For some, retirement feels like a far-away idea and for others, it’s not too far-away reality. Whether you have a 40, 20 or 10 year time horizon until you reach retirement age, how you’re prepared financially for these golden years is important to start considering now. Many Kiwis rely on the equity in their property as their retirement plan, but is this the best way to be investing for retirement? Or, in today’s low-interest rate environment are there other suitable ways to be setting yourself up for, and growing your wealth through retirement?
The realities of retirement
A few years ago, my parents downsized. For many years prior, they rattled around in a house with extra bedrooms and bathrooms that needed cleaning. Some rooms changed function multiple times or were entirely mothballed, accumulating and storing surplus possessions as if they will reach antique or heirloom status and start to appreciate in value. Yet ultimately it was their castle, an extension of their personality and personal history, a place where rural friends could arrive unannounced and most importantly, the place where they felt comfortable for its familiarity and memories – in simple terms, a home.
I often joke with clients and friends that the average Kiwi’s retirement saving plan is downsizing from a 4 bedroom home to a 2 bedroom home when the kids leave home. The reality for my boomer parents and many others is that by the time they reached retirement, their homes climbed significantly in value, mostly thanks to a fall in general interest rates. Consequently with term deposit rates as an all-time low in New Zealand, many approaching and in retirement see their house as their goldmine. A dangerous viewpoint, I believe. However for them, as for my parents, there comes a liquidity need where cash is required to support the desired lifestyle.
What are the options available to those approaching this stage of life?
Start by looking at your lifestyle
The first is to consider the cost of the lifestyle required, both at home and for activities. A big house has higher rates, costs more to heat, maintain and insure. At some point, not that anyone wants to put a date on it, driving becomes unsafe and the car is obsolete. (As an aside though, I could never understand why my parents didn’t use taxis/Ubers more, as for many suburban locations they are more convenient and cost effective than car ownership and parking hassles – creature of habit and defenders of independence we are).
Meanwhile, there are many work-related expenses of clothing, travel and lunches that can disappear. This is not to suggest budgets need to reduce, just the expenses through retirement are likely to be different. You’ll have a Gold Card too don’t forget!
Working out a budget will give you an indication and hopefully some comfort. You can do this on your own (here’s a template), or with a professional financial planner or with a free family budgeting service you can find at www.moneytalks.co.nz. As a result, at some stage, most people need to release equity from their home or reduce their housing expenditure, keep reading for more on this.
Then it’s about gaining perspective
The second option is to get some perspective on your years ahead. Assuming you are not ailing in some way already, many people’s retirement will be 25+ years long. However, those years are not identical for expenses or types of expenses. Which reminds me of a cute slogan for the stages of retirement: The Go-Go, the Slow-Go, and No-Go years!
The Go-Go Years (65ish-75ish)
Immediately into retirement most people tend to be more active because they suddenly have more time on their hands. Spending is typically high because retirees are busy travelling, completing bucket list ideas and enjoying hobbies they didn’t have time to pursue when they were still working.
It may be wise to allocate extra funds if you think you’re likely to be the classic Go-Go senior during this time. Your fixed expenses will probably be the same as during the next period, but you will want money for vacations, sports, club memberships, and the like. Don’t be so stuck in a conservative mindset that you miss out on enjoying your Go-Go years and money allocated for fun!
Luxury items, travel, and recreation are less likely to be a burden on your budget if you plan for them in advance and have the funds to realize your dreams. Often some paid work is still appealing too, whether it be for social and mental stimulation, this luxuries budget or to give back to your profession.
The Slow-Go Years (75ish-85ish)
During this middle period of retirement, people typically start to spend less money. You’ve probably completed many bucket list adventures or acquisitions and others have seemed less important. The weariness and changeability of travel and activities that require a high degree of energy are less appealing. People in the Slow-Go phase often swap tennis and dancing lessons for modest social activities and family fun with the grandchildren taking centre stage. This physical slowdown results in a financial slowdown as well for most seniors. If you’re not traveling as much and staying in for dinner, naturally you’ll spend less money.
The No-Go Years (85ish+)
Today’s retirees are living longer and more active retirements than any before. The final phase of your retirement is going to depend on your level of mental and physical health as you age. Your No-Go period might be five years, or it might be 20. You’ll see another slowdown in activity during this period, usually with a reduction in social activities and the ability to get around.
Your No-Go spending will adjust to your ability to live independently. Some seniors can age in place in their own homes, while others may need to transition to a retirement village or rest home. Healthcare expenses can be critical at this stage but unlike other countries, in New Zealand the public health system covers almost everything. Without dwelling on exceptions, in these No Go years many retirees find that their NZ super payments cover all or almost all their outgoings. Those who still have most of their wealth in this time generally find they don’t have a substantially different lifestyle but just leave more to their heirs.
So, what’s a good investment strategy in retirement?
While it is hard to generalise when everyone’s personal and financial situation is unique, there are two rules of thumb you might wish to consider.
Number one is to have or have access to 3 years of net expenses (that’s the expenses you worked out earlier less income, less NZ Super) in a stable low risk investment like a call account or series of term deposits. Then to invest the rest in higher growth assets such as property, shares or Kernel index funds, and to consider replenishing the low-risk investment once a year.
Number two is to subtract your age from 110 as the percentage invested and have the rest in low-risk investments. For example, at age 65,you would invest 45% in growth assets, (110 – 65 = 45) and at 75 you would invest 35% in growth assets.
Both these strategies protect a portion of capital against dreaded market fluctuations which can be more stressful as the use-by date comes closer, and the feeling of having less time for recovery gets stronger. Overall though, some of the retirement savings even into your 80’s has enough time to “crash” and recover to a long term average, before you need to spend it or the kids get it. Remembering that based on 100 years of history, the share market grows in value more than property over 10+year periods.
How much money do I need for retirement?
This is almost an impossible question to answer as it requires so many assumptions about future growth, inflation, and timing.
KiwiSaver providers have been forced by regulation to estimate it on annual statements based on a complex formula subject to much variation and a growth rate of just 0.5% above 2% inflation. Not to mention, these can lead to some astronomical and offputtingly large numbers in the millions as required balances. However, that’s not helpful either so here’s a rule of thumb from the Society of Actuaries.
Spend 6% of your wealth at retirement each year, and you will have 20 years minimum plus probably some left over for the kids. So, to reverse that, if the net expenses amount you estimate is $30,000 a year, you should aim for $500,000 in wealth at retirement.
The table below gives some variations after tax assuming NZ Super eligibility:
|Retirement amount||Annual budget (single)||Weekly spending single||Equivalent single salary (before tax)||Annual budget (couple)||Weekly spending couple||Equivalent couple salary (before tax)|
Pros and cons to downsizing
Naturally, there are pros and cons to downsizing your house as you near retirement.
The pros are that a smaller house or apartment is likely to have lower costs. Ideally it’s also easier to maintain and it’s in a location further from the (former) workplace and closer to activities, friends or family. It can set up the lifestyle that you have been working towards and wishing for.
On the other hand, the cons are that it can be disruptive, costly and even confronting to move. It also might mean new routines, providers and even friends can be required in a new community and location, which can be daunting. That said, it’s encouraged to make this move sooner rather than later, especially if dementia or mental illness are in the mix.
Furthermore, while retirement villages can be very popular with social activities, independent living and increasing support when assistance is required, the purchase price, amount of capital depletion and weekly maintenance fee can be surprisingly high. You may not actually free up as much money as you thought. Research by the Financial Services Council found that downsizing gave an average of just 3.3 years of income.
Is there a way to stay in my house and fund my retirement another way?
Consequently, or even as defiance of the concept of old, many people wish to stay in their own house for as long as possible. And a way to do this is through home equity loans also known as reverse mortgages.
You can find plenty written about these online, but for context, it involves simply borrowing an increasing amount of money secured against the value of your house. The loan is repaid only when the house is sold. The interest rate is higher than a mortgage and only a fraction (20-40%) of the house’s value can be borrowed but it’s a way to liquidate part of your home’s value without selling it. An alternative option is to have a boarder which might appeal or not for a variety of personal reasons.
What about my mortgage – should I pay it off?
The question of whether to pay off your mortgage in the first place, or leverage this to get into more debt and diversify elsewhere, is one that we see this question popping up regularly. At its core, it’s dependent on a view on future interest rates. If interest rates stay low, as many presume they will, then there is little benefit in paying down the mortgage more than the table loan amount.
With any extra money or savings, you can diversify into other investments, be that other property, businesses or growth funds here or overseas. Bear in mind though if interest rates rise (which they haven’t materially and sustainably for over 30 years) asset prices tend to fall, which could leave you worse off.
So, the two suggestions here are firstly to ensure you could handle higher servicing costs where you have 50%+ equity in your home. The second is to diversify where NZ interest rates have less correlation, such as overseas growth funds.
What about relying on the pension as an investment strategy?
As mentioned above, the NZ super pension is often sufficient income for those in later retirement, so the question is whether you think a future government will reduce or remove NZ Super.
Personally, I think it is highly unlikely because the NZ Super Fund is intended to be utilised to maintain its existence . It would be political suicide as currently 15% of the population receive it, rising to 25% of the population by the time millennials start to reach 65. Already a long term, well-signalled 20 year intent to raise the age of eligibility to 67 was removed within a year by a new government.
Oftentimes there can be a lot to consider when it comes to ensuring you are financially secure heading into retirement. If there’s anything 2020 has shown us is that it we can never predict what might happen in the future, but we focus on our energy on what we can control. Starting to plan and make suitable changes for retirement today, is something we can control.