Stop fearing cognitive decline and start managing it
Effective financial and estate plans will allow investors to enjoy their retirement years without innate fears about cognitive decline, Mick O'Brien writes.
A wave of retiring Baby Boomers have become particularly well-educated about the challenges they face in managing their retirement income, coping with volatility, and handling other market risks.
But there is one glaring omission which evokes so much fear and anxiety that few are willing to plan for it — how to tackle the natural decline in cognitive abilities we all suffer as we age.
Only about 39 per cent of investors said they have a suitable plan in place if their decision-making abilities decline, according to a recent State Street Global Advisors' survey. It leaves the door ajar for poor decision-making which can decimate a lifetime of savings, as well as more predatory dangers such as fraud or abuse.
It doesn't take full-blown dementia or Alzheimer's disease to be at risk. Most people's financial decision-making abilities peak in their early-50s while financial literacy scores decline by about one percentage point each year after age 60 thanks to the ageing process.
It is a major issue for Australia's ageing population. More than 3.1 million Australians were aged between 65 and 84 years in 2015 and that number is expected to reach about seven million by 2054 to 2055, according to the government's Intergenerational Report.
Unfortunately, many older Australians remain blissfully unaware of these changes in their abilities with self-confidence levels remaining high. This lack of self-awareness leaves older investors even more at risk as their financial skills decline.
It is a key reason why the elderly are the victims of financial scams by strangers or, sadly, financial abuse by friends and family.
Up to five per cent of Australians over the age of 65 have experienced abuse, with financial and psychological abuse the most common forms, according to a Sydney Law Review analysis.
These dual risks of cognitive decline — financial mismanagement and potential fraud — make it a significant issue for all Australians.
Heightened risks in self-managed super funds
The risks are particularly heightened in the $620 billion self-managed superannuation fund (SMSF) sector where the average age and super balance is significantly higher than in the broader population.
Almost two-thirds (62.6 per cent) of SMSF members are aged 55 years or older and have an average account balance of just over $560,000, according to the Australian Taxation Office (ATO).
However, in practice, one member usually controls the entire SMSF on behalf of a couple (although both have the same legal obligations). If that member becomes impaired, the entire SMSF's assets — an average of more than $1 million — is at risk.
The risks associated with age-related cognitive decline are so large that last year ATO assistant commissioner, SMSF segment, superannuation, Matthew Bambrick, described them as a "time bomb waiting to go off if not addressed now".
It is not just the quality of investment decisions which are at risk when an investor begins to lose their financial decision-making capacity. Funds can also quickly breach their legal obligations (such as drawing down a minimum pension) and lose their tax concessions.
The tipping point between mild cognitive impairment, such as misplacing an object or forgetting a word, and more serious conditions such as dementia and Alzheimer's disease, can come quickly. Unfortunately the signs are not always clear until it is too late.
A recent study published in the Australian Journal of Management (financial literacy, financial judgement, and retirement self-efficacy of older trustees of SMSFs suggested that people may be less able to recognise cognitive declines compared to behavioural declines.
"This emphasises the importance of external testing, rather than over-relying on self-report measures," the study's authors wrote.
These dangers are very real: once an older investor loses their mental capacity to make decisions, they also lose their legal capacity to make decisions, leaving them in limbo.
Without a pre-existing plan, family members then face a significant emotional toll as they undertake costly court action to resolve the impasse.
Early planning: strategies to protect investors
Planning for retirement has never been more challenging. Australian lifespans now rank among the longest in the world at a time when generating adequate retirement income is particularly difficult thanks to a new low-interest rate world.
But investors need more than an investment strategy — they need a holistic plan which also takes into account the potential impact of natural cognitive declines associated with ageing.
Investors, their families, and their financial and estate planners, need to tackle the issue before it arises.
Dementia currently affects more than 354,000 Australians, including approximately 25,000 people under 65. One-in-ten people over 65 currently and three-in-ten people over the age of 85 have dementia, according to Alzheimer's Australia.
A good time to start these discussions is when investors are at their cognitive peak and considering their retirement — their early-50s.
While it can be a highly sensitive and emotive topic, approached in the right way, it should rightfully be seen as just another form of risk management.
While many investors are comfortable with estate planning however, the focus is largely on what happens to their assets after death.
A thorough plan needs to also address the many health and lifestyle changes that take place during the retirement years, which can now typically stretch for more than 20 years.
A thorough estate plan should include appointing a power of attorney, who can make financial decisions (often also covering medical or lifestyle decisions) on behalf of the investor if they become unable to do so.
Many investors choose to appoint an independent trustee to this role, saving family or friends from making difficult decisions while carrying a heavy emotional burden.
An independent financial power of attorney (or an independent executor in a will) also ensures that the investor's interests are placed first, given the complexity of many family structures today and, sadly, the potential for elder abuse.
SMSF members, in particular, need to consider what happens to their fund, given their more stringent legal obligations as trustees.
They should specifically address the circumstances when their fund should be wound up and assets transferred to a more appropriate structure.
One option is a small Australian Prudential Regulation Authority (APRA) fund, where a trustee technically manages and controls the fund but still allows the member freedom and flexibility within their investments.
Small APRA funds have a number of advantages including not triggering capital gains tax or disrupting existing pension payments.
Whatever the final mix of strategies, it takes understanding and empathy to help guide investors through this journey. It is one that many investors would prefer not to think about.
But with an effective, holistic financial and estate plan, investors can overcome their innate fears about cognitive decline and create the foundations to enjoy their retirement years for as long as possible.
Mick O'Brien is the managing director at Equity Trustees.
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