The biggest fear for most retirees is living longer than their money. So, we always start with the broader retirement discussion – where are you, where do you want to be, how will you get there, what will be the challenges along the way.
We then work with clients to develop a series of realistic objectives that are stress tested against the major risks of spending more, lower returns than anticipated, the sequence of those returns, higher inflation and living longer.
This gives clients genuine insight to the challenges ahead and provides the framework for all future financial decisions – do choices get you closer or take you further away from objectives?
When it comes to minimising longevity risk (or any risk for that matter), we think the simple strategies are generally the best.
Perhaps the most powerful strategy of all is to start retirement with more than you think you’ll need. This might mean having to work a bit longer. Delaying drawdown for even a year or two can make a big difference to how long a nest egg will last.
And then there’s managing cashflow, which is a simple yet effective strategy. If you don’t have control over your spending, you don’t have control of your situation. We encourage clients to pull their horns in if necessary.
It’s also important to keep a lid on fees and taxes. The tyranny of compounding fees will undo the miracle of compounding interest.
Finally, help clients understand that a long-term retirement should be supported by a long-term investment strategy. By doing so, many of the bumps and dips in investment markets become less troubling. So, build a properly diversified strategy and only take those risks that provide a reliable reward.
The key to managing longevity risk is to have deep understanding of the expenditure your client is likely to require as they age.
The simplest form of projection has an account based pension eroding over a 25 year period but hopefully lasting longer than the client. A rudimentary response to the investment longevity question is to have a risk return conversation with the client and put in place an appropriate asset allocation.
However, we all know that our lives are not a continuous predictable cash drawdown. Risk profiles and asset allocation conversations rarely mean a lot to the client. The better adviser/planner is a Financial Life Adviser (a term used by Joe Duran from United Capital), where the adviser/planner specialises in making the money work to support the changing needs of our clients. Holidays, renovations, medical expenses, family emergencies, new cars, aged care and a thousand other lump sums are the greatest risk to our client’s capital longevity, not market volatility.
RI Advice has developed a modelling tool to explore personalised scenarios live in front of clients – called The Wealth Report. This tool creates a living financial model that takes advice relationships permanently away from the investment piece to client self actualisation.
Advice is about making good decisions and avoiding bad decisions. Sharing your client’s journey as their personal guide and counsellor is the best way to manage longevity risk.
As financial planners, we know the risk of clients’ outliving their retirement savings is very real, however, it’s also a risk that clients often prefer not to face up to. For me, the starting point for managing longevity risk is persuading clients to accept the possibility of outliving their money and then providing them with the strategies, portfolios and behavioural skills to set them up for success.
Behaviour changes: We spend much of our time encouraging our clients to understand and appreciate that there is a real risk they’ll outlive their money. When there is an understanding of various trade-offs, most clients need to consider that it’s easier for them to make informed decisions and take ownership of their actions.
Portfolio risk: The portfolio needs to be aligned to the client’s risk tolerance. However, in the case of retirees, we need to be cognisant of the impact a loss may have. The desire to generate healthy long-term returns is also important, so the risk/return trade-off takes on different meaning for a retiree.
Legislative risk: Social security benefits can make up a significant portion of a client’s income and can’t be dismissed. Consideration of tax implications on a client’s finances is also fundamental. As we know, tax and social security rules change often, so it’s important to be aware of the impact changes have on a strategy and adapt accordingly.
Strategy and products: Using a range of products can make a strategy more robust and flexible for the future. Providing an element of guaranteed income, whilst maintaining access to capital, is nirvana to some clients, particularly if it also provides an uplift in social security benefits. Many clients though prefer to trade off secure income for the long-term benefit of capital growth.
We approach clients’ longevity risk in a number of ways, however, the most effective strategy is regularly talking to clients about this issue, revisiting potential outcomes and empowering the client to make smart decisions for the long-term.
Running out of money is a deep fear of all retirees. Clearly, the best mitigation of longevity risk will be to start with a large sum and use it for a short time – unfortunately, this approach rarely lines up with the client’s reality.
We start planning for longevity risk well before the client’s preferred retirement date arrives. Our approach will focus on what the client has most control of – the amount they spend. Whilst all the variables matter, unsustainably high drawings are the single most preventable action that will accentuate longevity risk!
Clients will generally live longer than they expect. They need to consider that while super pensions start with a minimum draw of 4 per cent per annum, they will increase to 9 per cent by age 85. Spending all the super pension at the beginning may be fine, however, we counsel for increased savings in line with increases in the minimum draw.
Investment maxims do not change. We remind clients that asset allocation will remain the key driver of future returns and valuations will provide the best guidance to the relative risk/return attributes of investments within their overall portfolio. Diversification within the retirement portfolio will remain the key tool to balance investment and longevity risk.
Finally, we remind clients that drawing a regular pension requires the portfolio to retain enough liquidity that it can fund three years of payments without touching growth assets.
When meeting with new clients, longevity risk is a part of our conversations. Three of my four grandparents, and my husband’s, survived well into their 90’s, so it’s a topic that’s close to my heart.
Discussions about whether people want to spend 30 years in retirement or they’re happy to work longer, is vital. We also talk about what our clients have planned for their retirement years. Spending over 25 years doing nothing, is some clients’ idea of heaven, and others’ of hell.
Some like to reduce their hours, spend more time with the grandchildren, travel, try new things or volunteer.
I’ve also had retired clients go back to part-time work, as they felt they were no longer contributing to society or were bored and just wanted to feel needed again.
With an increasing pension age and low retirement savings for many, it’s certainly a conversation that takes on new meaning and the earlier clients are having ‘the chat’, the better.
After all, we all want the benefit of years, savings and compounding interest on our side, especially when we’re in such a low interest rate environment and the hunt for yield is real.
Most of our clients don’t qualify for the Age Pension, so don’t have a guaranteed level of income to rely upon throughout retirement. Instead, they rely upon their asset base to generate sufficient income to provide for their entire retirement, which is continuing to increase in length.
We utilise several strategies to effectively provide a ‘privately-funded Age Pension’, combining short-term annuities, a lifetime annuity and an allocated pension. This strategy is only applicable to clients who have sufficient capital to buy annuities, with a great enough income to support their expenses.
This layering approach provides a guaranteed fixed level of income for essentials and a higher spend in the first five or 10 years of retirement from the annuities component, allowing the allocated pension component of the strategy longer to continue growing, whilst the cash flow is maintained by the annuities in the early years.
The lifetime annuity acts as a financial backstop to provide a guarantee that, regardless of market outcomes and changes to asset positions over time, the client will never need to solely rely on the Age Pension should they become eligible.
Having an ongoing relationship with clients, and knowing in advance a clients’ estimated retirement date, allows us to de-risk their assets in the lead up to retirement to reduce sequencing risk, should a significant sharp market decline occur just before or after their retirement date.
These two strategies form just a part of preparing clients financially in the lead up to and throughout their retirement. And combined with proactive investment management, we aim to provide our clients with increased peace of mind, allowing them to enjoy their retirement years.
Longevity risk is a major issue for clients. Twenty years ago, we were talking to clients about travel in their 60s and not expecting a lot of expenditure beyond this. Now we have clients in their 70s skiing. They are travelling the world like never before and well into their 80s. The birth of the cruising retirees has emerged.
We need clients to continue to have short-term money that cannot drop and we need some balanced approach to increase returns over time.
Some are happy to have an allocation to growth but this is up to the individual. Cash may feel good but longevity in a low interest rate cycle can be the greatest risk. Technology allows us to build a portfolio for clients to separate income and growth.
Clients also need to be cautious of the ‘off the shelf’ balanced approach and looking at returns from funds that are targeting accumulators. This may be more risk than they should take and the negative years hurt in retirement.
Investing is hard and unfortunately, people have begun to think it is easy. There needs to be strategy and a constant understanding of the exact risks they are taking. If we get this correct, then their biggest problem should be deciding on what exotic destination to travel to next.
Ideally, we work with clients well before they get to retirement, so they can plan for a longer than expected statistical life expectancy. These clients are well prepared for a potentially longer time in retirement, as we have had time to cater for this eventuality.
For clients who see us at their retirement, it’s a lot harder, as we have to deal with the investments they have at the time. With the introduction of the new Pension Loans Scheme on 1 July 2019, clients potentially have more options in retirement if they own their own home than they did before the old scheme was amended.
The downsizing contribution into super is another opportunity if clients are out of capital due to higher than expected longevity.
We are also finding some clients are inheriting money from elderly family members or parents in retirement. This injection of capital in later years is also proving to be helpful in enabling them to live on a higher income than the Age Pension alone.
Some clients spend a lot more money in their early years of retirement deliberately and then cut back in later years once they have got the travel bug out of their system, or health and higher travel insurance costs make extensive travel, especially overseas, more difficult.
Every client is different. However, by getting advice, our clients manage their longevity risk better than those who attempt to grapple with this issue without advice.