A man’s home is his retirement
Australia’s love affair with property is well documented, but many baby boomers are selling up to fund their retirement. According to MLC's Andrew Barnett, this shows the need for better products in this complex area.
Home ownership has long been the Australian dream. But for the 4.8 million individuals retiring during the next 20 years, the home has become more than just a man’s castle. It’s also the treasure within – a means of funding the retirement years.
A recent MLC survey of 250 financial advisers (both aligned and non-aligned) found more than a third of the respondents’ clients will downsize their home, about one-third will sell their investment property, and about one-third will sell an existing business during the next five years to shore up their retirement savings.
While the survey results aren’t precise, they are directionally instructive. They support studies conducted during the mid 2000s, which found a third of baby boomers would be willing or would expect to downsize or sell their family home once they stop work.
Figures from the Australian Bureau of Statistics (ABS) also highlight this heavy reliance on bricks and mortar as the primary nest egg.
According to the ABS, the mean superannuation balance for individuals aged 55 to 64 years old is $183,000 or 20 per cent of net wealth, which is well short of what is needed to fund retirement for this cohort.
The family home, however, represents 47 per cent of net wealth. Investment properties represent another 15 per cent, while an individual’s own business makes up 9 per cent.
Other investments such as shares form the remainder of total net wealth.
It’s clear to see that the retirement of baby boomers will be funded by consuming the capital represented by non-super assets, such as property, rather than merely drawing down their superannuation balance and spending income from non-super assets such as dividends, interest, and rent.
It’s unsurprising that investment properties are reasonably highly represented in this breakdown.
They are another staple asset of Australians, courtesy (once again) of the prominent position property ownership commands in our national psyche and the tax deductibility of interest introduced in 1987.
However, they’ve been a particular favourite of baby boomers. Statistics from the Reserve Bank show that 27 per cent of boomers have an investment property, while this same demographic owns one half of Australia’s total number of investment properties.
Property has been a good investment, particularly during the past decade. But in many cases it’s not the optimal ongoing investment by the time retirement rolls around. That’s why people sell their investment properties or downsize.
They may need the money from the sale for liquidity, the low returns from investment properties due to falling rental yields may mean they can’t live off the income of the property, the gap between the rental yield and the mortgage rate might be too much, and then there’s the problem of negative gearing without an income.
Of the 27 per cent of boomers who hold an investment property, 40 per cent have a mortgage.
The real estate industry has been an early harbinger of this sell-down dynamic – understandable, as it directly impacts the sector.
In January, Head of the Real Estate Institute of WA David Airey was quoted in newspaper Perth Now warning “scared baby boomers” against selling their investment properties.
Putting risk aside for a moment, pre-retirees and retirees need investments that have opposing traits to property’s markers of illiquidity and low-growth (in comparison to the past decade).
They need liquid investments should they face unforeseen costs in retirement and high growth assets to mitigate the risk they’ll outlive the money they had upon stopping work.
Let’s take the requirement for high-growth assets. The rate of growth on assets during retirement has a singular importance in determining income.
There is a commonly-held 10-30-60 rule of thumb used in financial services that suggests 10 per cent of pension income is from contributions made during accumulation, 30 per cent is from market growth during accumulation, and 60 per cent is from market growth during decumulation.
The benefit of market growth is particularly applicable to retirees who don’t have sufficient assets (and there are many of those) and who rely on this growth to provide them with the money to live out their retirement.
Furthermore, with retirement stretching potentially 35 years, the compounding growth is even more beneficial.
Higher growth brings with it, of course, higher risk. When capital is consumed in retirement, this takes the form of sequence of returns risk.
This risk is greatest at the beginning of retirement when people have the most to lose, as opposed to the end of retirement when they have fewer assets that will be impacted.
The sequence of returns over a given period is irrelevant to the financial outcome if there are no contributions and no withdrawals. Introduce these cash flows, especially withdrawals, and the outcomes can vary markedly.
Which brings us to a conundrum. Retirees need growth assets because savings are insufficient and retirement may be long, and they need liquidity because they’ll be drawing down the asset and they will likely face unexpected expenses.
But assets that offer both growth and liquidity tend to have higher risk.
So what’s the solution? The market needs innovative products that have more optimal combinations of growth, liquidity, capital stability, and longevity protection.
The Australian market is quite immature when it comes to these sorts of products but there are plenty of examples if we look abroad.
In income products, they include:
- corporate bonds
- equity indexed annuities, and
- deferred lifetime annuities.
In asset management:
- target date
- target return, and
- target volatility funds.
In risk management:
- variable annuities, and
- funds with nimble glide paths that employ sophisticated capital protection and volatility management techniques.
Services that engage and educate individuals are also crucial given the importance to the individual, their families and the Government of getting retirement funding right.
Diversified financial institutions in particular may benefit from the fact that retirement is a ‘whole of wallet’ consideration, and wealth products and banking products will be considered holistically.
Finally, the need for financial advice will also increase. This will happen naturally as the number of pre-retirees grows, a segment where one in three is currently advised, compared to one in five for individuals in their forties.
It will be amplified by the need to consider complex planning needs across assets, and the emerging choice of different product solutions.
Family homes will be downsized and investment properties will be sold in increasing numbers by retirees who view property as an important source of funding for retirement.
As the products on offer for this sector of the market evolve, however, retirees will be able to invest the proceeds in solutions that better meet their needs.
Andrew Barnett is general manager, MLC Retirement Solutions.
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