CPD: Financial confidence and certainty in retirement

With certainty of income and ready access to capital, retirees will have the confidence to relish their post-work years.

As an increasing number of Australians face retirement, there are mixed emotions. Will it be a time to realise dreams and accomplish long-held plans? How can I be certain that my retirement savings will last the distance? What comprises do I need to make to allow for future needs and contingencies?

Even with the best retirement plan, it can be challenging for clients to plan for the future when there’s the uncertainty of not knowing for how long they will need a regular income, or the unplanned health or aged care needs that might arise. Add to that concerns around the cost of living today and in the future, and it’s not surprising that so many Australians are not financially confident or certain about retirement.

When it comes to managing finances – both pre- and post-retirement – confidence is an important factor in decision-making. Why? Because it helps individuals navigate through life’s complexities and make good decisions.

Are Australians confident about retirement?

Recent research into making retirements more epic^[1] reinforces the dichotomy between two groups of Australians. Some are well prepared, confident, happy to spend their money on the retirement lifestyle they worked so hard to earn. Others are less certain, not sure if their money will last, if they’ll cope with the rising cost of living, what the future might hold.

Confidence in retirement is good for the individual, good for their community and good for the economy; rather than living frugally, confident retirees will spend in their community, support business and live the retirement lifestyle they’ve looked forward to. Anxiety about finances can have a detrimental impact on physical and mental health and often lead to unwanted changes to lifestyle to rein in spending.

The respondents to the above-mentioned research are, on the whole, reasonably confident that their retirement savings will fund a comfortable retirement lifestyle; however, only 24 percent are ‘absolutely’ confident. More than 50 percent think they ‘probably’ have sufficient savings for a comfortable retirement, although that doesn’t suggest confidence or certainty. The remaining 20 percent are uncertain or sure they won’t have sufficient savings to fund a comfortable retirement (figure one).

While the notion of comfortable will vary from one person to another, taking guidance from ASFA’s retirement standards, the lifestyle elements of a modest retirement are unlikely to meet the aspirations of most retirees.

Figures two and three measure the confidence of singles (figure two) and couples (figure three) about retirement funding for whole of life – what’s the risk that they will outlive their savings? The majority of singles and couples are ‘somewhat’ confident their retirement savings will last the distance, while 19 percent of singles and seven percent of couples have no confidence in their savings. This highlights an important factor – while many costs are similar for a couple or a single (running a home, a car) – single people typically have lower retirement savings. It not surprising then that more couples are ‘very confident’ about their retirement funding lasting their whole life (27 percent versus 20 percent for singles).

The rising cost of living has been top of mind for many people worldwide. Approximately four out of five respondents are unsure or not confident about being able to afford the rising cost of living throughout their retirement (figure four). A lack of confidence about the longevity of retirement savings and the ability of those savings to cover anticipated cost increases can have negative repercussions. Uncertainty can create anxiety about finances and increase the propensity to live a frugal lifestyle in a bid to ‘self-insure’ against meeting future needs.

To ensure financial confidence in retirement, clients need the certainty that arises from secure income streams and the knowledge to navigate retirement systems and achievable retirement goals.

Education

Informed people are usually confident people. There’s a lot to know about the retirement system and navigating it can be a challenge.

Throughout the accumulation phase, clients may have been less interested in superannuation; the combination of employer contributions and salary sacrifice (for some) invested for decades often result in a satisfactory outcome with minimal input.

At retirement, everything changes. There’s a greater need to understand how superannuation works and how it will provide retirement income.

There’s a need for clients to understand retirement income products both within and outside their super fund. There is also the need to understand how the client’s assets, income and superannuation will interact with the Age Pension and other government entitlements.

Once a client has a clearer understanding of how the retirement system can support them, the conversation can move on to specific retirement income strategies; from where each individual will get their retirement income and how they expect to spend it.

Addressing longevity is an important aspect of retirement planning. As individuals age, their expenses and financial needs evolve, sometimes significantly. Lifestyle expenses such as travel and hobbies may be replaced by care and medical costs, and often the expense of a transition to residential aged care.

One of the most common concerns among Australians is the risk of outliving their retirement savings. To provide your clients with confidence and financial security, it is vital to make longevity a central element of their retirement strategy and introduce it early in client discussions. By encouraging clients to envision a long and fulfilling retirement, you can turn the challenge of longevity into a motivating factor for more comprehensive and thoughtful retirement planning.

Certainty and financial confidence

Retirees need certainty of income and access to capital to be financially confident. This ensures they can savour their retirement years with financial security and peace of mind, enabling them to flourish in retirement and enjoy this next well-earned phase of life.

However, the current range of super-based retirement income strategies is limited. The options generally don’t fully address the financial confidence retirees need to enjoy a comfortable lifestyle.

At one end of the spectrum, Account Based Pensions alone provide flexibility, but can leave retirees shouldering significant investment risk, especially when used in isolation. At the other end, traditional lifetime Annuities are poorly understood and generally perceived as an expensive and inflexible solution. The Age Pension barely provides enough income to sustain a modest retirement lifestyle by ASFA standards.

Traditional retirement income products involve tough trade-offs between income certainty and flexibility and are often subject to unpalatable limits as to how one can invest, withdraw or use their money. Many of the available products and strategies are perceived as rigid and difficult to execute, often pushing retirees to adopt sub-optimal self-insurance actions such as budgeting and lifestyle limitations to eke out their savings.

Account Based Pensions

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 – they leave retirees exposed to multiple risks. Fear and uncertainty come to the fore with concerns about fluctuating, market-linked account balances. This uncertainty may see retirees forego holidays, family visits and other comforts to cushion the impact of future, unknown, investment downturns or unexpected personal costs^[2].

An ABP is a regular income stream bought with money from a super fund upon retirement or as part of a transition to retirement strategy. It offers regular, flexible and tax-effective income from superannuation and can be accessed when the individual reaches ‘preservation age’. It lasts as long as their super money does and importantly, it is not a guaranteed income for life.

With an ABP, retirees (and their adviser) typically get to choose:

• How much of their super balance they wish to transfer to the ‘pension phase’ (subject to balance transfer cap rules)
• The size and frequency of income payments (subject to government minimum drawdown requirements)
• How the capital is invested (through the super fund)

Traditional Annuities

A traditional Annuity is a form of retirement income that provides a guaranteed income for fixed period, which can include the term of a retiree’s life. An Annuity can be purchased from a super fund or life insurance company using superannuation or other savings.

And, while an Annuity is less flexible than a typical ABP, it does provide income certainty for the selected term, which could be:

• a fixed number of years
• the client’s average life expectancy
• the client’s lifetime.

While an Annuity can in some instances provide a lifetime income, the product’s drawbacks and complexities have meant a smaller proportion of retirees have elected this option.

 Age Pension

Designed as a safety net, the Age Pension is the most common income support payment available for people aged 65 and over. On 31 March 2023, around 2.6 million Australians received a full or part Age Pension^[3].

Administered by Services Australia, the Age Pension is available to retired (or semi-retired) Australians aged 67 plus. It involves a substantial application process and is subject to an assets test (which excludes the family home) and an income test. The latter includes any income received from part time work, as well as retirement income received from an ABP or annuity, although some annuities receive favourable treatment.

As a safety net, the Age Pension is fit for purpose. As a sole retirement income stream, it makes for a challenging retirement and would not instil the confidence retirees need to enjoy a comfortable lifestyle.

Pros and cons

 Next generation retirement income products

The 2020 Retirement Income Review found Australian retirees want longevity protection and guaranteed lifetime income products to protect their quality of life^[4]. The resulting Retirement Income Covenant requires superannuation funds to deliver member retirement solutions (decumulation) in addition to the historical focus on accumulating assets, inevitably spurring demand and supply.

More recent research highlighted by the Review showed that retirees were interested in incorporating guaranteed lifetime income products into their retirement strategies but found it difficult to select a suitable product.

The ongoing body of evidence indicates that Australians will need the support of trusted financial advisers and institutions to review and implement an appropriate retirement income strategy as new solutions come online.

Next generation of retirement products will improve further on earlier efforts with outcome oriented solutions designed around core features that include:

Over time, it’s expected that guaranteed lifetime incomes will form the foundation of future retirement strategies. Retirees and financial advisers will also have to consider questions when selecting lifetime income products with due diligence likely to cover issues such as:

• the product provider’s legal obligation and ability to honour their long-term commitments
• whether the income stream is guaranteed
• how easily capital can be accessed should personal circumstances change
• the regulatory regime that covers these products
• the product’s underlying investment structure.

Australia’s shifting demographics toward an ‘older for longer’ population highlights the importance of retirement strategies that provide income certainty and the opportunity to access capital. Clients close to retirement are increasingly wary of the risks posed by longer life expectancies, market volatility and increases in the cost of living. And as this new wave of retirees – flush with ever-larger superannuation balances – rolls into the post-work phase, they need products and strategies that address their concerns.

Retirees need innovative solutions that provide for longevity without sacrificing financial flexibility; retirement strategies need to incorporate a more comprehensive suite of features including guaranteed lifetime income, market-linked returns, downside protection and the ability to make withdrawals.

With certainty of income and ready access to capital, retirees will have the confidence to relish their post-work years and be empowered to thrive in and embrace this well-deserved chapter of life.

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Notes:
[1] Allianz Retire+ and Epic Retirements, How do we make retirements more epic, August 2024
[2] L Lucas, ’Why do people spend the way they do in retirement? Findings from EBRI’s spending in retirement survey’, Employee Benefit Research Institute Issue Brief, 14 January 2021
[3] Income Support for Older Australians, Australian Institute of Health and Welfare, September 2023
[4] Australian Treasury, ‘Retirement Income Review: Final Report’, 20 November 2020