30 May 2017

Retirement Advice Cautioned

Here’s a surprising statistic: there are something like 120 actuaries operating in NZ.

Not many people know that; fewer care. 

But despite its low-to-zero public profile, the actuarial profession performs a highly influential role in the financial lives of all New Zealanders.

Actuaries use their knowledge of sophisticated statistical techniques to knock some sense out of the every-increasing piles of data cluttering up the world. Behind every good population projection, life insurance policy, investment return assumption, or annuity-style product – including the Lifetime Income Guarantee – there is, you should hope, a good actuary.

In short, actuaries provide the intellectual and mathematical backbone on which we can sensibly load our plans for the future.

As a rule, actuaries tend to be a publicity-shunning bunch but recently a collective of the NZ profession put their heads above the parapet with the release of a new paper on retirement income planning.

Admittedly, the title - Decumulation Options in the New Zealand Market: How Rules of Thumb can help - is not best-seller material.

The first word in the title alone – decumulation -  may prove off-putting to the non-actuarial audience. But quite simply, decumulation (a word not yet recognised by Microsoft Word) is the opposite of accumulation: in other words, decumulation is spending your savings.

And how New Zealanders could decumulate their way safely through retirement was the subject of the NZ Society of Actuaries (NZSA) paper.

The actuaries came up with four ‘rules of thumb’ (pared down from an original eight) to help retirees get a grip on their long-term income and spending plans, as follows:

  • 6 per cent Rule: Each year, take 6 per cent of the starting value of your retirement savings;
  • Inflated 4 per cent Rule: Take 4 per cent of the starting value of your retirement savings, then increase that amount each year with inflation;
  • Fixed Date Rule: Run your retirement savings down over the period to a set date – each year take out the current value of your retirement savings divided by the number of years left to that date;
  • Life Expectancy Rule: Each year take out the current value of your retirement savings divided by the average remaining life expectancy at that time.

While the rules might serve as a useful starting point for New Zealanders looking to apply some degree of rationality to their retirement-income planning, they do underplay two of the biggest risks faced by retirees: unknown life expectancy (also known – by actuaries – as ‘longevity risk’; and, volatile investment returns.

Just what constitutes a safe withdrawal rate is not absolute, highly contestable and at the very least subject to constantly-changing individual circumstances. 

Rules-of-thumb that simply require retirees to divide the dollar amount of their accumulated savings by an assumed future end date can leave them unnecessarily exposed to ‘longevity risk’.

Modern annuity products, which guarantee a certain level of income for life without depleting retirement savings early, have been taken up in many developed countries to manage this problem.

In fact, the recent Organisation for Economic Co-operation and Development (OECD) ‘road map for the design of good pension plans’ recommends governments should, among other things:

  • Encourage annuitisation as a protection against longevity risk; and,
  • Promote the supply of annuities and cost-efficient competition in the annuity market.

The NZ actuaries, too, recognise that their ‘rules of thumb’ have been built around a somewhat idealised ‘average’ retiree: statistical models, no matter how sophisticated, are, after all, not real people.

As the NZ actuarial paper says “it’s important to consider your own personal situation”, especially for the vast majority of New Zealanders who won’t conform to the actuarial ideal.

“Whatever your circumstances, you may wish to speak to a financial adviser,” the NZSA says. And the odds are the actuaries could actually be right.

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