3 factors affecting retirement income

High life expectancy and low interest rates may make it harder for some retirees to live long and prosper.

Here we look at three elements from an AMP Capital Investors report; that affect a post-work reasonable income - interest rates, inflation, and longevity.

Interest rates - high valuations, low returns

Historically low interest rates have driven valuations of defensive assets such as cash and fixed interest to unprecedented highs. Generally, a defensive asset is seen as a lower-risk, lower reward investment.

High valuations mean low yields (or percentage income returns in the form of dividends and interest) for defensive assets.

AMP Capital Investors reports record ­low yields across many fixed income assets and some types of property. Term deposit rates are also at fresh lows, following the Reserve Bank of Australia's reduction in interest rates.

Low interest rates affect variables such as inflation and investment returns, which in turn affect how we save for retirement.

The inflation perspective

Inflation has a big impact on retirees who are less able to earn and save more after their working lives have finished. Falling returns mean providing for retirement is challenging, but although returns are low now compared to in the past, the impact is eased when you take inflation into account.

Inflation was running at around

15 per cent in the late 70s and 80s, which ate up much of the bond and term deposit returns.

Nevertheless, the combination of low interest rates and low inflation make it hard for retirees to find returns.

There are risks too, should the current global inflation rate of about three per cent shift higher than the defensive asset classes. As these assets are priced for the very low inflation of today, they would face major negative revisions.

The longevity conundrum

Australians are also living longer, increasing the risk that a retiree will outlive their savings. Back in 1980, a man starting a pension at age 65 had a life expectancy of 78 - 13 more years. Now, a male starting a pension at 65 has a life expectancy of 86 - an additional 21 years. While this is great news in many ways, financially it means higher income needs and the need to grow the assets over time to make up for rising costs of living.

This is a concern in an environment which sees retirees drawing down on their pool of retirement assets because they can no longer generate sufficient income returns. This means retirement account balances are being depleted relatively quicker than in the past, especially if retirees lack exposure to growth assets to generate some capital growth over their longer lives.

Supporting an ageing population to achieve their retirement goals in a market of lower investment returns is a major challenge. A stable policy framework for superannuation and a long-term approach will be important in giving retirees the best chance of achieving a comfortable retirement.

Planning ahead

When investing with a goal - such as retirement - in mind, it pays to think long term.

Of course we are also here to help you work out what's right for you.

(i) Retirement today - the challenge of retirement returns. AMP Capital Investors, 19 August 2019.
© AMP Life Limited. First published October 2019