We are all used to the idea that if you save more money you are better off.
However, the way the age pension interacts with the superannuation system has created some perverse outcomes which in some cases mean that retirees are better off spending money than saving it.
Some interesting research by local exchange traded fund provider BetaShares found that people with superannuation balances between $350,000 and $600,000 at retirement age were particularly at risk for a retirement trap that could shrink their income if they accidentally save more.
The problem arises because the pension assets test progressively decreases the benefits pensioners can receive based on their wealth, meaning only those with well over half a million dollars in super escape the retirement savings trap.
Some retirees are better off spending than saving
BetaShares senior investment specialist Dr Roger Cohen, who co-authored the research, said it was ironic that the common, accepted wisdom of accumulating more savings should result in a higher income in the retirement years did not always hold.
“Our analysis shows that, for certain people, under the current system, accumulating more money can actually produce the reverse.”
The average super balance for Australians aged between 55 and 64 in 2017-18 was $332,700 for men, and $245,100 for women, based on ABS data.
Pension multiplier exposes the retirement trap
To work out the effect, Dr Cohen measured retirement incomes using a ‘pension multiplier’ in which a number bigger than or equal to one that shows the size of a retiree’s income relative to the age pension.
So, a retiree with a pension multiplier of 1.5 could expect to receive an income one and a half times larger than if they lived off the age pension on its own.
Using this measure, Dr Cohen found the retirement trap caught people using a wide range of vastly different retirement strategies, ranging from the very defensive to the highly aggressive, meaning that investment strategy was not the answer to escaping the retirement income trap.
Smoother transition needed
“The transition from full entitlements to the age pension to no entitlements needs to be smoother,” Dr Cohen said.
“It is certainly an undesirable situation that for some people, more is not necessarily more.”
“Without considering the eventual policy changes from the Retirement Income Review, our research shows that people in retirement can only escape the ‘retirement trap’ if they accumulate an asset base well over half a million dollars.”
The retirement income trap is the result of the progressive reduction of age pension entitlements as assets and income in retirement increase above certain thresholds.
Wide range of incomes and asset levels caught in the trap
For an individual, there is an income range between $174 and $2,026 per fortnight, where for every additional dollar earned, the pension was reduced by $0.50 and this effectively reduced the value of additional earnings for retirees in this range, according to the study.
On the assets side, for individual home owners whose assessable assets are above $263,250, the pension is reduced by $3 a fortnight (or $78 per year) for every additional $1,000 in assets. To offset this reduction, each $1,000, if invested, would need to generate an annual return above 7.8%.
High risk investments needed to win
Retirees caught in the trap are better off spending additional assets unless they can invest them and achieve returns that are well in excess of 7.8% a year if they are to exceed the pension entitlements that are lost.
Most assets that return more than 7.8% a year are well above the risk levels most retirees are happy with.
Research from the Association of Superannuation Funds of Australia (ASFA) found most Australians need close to $600,000 in savings to achieve a comfortable lifestyle in retirement.
ASFA found the average single Australian needs an annual income of $43,787 to pay for the necessities while still leaving money for holidays and other leisure activities.
Couples would need an annual income of $61,786 to achieve the same.
That equates to a super balance of $545,000 for singles and $640,000 for couples.