KEY POINTS:
The art of investing leads to the accumulation of wealth. It's something that investors learn to focus on and looms large with those who want to retire on more than NZ Super.
Yet "decumulation", the using up of wealth in retirement, is a buzzword that few investors have
ever heard of.
Very few people think about what they will do with their retirement pot when they stop working.
Some take the money and blow it. Others, says Superlife director Michael Littlewood, find it impossible to dip into the capital having programmed themselves to save.
A generation ago retirees with private superannuation savings bought inflation-linked annuities, investment vehicles offered by insurance companies that guarantee a stream of fixed payments over the life of the annuity. The insurer, not the retiree (technically the "insured"), takes the investment risk.
The risk is quite simple. The insurance company knows that on average an individual will live for 20 years if female and 18 years if male from age 65. The insurance company takes its cut and then divvies out an annual sum to you to live on, which can be linked to inflation. If you live for just two years, the insurer makes a profit and if you live to 105, it doesn't.
The trouble is that the annuity industry in New Zealand has all but died a death.
One big problem for the life insurers is that without compulsion, says Littlewood, the people who buy annuities are those who expect to live for a long time. Those who expect to have a short retirement don't, which didn't make for good business.
In the past, company superannuation schemes often had a clause in the trust deed that on maturity the money had to be used to buy an annuity, which gave a reason for the insurers to provide them.
In the United Kingdom it's compulsory for people to invest 75 per cent of their pension pot into an annuity, which in turn ensures that the providers flourish. The UK Government's argument is that it subsidises the accumulation of money in people's pensions by providing generous tax breaks. Come retirement it doesn't want pensioners blowing their retirement money on the high life and then becoming dependent on the state after a few years because it's all gone.
It's an issue that vexes Susan St John, senior lecturer in the Department of Economics at the University of Auckland, when she thinks about KiwiSaver. She simply can't understand why the Government is topping up individuals' KiwiSaver accounts with tax breaks, but hasn't written into the legislation any requirement for annuities to be bought.
"If they changed it now, it would be retrospective. People have entered with one set of rules.
"Because [KiwiSaver] was rushed through by the Government there was insufficient time and consideration given to this."
So how do new retirees plan their decumulation? The answer is that many don't. They take any lump sum they get from their private superannuation, spend some on an overseas trip, boat, or house renovation, and then invest the rest - perhaps in fixed interest or debentures because they fear the stockmarket.
Yet, says Russell Investments' investment strategy director Don Ezra, 60 per cent of a lifetime's accumulation of wealth comes after retirement, providing you keep money invested for the average life expectancy. Only 10 per cent comes from contributions and 30 per cent from investment growth before retirement.
The risk is that unless a good chunk of the equity is in an investment that keeps pace with inflation, it may be decimated by the time an individual needs it.
Ezra says that too often the financial risks of retirement are ignored. In many countries, New Zealand included, retirees get a lump sum of money and no real advice over and above a few pamphlets about how to invest it.
Littlewood says his company creates "mock" annuities for clients - investment vehicles that give them a regular monthly income. Unlike an annuity, however, the client takes the risk that they'll live longer than the money lasts rather than the insurance company.
Typically Littlewood looks at how much the retiree needs over and above their NZ Super payments. He then works out a plan that keeps the next two to three years' spending money in "cash-type investments". The equity to be drawn down for the following six years is kept in bonds with staggered maturities, and then the remainder in higher-growth assets.
As each year passes, the mix of investments changes to ensure the client receives a fixed monthly amount, seamlessly.
AMP Financial Services general manager of savings and investments, Roger Perry, says financial planners typically look at the sum of money an individual needs on a monthly basis and invest that money conservatively to ensure it lasts. "Any surplus, we will invest in something more aggressive after doing a risk profile." This helps to protect against inflation so that the capital is intact when it's needed.
Few investors, says Littlewood, can live off the returns from their retirement pot. Most eat up the capital. "According to Ministry of Social Development figures the average financial assets people have at age 65 is $25,000." MSD also found most retirees live comfortably on NZ Super, he says.
Having said that, some retirees unnecessarily deprive themselves because they can't switch from the accumulation to decumulation mentality, says Littlewood. "There is a real psychological issue to get people accustomed to the idea of spending their retirement savings."
Perry adds that there is a lot of fear from investors about the longevity risk. But expenditure surveys in New Zealand show that people tend to reduce their spending after age 75 or 80.
Another increasingly popular method of "decumulation" used by people whose assets are mainly the family home is the equity release mortgage, or lifetime loan, as it's often called. This is a mortgage that requires no payments until the homeowner dies or moves on from the home. In the meantime, the debt is compounding and a lump sum is taken out to repay the loan when the property is sold.
Many of these loans are relatively small - to pay for home improvements, a replacement car, or overseas trip. Compounding debt with no repayments, however, can grow into a sizeable sum very quickly.
Even a $20,000 home improvement loan at an interest rate of 11 per cent, compounded monthly, would amount to $178,700 after 20 years, excluding fees, eating up a fair chunk of the value of the average New Zealand house.
Perry believes that the annuity market may be reinvigorated if proposed tax changes go through. One of the main reasons annuities died a death, he says, was the tax treatment. They are taxed at a flat rate of 33 per cent, whereas most retirees have a marginal tax rate of 19.5 per cent. Under those conditions it makes no sense to buy an annuity.
Inland Revenue is consulting the life insurance industry about the taxing of annuities, life insurance policies and equity release mortgages.
If annuities were taxed at a customer's marginal rate, they would be more likely to buy such products and providers might start to offer annuities again, says Perry.
