When I'm 104 - 15th October 2003

Annette Sampson - Sydney Morning Herald

Are growth pensions the answer to longer life expectancies? Annette Sampson examines the advantages and risks.
There's a television commercial you may have seen for the Colonial First State investment group. "They say I could live to 100," intones an executive. The message is clear: it's time to get serious about our retirement investments. But while most of us don't have to worry about living to 100, increasing life expectancies have changed the retirement landscape.

Today, a 65-year old male can expect to live to 81; a 65-year old female is likely to reach 85. And the odds get better each year you manage to stay alive. At 80, the average male's expected lifespan has drawn out to 87; at 85, it is more than 90. And if he does reach 100, there's a good chance he'll make 103.

It's a far cry from the days when people retired at 65 and were dead a few years later.

"When my father retired in the early 1980s he was 72," says financial planner, Harold Bodinnar. "He lived another 10 years, which was considered quite old. Even as little as 20 years ago, people were spending 10 to 15 years in retirement. Now we're looking at 20 at least, and in some cases as many as 40 years."

Increasing lifespans, not to mention dramatically lower interest rates, have forced many people to rethink the traditional financial retirement model. When retirement was short, and interest rates were high, it made sense to gradually move to conservative investments as you neared retirement, and to rely on investments like annuities and term deposits for your retirement income. The returns were good, your capital was safe, and you didn't have to worry too much about the long-term effects of inflation.

But over 20 or 30 years or retirement, inflation can deal a major blow to your finances. A lump sum worth $100,000 today would be worth the equivalent of just $60,000 in 20 years' time if inflation continues at just 2.5 per cent. After 30 years, your $100,000 will be worth just $47,000.

"If you have investments that only provide you with an income, you'll go backwards," says Phil Clinton, a financial planner with Newell Palmer Securities. "Look at what happened in the late 1980s when interest rates were 16 to 17 per cent. Five years later they were at 8 per cent and people who had no growth in their capital were behind the eight ball."

Increasingly, retirees are being encouraged to incorporate growth assets in their investment portfolios. Many retirees own investment properties, but shares are widely favoured by investment planners because they are more liquid and can be sold quickly - and in smaller quantities - to fund living expenses.

Peter Hogan, the national technical services manager with Colonial First State Investments, says there are also tax advantages generated by growth investments that can help boost retirement incomes. Retirees on less than the 30 per cent tax rate, for example, can now claim a refund on any excess tax credits on dividends from shares that they can't use to offset their income.

And for those eligible for the age pension, earnings on shares and managed funds in excess of the deeming rates are not assessed for the pension incomes test. Hogan says the deeming rates are 2.5 per cent on the first $59,400 of savings for a couple ($35,600 for singles), then 4 per cent on any excess.

The push for growth has even extended to talk of a new retirement income product - the growth pension - that would give retirees generous social security concessions, while at the same time allowing them to invest in the share and property markets. In its last election campaign, the Coalition promised to look more closely at these products and has been talking about them with the industry since.

Richard Gilbert, the chief executive of the Investment and Financial Services Association, says growth pensions would give retirees greater control of their assets. "Our research shows people are happy to take some risk because this is a long-term product. It is senseless economics to put all your money into a 4 per cent annuity when the long-term returns from the sharemarket run at 7 to 8 per cent."

Unlike the existing complying annuities, Gilbert says growth annuities would allow your remaining account balance to go to your estate when you died. But you couldn't withdraw the money yourself and the product is designed so your capital would be used up by the end of the annuity period.

Unlike allocated pensions, which have minimum and maximum levels of income that you can draw down depending on your age, Gilbert says growth pensions would require you to draw down a set amount each year, depending on your age and account balance. This would mean the income from the pension could vary quite a bit from year to year.

So it would be something of a halfway house - less flexible than products like allocated pensions, but more rewarding (and risky) than the highly unpopular but predictable complying pensions.

Hogan says the idea is that, in years where the income from growth pensions is low, retirees may have some access to the age pension. But in good years, they may not have access to social security at all. He says while they don't guarantee you an income for life (as complying pensions can do), they may offer better returns and income for those prepared to accept this risk.

Clinton says that while growth investments do involve extra risk, retirees should at least be trying to get sufficient growth to maintain the real value of their capital after inflation. "We're not talking about chasing high growth," he says.

Clinton says if retirees include in their portfolios investments like shares that pay a fully-franked dividend yield of 4 to 6 per cent, it doesn't matter if they don't increase in value for a few years because the investors is still getting a good return through tax-advantaged income. He says infrastructure investments, listed investment companies and listed property trusts can also suit retirees' needs.

It requires a bit of a change in mindset, but Peter Thornhill believes retirees shouldn't even be thinking about shares as growth investments.

"Shares are the best income asset you can own," he says. "The fact

that you may get long-term growth

is just an added bonus. What is more valuable is that, as long as you have a well-diversified portfolio, shares should provide you with a generally stable income that grows over time."

But as the past couple of years have shown, shares and other growth investments (let's not forget that property can do the same) go down as well as up. Unless your retirement plan has catered for this, the results can be disastrous.

Some of the big losers of the past few years have been retirees who bought growth investments - often through retirement income products such as allocated pensions - in the late 1990s and have seen their capital shrink ever since. Unlike younger people - who can earn more to replenish their savings - these retirees are drawing down on their investments to fund their living expenses and often feel they will never regain what they have lost.

Ideally, says Hogan, investors should build a buffer into their retirement savings so that they don't need to draw down more than the compulsory minimum income in the early years of their pension.

Bodinnar says retirees should be aiming to maintain or grow their assets for the first 10 to 15 years of retirement, with the expectation that it will fall as they get older. But to avoid having to sell investments at low prices to meet income drawdowns, he says he would advise all his clients to keep three years' worth of income payments in cash or a secure fixed interest product.

Thornhill likes holding a couple of years' worth of income in cash when you start an allocated pension. Income from your investments, he says, can "replenish the can" each year to help maintain a buffer against adverse market movements.

But he is highly critical of many promoters who, he claims, run products that are inappropriate to the needs of retirees. He says many retirees are sold "growth" investments run by fund managers who trade a lot. "They don't provide much of a genuine income stream and investors are left with returns that rely on growth in the underlying unit price," he says. "That's where the whole growth argument in retirement becomes much riskier."

Thornhill says there are funds that provide a steady income, but they are in the minority. He says listed investment companies like Argo and Milton have provided steadier income streams over the long term than many managed funds.

"I've been invested in some funds for 14 or 15 years and I'm very aware of the erratic nature of their distributions," he says. "With their heavy trading, you often get your own capital back as income and you don't want or need that. Retirees have to choose very carefully which fund managers they use and they certainly can't afford to hold speculative shares in retirement. They need the good, boring stuff."

Hogan also emphasises that retirement planning isn't setting a strategy and forgetting about it. Retirees need to adjust their strategy to their changing needs.

"You'd hold a greater proportion of your money in growth assets at 65 than at 80," he says. "Though if you're 80, and can expect to live another seven years, there's still an argument for saying you should have some growth investments."

Clinton says there are no hard and fast rules on how much grow is enough - or too much. This will depend on your objectives, finances, and how you cope with volatility.


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