It has always been possible for people to contribute to their retirement incomes from their own resources – from earnings, savings and investments and by running down these assets – a process known as decumulation – assuming that such assets are available.
Many people die with money in the bank. This may reflect intentional bequest motives, “rainy day” nest eggs (forgive mixed metaphor), conservatism, insufficient knowledge of decumulation options, premature death or inertia. Attitudes towards bequeathing are important. But with increased longevity, those receiving bequests may well be into their 60s – a way of funding the next generation’s retirement lump sums? The fall in home ownership will, of course, reduce the availability of funds to be passed on. Inheritances can be a way of funding later life health and residential care costs (covered in the previous blog).
There are numerous options for decumulation, with the possibility that people will use several methods:
• Invest KS lump sums and other savings, using the returns for current income needs, and leaving the capital for a “rainy-day”, or bequest.
• Draw down capital and accumulated interest regularly, based on a target income, which can be altered if circumstances change.
• Trade-down to smaller/less expensive housing, which may be more suitable for later life; or move into a retirement village where greater certainty about housing costs is offset by a significant charge on capital and limited options to move on to other housing.
• Commercial equity release schemes, mainly in the form of reverse mortgages with compounding interest on released capital loans, are further options. This also means a much reduced ability to move house and loans must be repaid on the client’s death or move into residential care.
• Commercial annuities. A private sector life annuity market is not well developed in New Zealand as providers face uncertainties about how long people will live and therefore their profits. Regular annuity payments may also affect benefit eligibility (Accommodation Supplement and the Residential Care Subsidy). New products, such as deferred and variable annuities, may be coming along, and a recently launched product – Lifetime Retirement Income – offers a tax paid fortnightly income for all of the investor’s life, based on returns from an initial invested sum.
Given the need to achieve an adequate income in retirement by supplementing New Zealand Superannuation (NZS), and the growing pressure on government support, decumulation may become a more important part of the policy mix.
Prolonging working lives
Earning income after the age of 65 will help to supplement NZS and increase retirement income. This is a growing trend. It has resulted from better health, interest in work, the need for social contact and stimulation and also serves an economic purpose by helping to ease labour and skills shortages. It will also raise the tax base and improve the affordability of NZS.
There is no work-test for NZS and no compulsory retirement, so current policy settings encourage working longer. Increased flexibility of employment, both part-time and part-week, would also make it easier to “work longer,” along with improved capability by employers to manage an ageing workforce.
NZS settings were developed on the assumption that a high proportion of retired New Zealanders would be home-owners, which is still the case. Mortgage-free homeownership results in relatively low housing-related expenditures. So this is a way of pre-funding some retirement accommodation costs – offset by the payment of rates, insurance, repairs and maintenance expenditures.
But home ownership rates have been declining for all age groups, falling from a peak of 73.5% in 1986 to 65% in 2013, with projections of further decreases, which will work their way up the age groups. A Department of Building and Housing report predicts that, by 2051, 21% of households where the reference person is 65 years old or older will be living in rented accommodation. This will have an impact on the adequacy of NZS.
Evidence suggests that NZS is sufficient to provide a minimum standard of living, but any reduction of support in this or in other areas (health, housing subsidies) may result in increases in income poverty among older people, especially older renters.
The maturing of Kiwi Saver (KS) accounts and other savings, and income flows from decumulation, have the potential to contribute significantly to a comfortable standard of living in retirement. However, people on low incomes, with few assets or savings, will still rely on NZS. And for people already close to retirement there may be insufficient time to accumulate a substantial KS fund to draw on.
By OECD standards, New Zealand spends a low proportion of its GDP on pensions, mainly because of flat-rate NZS compared to earnings-related pensions overseas. In 2015, this was 5.1% of GDP as opposed to 8.2% for the OECD overall. There are many other legitimate claims on government spending, ranging from poverty relief for working-age families, education, affordable housing, mental health services, tax cuts, etc. Easing of the “burden” of NZS, perhaps with the maturity of Kiwi Saver accounts, may open up resources for reallocation.
As well as financial considerations, looking at retirement income policies highlights the importance of social and behavioural issues. What about intergenerational equity and fairness between age groups in terms of what they contribute and what they get? Rising expectations of lifestyles and access to services are often attributed to the baby boom generation. I have suggested the need for savings and decumulation and probably a higher degree of self-funding. But deeply ingrained in NZ society are feelings of entitlement to government support and a historic preference for home ownership over renting. The political implications of any drastic changes are very clear.
I believe that the debate about retirement income policies at the public level needs to be widened, as suggested by the Commission for Financial Capability, with better understanding of inter-connecting policies, personal and political trade-offs.