Live long and prosper?

The looming financial and social challenges posed by longevity can no longer be ignored, writes Indy Singh.

Why would we consider longevity a problem? Novelists refer to the elderly as having lived to a ‘ripe old age’ and having ‘enjoyed the full benefits that life can offer’.

The physical and financial support needed for the elderly to live longer and, importantly, to live well is a growing issue.

Fortunately our pension system is reasonably fair and accessible to a large ageing population.

This is a far cry from the one of earliest pension programs, which was launched in Germany in 1889 by Otto von Bismarck and provided an income for life for any worker who reached the age of 70.

Unfortunately, the average age then was only 45 years, so only a few lucky ones benefitted.

Life expectancy at birth has risen largely due to medical advancements and improved facilities, but also due to people living healthier and fitter lives.

For instance, a man born in 1945 and now 65 years of age would have been told as a child that he was likely live to an age of between 65 years and 67 years. What has actually transpired is quite different.

The latest Australian Life Tables show significant mortality improvements, and while the life expectancy of this man is now around 83 years, he could be one of the 20 per cent in his age group who will live beyond the age of 90 years.

What is a matter of importance for policymakers is the ageing or ‘greying of Australia’. For instance, in 2007 the number of Australians aged 65 and over was around 2.7 million or 13 per cent of the population.

With younger Australians comprising roughly 20 per cent of our population, it is left to the remaining 67 per cent to provide the people who contribute to government revenue through their personal exertion and productive output.

As we know, the contributors to government revenue are, for various reasons, much fewer in number. Welfare and social security payments comprise around 40 per cent of all government expenses or almost $100 billion, and of this the age pension comprises $33 billion. Health costs consume another whopping 18 per cent.

The recently announced pension increases of $32.49 per week for singles and $10.14 per week combined for couples on the full rate will cost the system $36 billion by 2012-13.

So if this is our expenditure position when we have a population of 21 million people and 2.7 million above the age of 65, what could we anticipate in say 50 years time when our population is expected to be around 40 million, as the table shows.

By 2056 nearly 25 per cent of our population or almost 10 million people will be above the age of 67, which is likely to be the new threshold for qualifying for an age pension, unless of course the Government at that time thinks otherwise.

This demographic will most likely demand a huge share of funds from the Government, putting severe stress on those in productive employment to provide the funds.

Longevity becomes a real issue when people switch from generating wealth for the community to withdrawing their savings. In particular, those in poor health become a serious financial burden for the community and relationships within families and communities become strained.

Let us hope we never see the day when a choice has to be made between giving a hospital bed to an elderly retiree or to a young person who can return to contributing to the economy.

There are a number of issues that affect an elderly individual. There are questions about:

• having sufficient funds to live a retired life free from financial worry;
• the type of investment during the accumulation phase and in retirement;
• how much money should be drawn out from savings in retirement;
• the cost of medical care, particularly in latter years;
• the ability to care for oneself;
• difficulties finding a nursing home bed; and
• family relationships and loneliness.

Data shows most Australians are not saving enough to enjoy a retirement that is free from financial worry. Current trends show that retirees tend to run out of funds in the first 15 years of retirement and subsequently rely on government age pension support.

The 9 per cent (potentially 12 per cent) superannuation contribution guarantee may also not be adequate, particularly when a disinterested workforce is encouraged to contribute into defensive default funds under the inducement of lower fees.

To make matters worse, short-term market volatility is exploited by the general media as something to be feared and considered as a permanent feature.

This sensational journalism contributes to making genuine savers fearful of investing in growth assets, which is an appropriate strategy for a long-term financial plan.

A common approach to measuring the life cycle of a person’s retirement savings is the 10:30:60 rule.

It implies for a retiree that of each dollar spent in retirement, nearly 10 cents come from contributions while working, nearly 30 cents come from investment earnings during accumulation and nearly 60 cents come from earnings during retirement.

One can alter the amount of savings or withdrawals or investment earnings, but the rule generally stacks up. So if we get the accumulation wrong and blindly invest in say a defensive default fund, the initial saving is a reduced amount, and this results in a person having insufficient funds in retirement.

It is for this reason that we advocate the use of a financial planner who can understand an investor’s risk profile and other non superannuation financial needs before recommending an appropriate strategy to optimise the level of savings.

There has been too much focus on fee saving and denigration of the service that a good financial planner provides — largely by industry funds that wish to retain money within their funds, but this could eventually cost their clients dearly in retirement.

How much money is sufficient in retirement is a question that has perplexed us for ages.

The full pension for a couple is around $26,000, so we can assume that this is the basic amount (indexed to match inflation of say 2.5 per cent a year) required to live with some respect.

If this was to be drawn from a lump sum earning at the rate of 7 per cent a year and an account based pension paid from age 65 to age 87 years, with the lump sum reducing to zero at age 87, the initial lump sum amount would need to be around $450,000.

Very few Australians can boast that they have this amount saved. Indeed, a recent study on superannuation savings suggested that the average savings of a 65-year-old man was just under $100,000, while for a woman it was only around $10,000.

Quite possibly a visit to a financial planner in their earlier years would have helped them to develop a discipline and saving mentality, which with the right choice of long-term investment strategy could have given them a much higher level of funds in retirement.

The next question is how much should one draw down on assets in retirement? Moreover, what assets should one invest in?

The answer is one could work with a professional financial planner to address the issue of longevity. It may well mean that a minimum amount should be drawn from an account-based pension, unless there are sufficient assets.

Market volatility is another matter to consider, especially if all assets are growth oriented and reduce dramatically due to short-term volatility.

Continued withdrawal of a fixed amount from a reduced asset base can cause a rapid depletion of one’s assets.

Some commentators argue retirees should only invest in a very cautious manner to avoid any short-term falls in capital value.

Other studies show this approach can be seriously counterproductive and simply ensures capital is depleted at a faster rate than necessary.

Diversification and proper structures of investment are key here so that one may continue to draw down from assets that are not affected by market volatility, giving their growth assets the breathing space to recover in value.

Another danger for investors facing the prospect of having inadequate savings for a comfortable retirement is the growth in the ‘silver bullet’ industry.

We have already seen investment product providers and some parts of the industry recommend inappropriately aggressive strategies and dubious investment vehicles purported to deliver returns that are often not only unachievable but also have often unexplained downside risks.

People will be vulnerable to such advice if they feel the need to play ‘catch-up’ by leaving their planning too late.

The most obvious and probably first adverse impact of ageing is one’s health. Muscles, tissue, organs and bone structure weaken.

This weakness makes us vulnerable to illness, infection and disability. The Government already spends 43 per cent of its revenue on welfare and social security. Whether expenditure can remain at this level is dependent on the revenue earned by the Government.

Anecdotal evidence suggests government support will decrease unless the revenue base grows faster than demand from the aged members of our community.

We may downsize our home as we age, but be prepared to set aside a large amount for future health care costs. This may include home care, long-term care for serious illnesses, special surgery and so on.

A study in the US found medical expenses in the last year of one’s life are around five times the expenses of any other retirement year, with 30 per cent of the expenses being made in the last month.

The increasing number of elderly people will undoubtedly put severe pressure on our hospital network, medical services and insurance costs. The question of legalising euthanasia is most likely to recur.

As we age and live longer, we will need to either be cared for at home or find a bed in a nursing home. There is an acute shortage of beds in nursing homes already.

Either large numbers of new nursing homes will have to be constructed or Australians may need to change their social habits and start bringing in their parents and even their grandparents to live with them.

Homes with granny flats, rather than units, may start to become popular again.

Social stresses will arise when a 50-year-old has to provide for elderly family members and at the same time pay the expensive education, travel and living costs of his or her children.

There are many issues that are likely to arise as we age.

Predominantly, we need to look after our health and save properly under the guidance of our financial planner.

Money can’t buy love or health, but proper financial planning can give us a chance of being financially independent when our ability to earn a living is substantially reduced.

Indy Singh is the chief executive of Fiducian.