One of the main roles a financial adviser plays is to give their clients licence to enjoy the thrill of retirement. A key part of that work is eliminating income shrinkers, sub-optimal choices that can cramp a client’s retirement lifestyle.
Here are three common income shrinkers and how advisers can help clients avoid them.
1. Paying down a mortgage
Many clients may need to pay down a mortgage in retirement as a result of a combination of elevated house prices and delayed household formation.
According to the Retirement Income Review1, the average age at which owner-occupiers finally pay off their mortgage increased by 10 years – to 62 – between 1981 and 2016. Indeed, more than 50% of owner occupiers aged 55-64 still carry some mortgage debt.
Older mortgage holders don’t just have to deal with a constant drain on their lifestyle income. They’re also more vulnerable to economic shocks – such as rising rates – and the financial and psychological stress this causes.
Paying off debt in retirement has a whole range of downstream effects.
• It may leave less money to invest in growth assets to support income for longer in retirement.
• It means lending or gifting money to children carries more risk – if it can be achieved at all.
• And it’s a reason many older Australians stay in the workforce after their preferred retirement age.
On current trends, all these stresses are likely to affect a wider range of retirees in the future.
Something we are seeing is more retirees are retiring with home loan debt and that limits their options. Ideally, advisers would help clients accelerate home loan repayment whilst they’re working. Or help them strategically salary sacrifice into super so they can take a tax-free lump sum on retiring (aged 60 or more) and use that money to clear debt.
Sometimes eliminating home loan debt is not optimal. If retirement savings are earning 6% tax free and mortgage debt costs 3-4%, it may make sense to gradually reduce that debt rather than deplete retirement capital.
2. Experiencing a catastrophic market event
Sequencing risk is one of the most dangerous risks for retirees. That’s the possibility a GFC/COVID style event smashes such a large hole in their capital that it permanently shrinks their potential retirement income. Proponents of lifetime income streams argue the ability to ‘exchange’ a chunk of retirement capital for a lifetime income is a useful counterweight to sequencing risk.
Government enquiries like the Retirement Income Review suggest many retirees limit their lifestyle spending due to the Fear of Running Out (FORO) and/or lack of clarity around their future spending with most only drawing the minimum legislated rate.
3. Gifting or leaving money to their children
Many retirees place a premium on passing on capital or a property to their children. That sacrifice also happens before death, with many retirees gifting home deposits or school fee cash to their children.
Reducing the lifestyle effect of those capital drawdowns requires judgement.
“With some clients I’m trying to convince them to be more selfish, to think less about their kids’ lifestyle and more about their own,”
say Clinton Smith of Abound Financial & Lifestyle. “If you die and leave a two-million-dollar property,
your kids are going on all the holidays you didn’t.”
Yet retirees – and their advisers – must consider the whole board when it comes to helping their next generation without trimming their own sails. In some situations that’s considering the impact of inheritances. At other times it’s shuffling the components of a clients’ portfolio for maximum effect.
That might mean planning to use up all financial assets but leaving the family home to the next generation. Or ring-fencing a lifetime income stream and allocating their account-based pension and other assets to fund bequests and gifts.
AMP’s guide to retirement income
This is an edited chapter from Retire with Confidence – North’s guide to the new world of retirement income. If you’d like to read more, download the full paper here.
1. Retirement Income Review, Australian Treasury, p121
