Towards a smarter way of planning retirement savings

A new online calculator is more responsive to individual needs

Increasing the superannuation guarantee levy is often touted as the panacea for a comfortable retirement, but what if it comes at the cost of financial hardship for a young family saving for a home and their children's education?

It is a scenario prevalent enough to put anyone off planning for their retirement, let alone engaging a professional to help them through the maze.

At least part of a simpler picture rests with the readily available web calculators used by consumers and qualified practitioners to help with crucial financial decisions. 

Based on the input of some basic parameters such as income, expenditure and life expectancy, it is easy to see how over time one's assets quickly deplete, opening the way for reliance on the Age Pension. Or not, as the case may be.

With a bit of tweaking with the asset mix of investments a person's retirement age could be bought forward or their spending prolonged, provided they are comfortable with a certain level of risk.

According to UNSW Business School associate professor Anthony Asher, what's missing in most web-based calculators – and possibly financial advice that stems from the information fed into and generated by the calculators – are the implications of financial decision-making around the things that matter most to people.

"Children and a home are much more important to younger people than their superannuation, yet this is where a lot of the calculator and adviser questions focus. The reality is the average person currently retires with half their wealth in housing and less than half their wealth in super," says Asher.

Asher's aim, along with co-investigators Adam Butt from the Australian National University, Gaurav Khemka from Bond University and Ujwal Kayande from Melbourne Business School, is to produce a gold standard web-based calculator to help people meet their financial goals.

‘Children and a home are much more important to younger people than their superannuation’ 

ANTHONY ASHER

A more accurate picture

Most calculators start by asking you to set your target retirement income and then adjust how much you save based on those targets. But no one wants to drop their standard of living now so they can have more later, especially if it means giving up buying a house or the childcare they want and need, Asher says.

He believes it would be considerably more engaging and empowering to factor in what is important to people and show how someone's standard of living could remain constant throughout their lives.

"Obviously there will be ups and downs along the way, like promotions and redundancies, but if people can be clear about their goals from the start then they are more likely to be engaged with their finances for their future," says Asher.

That is where financial advice around life and disability income protection insurance could be introduced and in a more meaningful way, he says.

If part of the reason behind the lack of engagement people have with their own finances and financial advisers stems from the information they have, then taking up Recommendation 37 in the government's response to the Financial Systems Inquiry could help.

Asher says the recommendation to facilitate access to consolidated superannuation information from the Australian Tax Office (ATO) to use with ASIC's and superannuation funds' retirement income projection calculators would certainly help present the correct data for people.

"People do not keep detailed information on their financial position. Financial advisers say clients often don't even know what they are spending. The ATO has data on earnings and financial assets and liabilities, and so if people could just plug into that, there would a much more accurate picture," he says.

‘People need to know the impact on their spending when investment returns differ from [what's] expected’

ANTHONY ASHER

 Context of real-world risks

An advisory group has been set up with key players in the retirement income space, including Challenger Limited and StatePlus, to help align the proposed Financial Planning Calculator with consumer needs and guide it to extend best practice in the industry. Asher and his team hope to release a version for research purposes later this month.

Challenger Limited's head of retirement income research, Aaron Minney, says a key component of best practice is that the calculator actually considers a range of outcomes, rather than just assuming you always get the average.

This enables the user to have some context of risks in a real-world setting, he says.

One particular component is the flexibility around earnings. Users can project a switch to part-time, planned time out of the workforce and plan for key family events.

"This should help engage younger superannuation members who might be more worried about a mortgage and their children than they are about paying for a retirement that seems a long way off," says Minney.

He believes it is important that when people do reach retirement they know about generating their income in retirement.

"Hopefully this can help people engage with their super, and the objective of income in retirement, at an earlier age," Minney says.

Part of the motivation for the new calculator is the findings here and in the US of considerable variations in the advice given by website calculators and personal financial advisers.

Asher says he has found that existing web calculators give widely varying advice on the amounts required for life insurance. Studies have found that the reasons for someone being under or over-insured can be questionable financial advice, procrastination and the unpleasantness of thinking carefully about one's death.

Asher believes it likely that there are similar reasons for not considering the consequences of not saving for retirement, and providing for longevity.

Concern areas of the heuristics presently being used by advisers and implicit in the web calculators available include the 'bucket' asset allocation approach which allocates low risk assets to fund 'protected consumption' and invests the balance in higher risk assets.

"It effectively assumes that it is possible to lose all of the higher risk assets, and so probably leads to under consumption (as they will not all be lost) and too low an allocation to potentially higher returns," says Asher.

 Impact on spending

On the other hand, calculators typically allow users to change asset allocations (or expected return assumptions) without outlining the risk behind doing that.

"Information about the statistical distribution of returns is neither helpful nor relevant. People need to know the impact on their spending when investment returns differ from [what's] expected," says Asher. 

"We are experimenting with different ways of communicating this. The calculator will attempt to elicit user's aversion to having to reduce consumption if investment returns do not meet expectations.

"A common assumption is that assets run out at life expectancy, and spending drops at that stage to that which can be afforded by the Age Pension. No allowance is made for the likelihood that all but the completely myopic will reduce consumption some years before assets are completely exhausted." 

Annuities will be added later into the investment mix as they must have a potential role in rational asset allocation – especially as people age.

Asher says it is important to focus people's attention on the choices that they have to make (how much to spend and where to invest) and give them greater confidence to spend and invest both for their own benefit and the good of the economy.

Oliver Wendell Holmes apparently said: "I would not give a fig for the simplicity this side of complexity, but I would give my right arm for the simplicity on the other side of complexity."

"Current calculators too often seem to stop on this side of complexity. We acknowledge that we are building a more complex calculator. We do not know that we will find simplicity on the other side, but it must be worth the effort," says Asher.