SMSF retirement income strategies: Managing risk, income and longevity

In this interview, we speak with Melanie Dunn, actuary and head of retirement at Accurium, about the risks most SMSF retirees underestimate, how to balance income certainty with flexibility, and the practical steps you can take to stress test your retirement strategy.

Robert Barnes

What are the biggest challenges SMSF retirees face in generating reliable retirement income?

Melanie Dunn

Yes, great question. And I think, look, approaching retirement is a really challenging time. You’re planning to retire from work and all of a sudden you’ve got to start using all of this savings, this wealth you’ve accumulated, figure out how long it’s going to last, how much can you spend, all these big, big questions. And seeing a financial adviser can be really helpful in providing you with confidence that you’re going to be on track. There’s a lot of research that shows that people who have a solid retirement plan have a lot more certainty and comfort about their retirement. And the challenges are great. You know, you’ve got to understand what you’re going to spend in retirement. A lot of people might not have done a budget. You might not know where your salary is going each month, so Sitting down and working out what you’re spending and how that might change in retirement. You know, you might want to create a golf club membership, you might pay off some debt and not have to pay those repayments every year. So working out what you’re going to spend is really critical to answering some of these big questions.

And of course, at the moment, no one has to tell you, don’t forget inflation and the cost of that over time. Think about what you’re invested in and is that mix right for retirement? And look at the timeframe. This is one of the biggest things that people maybe underestimate, but I think more and more people know grandparents or friends or relatives who live into their 90s or even to age 100. So thinking about spending, investments, and your timeframe when you’re looking at, you know, modelling out or talking to your adviser about how long your money might last.

Robert Barnes

APRA funds must create a retirement income strategy, but SMSFs don’t. What risks do SMSF trustees underestimate when planning retirement income?

Melanie Dunn

Yes, you’re right. So, the APRA funds have to look at a retirement income strategy. There was no requirement for SMSF trustees to do that, but we of course have the SIS Act retirement foreign investment strategy. We have to formulate and regularly review a strategy that thinks about all these key things, retirement risks, liquidity, diversification, how we’re going to meet our pension payment liabilities into the future. So, if you’re sitting there and thinking, okay, I’m going to retire, how do I create a plan that considers all these things? Look, it’s really important, as I said, think about your spending, your investments, and your timeframe. And the one that a lot of people underestimate, I think, is that longevity, risk. You know, what I love to talk about, and with my actuary’s hat on, you know, I’m pretty passionate about this space, but you know, how long are you going to live? If you Google that, you’ll probably come up with 100 different answers. There’s a lot of different ways you can calculate life expectancy, which most statistics are based on the Australian Government Actuary life tables, and that’s actually based on data from the 2021 census. So it’s already 5 years old.

So best practice is we allow for future improvements in mortality. This idea that we’re living longer, and that’s just a starting point. So life expectancy is the average, the average age we expect someone of a gender and an age to live based on the Australian population. But the fact is the statistics say that more than 50% of people live beyond that age. So you’ve got less than a 50% chance your timeframe is long enough. So longevity risk, I like to talk to people about thinking a bit like investment risk, you know, a risk-based timeframe. So what you can do is use these statistics to work out, well, I like to call it 25% age. What’s the age beyond which only 1 in 4 households will live beyond? And I think that’s a really great starting point as the timeframe for an advised retiree household or an SMSF retiree. There was some great research out of the Uni of New South Wales last year that actually got some proprietary information from the government, from the census, and looked at life expectancies based on different characteristics like home ownership, wealth, socioeconomic status, if you were married or not.

And what they found was people with the kind of most advantaged characteristics versus the least advantaged, for men there was an 11-year difference in the average life expectancy at age 60, and for females it was 9 years. Now as an actuary, that is like really material. And what they found was that the population is kind of down the lower end, But if you think about yourselves and, you know, your status, you probably own your home, you probably are from a more socioeconomically advantaged background, maybe higher net income, your life expectancy is probably above that, above the population average. You’re probably up near that 25% age. So I’d really encourage people to, you know, really make sure you’re thinking long enough because that’s really critical to answer those questions like how long will my money last? What can I afford to spend?

Robert Barnes

How should retirees balance income certainty with flexibility? And how does that change over retirement?

Melanie Dunn

Yeah, look, it’s hard to create a retirement plan. There’s the 3 key trade-offs we talk about, you know, maximising your retirement income if that’s an objective for you, balancing the risk you’ve mentioned, sequencing risk, market risk, longevity risk, inflation risk. There’s quite a few things to do there. And this flexibility to access your savings, this idea that you don’t quite know what’s down the track, you want to be able to access your money if you need it. So, you know, when you’re doing some retirement modelling or when you’re speaking to an adviser, It comes back to that spending, being very clear on, you know, what is the realistic outcome that you want, you want, and those ad hoc needs, you know, do you want to allow for some aged care planning down the track? Do you want to always have $100,000 in your bank account for uncertainties? We can build those things into our retirement modelling as part of setting a retirement strategy, and they are really important to allow for. In terms of the trade-offs, I think, you know, What can you do? People talk about bucketing, you know, making sure you’ve got some liquidity on hand to weather a few years of poor market outcomes so you don’t have to eat into those growth assets, or making sure that if the markets go down and your assets are, you know, under threat, maybe you reduce some of your spending that year if that’s possible for you.

So there’s a few different things you can think about, but obviously speaking with a professional can always, you know, help give you some certainty around those different strategies.

Robert Barnes

What tools can non-advised trustees use for retirement modelling?

Melanie Dunn

It’s harder, isn’t it? Yeah, I mean, MoneySmart has some great information. You know, the government tries to put some good information on there. There’s some simple calculators available on that website. And if you’re just engaged enough to start thinking about this, that’s a great point. You know, you’re starting to think, what if the markets do this? What if I spend this much? You know, playing around with some of those free online tools. Obviously, the more sophisticated tools that really dig into what we call stochastic modelling that allows for the future uncertainty of returns and really digs into stress testing your strategy. It’s true that there’s, I don’t think there’s any kind of free calculators of those available.

Robert Barnes

Telstra Super.

Melanie Dunn

Oh, Telstra Super, yes, some of the super funds, of course. So if you are with a particular retail fund or you want to jump on the website of some of the industry funds, there are some tools available there. And because of this retirement income strategy, they are building more sophisticated member engagement and tools available for people. So it is great to see some of that sophistication become available to the market.

Robert Barnes

What role do different asset classes play in sustainable retirement income, and are some over or underused by SMSF retirees?

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Melanie Dunn

Look, always new and shiny things come around, isn’t it, that we need to think about. And I think, you know, if you’re a considered investor, you already know the basics. You know, it’s really important to think about diversification. It might be true that over the long term, you know, Aussie equities might have outperformed other asset classes. In the short term, there’s more volatility. So this risk-return trade-off is something to be aware of and thinking about what pools of buckets of money you have that you want for different purposes. So if you know you want to go on a holiday, it’s going to be $50,000 in 3 years’ time, you want to be in an asset class that’s not too volatile because if the markets tank and you take that money out, then you’ve had a detrimental impact on your portfolio. So thinking about where your money is invested and what timeframe is appropriate for that. And, you know, making sure all your eggs aren’t in one basket is generally, for most people, a good approach to manage this volatility, this market risk. Inflation risk, you know, that’s challenging, making sure some of your investment returns are producing real, you know, positive income above inflation so that you can draw that spending each year that takes account for the costs rising over time.

And still grow your portfolio as you need to last in retirement. And longevity risk, you know, that one’s a bit more challenging. In terms of an asset class, there’s some products now available, a lot of innovation is actually happening in this space called lifetime income products, lifetime income streams. People might have a view of the old lifetime annuities, but there has been a lot of innovation in this space and I would encourage you to go out and see what’s around because there’s so many new features. They offer reversionary now, death benefits, Lots of different income indexation options. So a really interesting asset class, particularly for those members with assets above the assets test thresholds or just outside the Age Pension. Got some great Centrelink concessional treatment as well. So yeah, if you’re not familiar with that type of product, you’re probably familiar with account-based pensions and accumulation assets. But yeah, go and have a look at lifetime income streams.

Robert Barnes

In retirement modelling, which assumptions are most critical to get right?

Melanie Dunn

Yeah, that’s a great question. So when you’re doing that retirement modelling, it’s true that spending has the biggest impact on the outcome. If you’ve got $1 million and you want to spend $50,000 a year versus if you want to spend $250,000 a year, like that’s hugely material. So understanding your spending is the number one. Then of course, thinking about investment risk. So what most calculators or models do is use a fixed assumption. So you might look at the average over the past 10 years and go, this is what this portfolio achieved. Let’s assume that continues into the future. I’m sure you’re all aware of all the disclaimers. You know, the past is not a reliable predictor of the future. And even further, when we’re using those models, you might play around, what if it’s 5% a year? What if it’s 3%? It’s kind of being conservative. But the fact is, we know all of that will be wrong, right? You’re not going to receive 5% every year or 3% every year in the future. So this is where that stochastic modelling comes in. If you can find tools that allow for these future variations, so they do thousands of simulations where You know, year 1 might be 5%, then 7%, then -20%, then +10%, you know, all correlated to represent the distribution of real-world returns.

Now, why that matters for your portfolio and your modelling is that it’s allowing for real-world risk. You know, what happens to your portfolio outcomes if things go up and down? And that sequencing risk is really key in retirement. So those types of models can be really valuable for helping you stress test your portfolio.

Robert Barnes

How often should retirees review their retirement strategy and what triggers should prompt an earlier review?

Melanie Dunn

It’s a mix and it probably depends on your objectives and how kind of safe you’re being with your outcomes. So, you know, retirement is a great one to make sure you are reviewing your strategy and testing how things go in those first few years into retirement. But primarily when big things happen, when things change, you know, maybe you sell an asset and you want to reinvest it or If you get an inheritance or you need to make a big payment, they’re all obvious times to reset it. But then it kind of depends on your strategy. So if your strategy is you want to preserve your capital and you’re living off the earnings, well, you know, that’s what you’re doing. It’s not going to change too much over time. So maybe every, you know, 3 or 5 years, you kind of safe enough. Now, if you’re a spender and you want to, you know, spend the kids’ inheritance and consume your savings, that is an amazing objective. But that’s also a bit riskier because you’ve got to make sure you’re on track as the markets go up and down. So you might check your you know, run your modelling or check your strategy every year or every couple of years just to check how things maintain the course and make sure you’re on track.

Robert Barnes

Are you seeing any emerging trends in how retirees are structuring their portfolios or drawing income?

Melanie Dunn

Other than the lifetime income streams, I think is where we’re seeing a lot of space and a lot of that’s being driven by governments and the work with the APRA funds hasn’t quite hit our SMSF sector yet. I do think it’s a really interesting asset class people should start to be aware of. I think other trends, obviously just with the ongoing cost of living, we’re seeing maybe people deferring retirement a little bit longer. Obviously we have the condition of release age 65. Once you hit that age, you can access your super. We have our preservation age now all aligned at age 60, and we did a lot of work last year actually. It was really interesting. People were thinking about when can I access my money? When can I start to retire? And they thought, oh, maybe I’ve got to actually fully stop working. That’s not quite the case, is it? You know, after age 60, as long as you cease an arrangement of gainful employment, even if you’ve got other work that you’re still doing, that’s a condition of release and you might be able to access your superannuation. So the Census has just started recruiting short-term roles, elections are in South Australia, there’s one here, another great time.

So yeah, if you’re unsure, talk to some professional, but there’s plenty of opportunities I think that we are seeing people be more aware of. For opportunities to start accessing their superannuation and transition into retirement.

Robert Barnes

For SMSF trustees, what practical steps can improve the sustainability of retirement income?

Melanie Dunn

Oh, that’s a good one. I think be engaged and find that calculator. If you’re advised, go and talk to your advisor and try and stress test your strategy. That, you know, that will give you so much confidence that you’re on track. If you just do a little bit of work to think about your spending, think about your investments, think about an appropriate timeframe that’s realistic for someone like you and model that out and have a look and keep an eye on it. And I think, you know, that’s the most— every model’s different, every model’s wrong really. We can’t predict the future, but by being engaged and thinking carefully about the risks you face in your portfolio, I think that’s the most important thing. Don’t just hope for the best and cross your fingers. I’d say if you are engaged and you are thinking about it, you know, that’s a great start to having confidence in your retirement.