Financial Independence in Retirement
Historically, citizens around the world funded their own retirement without any dependence on governments. This changed in the 1930s, when amongst many global measures, the US President Franklin D. Roosevelt introduced a limited pension in response to the Great Depression when poverty rates among senior citizens exceeded 50%. Age 65 was chosen for pension eligibility based on actuarial studies that showed this age produced a manageable system that could easily be self-sustaining with only modest levels of payroll taxation.
However, the idea of a pension soon became more universal. As a consequence, the 53,000 US citizens receiving social security benefits in 1937 has ballooned to over 50 million today.
Living to your early 60s in the 1930s was the equivalent of living into your late 80s today. But as the average life expectancy increased over the decades, the age of pension eligibility did not. Today in Australia, 35% of Federal Government expenditure is on social security (as shown in the graph below), and this percentage will continue to rise rapidly. It’s simply not sustainable.
Source: Commonwealth Government 2012-13 Budget Papers
In Australia, if the mediocre annual pension of $27,900 for couples isn’t enough to encourage people to be self-funded retirees, then the realities of an ageing population with declining financial reserves in many cases may inevitably result in severe financial distress.
It won’t be long before a Federal Government needs to make Australians face a simple fact: if you want to retire before you are 70, you’ll need to be self-funded.
Planning for retirement presents a number of questions that need to be answered.
When should I retire?
There are many matters to consider when planning for retirement such as the lifestyle you want, where you want to live, how much income you will need and the best way to transition to retirement. That’s why it is essential to plan well ahead to ensure that you are prepared.
There is also research that shows many men die within five years of retirement principally because they have failed to take steps to redefine the basis of their self-worth without the role of primary breadwinner. Living a full life with interests and hobbies is important whilst working and becomes even more important when you leave full-time employment.
In our experience, the definition of ‘retirement’ is different for everyone and there is no right answer. Many people are increasingly transitioning to full retirement over years or even decades.
How long will I live?
Knowing the answer to this question would make our role as adviser much easier! We factor in health, family longevity and life expectancies in trying to make a reasonable assumption, as this can have a material impact on the investment strategy we implement for our clients.
In the table below, we summarise the probability of survival for Australian males and females:
Source: Australian Life Tables 2005-2007 issued by Australian Government Actuary
Increasingly it makes sense to plan on living well into your 90s. However, many people seem less mobile or able to travel beyond age 80, at which time we often observe a noticeable decrease in annual income needs.
How much will I need to live on?
This is a commonly asked question with no simple answer – we all have unique situations and expenditure requirements. For each of our clients, we spend a lot of time trying to quantify this and then put a plan in place to maximise the probability of them achieving it. Our goal is to assist clients to maximise the probability of receiving regular and dependable after tax and inflation adjusted cashflow.
We have noted that many clients appear to enjoy comfortable lifestyles complete with wonderful travel experiences with a budget of $120,000 to $180,000 per annum after tax. The amount of capital you would need to even achieve this income range is still dependent on when you retire; your willingness to tolerate investment risk; and preparedness to erode the value of your capital over time and possibly leave less for your beneficiaries.
What can I leave to my children or beneficiaries?
We encounter a wide range of legacy plans for our clients. Some want their last cheque to bounce. Some feel that giving their children a good education and other opportunities early in life is sufficient, and the rest of their capital is theirs to enjoy. Increasingly, we find many clients wish to philanthropically assist less privileged people in the community during their lifetime. Others still want to leave a certain estate size to their beneficiaries, which may include their family house.
We have to factor all these different goals into our client’s plans.
It is often people with no beneficiaries who wish to see their last cheque bounce. For them, a reverse mortgagei can provide a contingency plan if they find their lifestyle erodes their capital faster than anticipated.
We help other people develop plans on how they can make a philanthropic impact, either during their lifetime or after. This often requires significant planning to ensure their estate makes a measureable impact – we call it social investing rather than just charitable donations. Everyone who is philanthropic should expect to see quantifiable benefits from their giving.
What should I do now?
Enjoying a comfortable retirement means planning for it well in advance – and you can never start too early. In our experience, most people need a hand, including those with high incomes who often need to start with cashflow management to ensure they are putting aside funds for life after full-time work.
Our comprehensive and intimate client discovery process is designed to help create a Capital Target for each client that allows them to visually track their progress against their lifestyle goals over time. It provides them with confidence and transparency that they can afford the lifestyle they aspire to.
Many of our clients are also increasingly concerned that their children and grandchildren should be as financially well organised as them. We are working on a variety of strategies to help educate the children and grandchildren, and will happily meet with two and three generations of families as appropriate.
i – A reverse mortgage draws down the equity in your home and charges interest like any other loan, but no repayments are necessary. Interest compounds each year and the loan is repaid when the house is sold, you move into aged care or you die. You cannot be forced out of your home even if the value of the loan one day exceeds the market value of your house. There may be restrictions on how much you can borrow using a reverse mortgage.
Author: Rick Walker
Note: This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.