Retirement crystalises many fears for older Australians. Chief among them is the fear of running out of money, a fear which encourages frugality and lowers living standards.
It is one of the most complex tasks that super trustees will tackle as investors face significantly higher risks in retirement, have disparate goals and a wide range of personal circumstances.
Retirement goals
Retirees need secure income to last throughout their lives, effective risk management to protect their savings and flexibility to pay for unexpected events such as deteriorating health.
Unfortunately, many retirees choose to hold account-based pensions and draw down benefits at the minimum allowable rates, according to the Financial System Inquiry.
But defining an appropriate retirement income stream is a difficult task.
Trustees need to decide on a specific target income level. In doing so they need to consider:
• External benchmarks. For instance, consider some basic spending needs in retirement such as the ASFA Retirement Standards.
• What percentage of their projected assets their income will be
• How this compares with their current income and spending
• How this will vary with different life stage needs
With these in mind, investors may calculate an appropriate annual income that will last a pre-defined number of years during the drawdown phase.
However, income is only one of the needs in retirement.
Considerations
Trustees will also need to consider providing a measure of liquidity and capital protection to allow for uncertain retirement needs (such as aged care expenditure) or other goals (such as bequests).
Considerations can include other sources of funds, assets and income, from which the member and their family can draw upon for retirement needs, as well as their personal circumstances.
These play key roles in determining the potential value of the longevity insurance provided by the age pension and other government benefits.
Retirement is a more complex period than accumulation and retirees face many risks. Members have vast differences in their capacity to accept risk (often depending on the size of their retirement savings relative to their needs) as well as how willing they are to accept risk – the more familiar concept of risk tolerance.
Trustees will need to consider risks such as:
• The variability of their retirement time horizons, and how various forms of inflation might affect their needs over time
• Longevity risks
•Investment risks, in particular balancing the need for growth with sequencing risks introduced during retirement drawdown
•Flexibility risks. Retirees’ health needs and personal circumstances can fluctuate wildly without the natural shock-absorbing capacity afforded by time in the workforce
• Expectation risks. Managing the risk that your income is too low, doesn’t last as long as expected or doesn’t meet your level of certainty.
Craig McCulloch is a principal and head of analytics at Milliman.
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