how India is implementing it. They simply banned the higher notes forcing the use of digital pretend currency.
    They used legislation to do it.
    older&wiser
    15th Jan 2017
    2:46pm
    Rae - agree. I can pretty well bet that in the coming years, the govt will control any super you have, and dole it out.
    Plus the ridiculous current system of the rates the Gov deems pensioners to be earning. Grossly unfair and wrong.
    In Outer Orbit
    13th Jan 2017
    11:08pm
    Who is happy to be living out their old age in Australia rather than Aleppo? Too much doom and gloom above when most of our glasses are still half full, at least relatively.

    Governments tell oldies to panic because there will be insufficient young people available to care for all the dependent oldies expected. And they tell the working generation to panic because automation is going to make millions of people of working age idle. If workers are all idle surely a few of them can care for the oldies instead. And all these clever machines are anyway supposedly being developed to make our lives better, not to wash half of humanity down the gurgler. Problem solved surely. Hands up everyone who has had enough of being encouraged to live in fear. Best advice seems to be to log off, go outside, feed some chooks, plant some veggies and "Carpe diem quam minimum credula postero" ('seize the day, put very little trust in tomorrow' ...). All things pass, including all of us and even Trump's Towers will not stand indefinitely. Have a nice day everyone.
    LiveItUp
    14th Jan 2017
    3:55pm
    https://www.investsmart.com.au/investment-news/smsfs-in-a-high-risk-cash-gamble/138745?utm_source=isgroup&utm_medium=email&utm_campaign=free-weekend-130117

    Shows return on various types of investments but remember it does not include the sharemarket run in last quarter 2016.
    Priscilla
    18th Jan 2017
    1:40pm
    It is essential to use cash as there are too many scams targeting the use of cards and also the charges imposed by banks and business that make it too expensive and unsafe to use cards.


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