Take cover from retirement
risks?
It's best to err on the
side of caution when you start feathering your nest
egg
- By Lorna Tan, Senior Correspondent
(The Sunday Times / Jun 13, 2010)
Japan, the world's most aged society, is preparing for a surge in
retirees in 2012, when its first batch of official baby boomers
turns 65.
Singapore, like many other advanced nations, is facing similar
challenges.
The Republic is expected to approach 'aged society' status,
according to a United Nations benchmark, at the end of this decade.
Singapore is currently considered an 'ageing' society as more than
7 per cent of its population are 65 or older.
A society becomes 'aged', according to the UN, when the number of
people 65 and over tops 14 per cent. Japan has already been
accorded 'super aged' status, with over 20 per cent who are 65 and
over.
Nearly 23 per cent of Japan's 126 million people will reportedly be
65 and older this year, the highest proportion in the world.
In a recent interview, Mr Satoshi Nojiri, US fund manager Fidelity
International's director of Fidelity Investor Education Institute
in Japan, said Singapore will soon encounter the same retirement
issues facing Japan now.
For instance, Fidelity's latest survey of 10,000 Japan workers
indicated that the majority recognised that health-care costs are
the largest expense in retirement. About 44 per cent of respondents
had not started saving for
retirement and those who had, had saved only one-sixth of the
retirement income needed.
Mr Roy Varghese, foundation adviser and director at Ipac Financial
Planning Singapore, said that unless one is flush with cash, one
should delay retirement for as long as possible.
Retirees should also be mentally prepared to return to the
workforce if the need arises and to consider downgrading or selling
their homes to raise funds.
The Sunday Times highlights some retirement risks worth
considering.
Longevity
risks
With advances in medicine and technology, there is a greater
probability of outliving your savings and assets.
'So don't underestimate your life expectancy,' cautioned Mr
Nojiri.
This was the main reason that the Singapore Government initiated
the national annuity scheme Central Provident Fund (CPF) Life,
which provides a regular payout for as long as you live. The
payouts are funded by the CPF Minimum Sum (MS), which will be
raised to $123,000 next month.
But other sources of retirement income are necessary to ensure a
comfortable retirement.
Health-care costs
risk
This is expected to be the biggest cost in retirement. Studies have
shown that for a person above 65, medical expenses are
substantially higher in his last year of life.
However, most healthy people underestimate health-care or nursing
care costs, pointed out Mr Nojiri.
One solution is to pass on some of the risk to insurers. It is
worth your while to shop for a suitable hospitalisation and
surgical insurance plan. It is a no-brainer to opt for one that
provides a lifetime cover, guarantees yearly renewability and comes
with an 'as-charged' feature that does away with benefit
limits.
Premature retirement
risk
Leaving the workforce before you have accumulated enough for your
nest egg is another risk, said Mr Varghese.
You would not want to be caught in a situation where you realise,
too late, that there is a substantial gap between how much you have
saved and how much you need during retirement.
'Some people quit their careers too early, thinking they have saved
enough for their 30-year 'vacation'. For some, it may be
impractical to consider re-entering the workforce after a five- to
10-year break when reality sets in,'
said Mr Varghese.
If you plan to retire at 60 - after leading an economically active
life for nearly four decades - and expect to live till 90, that is
an incredibly long period without a regular pay cheque. To sustain
a meaningful retirement, it is
prudent to calculate your retirement income seriously instead of
relying on rough estimates.
When arriving at a suitable target retirement sum to be accumulated
before quitting full-time work, a fixed payout rule may be helpful.
So if the annual fixed payout rate is 4 per cent, it means that you
expect a slow drawdown of a lump sum based on 4 per cent of your
investments.
Let's assume a couple require a monthly retirement income of $3,000
from age 60, which means an annual lump sum of $36,000. To achieve
this, the target retirement fund is worked out to be $900,000 which
is assumed to be eventually used up or drawn down by the couple
over the next 30 years. This is assuming that the sum is invested
in a low risk portfolio with an expected annual return of 4 per
cent which takes into account an inflation rate of 3 per
cent.
Ipac worked out that if the couple require higher monthly
retirement incomes of $5,000 and $10,000, the target retirement
funds at 60 would be $1.5 million and $2.4 million,
respectively.
Withdrawal
risk
Even the best laid plans may be derailed owing to bad planning or
unforeseen circumstances. One example is excessive spending in the
early years of retirement.
Mr Varghese noted, for instance, that some folks may be tempted to
go on a round-the-world trip or splurge on an expensive car shortly
after retirement. This is not prudent as the indulgence may result
in reducing the number of years that your retirement fund can last.
When this happens, you may be forced to sell the family home to
make up the shortfall.
Let's say a couple expect that they require a monthly income of
$3,000 to meet their retirement needs but they spend $5,000 in the
first year instead, with subsequent increases of 3 per cent a
year.
In this scenario, they decided to cut spending only from the sixth
year. Mr Varghese worked out that because of the overspending in
the initial five years, their total retirement fund of $900,000
could last only till 84 years of age instead of 90. In other words,
they face the possibility of struggling for cash for six
years.
'Be disciplined in the first two years of retirement in terms of
discretionary spending. If the desired lifestyle expenses were
underestimated, part-time work must be considered to beef up the
nest egg,' he advised.
Asset allocation
risk
For all investors, diversification is key as it is unwise to put
all your eggs in one basket. But this factor is even more critical
for older investors and retirees as they do not have the advantage
of a long-term investment horizon.
Mr Albert Lam, investment director at IPP Financial Advisers,
recalled the experience of a distant relative who had retired but
had made the mistake of investing only in blue chips, believing
that nothing could go wrong.
'In his first year of buying 'safe' blue- chips, he was up $1.5
million, but in the second and third year, he lost $700,000 and
$1.5 million, respectively. He has had to downgrade from his
comfortable retirement home and find part-time work so as to
provide for his spouse and himself.'
Mr Lam suggested that a more suitable portfolio for a retiree would
be one comprising mainly fixed income assets. This will ensure a
lower range of volatility and at the same time provide some returns
to offset the inflation effect.
Mr Varghese recommended the following asset allocation: cash (25
per cent), global fixed income (40 per cent), global real estate
investment trusts (10 per cent) and global equities (25 per
cent).
He added that it is prudent for retirees above 80 to have their
retirement funds mostly in cash so as to mitigate market
risks.
Wherever possible, try to balance withdrawal with the investment
performance of the retirement portfolio so as to ensure that the
funds last longer, said Mr Nojiri. This is because the returns of
the portfolio are not guaranteed and are subject to market risks
and economic factors.
Inflation
risk
The rate of inflation is an important factor when planning your
retirement funds as it will erode the value of your funds over
time.
'You may not realise how big the impact of inflation is in 10 years
even if it is a small increase each year,' said Mr Nojiri.
For instance, based on an average inflation rate of 3 per cent,
$1,000 today will be worth only $642 - in terms of today's spending
power - in 15 years' time.
This year, Singapore's inflation is projected to come in at 2.8 per
cent.
To illustrate the impact of inflation, let's use the above example
of the 60-year- old couple who require a monthly retirement income
of $3,000 and have accumulated $900,000 to last them 30
years.
If we assume three five-year periods during the 30-year timeframe,
where the future inflation rate is a higher 5 per cent a year, the
couple's expenditure will also rise by 5 per cent a year, as they
will require more money owing to inflation.
Mr Varghese worked out that the impact of higher inflation to the
portfolio will be a reduction of the drawdown period to age 84
instead of the original 90.
'Do not underestimate the possibility of higher than normal
inflation rates in old age,' he warned.
Liability
risk
Currently, most banks here do not extend housing loan repayments
beyond the age of 70. However, there are other liabilities that you
may be saddled with in your golden years, such as personal loans,
car loans and insurance premiums.
'This could put a heavy burden on you if you have no income coming
in,' said Mr Lam.
As such, he advises that should such loans be taken, the interest
repayments should be offset by income sources from employment,
businesses or investments.
Extended bear
markets
An example of an external factor that will have an impact on your
retirement portfolio is an extended bear market where prices of
equities fall over months or years. If you are caught in such a
scenario and are over-invested in equities, you might be forced to
sell out at the worst time - when prices are at an all-time
low.
Instead of timing the market, Mr Varghese's advice is to stay
invested after a market decline to benefit from the subsequent
recovery.