Retirement income: expectations versus reality

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Glenn Freeman: In this edition of "Ask the Expert" I'm speaking with Lesley-Ann Morgan from Schroders about the expectations that people have in retirement versus the reality and how adequate planning can help to bridge this gap.

So, Lesley-Ann, thank you very much for your time today.

Lesley-Ann Morgan: Thank you for inviting me.

Freeman: Now, we are talking about retirement and investing in retirement. Now, what do retirees need to think about when they are preparing their investment portfolio as they are approaching retirement and the end of work?

Morgan: I think there's quite a few questions that people need to be asking themselves. They need to be thinking about how much income they are going to be needing in retirement. So, that covers basic living expenses and other things that they would like to do with their money. And further out, they need to think about age care and other things that they may spend their money on as they get very elderly.

In terms of their investment portfolio, they need to really consider whether or not they have enough in their account and if they don't have enough in their account, they need to think about whether or not they have got enough growth assets in their portfolio. Because people are living longer than they ever used to live. So, if they are underfunded and they are living longer, they probably need more growth assets than maybe they expected.

Understanding the impact of inflation is really important. And actually, inflation on medical expenses and inflation on age care is usually much higher than regular inflation. So, people really need to think about that. And it's often not something that people do think about, especially when it may be more than 20 years away when you are going to go into age care. So, planning for that as a part of your whole pension provision is important and it's tough. It's a thing that people often don't want to think about, but they should be thinking about.

Freeman: In terms of the investment portfolio, how does the approach that people make shift when they are moving from that accumulation phase of their investing years through to the drawdown period when they are actually finishing work and wanting to draw that income?

Morgan: Yeah. So, actually, the investment portfolios often don't need to differ very much at all. They still need some growth in them as I've already mentioned already. But actually, having that kind of objective-based inflation plus type of approach to investing works really well just before retirement and also into retirement as well. But importantly, people need to start to worry about whether or not they are going to get some big losses in their portfolio. So, when they get into retirement, they need a manager or a portfolio that actually really thinks about some of those losses and manages those losses quite well, so that if you suffer a very large loss when you first retire, you're obviously going to have less income in retirement. So, you want to try and avoid that when you get into retirement.

Freeman: You've mentioned something about the retirement funding gap. What is this gap and how can people actually seek to close that?

Morgan: Yeah. So, the funding gap is the difference between how much you think you are going to need in retirement versus how much you will have predicted to have saved by the time you get to retirement. So, if you have a few years to go before you get to retirement, one of the best ways is obviously to try and save a bit more. And we are hearing a lot about people wanting to save more at the moment to be able to deal with that issue. If you are very close to the retirement, then obviously saving more is going to be a bit difficult or it might be that it doesn't going to make that much difference. So, once you get into retirement, investing really carefully to make as much return as you can without taking took much risk is going to be one of the better ways to break that gap between what you need and what you expect to have saved.

Freeman: What do you generally find? Do people underestimate how much they are going to need? Do they overestimate? Or are they living more frugally than they perhaps anticipated they would be able to?

Morgan: Well, it's not a particularly clear message in Australia actually. There's been lots of evidence to show that people are living frugally in retirement. But it's not clear whether or not that's actually kind of the generation that's in retirement at the moment or whether they are actually having to live frugally because they haven't got enough to retire on. Some evidence of research study that we did at Schroders recently shows that people really underestimate how much they are going to have to spend on their basic living expenses. This was much higher than expected and as a result, people were having to cut back on the fun things that they really wanted to do in retirement. So, having to cut back on their hobbies and cut back on doing some of the other things that they'd look forward to doing in retirement. So, really understanding how much of your total account is going to be used on utility bills, just heating or looking after yourself in retirement, feeding yourself in retirement is important. You need to understand that before you start to think about how you spend all the rest of your money that hopefully you saved up looking forward to retirement to spending.

Freeman: I think those complexities is part of the reason why there's such a big message around the importance of people getting financial advice and that's why so many people do speak to an adviser for the first time only once they are pretty close to retirement.

Morgan: Yeah. I mean, getting advice, particularly for people who are likely to be means-tested through the age pension is important, because understanding that interaction between your investments and the age pension is important to work out how much income you are actually going to have to live on.

This report appeared on 2022 Morningstar Australasia Pty Limited

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