Bumps that could crash your retirement

Retirement is often touted as a paradise on earth with no work deadlines to meet, no meetings and the freedom to do what you like, whenever you wish. That’s fine in theory, but the reality can be quite different.

Think about most people’s lives – cared for by parents in the early years, before being subject to the discipline and structure of school and then higher education before forging a career. At this stage, you may form a relationship, buy a home, have children and undertake the long journey of making a life for yourself, while educating the children and paying off the house.

Suddenly, retirement arrives and you’re master of your own destiny. Unless you’ve planned the future well, there will be no more structure, no more goals and the only source of income will be your superannuation and savings. It’s one of the biggest transitions in life.

Some people do it well. Many get by okay. Some end up miserable.

It’s also a potential minefield. This is a time when the regular salary is no more, and any mistakes can be extremely costly. But the problem is that most people don’t know what they don’t know. If they go down the wrong track, or don’t take advice, the consequences can be horrendous.

It’s been said that having a fulfilling retirement requires “something to do, someone to love, and something to look forward to”. And that pretty well sums it up. Also, it helps if your health is in good shape.

There is a wealth of research telling us that those who prepare and plan for retirement tend to have a much happier, healthier retirement than those who suddenly find themselves out of work with no plans.

Ideally, retirement should not be something that is thrust upon you, but something you move into gradually.

Well before your retirement date, sit down with your partner if you have one, and think about how your life will be when you do retire. Major questions are where you will live, how you will occupy your time, what exercise and sport you will take up and where you will invest your money.

A great first step is to do a retirement budget, which is not difficult if you use your present expenses as a guide, subtracting items that are purely work-related. For example, if you’re going to have just one car, that’s a further reduction in costs.

A major issue for most is how long the money will last. My retirement drawdown calculator is a great tool. And the life expectancy calculator at mylongevity.com.au is great for forecasting how long you might live and what factors influence your longevity.

Try before you buy

If you intend to make major changes, I suggest a ‘try before you buy’ approach.

If you’re thinking of becoming a grey nomad and spending years travelling around Australia, hire a caravan and take a two-month trip to see if you like it. If you think that retiring to a coastal town would be perfect for you, rent in that location for at least six months.

A major part of retirement happiness is social network, which normally comes from your job, family, sport and other associations such as church. A major change to your abode means all those relationships may be lost. If you think you’d like to downsize from your lovely big home to an apartment, rent an apartment for three months. For some people it’s a joy; for others, it’s hell on earth.

Age Pension and super

Then there’s the question of whether you intend to apply for Centrelink benefits. Pension age – the age that you can access the Age Pension – is increasing to 67 for people born after 1 January 1957, so anybody who wants to retire before their pensionable age needs to ensure they have enough capital to live on until they are eligible for a pension.

There’s an even bigger factor. Because of the way the mathematics work, the largest increase in any long-term compounding investment, including your superannuation fund, comes at the end of the period. Remember, every time your portfolio doubles in size, there is more growth in the final double than in the sum of all the other doubles combined.

The numbers are mind-blowing. Think about a person aged 60, earning $100,000 a year, with $500,000 in super. If their fund earns 8 per cent per annum, the balance would be $800,000 in another five years. That’s an increase of 60 per cent in superannuation just by working another five years.

The financial side is important, and obviously the longer you can defer your retirement the more your superannuation should grow – and the longer it will last. It is highly recommended that you do some sort of work after you retire. Ideally, it could be part-time work that will add meaning to your life, as well as boosting your superannuation, or it could be voluntary work, or even working on a hobby. It’s not always about the money.

There will be some who have a self-managed super fund (SMSF) or are thinking of starting one. Step warily – SMSFs can be a minefield and often one partner does all the work leaving the other in the dark. If the person controlling the fund starts to lose capacity, the other partner can find themself way out of depth and open to serious mistakes.

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Case study: A couple in their early 70s had an SMSF. They downsized the home with the aim of contributing $600,000 to super under the downsizing rules. Unfortunately, they had not complied with all the regulations and so were not eligible to take advantage of the downsizing rules. As a result, the super fund received an unauthorised contribution of $600,000 and they had all the costs and fees and penalties of rectifying it.

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The pension rules are geared to encourage us to work a little: the first $150 a week you earn from a business or personal employment is exempt from Centrelink’s income test.

Let’s look at a couple of pensionable age, who have assessable assets of $405,000 made up of $380,000 in super and the balance in car and personal effects. If they draw down the standard minimum of 5 per cent a year from their superannuation, that gives them income of $19,000 a year. If they also each earn $7800 per annum from paid work, they would be eligible to receive the full pension of $40,238 a year. That means a total tax-free income of $74,838 a year.

A major finding of the government’s Retirement Income Review was that the retirement system was complex, and most retirees had trouble handling the interplay with other systems such as the Age Pension, aged care and income tax. As a result they can make major errors.

Case study: When I was writing Retirement Made Simple, I received an email from a man who told me he and his wife had gone tenants in common with their daughter on a 75:25 basis 20 years ago, to help her buy her first home for $300,000. For 20 years, she has paid all expenses in relation to that house. The parents are now faced with a double whammy: the house is worth $900,000, which means their 75 per cent share is worth $675,000. They are on a minuscule Age Pension, which may well vanish altogether if the house keeps increasing in value. They are caught between a rock and a hard place. If they transfer their share to her now, they would be liable for a large sum in capital gains tax, and still have to wait out the required five years before the asset vanished from Centrelink’s records. If they had gone guarantor, instead of putting their names on the deed, this situation would have been vastly different. That mistake probably cost them over $300,000.

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How to access the value in the family home

The government has made it abundantly clear that retirees are expected to utilise their capital as they move into their final years. But the big question is how to do that. One option is to downsize to a cheaper home but, as I pointed out in Retirement Made Simple, this strategy often has the major disadvantage of converting an exempt asset – the family home – to an assessable asset. If you are receiving a part Age Pension now, increasing your assessable assets could severely reduce your pension or you could lose it altogether.

To make matters worse, the costs of moving from one home to another are high, which usually means a net loss of capital. Most importantly, retirees want to remain in their local communities, and it may be hard to find a good quality smaller home nearby.

One benefit of downsizing is that the government lets each homeowner put $300,000 of the proceeds of downsizing into their superannuation as a non-concessional contribution. Even that incentive has not convinced many older Australians to leave their family homes. So not downsizing may leave retirees asset rich, but remaining cash poor.

A reverse mortgage may be the solution, but it’s important to do the numbers. At reverse mortgage rates of between 4 per cent and 5 per cent, the debt will double every 15 years if no repayments of principal and interest are made. This may not bother somebody aged 85, but it could be different matter if you are 70.

An option is to discuss the possibility of a reverse mortgage with your family, and see if it is possible for them to pay the interest. This would prevent the debt increasing and preserve more of the estate for the beneficiaries.

Finally, it’s important to stay up to date. Join retiree associations such as National Seniors and the Association of Independent Retirees to meet some interesting like-minded people and stay up to date with what’s happening in your world. And, of course, don’t forget other great free publications such as YourLifeChoices and my monthly newsletter. We need all the help we can get – staying informed is a major part of doing that.

Noel Whittaker is the author of Retirement Made Simple and several other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Visit noelwhittaker.com.au.