Josh Funder- CEO Household Capital
Retirement Longevity, Housing & Funding
Josh Funder: My name’s Josh Funder. I’m the founder and CEO of Household Capital. And it’s a real pleasure to make a contribution to this year’s 2020 Third Pillar Forum. What we wanted to address today is three foundational challenges of retirement: Longevity, housing and funding. Now, if we can get those right for Australian retirees, what we can do is let them live a good life and get on with the fun stuff of retirement, but we’ve got to get those basics right first.
Josh Funder: Let’s think about the first one: Longevity, how long you’re going to live. And nobody knows the answer to that. What Household Capital has done is to use demographic, mortality and housing choice information from the Australian Bureau of Statistics, the Australian Government Actuary, as well as Household Capital’s internal information to generate four life stages as a profile for Australian couples to guide their retirement. So Australian retiree couples can expect a significant number of years at home together. If you look at this chart, there’s a whole range of years where they are together at home. And then what happens is one of the couple, one of the spouse will go into aged care, but they’ll do so briefly, probably because they’ve been able to live well at home with their partner. What happens after that, you can see on the chart, is that the surviving partner lives at home by themselves for some or a few years more. And then finally, the surviving partner goes into aged care for a couple of years, and they go in for a bit longer for their final years. That’s the average PEP.
Now, what’s happened over the last 30 years is that longevity has extended. And when the average baby boomer is going to live to 90, the average surviving spouse of a couple is going to live to 90, it means you have to plan to live until your 95 because half people, at average, they’re going to live a little bit longer. So that’s the longevity challenge: How do we support Australian couples, and singles, to get through retirement and plan to live longer than average so that they don’t get caught short?
So the second challenge is housing: How can we make sure Australian retirees have the right housing throughout retirement? The fundamental premise here is when we survey retirees, we surveyed around 4,000 of them last month, more than 3/4s of them over the age of 60 want to remain in their home throughout retirement. And the recent pandemic experience has really challenged both the health and the finances, but more importantly, the confidence of a generation of older Australians. A lockdown has really reconfirmed to many that their family homes are the safest place to live, not just throughout a pandemic, but throughout their retirements. So downsizing isn’t right for most Australians and actually, long-term, in-home aging and aged care is the desire and the expectation. Furthermore, the Royal Commission into Aged Care, in combination with that high incidence of COVID mortality and morbidity in aged care, has horrified Australians. So no Australians have had an increase in desire to go into aged care, and most of them want better in-home care, longer in-home care so they could age in place and not go into aged care prematurely.
Now, while many government policies are aimed to support in-home aging, and in-home care aging is popular and more cost-efficient than institutional aged care, it costs the government a lot less for people to stay in their homes during retirement, nobody’s got confidence that the overall funding for aged housing and aged care by the government is going to work. Most people think the government simply can’t pay for the aged housing and aged care costs. So part of the answer must be to involve recognizing the fundamentally dual role of the family home in both providing housing and providing funding, in providing access to the family home as a roof over your head and a pool of savings that you can draw on to fund retirement. Another part of the solution is to allow Australians to better fund their own retirement. So the next step in solving the challenge of longevity and aged housing in an aging population is to generate widespread awareness that the family home is both the best place to live and the right way to fund retirement.
So let’s move to that third challenge: Funding retirement, and we really want to challenge the traditional approach. Historically, a 4% draw-down around the world has been a rule of thumb that people have used as a safe withdrawal rate. And that’s meant to mean that you can draw 4% of the savings at retirement each year during retirement. And that improves your chances that your savings would last up to 30 years, which historically, was what people had to prudently plan around. Now, there are two main challenges to the usefulness of that 4% rule. It was used to generate a sustainable retirement income for 30 years, but since then, longevity’s increased, so you need your retirement income to last more than 30 years. But secondly, we’ve now got a significantly large growth environment. Your savings are going to need to work longer, but they’re not going to be working as hard for you. Dividends, interest rates, portfolio appreciation, they’re all going to be longer for the next two decades. So combined, these two major challenges of increased longevity and reduced investment returns reduce the probability that retirees can be successful in making their own retirement savings last over 30 years and meet their longevity. So retirees nowadays need to find new ways to generate their income for longer from lower investment returns.
Let’s take a case study. We’ve got a retired couple and they’re both 67 years of age, and they’ve got $250,000 in super and they own a $750,000 home, and they’re trying to fund their retirement. Now, that represents a very typical situation in Australia. That is the median case for a retired household couple, and it’s the reality. It’s not the average, which is much higher. This is what’s facing that couple. But that couple in Australia also enjoy pretty good longevity, according to that first chart, and they enjoy their own home in their own community, and that’s where they want to stay. So the new reality for that couple, looking ahead, is that they face 5% returns on their superannuation, not 10 like the good old days. They’re going to need to pay 0.75% each year to manage their investments. And let’s say their investment volatility in their super portfolio’s about 6%.
What they’re also facing is that house price growth, in the long-term, is expected to be about 3%, and the volatility of their house as an asset to be about 3.5%, and that costs them about 5% a year to access the equity in their home to contribute to their funding. The final piece of the puzzle for that couple is that long-term inflation in what they need to pay to meet their retirement funding needs is 3%. So CPR is at 3%.
So with all those factors, which is actually what are facing retirees in Australia today, how can they navigate the next 30 years of their lives? So let’s take a look at this chart. If that couple draw 4% a year of their super, the old rule of thumb, but they do that in a low-growth environment, you can see that it only provides 20 years of income. And that that income is inadequate. It’s well below the ASFA comfortable level. And what you can also see from this graph is that when one partner dies and the pension goes down, that effectively, the super runs out at about that time. So that the surviving partner has to live at home and in aged care on the pension without any super. Well below the ASFA comfortable level. That is not a good outcome. And clearly, the 4% rule doesn’t go the distance, and the couple’s retirement savings run out well before their expected longevity. But actually, the biggest problem with the 4% rule was that it focused on sustainability, how long you can stretch out your retirement savings and make them last.
Now, when most financial advisors have focused their efforts on richer clients, the top 15% of Australians, and they might have $1 million in retirement savings and super, well, making it last for 30 years meant that that savings would last, but it’ll also be enough for them. But as you can see from this graph, in a low growth outlook, the 4% rule falls short of meeting the challenge of modern longevity, it doesn’t go the distance. But it’s also the problem that most retirees don’t start with $1 million in superannuation. They don’t have adequate savings to start with. So helping the majority of retirees who start with 200, $250,000 in retirement savings to have both adequate and sustainable incomes, that should be a major focus.
And in the example on this slide, the couple were forced to live on a retirement income consistently well below ASFA comfortable index of return, and that surviving partner lived alone on the pension for the last seven years. The 4% rule, the draw-down rule of thumb left almost that decade of retirement funded only by the pension. Another really important thing to note is that during that whole time, that couple had very limited flexibility to maintain a quality lifestyle, but also to manage unanticipated expenses like healthcare, improving the home if their roof leaks, in-home care, or even simply to fund and enjoy extended longevity.
So what that is to do is to recognize the conundrum of Australian retirement funding. How do we help Australians draw on all three pillars of their wealth? And at its heart, the Australian retirement conundrum is pretty simple to state: Australians are world-class savers, but they’ve saved principally in the form of accumulated home equity. Now, while this allows Australian retirees to live at home in the communities they know well, where their family live, and that connectedness drives the outcomes of their retirement and their happiness, the emphasis on saving in non-financial assets like the home has left Australian retirees unable to afford many of the simple pleasures. And it’s also left them in a situation where it’s very hard for them to manage the unexpected capital costs, or to manage unexpected longevity.
Now, the solution to this conundrum is arguably simple as well: Access some of the home equity to improve retirees’ lifestyles, alongside the pension and their superannuation. But Australians have no widespread experience of responsible and long-term access to home equity as part of their wealth management and in their retirement funding. So quite simply, it’s our system that has not provided them the tools they need to fund their own retirement with their own savings. It’s not provided universal access to all three pillars of retirement funding. So that challenge, that conundrum, not withstanding that there is hope on the horizon in new forms of home equity access that allow borrowers to release a part of their home equity to provide an ongoing basis of a flexible and sustainable and responsible retirement funding plan, meeting both income and capital needs over 30 years of longevity.
So let’s think about a new approach, let’s mix it up. Let’s challenge that 4% rule and see how we could provide a simple rule of thumb that would provide sustainable, adequate, long-term, responsible retirement funding for retirees in Australia. We got a 3% plus 1% rule. And the idea here is that Australian retirees are already amongst the wealthiest in the world in their savings. Median wealth per household for members over the age of 65 is an eye-popping $1.4 million. And just recently, we beat Switzerland to be the wealthiest set of retirees in the world. But in most cases, around $1 million of that wealth is stored in the home, and that’s where the couple want to stay during their retirement. So instead of an old 4% rule of thumb drawing on only your super or your invested assets to get through retirement with confidence, what Australian retirees should think about now is a 3% plus 1% rule. By all means, draw 3% of the value of your investments at retirement a year. That will go further, but it won’t get you adequacy. Add to that, 1% of the value of your home equity per year, and together, you get sustainable and adequate retirement funding.
If you look at this chart, this second example, that same couple can do a whole lot better using the 3% plus 1% rule when they’re starting retirement in a much more typical Australian situation, being asset-rich and income-poor, having done most of their savings throughout their lives into their home and only halfway through their careers getting superannuation. So take a look. To improve the chances that superannuation’s going to last 30 years, draw down 3%. And with a 90% probability, that 3% draw-down will get them the distance. You can see on this chart that superannuation’s going to run out when they’re 97. Now, while that 3% draw-down on super would be more sustainable, it would provide our couple with an even more inadequate income, it’d be lower to go longer, and it would further reduce their lifestyle and their retirement well-being outcomes.
By adding an additional 1% per annum draw-down from home equity, the three plus one, our couple here on the chart could start to begin to achieve retirement income that’s both sustainable over more than 30 years, and adequate relative to comfortable lifestyle standards. Now, you can see here, their income is much closer to ASFA comfortable, right through retirement. And right through retirement, the life of the couple together, and the surviving partner, the three plus 1% super and home equity draw-down means that in a low growth environment, that coupled provides both adequate, lifelong income. And during that time, they didn’t go just to the pension, they always had access to their super and always had access to their home equity. And what that also meant is that access to that income closer to the ASFA comfortable standard. And they had access to contingent funding, they could draw on their own capital to meet unexpected, lumpy needs.
So that flexibility to draw on additional funds along the way, they needed to renovate the home, made unexpected expenses, fund health care, help their kids, would mean that couple could live even longer than 100 if they chose to. And the probability that they had enough superannuation and enough home equity to fund their full life would be over 90%. That would give Australian retirees, using the three plus 1% rule confidence to navigate retirement into an unknown era of longevity.
So let’s go through some of the conclusions on the Australian path to a sustainable, adequate and balanced retirement funding system. The three plus 1% rule of thumb has several major implications for that retirement funding system. Firstly, three plus 1% provides a sustainable adequate retirement funding plan for the majority of median Australian retirees, not just those with $1 million in super. Three plus 1%, as a rule of thumb would improve retirement outcomes, their lifestyles and the well-being of millions of Australian retirees. Three plus 1% will help Australian retirees draw on all three pillars of their retirement funding and their own wealth flexibly throughout retirement to meet their own funding needs and so fund their own retirement. The three plus 1% rule harnesses the value over the family home for those two critical things, retirement housing and retirement funding through longevity. Three plus 1% rule also diversifies retirees’ sources of retirement funding across both their portfolio and superannuation and their home asset, and it improves the probability that they’ll successfully fund their lives adequately for their full longevity.
The three plus 1% rule of thumb is transformative in that it preserves significant savings for the retirees along the way, for contingency funding, for them to be the Bank of Mum and Dad, and also at the end of life to leave a bequest. But to do that flexibly without unduly depleting their own available retirement funding. The three plus 1% rule is really important because it supports age appropriate housing for in-home, in-community aging at all stages of retirement, allowing enough funds to renovate the house, to put in the stair rail or the shower rail, and to make sure that that house is appropriate for the couples as they age together for the surviving partner and to keep them both out of aged care for as long as they possibly can. The three plus 1% rule maintains a significant reserve of value to fund in-home care, and then also to fund residential aged care when people need to move out of the home for their own well-being. That three plus 1%, as we propose it, would boost retiree consumption, and retirees spend their money locally in the economy that would provide a long-term stimulus to our economy, much needed as we rebound from pandemic. Three plus 1% rule would bring to bear $1 trillion of retirees’ savings to fund their own retirement without including the home and the assets test for the pension or imposing a death tax to recoup the costs of aged care services.
So we think it’s a profound change in the availability of retired funding… Retirement funding and the availability of people to access their own wealth to fund their own retirement. And the availability of people to have choice and flexibility about how they dispose of their wealth right through their lives. There are some clear policy considerations for Australian retirees to gain widespread access to home equity retirement funding. Let’s think about the first and most immediate one. During pandemic, the federal government has reduced the minimum draw-down on pension phase superannuation accounts. It used to be 4% at retirement per year and then it would increase over time. And they’ve reduced that by 50%. So that now the minimum draw-down a retiree needs to make at retirement is 2% a year. Now, as the government considers reinstating a higher level of minimum draw-down, they need to consider the sustainability of superannuation accounts, in a low-growth future, where people enjoy significant longevity. A 3% draw-down equivalent would extend the availability of superannuation by up to 10 years to the age of 96 for most retirees at a 90% confidence. A 3% minimum draw-down scaled over time would improve the sustainability of our retirement funding system, but it wouldn’t improve the adequacy.
That second important policy point that we’d like to make in conclusion, is to say that home equity can make an important contribution to the adequacy shortfall, to the wealth and excess shortfall facing baby boomers’ retiree who only received 3% super contributions partway through their working lives. But they’ve been savvy to save, and then they’re now the wealthiest retirees in the world by buying their homes 40 years ago. Making widespread the availability of home equity retirement funding has implications for self-funding at retirement, has implications for lightening the load on the united pension, it has very serious implications for how we solve the aged care funding crisis identified by the Royal Commission, and how people can fund in-home care longer throughout their lives. So housing is an important determinant of aging outcomes. You do better at home, you’re happier, you’re in community, your relationships are more vibrant, you have a house over your head, you have a source of funding for your retirement, and you have more confidence with which to live a good retirement and live into the future.
What’s important here to acknowledge as well is that all of the three plus one rules and the benefits from it would apply to the vast majority of Australian homeowners. But as a society, we really need to recognize that some of the most vulnerable people in our community are people who don’t own their own home, are retired, are on their pension and are renting. So it’s very clearly that that category of people, particularly women need better assistance through rental assistance, through vulnerability services, and an affordable housing system. With that, I’d like to leave you with our summation. A 4% draw-down rule for most Australians doesn’t go the distance, but a three plus 1% rule, drawing on your available superannuation, as well as your home equity, meets the needs of the vast majority of Australians and can transform retirement funding over decades to come. Thank you.
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