CPD: The retirement spending plan

A retirement spending plan will differ during the stages of retirement.

Retirement is often seen as a time of relaxation, freedom and the opportunity to enjoy the fruits of a lifetime of hard work. However, without careful planning, the financial aspects of retirement can quickly become a source of anxiety. A crucial aspect that may often be overlooked is a comprehensive retirement spending plan.

Unlike during your clients’ working years when income is typically stable and predictable, retirement is a seismic shift. Not only does it require a change in mindset, but it brings a shift to living off savings, investments and a fixed income. This transition demands a clear strategy for managing expenses to ensure your clients’ funds last throughout their retirement years. A well-crafted spending plan not only helps your clients maintain their desired lifestyle, but also provides peace of mind by reducing longevity risk – or the risk of clients outliving their savings.

Are Australians prepared for retirement?

Most Australians spend years saving for retirement. They make plans that involve travel, hobbies, family time and more. Unfortunately for many, when the time comes to start spending the savings they have worked hard to build, there’s no spending plan, or strategy, in place. At this point, many readers may feel smug in the knowledge that their clients do have such a strategy ready to implement when the time is right. However, there are many prospective clients who don’t. Unfortunately, some of those may well have started spending. This does, however, provide an opportunity for advisers.

Recent research into making retirements more epic^[1] suggests a propensity to front load expenditure, with 67 percent of respondents expecting to have higher spending in early retirement (figure one).

This coincides with the ‘honeymoon period’, that first flush of retirement when a client savours their newfound freedom and spends time doing the things they love. It’s a period that can span six months, ten years…or more! As every client is unique, so is every retirement. Each client’s individual experience and circumstances will determine the length of their honeymoon period.

Given the propensity of Australian retirees to travel – incredibly, 71 percent of Australians prioritise spending their retirement savings on travel^[2] – it’s not surprising that so many expect to spend the bulk of their retirement savings in the earlier years of retirement. Further, 44 percent of respondents anticipate retirement spending that is higher than their basic needs (figure two). What does that mean for the remainder of retirement, a time when significant health and care costs often take centre stage?

When the data presented by figures one and two are examined collectively, it’s evident that fewer retirees are preparing for the later stages of retirement. This is emphasised in figure three, which shows that 73 percent of people have not planned or budgeted for health care or aged care support in their later years.

The honeymoon period often ends because of health or mobility issues; spending on travel or hobbies makes way for increased expenditure on health, care and related services. If the individual’s retirement spending plan has not accounted for this ‘back-loaded’ expenditure, there is a risk of outliving retirement savings and becoming reliant on the Age Pension.

At the other end of the spectrum, among those who save for the later stages of retirement, there can be the propensity to limit their expenditure. While on one hand it’s a positive that they are less likely to outlive their savings, it could mean those individuals are being overly frugal in retirement because they don’t have a spending plan and they’re ‘self-insuring’ against longevity risk. There needs to be a balance.

Retirement spending plan

A retirement spending plan provides a clear roadmap for managing finances throughout retirement; it manages clients’ savings to extend across as much of their retirement as possible. Without a well-structured plan, retirees risk depleting their funds too quickly or underspending due to fear of running out of money.

A spending plan takes into account fixed and discretionary costs, as well as an individual’s health and life expectancy, allowing retirees to make informed decisions about their lifestyle and financial commitments. It can also identify potential shortfalls early, providing an opportunity to adjust investments or spending habits to stay on track.

How much is enough?

Possibly one of the most asked questions – how much do I need to retire?

Every retirement is different, but it’s safe to expect that most of your clients want at least a comfortable retirement, as defined by ASFA. The organisation’s retirement standard^[3] is generally regarded as reasonable measure of the annual expenditure required to sustain a modest or comfortable retirement (figure four).

While the budget for the earlier stage/s of retirement is higher than for those aged around 85, it’s not a significant difference. This is a potential issue for those planning to front load their retirement spending.

Pre-retirement

There are a number of strategies your clients could consider pre-retirement to boost their retirement savings – and therefore the spending they can enjoy in the future.

The downsizer contribution

If clients are considering moving to a smaller or more retirement appropriate home before they retire, or even in early retirement, they can take advantage of the federal government’s downsizer contribution to boost their retirement savings.

Those clients aged 55 or older can contribute $300,000 (single) or $600,000 (couple) from the proceeds of the sale to their super fund. It’s treated as a non-concessional contribution and does not count toward the contribution cap – although it does count towards the transfer balance cap^[4].

There are eligibility requirements that include:

• the home must have been owned for 10 years or more
• the home is in Australia and is not a mobile home
• the proceeds from the sale of the home are either exempt or partially exempt from capital gains tax under the main residence exemption.

The client must make their downsizer contribution within 90 days of selling the home and can only do this once.

When once considers the ASFA standard suggests a total super balance of $690,000 (couple) or $595,000 (single) to achieve a comfortable retirement, a downsizer contribution can potentially make a significant difference to a client’s retirement lifestyle.

A transition to retirement strategy

Those clients who have reached their preservation age and are still working can use a transition to retirement (TTR) strategy to draw on their super while still working. This can be used as a ‘super booster’, with clients contributing more of their income to super via salary sacrifice.

A TTR strategy enables clients to top up their income with a regular ‘income’ from their super fund, thereby receiving income from two sources: their employer and their superannuation. At the same time, they continue to receive super guarantee contributions from their employer and can increase their personal contributions. This can be an effective way to grow a client’s superannuation balance.

For those clients aged 60 (or over), the pension income from super is tax free. Until your client retires or reaches age 65, the maximum income they may draw in any year is 10 percent of the account balance.

The increased income can also be used to discharge debt or otherwise prepare for retirement.

Preparing for retirement

With increased house prices – and the greater need for dependents to draw on the bank of mum and dad – an increasing number of Australians are taking a mortgage into retirement. Over 50 percent of homeowners aged 55 to 64 are still repaying a mortgage; this represents a 135 percent increase compared to 20 years ago^[5]. There’s no doubt mortgage repayments (and paying out other debt) would likely take a sizable chunk of a fixed retirement income. Discharging a mortgage using a lump sum from super has been a prevalent approach in the past…however consideration has to be given to larger mortgages and the effect on retirement income.

It’s also important for clients to consider what they might need (or wish) to try and achieve before they stop full time work: large home repairs or renovations to make the home ‘retirement ready’, a new car or a bucket list holiday. Using earned income to purchase large ticket items rather than a lump sum from super means a retirement income stream that’s larger and/or lasts longer.

The plan

Retirement brings change that will transform your clients’ spending habits and reshape their financial needs. Everyday expenses tied to their working life will generally decrease, while spending on leisure activities, hobbies and travel are more likely to increase. Ultimately, it comes down to how much each client has saved and whether those savings will be sufficient to meet their future needs.

Evaluating this requires strategic planning, foresight and a few key assumptions. Each client’s life expectancy, health, lifestyle choices – as well as the size and composition of savings – will shape their retirement spending plan.

Step one: Budget

The government’s MoneySmart website, along with many super funds, offer a range of calculators for clients to create a retirement budget. This is the first step to create the spending plan. It’s likely that the budget will change over time; fixed expenditures such as care is unlikely to figure in the early years of retirement. Likewise, car expenses and many discretionary costs are likely to diminish with age.

The budget needs to include fixed expenditure, such as:

• home costs – council rates, body corporate fees, insurance, repairs and maintenance
• utilities – water, electricity and gas
• car expenses – petrol, registration, insurance, repairs and maintenance
• communications – mobile and fixed line phones, internet
• health – insurance, medical appointments and pharmaceuticals
• care – in-home or aged care costs
• food – groceries and fresh foods.

The budget should also include discretionary items; some are necessities, but the quantum of expense has an element of choice, while others are purely elective. Such expenses include:

• clothing and footwear
• household appliances
• media – subscriptions to news, magazines or streaming services
• computer and software
• leisure activities – eating out, cinema, hobbies and more
• travel – domestic and international.

Longer-term costs

When creating a retirement budget, clients need to consider both the likely expenses in early and later retirement. One of the largest costs later in retirement is aged care, whether delivered in-home or in a residential aged care facility.

For clients who move into residential aged care, there is the one-off refundable accommodation deposit, which is generally a significant sum, as well as ongoing fees and charges. Having a plan and appropriate budget to support aged care needs can provide clients with a greater degree of choice and flexibility in selecting appropriate care.

Retirement income

Setting the budget looks at the expenditure your clients’ needs (fixed) and wants (discretionary). That then needs to be measured against the reality of the client’s anticipated level of retirement income. For without the requisite level of retirement income, the client cannot meet their needs.

There are several ways a client can withdraw from their retirement savings. Most Australian retirees manage their income needs via traditional asset allocation strategies within an Account Based Pension (ABP). While a common choice – and one that generally works well in a bull market – APBs can leave retirees exposed to multiple risks.

An ABP offers regular, flexible and tax-effective income from superannuation. Your clients can access an APB when they reach ‘preservation age’ and it lasts as long as their super money does. But…it does not provide guaranteed income for life.

On the upside, the capital providing the APB can be invested in growth assets that can increase the value of the investment and the longevity of the income stream. An APB is tax effective – tax is not paid on pension payments from age 60 and investment earnings are also tax free.

On the flipside, capital invested in growth assets may be subject to a range of risks arising from market volatility that might reduce the longevity of the income stream. ABP payments are linked to market performance; if drawing a fixed percentage of the balance, pension payments may increase or decrease in line with market movements.

ABP payments can be increased to compensate for market falls, even if the total value of the capital has fallen; however, this draws on a higher percentage of capital and increases the likelihood of consuming income producing assets more quickly.

Another option is the traditional annuity. While the product shares longevity risk (and in some cases investment risk) to an insurer, there are several reasons that have led to a low level of take up by retirees (and advisers). Some annuities have market linked income streams that may fluctuate in line with market movements and once income payments have started, there’s no opportunity to change the amount received. Money is locked away until the term of the annuity ends; retirees can be left unable to cover large or unexpected expenses, causing financial stress.

More recently, the emergence of ‘next generation’ retirement income products encapsulate the features needed by retired Australians. These needs include a guaranteed lifetime income, protected growth options and flexible access to capital. Such products represent a paradigm shift in retirement income. They offer simplicity, affordability, flexibility and growth potential in one comprehensive package. Through advancements in technology, innovative product design, and a renewed focus on user experience, these products have become more accessible and user friendly than ever before.

Next generation solutions have been designed to deliver increased confidence and certainty to retirement so the only indecision may be how to best enjoy this new phase of life. And, when creating a spending plan for clients, it can be so much more accurate when you and your client both understand exactly what their guaranteed retirement income will be throughout their retirement.

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Notes:
[1] Allianz Retire+ and Epic Retirements, How do we make retirements more epic, August 2024
[2] Equip Super research, 18 July 2024
[3] https://www.superannuation.asn.au/resources/retirement-standard/
[4] ATO, About Downsizer Contributions
[5] The Australian, If retirement beckons but you’re still paying off a mortgage, here’s what you can do, 16 August 2024, citing ABS data