For many people, the scariest thing about retiring isn't working out what they'll do to fill the hours or wondering what's ahead. That's the exciting bit. The scary bit is deciding what to do with their money.
While the growing trend for older people to continue with at least some form of work in retirement has made the old all-or-nothing approach to retirement a thing of the past, most people will still reach a day when they receive their final "real" pay cheque. It might look big, but it's the money that has to sustain you through your retirement - another 20 or 30 years.
But while Australia's super system is arguably world-class (despite its faults) in getting us to retirement, it has one big failure: once you decide to retire, you are effectively on your own.
A recent report into pension systems by the Organisation for Economic Co-operation and Development identified a range of measures that are essential to sustaining a successful pension system. And while Australia measures up well in the accumulation stage, a partner with Mercer's retirement, risk and finance consulting business, David Knox, reckons we're falling short when it comes to retirement.
For starters, while the OECD correctly says this whole business of saving for retirement and funding your retirement should be integrated and seamless, it doesn't work like that. When you retire, it's decision time. Even if you're happy with your super fund and want to stay put, you still have to transfer the money from your fund's super product to its pension product - it doesn't happen automatically. For Australian retirees, this is a critical decision because of the added risks involved in our retirement system.
Retirement is basically about taking your finite financial resources and investing them so they provide you with money to live on for the rest of your life.
Thanks to the global financial crisis, most of us are well aware of the first thing that can go wrong with that plan - a crash in investment markets. That can wipe out years of future income, and unlike people still in the workforce, retirees are drawing down on their savings rather than adding to them. This makes it unlikely that they'll ever recover the full amount lost when the markets eventually recover.
But the risk that most retirees are less aware of is longevity - the chance that you'll live longer than expected. Thanks to medical science and other advances, those alive today will live longer, on average, than any other humans that have ever existed. The average 65-year-old male can expect to live another 18.9 years - taking his life expectancy well past his 83rd birthday. If you're a woman aged 65, you would be pretty safe to start planning your 85th birthday party, as the average life expectancy is over 86.
Life-expectancy figures are averages. While some people won't make it to 83 or 86, about half the current 65-year-olds will live beyond their life expectancy. If you're healthy and have good genes, you need to be planning on 25 or 30 years in retirement rather than 15 or 20.
That's a long time to stretch your savings, and as the Institute of Actuaries of Australia pointed out in a recent paper on longevity, it makes us even more vulnerable to market crashes. It says if you're looking at a 30-year retirement, you'll probably see three to five market crashes during your retirement. Yet many super funds offer similar default options to retirees as they do to 25-year-olds who are just starting to save. It's a recipe for disappointment.
Groups such as Challenger promote the benefits of annuities as a way of insuring against both investment and longevity risk. But most of the money is invested in account-based pensions, where the retiree takes on both risks.
Knox says there is growing interest in developing a deferred annuity market that would allow retirees to effectively insure themselves against running out of money. You could still have a flexible account-based pension (or fixed-term annuity) in the first 15 or 20 years of retirement, but purchase a deferred annuity that would kick in and provide an income once you turned 80 or 85.
But our retirement system isn't set up for that. Knox says one problem is that deferred annuities don't pay an income in the early years - the Australian Taxation Office does not regard them as pension funds, so they are not tax-free. Centrelink also includes deferred annuities in your assets in determining your eligibility for the age pension, even though you can't access that money.
Knox says the system is also biased against other measures to reduce investment risk in the lead-up to retirement. The OECD, for example, recommends life-cycle strategies, in which you are automatically moved to a more defensive portfolio as you approach retirement.
The super industry is also looking at measures such as risk overlays, in which you remain in a growth portfolio but buy insurance against market losses in the years leading up to retirement.
But Knox says the upcoming MySuper reforms are a disincentive to funds wanting to offer either approach to clients in their default funds as MySuper funds will have to charge the same fee to all members. If you're using a life-cycle strategy, fees should fall as you switch into more conservative investments. A risk overlay incurs extra costs to cover the costs of hedging the portfolio, but funds won't be able to charge these costs directly to those using the overlay. So if funds want to protect members approaching retirement, one group will end up subsidising another.
Longevity and retirement products were discussed at the recent superannuation round-table convened by the Financial Services Minister, Bill Shorten, and the government is aware of these problems. But it is high time more thought was given to addressing the whole question of investing in retirement. Getting people to save for retirement is only half the equation.