Two types of footage illustrated news reports of the financial market turmoil last week: the unlucky teams with frozen smiles ringing the start-of-trade bell at the New York Stock Exchange, and confused and anxious elderly couples staring mournfully at the plummeting ASX share price ticker.
The self-funded retirees of Australia are watching as the horses keep on bolting out the open stable door.
If you could sum up in one word the feelings of the average Australian retiree about financial markets, that word would be “confusion”.
Most people come to retirement with accumulated savings but very little accumulated knowledge of the risks they now face and how they can manage them.
Recent research conducted by the Centre for the Study of Choice, UTS and the Centre for Pensions and Superannuation, UNSW, indicates a remarkable ignorance among retirement age folk of the structures and financial products that could help them “close the stable door”.
In May this year our team surveyed around 900 people between ages 50 and 74 to find out how they were planning for retirement and how much they knew about the wealth management process ahead.
Without the buffer of regular wage and salary payments, making wealth last the distance between retirement and the end of life is a crucial problem.
Living too long
Depending on what the markets deal out, how long you live and how fast you spend your savings, you may find your financial resources have run out sooner than you would like.
So it helps to have a realistic idea of how long life is likely to be. While the men fell a bit short, the women in our survey underestimated their remaining lifetimes by an average of six years.
Is this a big deal? Well, yes. Take a woman who (luckily and unusually) comes to retirement with $200,000 of savings, and decides to spend a modest $30,000 each year.
If we assume that she gets the full pension and that her investment has typical returns and volatility, given her six year underestimation of lifetime, her chance of running out of personal wealth before she dies is about 25%. But if we use her true survival prospects, that chance rises to 40%.
Financial institutions have long recognised that living too long can be a problem and they have offered an array of products to insure people against that ‘risk’.
The ‘plain vanilla’ version is an immediate life annuity – a product like a reverse life insurance policy where, in exchange for a lump sum of capital, the insurer pays a guaranteed income stream for as long as the policy holder lives.
The full creative power (!) of the actuarial profession has been put to work on annuity design over many years, and the variety is almost endless – payment streams can run fixed terms, can rise with inflation, can revert to your partner, can start sooner or later or only begin if something bad happens… but very few people buy them. Only about 50 lifetime annuities were sold in Australia in the past year.
There are many reasons why people don’t buy life annuities, but one reason that has been given little attention in academic research is that people don’t know anything about the product.
Only one third of our survey sample had heard of “lifetime annuities”. Worse still, only half of those who had heard of them knew that the payment stream would last for “my whole life regardless of how long I live”.
Even more did not know that the payment stream was guaranteed. An analogy is only 10% of Australian car owners knowing that comprehensive insurance covers the cost of accident repairs.
People who are ignorant of the insurance being offered are unlikely to buy income guarantees or longevity protection.
Even the age pension, which is really just the government version of a lifetime annuity, is not very well understood, despite the fact that around two million Australians receive it.
One valuable insurance feature of the age pension is that it is indexed against both the cost of living (in fact a special index has been introduced to measure the cost of living of pensioners) and the growth rate of average wages – it is maintained at around 25-30% of male average weekly earnings.
Despite its popularity, 80% of our survey respondents were unaware of the level of payments offered by the age pension and around 50% did not know it was indexed against inflation and wage growth.
Moreover, in times like the past week, when financial turbulence drives down investment returns and erodes wealth, the age pension offers even more comfort to self-funded retirees.
The silver lining of pension means testing is that payments rise when income and wealth decline. So self-funded retirees are partially insured by the taxpayer against financial risks: a $1000 decline in income from some retirement products can be offset by higher pension payments of up to $500.
Unfortunately, a large minority of people we surveyed were also very blurry on the links between income and pension payments.
So if many retirees are unaware that they can purchase risk reducing products and receive help from the public pension, what happens to superannuation and savings at retirement?
A 2010 report on retirement intentions by Sacha Vidler from the Industry Super Network showed that plans for travel and leisure, paying off debt and supporting immediate needs rated above investing for the future as drivers of superannuation use.
Many people planned only for the very short term, though the results also suggest that as superannuation payouts grow larger, more people will switch to thinking about long term investing.
The challenge to industry and regulators is to continue to work to clear up the confusion and offer some affordable support to long-term planning: reducing regulatory complexity; providing clear and comprehensible information; and supplying well designed, economical retirement income products.