An Unhappy Retirement Awaits

saving for retirement
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Today, 1 March 2016, the All Ordinaries opens under 5000 points.

24 March 2006 — the All Ordinaries index closed above 5000 points for the first time.

A decade of no growth. And, with the deflationary pressures building in the global economy there’s a very real possibility of more market headwinds in our not too distant future.

A fall of 10% to 4500 points would takes us back to September 2005. A hit of 20% sends the All Ords to 4000 points — a level first seen in December 2004. A 40% correction to 3000 points, would return us to March 1999 — 17 years ago.

How the years can slip by when the bear decides to undo the bull’s work.

The market’s glory days are starting to become a distant memory.

The timing could not be worse for Baby Boomer retirees.

The promise of retirement is something most people wish their lives away for. ‘I can’t wait to retire.’  ‘Retirement can’t come quick enough.’ No more daily commute. No more 9 to 5. No more office politics. Days filled with ‘doing what I want to do’ await.

After more than 40 years of work, the thought of being your own boss is something most look forward to with relish.

The growing awareness of preventative health measures means the age of 65 today, is not what it was a few decades ago. These days, people are 65-years young. Living two and possibly three decades in retirement is a distinct possibility.

If what we’re being told about advancements in medical science are only half correct, many of today’s 60 year olds can look forward to receiving a letter from King Charles in 40 years’ time.

The prospect of a long life — with most or all of our faculties and reasonable mobility — should be one we eagerly look forward too.

But there’s one small fly in the ointment…the prospect of outliving your money.

According to the government’s Intergenerational Report, 80% of retirees (those over the Age Pension eligibility age) will be in receipt of a full or part pension for many decades to come.

Source: 2010 Intergenerational Report

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That’s a lot of people expecting to have their lifestyles (fully or partly) funded by future taxpayers…some of whom are not yet born.

This is not realistic.

There will be changes. Tests to access the age pension are going to get tougher. The first step in restricting access to the age pension starts next year.

The harsher asset test changes in January 2017, despite what’s been widely reported, will not change the percentages too much.

Age pensioners have been busy arranging their affairs — gifting, renovating, holidaying, contributing to spouse’s super (if spouse is younger than Age Pension age) and moving money into lifetime annuities — to ensure they sneak under the asset test limbo stick.

After January 2017, the single home-owner asset test limit is $547,000 and for a home owning couple it’ll be $823,000 (both these figures exclude the value of the home).

A couple with $800,000 in investments (cash, shares, rental property and/or account based pension/s) plus a car and home contents totalling $23,000 currently receive an Age Pension of around $13,000 per annum. After January 2017, they’ll get diddly.

According to the Association of Superannuation Funds of Australia (ASFA) latest data, the cost of a ‘basic’ lifestyle (for a couple) in retirement is $34,000. Whereas a ‘comfortable’ lifestyle comes with a price tag of $59,000.

Let’s split the difference (for the ease of calculation) and say $48,000 per annum is what you need to keep a roof over your head, food on the table, cover health costs and enjoy the odd treat in retirement.

To generate $48,000 THIS YEAR (let’s not even worry about cost of living increases in future years), our couple needs a 6% return on their $800,000.

In a world of low growth and low interest rates, 6% is not an easy number to achieve these days with any absolute certainty.

A rental property may deliver you 3%-plus after expenses and term deposits about the same rate. This still leaves you nearly 3% shy of what you need for a better than basic retirement.

The income shortfall means retirees will be tempted (as they reach for yield) to allocate a greater percentage of their portfolio to income securities (hybrids) and shares paying fully franked dividends. There are a number of individual share and hybrid offerings that deliver 6% or better, so in theory the problem is solved.

Maybe.

As always, life is never one dimensional. Read the not so fine print with any investment and you’ll soon discover NOTHING IS GUARANTEED, especially market related income returns.

Companies can sustain falls in revenue due to softer economic conditions, losses and some even go out of business.

Case in point:

Indicative annual dividend yield (based on a dividend payout ratio of 60% to 70% and pro forma forecast FY2014 NPAT) – 4.6% to 5.4%.

Extract from Dick Smith IPO prospectus

To avoid specific stock risk, the average retiree — with a few dollars and little investment experience — is likely to be marshalled into a public offer account based pension fund.

This is a managed fund that will basically track the index.

The All Ords index pays an average dividend of 4.6% (with about a 70% franking credit). When you add back the tax credit, the grossed up dividend is 6%…right on the number needed by our retiree couple.

Not so fast. The fund manager, trustee, administrator and financial planner all want a little nibble of that 6%. After passing through the various fee filters, our still happily retired couple might be lucky to end up with 4% (on the generous side).

‘But we need 6%’ they tell their planner.

‘No worries. Draw down the required 2% from your capital.’ replies the planner.

The assumption being the share market will deliver better than 2% per annum growth to offset the drawdown…even though this hasn’t been the case for the past decade.

Markets are not lineal…they do not move onwards and upwards in a straight line.

Even a modest 20% market correction requires a gain of 25% to make your dollar whole again. Whereas a 50% fall needs to be followed by a 100% return to restore your capital to its original value.

Not sure if you have noticed, but 100% gains do not come along every day, year or even decade.

Let’s say that due to all the debt and deflation woes the world is facing, we see the market experience a serious downturn in the next year or two.

If that happens, our reasonably well off retiree couple — who reached for yield — are going to find their retirement a not so happy one.

For example, if their portfolio has reduced by 30% (due to a combination of market downturn, capital drawdowns and a little bit of expenditure on travel or a motor vehicle upgrade) to $550,000, then the numbers look really sad.

Based on a net 4% yield, the $550,000 produces $22,000 per annum.  Fortunately (or, unfortunately) the reduction in assets now qualifies them for an age pension of $10,000. All up, our retiree couple have $32,000 in income. This is $16,000 less than what they need for an above basic, but below comfortable, retirement.

In the very early years of retirement our couple find themselves faced with the dilemma of drawing the $16,000 from their diminishing capital OR having to cut back their longed for carefree lifestyle?

The dream of golden sands, palm trees and cocktails is now replaced by ‘the devil and the deep blue sea’.

Our retiree couple will not be the only ones in this pickle.

Many a retiree, courtesy of a severe market downturn, are going to find they are eligible for an increase in age pension.

The government, feeling the budget squeeze, will tighten the eligibility screws again.

There’s a good chance they’ll legislate for the family home to be included in a newly determined asset test.

Should this happen, reverse mortgages — selling your home back to a lending institutions brick by brick — will become the go-to option for retirees looking to maintain even a basic lifestyle.

Financial institutions and planners will be all over this ‘opportunity’ like a rash.

But what happens if deflation takes hold and property values stagnate or fall for a period of time?

This scenario would put a spanner in the works for the amounts expected to be sourced from reverse mortgages.

The scenario of happy retirements has mostly been predicated on the status quo — share markets continuing to be the superior asset class, property values rising and government maintaining the age pension social contract.

But what if we’ve reached the stage in this very long cycle where expansion is now followed by a period of contraction?

What if, over the coming decades, we cannot keep growing to the sky?

Living longer, in a world that contracts for much longer than envisaged, is going to create enormous strain for retirees and governments.

My advice is to err on the side of caution — adopt a conservative asset allocation, live within your means, consider working longer (and saving more) and maintain a healthy skepticism of computer projections showing continuous capital growth.

I appreciate these words of caution are not what people close to retirement want to hear…after all, retirement is about freedom not further restriction.

Sadly, I think the markets have other plans for boomer retirees and an unhappy time awaits most of them.

Vern Gowide,

For The Daily Reckoning

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.
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