Saturday, June 6, 2015

Wealth Projector: The Problem with Retirement Calculators

As the Australian Centre for Financial Studies notes, in their white paper Measuring Retirement Savings Adequacy in Australia, it's an ongoing problem "how to best assess the adequacy of retirement savings during the pre-retirement years". In particular they note the importance of:

"the relative expected contributions of the various pillars of retirement income (compulsory superannuation contributions, voluntary superannuation contributions, the Age Pension and voluntary savings)".

They find that "ignoring the last of these pillars is a significant omission". Put simply, many traditional financial calculators are too simplistic in their approach.

Consider, for example, projecting how much superannuation a client will have at retirement. Many traditional calculators simply take the current balance plus contributions (and less fees), and compound it over the client's working life.

But what if the client has a partner? Clearly their family's 'superannuation at retirement' should include their partner's super. However we cannot just take the client's balance at retirement, and their partner's balance, and add them together. Because what if their partner retires a few years before them, and has therefore drawn into some super by the time the client retires? Or if their partner retires a few years later, such that the partner's portion of super cannot be unlocked at the client's retirement age? Such overlaps quickly complicate the 'balance at retirement' calculation.

Equally, many calculators project 'required superannuation' by simply dividing the balance at retirement over the next 20-25 years, plus a little growth. But this misses the client's other income streams, such as the Age Pension, rental income or income from shares ("a significant omission"). Further complicating the issue is that these income streams may vary over time. For example the Age Pension Asset Test will be affected as the client gradually depletes their super or share portfolio.

One can easily posit further factors which significantly affect wealth projections, such as: adopting a Transition To Retirement strategy; taking up a casual job in retirement; selling existing assets; redrawing into home equity; receiving inheritance income; and many more.

In summary: it is overly simplistic, and potentially misleading, to consider any aspect of a client's wealth in isolation. Only by considering a complete, holistic picture of a client's wealth future can we offer meaningful and long-term assistance.