If you’re very clear about what sort of lifestyle the client can afford and what is a prudent drawdown, clients appreciate this. When clients are asking, “Can I afford to retire?”, they are really asking, “What is my lifestyle going to look like if/when I retire, and does this match up with my idea of retirement”.
It’s always interesting to talk about ‘the kids’: How much do they feel like bequeathing them when they eventually fall off the perch? This in turn informs their decisions for spending now, and if drawdowns are getting too high, this can be a good point to come back to.
For younger clients, it’s important to build up their own investments for retirement, so they can decrease their potential reliance on Centrelink, and avoid legislative risk in that area, and be truly independent as retirees.
People having longer life expectancy is changing the way retirees think about their investments. Most ‘baby boomers’ entering retirement today have at least one parent still living, so the reality of having to make their finances last is top-of-mind for them.
The lifestyle expectations of today’s retiree is somewhat greater than those of the previous generation and they realise to fund this lifestyle will require more money.
A person retiring today has experienced an almost continuous 30 year reduction in interest rates, therefore, they do not expect to rely on steady interest payments from term deposits to fund their lifestyle.
While interest rates have reduced, asset values have increased.
When considering retirement today, at say age 65, the investment time horizon is reasonably 30 years, so the math is simple right now – an appropriate allocation of growth assets is required to maintain a lifestyle for the long-term. The average retiree understands a growing asset base means growing income over time.
Another interesting consequence of living longer is the impact on estate planning. Most people who are in their nineties have children who are retired and often financially secure, while the grandchildren are at a stage of life with large mortgages, school fees and so forth. The conversation about inheritance is important, especially when gifting could be an issue for Centrelink recipients.
So, for planners, clients living longer is a wonderful opportunity for advice.
The need to address ageing clients has become a niche area of law in which we specialise, as improved health care has led to Australians living longer lives. As legal advisers who have studied financial planning, we see the main consequences as follows:
The older person needs an advocate, as there is a longer period during which they are vulnerable to predators inside and outside the family;
The families of an older person might have to wait until they are retired before getting an inheritance – interim funding may be required;
The older person might have entered into a new relationship in the meantime – the relationship could be real or contrived by a predator. Everyone hates these kinds of surprises;
Siblings can fight over the hard decisions that need to be made – we help clarify wishes;
Changes to superannuation rules may mean that an Enduring Power of Attorney or a financial manager needs to work with an adviser to restructure superannuation in order to not to be over-taxed; and
A carer can successfully make a claim that the older person wanted them to have the lion’s share of the assets – the carer could be a godsend or a predator. We have seen both scenarios and suggest that advice is needed in each case or there may be expensive and stressful litigation.
With three of four of my grandparents living well into their 90s and the same for my husband’s family, I am all too aware of the longevity risk facing many Australians.
Most don’t need me to tell them that that may be spending a lot longer in retirement than the expected 18 years.
Clients intuitively understand that working for 45 years, whilst raising a family and paying down debt, cannot possibly fund a retirement of 25 to 30 years, yet most don’t start even thinking about retirement funding until their late 40s or 50s. Somehow, it seems too far away, which cuts down time to ‘get our house in order’.
It’s what to do with that realisation that matters. One of the first options many arrive at, is that 65 or 67 is unlikely to be the time they ‘hang up the boots’. For those who love what they do, this isn’t a hardship, but for those stuck in the daily grind, it’s a completely different story.
As retirement looms, it also means challenging thinking that switching to more conservative strategies is necessary. Preservation of capital feels vital, but running out of money and funding aged care is a whole other conversation.
Knowing that there’s likely to still be three or four market cycles looming ahead in retirement, places a completely different complexion on managing financial expectations of clients.
We all know that working out how much you need in those non-working years can be daunting. Firstly, what not to do.
Firstly, take extreme caution when you use retirement calculators that seemingly proliferate on every superannuation and financial services providers’ website. They are at best simplistic and in many cases just plain dangerous.
The place to start with is you and defining what is important to you both now and going forward. While ASFA regularly updates its retirement standards, they are a guide only. A good adviser can ‘monetise’ a client’s lifestyle both now and into the future.
The habits, lifestyle expectations and hobbies of an individual or couple will change as they age, not to mention the effect of longevity and the impact of changing health.
Reverse engineering solutions with quality planning software will enable you to build scenarios and work the various levers. These levers develop through discussion and enquiry, including working less but longer, assessing the need for risk, looking at downsizing options, and the Age Pension as a supplement to superannuation.
Done properly, you will take the client on a voyage of discovery, get buy-in and build an ongoing process to manage expectations.
If you had asked me five years ago what the most important consideration of my retiree clients was, it would have been funding their ‘grey nomad’ lifestyle and leaving an inheritance for their children.
But now I am seeing more retirees who are very concerned about longevity and how they will continue to fund their lifestyle for potentially 30 years and more. This is particularly evident for some clients who are in the position of having to consider aged care for their parents and therefore, have a better understanding of the potential costs associated with this.
I find that more planning is now going into addressing longevity, with retirees more concerned and interested in how long their funds could potentially last.
We are addressing some of the longevity concerns by placing a portion of retirement assets into lifetime annuities that will provide a guaranteed income for life. Retirees still want to maintain access to some of their capital, so the trick is finding the right combination between security of income versus access to capital.
I believe we need to address retirement planning in the same manner as addressing insurance needs. We need to consider potential future risks and ensure they can be managed effectively.
We Aussies are a successful bunch. Whether that be economically, on the sporting field or even just how we get on with each other. We are also super successful in the most important area of all – staying alive!
While living longer is one heck of a goal, this success creates problems in other areas. The obvious one is running out of money too soon.
As advisers, some of the most common questions we get are: ‘When can I retire’; ‘How much will I need’; and ‘How long will it last?’
For many, the answers are disappointing.
As an advice leader, being responsible means having the difficult discussion.
Hazy concepts don’t work. For us, the key is to remove ambiguity (or as much as you can anyway). A retirement income gap analysis and the subsequent discussion around ‘where you are, where you want to be, how you will get there and managing the risks along the way’ makes it ‘real’ for people.
This basic structure then becomes the framework for all future financial decisions.
Do choices get you closer to your goal, or take you further away?
Choosing the correct options then becomes much easier.
There are other benefits, too.
It creates perspective for clients – ‘If you continue on this path, this will be the likely outcome’ – whether that be good or bad;
Clear objectives give purpose, direction and focus; and
Being aware of the job ahead provides the insight to act.
Client concerns around outliving retirement savings is a frequent topic of conversation. In the context of establishing a resilient investment portfolio to support extended life expectancies, three important conversation topics typically arise.
Firstly, in-depth conversations are required to understand client expectations around their portfolio’s ability to underpin desired lifestyle costs in the future. This sets expectations for both parties on the extent that capital drawdowns are needed to meet future costs, and how comfortable the client is with this. Mitigating strategies, such as possible future reliance on the Age Pension, should be presented early in the advice relationship.
Secondly, whilst a well-diversified portfolio inherently includes a portion of volatile asset classes (such as domestic and overseas equities) to achieve a client’s need for future income and protection from inflation, it is important to distinguish resilient and predictable investment income from the variability of a portfolio’s capital value. Educating the client about their portfolio’s reliable income generating capacity to underpin lifestyle needs, provides comfort that short-term negative capital returns are less important to a comfortable financial future.
Finally, having sufficient liquidity embedded to fund 12-24 months of lifestyle costs, provides the client with a defence against sequence of returns risk, and extended periods of market underperformance, thus avoiding liquidating capital at the worst point of the investment cycle.
Statistics help illustrate longevity risk and they also provide a mechanism to assist with managing client expectations. Rather than using rules of thumb, mathematical models can provide a probability result of achieving longevity outcomes (sometimes known as stochastic models).
These models are a great client expectation tool that can also be used for sensitivity, scenario and correlation analysis. As we know, risks are dependent on current client positioning relative to an always changing environment.
In theory, these models help clients by showing the impact of real world events. This assumes that the assumptions in the models are not overly fixed. Unfortunately, some providers of these models assume one distribution (either uniform, normal or hyperbolic) with one mean and one standard deviation for each asset class. These fixed parameters will never reflect real world investment outcomes. A better approach is to use Markov chain-based models with non-stationary distributions, better reflecting secular trends apparent in different economic cycles.
Alternatively, there are models that overlay 100 years of stock market outcomes. The advantage of this approach is that it tests client longevity outcomes against numerous black swan events.
Client expectations are best set against realistic outcomes to avoid nasty surprises. It’s prudent to demystify the model used before relying on it. Most importantly, don’t rely on rules of thumb!