It's never too early to start planning for retirement. Now is the time to start thinking about wealth preservation.
Areas of concern
The major issues facing retirees can be summarised as:
- longevity - "how long will I live for, and will my capital last?"
- inflation - "will my money be able to retain its spending power"
- income - "from where will my income be sourced?"
Our life expectancies are increasing over time. This trend is rapidly rising due to the amazing amount of medical breakthroughs we are experiencing, as well as our increased knowledge on better living through diet and exercise.
The problem is that as we live for a longer period of time we also need to support ourselves for longer in retirement. There are no guarantees on how long our assets will last.
The second most important issue is whether our capital can keep pace with inflation. High-inflationary periods can erode capital over time if we have not allowed for sufficient exposure to growth assets. Having a large allocation to cash can actually be detrimental to an investment portfolio over the longer term.
To keep pace with cost of living increases over time, therefore, it is imperative an investment portfolio has some exposure to growth-type assets (such as Australian and international shares, and property). Just how much exposure will depend on each individual's aversion to risk.
The three main sources of income in retirement are:
- superannuation – in the form of a pension income stream and/or lump sum withdrawals.
- non-superannuation assets - in the form of returns from shares, property, cash and fixed interest.
- Centrelink - that is, age pension benefits
The capital required to provide the income from these sources (excluding Centrelink) will vary depending on how much you need in retirement, your age at retirement and how long you think you will need the funds to last.
How long you continue to derive income from your saved capital will depend on how much you spend each year – and how much you actually "spend" could be different to what you had "planned".
Of course, Centrelink is there to supplement your other income if your financial position qualifies you for a full or part age pension payment. However, there should be an attempt in your retirement planning to minimise dependency on Centrelink benefits. This mitigates any regulatory risk in relation to potential Government policy changes in the future.
Retirement portfolio strategies
How can you maximise your income and capital position? Consider the following tips.
For defensive assets
- During market uncertainty try to hold at least three years of income payments in cash, preferably in a higher yielding account. This should provide ample time to reflect on current markets and to ensure you do not need to draw down on capital to fund superannuation pension payments. It avoids having to sell down assets in low market periods.
- Within the 3 year cash allocation, consider having two years of payments in short term money market investments. These pay slightly higher rates than normal "at call" cash accounts.
- Maintain diversification of income assets with some potential for growth. There are a number of quality fixed interest investments available that pay reasonable income with some equity characteristics but without the same degree of risk.
- Try to draw down from defensive assets if extra funds are needed. Your aim is to preserve capital so if you need additional funds to cover larger lump sum expenses draw from your defensive assets where possible.
For growth assets
- Maintain your growth assets for at least five to seven years without accessing them. Your objective here is to achieve reasonable growth to manage longevity issues.
- Maintain a good spread of growth assets. Diversification across various sectors is the key to minimising capital losses during volatile periods.
- Consider some capital protection strategies if required.
- Take advantage of shares that offer franking credits. The pension phase in super is a tax free environment, which means franking credits are fully refunded back into the account. The long term compounding benefits of this to your account balance can be significant.
- Review your portfolio and rebalance regularly as required to ensure your desired asset allocation is maintained. This is the best way to ensure your portfolio continues to meet your objectives for risk and return.
Successful asset allocation means achieving your objectives with the least possible risk. To do this you need to understand the behaviour of asset classes and products.
Establishing an asset allocation that is consistent with your goals and risk tolerance should be your top priority.
Borrowing to invest
Due to the long-term nature and inherent risks of borrowing, it may not be an appropriate strategy if you are already in retirement.
However, most investors in this age group understand market conditions more, and have experienced the ups and downs that come with share markets. They are therefore more inclined to take a little more risk with their investment dollars.
Borrowing to invest is not without risk and when markets fall it is very important you keep in touch with your adviser so that you can both manage your loans as effectively as possible.
Risk profiles can change over time
Getting your investment risk profile right is very important. When you meet with your adviser, he or she will generally discuss your attitude towards investing and how much risk you think you can tolerate. A risk profile questionnaire helps determine this.
However, remember that your risk profile may change over time particularly as you near retirement. Your investment outlook could change from growth to more income-type investments. This is why it is important to re-assess your position on a regular basis.
Understanding the risk/return trade-off for the various asset sectors is very important. That is, the greater the returns, the greater the risk you take; and vice versa. Everyone wants nirvana – where risk is low and returns are high – but this is near impossible to achieve.
Putting risk/return trade-off into more perspective, you can see from the table below how defensive assets such as cash and fixed interest pay relatively good income, but have no growth and therefore low risk. Shares on the other hand have high potential for capital growth and so the risk factor is also higher.
At this stage of your life, most of your personal debt – your mortgage, personal loans, credit cards – would be under control or even eliminated.
For those who still have a mortgage or other personal debt, now is the time to pay it out. Or at least manage your debt within your retirement savings strategy.
With the changes to superannuation rules, many people are reconsidering the traditional strategy of using available cash to repay their debt as soon as possible. Instead, they are converting the debt to interest-only and using the freed up cash to contribute to their superannuation account.
At retirement, a lump sum benefit is withdrawn - tax free if over age 60 - which is then used to retire the debt completely. This can be a very effective method for some.
However, before you consider this strategy it is very important you seek advice from your financial adviser, who will work out whether this is the best plan for your circumstances. In some instances it may still be better to stick with tradition and concentrate on repaying your debt sooner.
In these later years, with your debts paid off, your main focus tends to be on health and having adequate income.
If something happened unexpectedly, the main concern would be day to day living expenses and medical costs during recovery. Making major changes after illness, such as home modifications, may also be a financial outlay that would need to be covered.
Trauma and TPD cover remains a priority for retirees as the lump sum benefit can help if you have been diagnosed with a critical illness. This lump sum could be used to make alterations to your residence or car, and to cover medical or remedial costs.
Life cover can supplement superannuation benefits or other income for a non-working spouse in the event of a death of the primary income earner.
Circumstances change with your stages of life so you should talk to an adviser about what product and features suit your needs.
Centrelink benefits are available for eligible seniors who have retired or are about to retire. Eligibility is based on two tests – the Incomes Test and the Assets Test. Your financial position (combined if a couple) is taken into account for these two tests, and eligibility for benefit payments is determined by the outcome of these tests.
We recommend you read the publication 'About to retire or in retirement? A guide to your options and services' which is published by Centrelink. This publication is a very useful guide to help individuals understand income support, what additional services and supplements are available and how you can make a claim. It also discusses residential aged care for those who are looking at their options fore retirement homes.
Estate planning is an area that can be easily neglected. Individuals often overlook the importance of having an up to date Will and Powers of Attorney.
Estate planning focuses on wealth preservation and wealth transfer so regardless of whether times are good or bad, your objective should still be to distribute your wealth to your nominated beneficiaries in the most effective way.
As well as your Will and Powers of Attorney, you should also be thinking about:
- Superannuation does not automatically come under the scope of your Will unless specifically nominating your Estate as the beneficiary. For this reason you need to establish additional nominations for your superannuation.
- Business succession planning - if you have a business you should have a business succession plan in place.
For more information contact an adviser at your nearest Morgans branch.