Future retirees should plan for a bumpier investment ride featuring more inflation but potentially stronger returns than forecast in 2020 under new guidelines released by a specialist sub-group of the NZ Society of Actuaries last week.
In an update to its previous ‘rules of thumb’ drawdown report, the Retirement Income Interest Group (RIIG) incorporates fresh market assumptions amid rising volatility, persistent inflation and higher interest rates that impact long-term planning for retirees.
“The income generated under the new assumptions appears to last for longer but is more uncertain than before,” the RIIG report says. “This is a reminder that a retiree on a drawdown plan should review every so often, especially if investment conditions change.”
RIIG outlines four basic ‘rules of thumb’ retirees could adopt to manage income in their post-work years, namely:
- a flat 6 per cent annual drawdown rate of capital accrued at retirement date;
- capping yearly withdrawals at 4 per cent of total savings but adjusted for inflation;
- the ‘fixed date’ approach where retirees calculate annual withdrawals based on their retirement fund balance divided by the number of years left until a targeted end point; and,
- a version of the fixed date system but with the annual calculation hinging on the number of years remaining before reaching an actuarially determined probable death.
The flat- and inflation-adjusted rules-of-thumb are relatively easy to implement while delivering consistent income with trade-offs around spending power in early retirement years versus the risk of running out of money pre-death.
Conversely, the fixed-date and life-expectancy systems require more complex management, imply more income volatility but with a higher certainty of lasting over the defined period of time.
According to the RIIG report, the rule-of-thumb models are designed as flexible guidelines rather than rigid schedules, noting retirees can easily switch between approaches or vary drawdown amounts – especially in early retirement years.
“Fixing a drawdown plan for life may work better later in retirement if or when spending patterns are settled and reviewing finances regularly becomes a burden,” the paper says.
However, RIIG says the rules-of-thumb offer a useful starting point for probing the likely outcomes of spending and investment decisions in retirement.
The paper models the drawdown consequences based on a starting point of $100,000 in a KiwiSaver account for members aged 65 investing in a balanced fund with annualised returns of 4.5 per cent after fees and tax (but before inflation of 2 per cent per annum): retirees could expect to derive annual income of between $5,000 to $7,500 based on those parameters.
“The most certain way to be able to draw down more income than the baseline illustration is to start drawdown at a later age. Increasing the proportion of growth assets in the invested fund should lead to higher returns which allows more income to be generated – but it also increases uncertainty and the potential for less income to be available,” the report says. “It is important that retirees do not ‘set and forget’ their drawdown plan.”
Under the RIIG projections, retirees could be ‘almost certain’ of deriving the target level of income until about age 82 using the 6 per cent rule to over 100 via the life-expectancy approach.
NZ males aged 65 in 2023 can look forward to a further 22 years of life on average (or 24 using the ‘most common’ age of death statistic); Kiwi females live on average to age 90 with the most common death age of 91.
The RIIG report says NZ mortality statistics remain more-or-less stable since the 2020 COVID-era analysis “though the future chance of living to the highest ages has slightly reduced”.
As an aside, the RIIG study notes most people tend to underestimate their future potential lifespan.
“This means they take on some longevity risk, defined as living longer than you expected your money to last. To guard against longevity risk, it is better to err on the side of assuming a higher lifespan than a shorter one,” the report says, adding the usual disclaimer acknowledging life is pretty random outside the confines of large statistical datasets.
“Although there are known risk factors that suggest an individual is more or less likely to live to a higher or lower age, there is still an element of chance in how life turns out.”
The RIIG members include convenor, Ian Perara, and Alison O’Connell, who also serves on the Retirement Commission advisory board.