The dilemmas facing retirees

Be savvy when structuring your post-retirement funds, writes Annette Sampson.

Be savvy when structuring your post-retirement funds, writes Annette Sampson.

If losing money is hard to take when you're working, it can be an absolute shocker in retirement.

The challenge of retirement is simple: start with a fixed amount of money and try to work out how best to survive on it for the next 20 or so years - potentially much longer if you're blessed with good genes and good health.

From day one, your lump sum is under pressure as you draw on it for income. Throw an investment loss into the mix, particularly in the early years of retirement, and your lump sum can disappear fast.

Research by consultancy Milliman has shown that, as a rule, a 10 per cent loss in the first year of retirement can double the risk of an investor's money running out within 30 years.

The combination of a reduced lump sum and regular income withdrawals make it much harder to get back to where you started.

But adopting a no-risk approach leaves a lump sum, and the income it generates, at the mercy of inflation. As time goes on, the income buys less and less, pretty much guaranteeing a meagre lifestyle later in retirement. The bad news is there are no magic bullets.

But there are options and strategies that can be used to minimise the risks.


The director of StrategySteps, Louise Biti, says the first step is for people to look at their retirement needs. How much "absolutely essential" income do you need to keep your head above water? What level of discretionary income do you need to live comfortably? And what level of income would you like for additional luxuries?

Once you have identified this you can structure your investments to ensure your "essential" income is absolutely secure, but the money backing your discretionary income can be put to work to (hopefully) provide a better long-term return.

The head of investment strategy for Towers Watson, Tim Unger, says the industry is coming up with new ways of achieving the returns retirees need with less risk (see box, below).

But he says nothing works perfectly all the time and you wouldn't want to opt for just one of these strategies.

"No matter where you are in your life, your best strategy is to be as well diversified as possible," he says. "Analysis would suggest the average member still has another 20 to 30 years to provide for so they should still be taking on quite a bit of risk. But that doesn't capture the impact of a fall on individuals."

Unger says the ideal investment mix will depend on things such as how long people expect to live, how reliant they are on super for income and how they would feel if their investments fell 20 per cent.

The managing director of Eureka Financial Group, Greg Cook, says people need their risk profile assessed properly.

"What happens in the good times is that a lot of people want to be more aggressive and when something like the GFC hits, they want no risk," he says. "People seem to see bad news, assume Armageddon will occur and want to shift their portfolio. But whatever they're seeing on the news is already factored into prices. I'm sometimes surprised by people who think of selling because they can see something no one else can."


Cook says portfolios can become more risky during a boom as rising asset values increase the proportion of money in risky assets. "If you've got a portfolio that's one-third invested in shares, you could find rising prices have lifted that to 40 per cent," he says. "You need to have the discipline to sell that extra 7 per cent and buy something that has been underperforming."

The practice leader at Milliman, Wade Matterson, says his research has shown it is retirees who opt for conservative strategies who are most likely to run out of money. He says investors have become more defensive since the GFC but are sacrificing future growth.


A common strategy used by financial advisers is the "bucket" strategy. The general manager for advice development at ipac, John Dani, says it involves putting together an accurate estimate of likely living expenses for the first five years of retirement and quarantining two or three years' income (estimates vary some say five or seven) in cash-based investments.

He says many investors are unaware they can use term deposits in many allocated pensions, but he warns against putting all your "cash" into one term deposit. "We'd recommend a rolling series of term deposits for, say, one month, six months and 12 months, so they're maturing as you need the income and you're not exposing yourself to the risk of having to reinvest it all at a lower rate."


Dani says the income for the next two or three years could then be placed in a capital stable "bucket", which could include a small exposure to the sharemarket. And by having short-term needs taken care of, retirees then have more flexibility to expose the rest of their retirement savings to growth, knowing they won't have to touch them for at least five or six years.

Cook says the bucket approach is most useful when using an investment platform as people have the ability to nominate which options their income will be drawn down against.

He says it can also be used effectively with self-managed super funds.


Most retirees opt for the flexibility of allocated pensions but Dani says there are other options that can offer a level of certainty for at least part of their savings. Guaranteed products offered by groups such as AXA and ING, for example, charge an insurance premium to ensure investments won't fall so long as people stay in the fund for an agreed term. He says these products can also provide a regular income.

However, Cook warns the cost - particularly over longer periods - can mean people pay more than they need to when markets "are like the other 95 years of the past 100".

Matterson says another form of protection is a risk overlay, such as the one launched recently by Fortnum. Instead of buying long-term capital protection, he says, investors can protect part or all of their portfolio on an annual basis for a fee of 0.75 per cent. "For example, if you have a balanced portfolio, you may not include the cash and bonds, and you can turn it on and off as circumstances change," Matterson says.

Annuities are another option, though not one popular in Australia. Biti says while they won't provide the best return on your money, "it's not necessarily about maximising your return but protecting your income for the essentials".

She says while retirees probably wouldn't put all their money in annuities, there is growing interest in using them for the income with which they need to take no risks. They also provide regular drawdowns, which can be useful for people used to drawing a regular salary.

Biti says part of the problem is that there is still only one company providing lifetime annuities, though companies such as Challenger now offer annuities for up to 30 years.

These can offer better value than the lifetime options because you, not the insurer, are taking the risk that you'll live longer than expected.

However, you're giving up access to your capital, whereas with term-certain annuities the benefit goes to your estate if you die before the term is up.

"With lifetime annuities you're in bonanza land if you live a very long life," she says. "But you have to outlive your life expectancy to get a decent return from them."

Dani says even when it comes to growth investments, retirees have different needs to wealth accumulators. "Income and cash flow is paramount for retirees," he says. "There is a growing trend towards investing in funds that focus on providing a reliable income over the long term by investing in high-yielding Australian companies, rather than reflecting the market benchmark."


Cook says it's critical to get the most out of tax concessions for older people and Centrelink benefits.

Dani says Centrelink benefits can operate as a "safety valve" for retirees because as the value of their investments falls, they may become entitled to qualify for a part-pension or for a higher part-pension. "It doesn't fully compensate [for the losses] but it's a partial compensation," he says.

Cook says many people don't realise that the cut off to qualify for a part-pension is a generous $1.018 million for a couple who own their own home and $686,000 for singles. The limits are even higher for non-home owners.

And while you may not get a lot of pension, he says even $1 of pension entitles you to the coveted pensioner concession card that provides a wide range of discounts on everything from pharmaceuticals to discounted rates and energy bills (see pages 8 and 9).

Biti says retirees' tax-free super after age 60 and the seniors tax offset mean many retirees should be paying little or no tax.


Dani says during the GFC many people coped with the loss by returning to work, or delaying their retirement. While that's not possible for everyone, he says it is "the most powerful lever" that can be employed.

"As a rule of thumb, every extra year you work after 55 adds three years to the longevity of your capital in retirement," he says.

Cook says even if people work just 40 hours over a 30-day period each year, they can also claim the super co-contribution up to age 71. "For a couple who retire at 60, that's potentially an extra $22,000," he says. "And they may be getting the age pension as well."


Dani says releasing equity in the family home is also an option and is being contemplated by an increasing number of retirees. Matterson says downsizing can free up capital to offset some of those investment losses, though it's not a step everyone is prepared to take. If you're receiving an age pension, it may impact on your entitlements.

Six solutions in the offing

It's the dilemma occupying expert minds: how to marry the need for growth investments in retirement with retirees' inability to bounce back from market falls?

"In depressed or volatile markets, the recommendation is usually to hold on to quality shares," the director of Strategy Steps, Louise Biti, says. "But for retirees that doesn't work because the issue isn't volatility of assets it's volatility of income."

A Towers Watson analysis of 43 funds offering a default option for retirees found the average weighting to growth assets was 67 per cent, not much below the 74 per cent average for their pre-retirement default options. Most funds' allocations were unchanged, with the average being pulled down in retirement by a small number of funds "fully de-risking" their retirement options.

While a balanced fund might be fine when working, there's a growing consensus it doesn't suit retirees. What's on the drawing board?

- Traditional life-cycle or target-date funds. Move you down the risk spectrum (more bonds, less in shares) as you near retirement. Some extend beyond it target-date funds more generally assume you'll retire at a set age and work towards it.

Verdict: A blunt instrument. They don't account for factors that might affect risk tolerance such as salary, gender, account balance or market activity. Worst case: you could be sold out of shares automatically after a fall.

- The new generation. Add sophistication to life-cycle idea. Funds dig deeper into membership to gauge risk level they should carry.

Verdict: The default option caters to the broader profile of fund members but your situation may be different.

- Risk parity funds. Replace equity risk with other types by applying leverage to lower-risk assets such as bonds. Towers Watson's Tim Unger says these funds have produced similar returns to traditional growth funds but have been less volatile.

Verdict: Not immune to losses. Unger says they did very poorly during the GFC for a short period but bounced back faster because people flocked to bonds. Ironically, they become riskier with market crowding (popularity).

- Dynamic asset allocation. This is about being "a bit smarter" when allocating where a fund's money is invested by taking account of whether investments are good value. No fixed-asset allocation but tend to take longer-term positions than absolute return and hedge funds.

Verdict: Hard to get right and even if correct, the time-frame required for the market to come to its senses can be longer than investors can tolerate.

- Target volatility funds. Level of volatility is set for the portfolio. As volatility increases, the fund moves to more conservative assets as it falls it moves into equities.

Verdict: Relies on volatility preceding extreme market movements. Milliman's Wade Matterson says when the US ran into problems with its debt ceiling last year, these funds felt the pain but experienced a much smoother ride and performed well when markets rebounded. Markets are most volatile in a big fall, so other protection may be needed as well.

- Risk overlays. Involve hedging against losses in sensitive years such as those leading to retirement.

Verdict: Can protect from losses at important times but hedging costs.

Market falls take their toll

Former teachers Brenda and Peter Spencer retired in the early 2000s. Both were fortunate enough to have decent super and started off by withdrawing a lump sum to pay off the mortgage and help out their children. They saw a financial planner when Peter retired to discuss what to do with their retirement investments.

Soon after, sharemarkets started to fall and the pensions, after a small rise, fell markedly. Brenda says they then told their adviser they thought they could take on a bit more risk.

After getting them to sign a waiver that they would not hold her accountable, they invested their three allocated pensions (four when Brenda retired two years later) in options such as Australian shares, industrial shares and small companies. The adviser suggested putting some money into cash to provide an income.

The couple had also continued a strategy of investing in shares using borrowed funds.

But in 2008, the global financial crisis sent their investments tumbling. Despite the general advice to stay put, Brenda says they switched three of their pensions into more conservative options.

It also seemed silly to be paying 7 per cent interest on the line-of-credit funding the shares, so the decision was made to cash in some of the pensions to repay the loan.

Brenda says the couple's income has fallen (no overseas trip last year) and they now take the minimum income required from their remaining pensions. Years ago, when their adviser suggested they could qualify for a part age pension, they decided against it. But in 2009 it was suggested again and they now receive a small Centrelink benefit and the attractive discounts that go with it.

"[The pension] is not as much as we lost from the combined allocated pensions, but it saves having to sell shares at much lower values," Brenda says. "If the value of the shares recovers, the pension will drop off."

Brenda says she still enjoys the sharemarket and Peter's retail pension is still worth more than when he started it, while her industry fund pension is steady, being invested mostly in diversified bonds and cash.

The couple reintroduced some growth funds to their portfolio in 2010-11. If things get tough, Brenda says there is also the option of downsizing from their apartment.

While she knows many others are doing it tougher, Brenda says when they retired the couple didn't think they would have any financial worries. While not uncomfortable, she says they are not as well off as they were.

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