Throughout your working career, retirement may have seemed a distant dream. However, it often approaches sooner than anticipated, which is why it’s imperative to have a clear strategy for how you intend to fund your retirement income needs. It’s likely that you have accumulated savings and superannuation over your working life and to make sure this lasts the distance through your retirement years, it’s important you balance your spending in retirement, with a strategy to ensure you generate sufficient income from your investments. If you don’t get this right, you may find your savings account draining faster than is sustainable or faster at least than is comfortable for you, possibly leading to unnecessary anxiety.
Having a retirement income is a top priority for 80% of Australian retirees, as there is peace of mind and security that comes with knowing there’s reliable retirement income going into your account. We often recommend our clients who are transitioning to retirement consider investing their funds in a diversified pool of investments and structures, designed to provide for their income needs when their working life is over. This article aims to elaborate on the different types and best income producing investments for retirement, to teach you how you can make the most out of your retirement savings.
Importantly, in a very low interest rate environment, each of these options must be considered as part of your personalised strategy and what you are trying to achieve. For example, when inflation is higher than cash rates, then your money is actually going backwards in real terms. While this does not mean that you should hold $0 cash, it does mean you need to be strategic about all of your retirement income investment choices, to help you achieve peace of mind in retirement and to give your retirement funds the best chance to go the distance for your retirement years.
Understand Your Options
Typically when thinking of retirement money, the first thing that comes to mind is superannuation. However, your super is only one portion of your possible income for retirement and most importantly it is how you use your super and other retirement investments that matters. There are many other options to enhance your funds in retirement, such as:
- Age pension
- Account-based pensions (or allocated pensions)
- Term deposit investment
- Bonds & Credit Investments
- Property and infrastructure investment
- Investing in shares
A Summary of The Above Investment Opportunities
The Age Pension is obviously not an investment, but we’ve included it as it forms a part of around 70% of retirees, retirement income in Australia. It was put in place to support older Australians in maximising their overall incomes. Pension rates are indexed annually to ensure they keep pace with inflation of wages and costs in Australia. You may be eligible for Age Pension payments when you reach a certain age, which we have outlined below.
We are fortunate to have access to the Age Pension as a safety net if our retirement savings run out. However, it’s a mistake to assume that the Age Pension is enough of an income to live comfortably. The reality is, even the full Age Pension entitlement isn’t enough to cover the cost of living for many.
If you think you may be entitled to the Age Pension, we discuss all the details and the eligibility requirements in depth in our blog: “Can I Get The Age Pension?”.
Account Based Pensions/Allocated Pensions
An account-based pension, also known as an ‘allocated pension’, is a retirement income stream which you can commence using the proceeds from your super balance. This is one of the most common strategies we recommend to our clients to produce an income for them throughout retirement. You are able to utilise an allocated pension once you meet preservation age, as this is when you have access to your superannuation balance and once you convert your super to a pension, your earnings will typically achieve the added benefit of becoming tax-free.
Allocated pensions work by transferring all or part of your super fund to an account-based pension, where you can invest your retirement balance in certain managed funds to produce a regular income using some or all of your super.
This strategy can also be implemented if you are yet to retire but have reached preservation age. In this instance, the income produced from the investments can be reinvested back into the investment strategy. We have outlined the preservation ages below for your convenience.
Despite annuities being less flexible than allocated pensions, an annuity gives you a guaranteed income for a number of years, providing a sense of security and peace of mind. The key difference between an annuity and account-based pension is that your payments with an annuity are guaranteed for as long as you live or otherwise for the defined term of the annuity.
Annuities are contracts sold by financial institutions (eg. insurance companies or banks) where the funds are invested in order to generate a fixed income later in life. Annuities go through two phases: accumulation and annuitisation.
The accumulation phase commences when investors fund the annuity with either a lump-sum or consistent payments over a period of time. The annuitisation phase commences when the annuity begins paying out funds to the individual.
It’s important to note that an annuity forms part of the eligibility tests to determine your entitlement for the Age Pension, so prior to setting up an annuity, you should double check if it affects your eligibility for payment. The impact can be positive or negative, depending on where the funds are drawn from.
Term Deposit Investment
Term deposits are a type of savings account, which can be a good low risk investment option, where you earn a fixed rate of interest. The higher the interest rate, the larger the income you can earn.
When applying for a Term Deposit, you choose how much you’d like to invest and the duration of time you want the money invested. The end of the investment or term is known as ‘maturity’, and at this point you are able to withdraw your funds or reinvest.
When choosing your Term Deposit, the following four points are crucial considerations:
- What is the Interest Rate and does it change over time?
- How long can I invest for?
- How much is the minimum to invest?
- Are there any set up and/or account fees? Is there a penalty fee if I want to withdraw my money earlier than scheduled?
Bonds & Credit Investments
Bonds & Credit investments are loans that an investor makes to a government, institution, or an individual, such as a mortgage holder, in return for an agreed income. Like term deposits, they typically form part of a defensive, income-focused portion of your portfolio, however; unlike Term Deposits, there is typically some capital movement up and down and this volatility will vary depending on the credit risk of the borrower and anticipated direction of interest rates in the future. For instance, if you are lending to a AAA rated government, the risk of default is extremely low and so you would expect less volatility than if you are lending to a company for instance. Because the risk of having all or part of your initial investment returned varies, depending on the creditor.
While bonds and credit investments should be considered as part of your income investing for retirement, it is not a set and forget strategy and you should therefore weigh up:
- What is the expected income Yield you can expect and what credit risk does the investment have as a trade off?
- What is your investment timeframe? Typically it is preferable to invest with a 2 – 3 year + time frame
- What diversification strategy do you have in place to manage liquidity? IE: given there can be capital movements, this creates flexibility for your retirement income needs
- What is the likely direction of interest rates in the future
- Are there any lock in periods and/or is there a risk of the investment being frozen?
Property and Infrastructure Investment
When investing in property and/or infrastructure, you need to have clarity around how your investment is going to meet your needs, and what compromise you will need to make to get there. Being clear on your goals lays the foundation for determining the best steps on how you execute them. An investment property can be a great way to help fund your retirement, but there is opportunity cost, such as limiting your ability to contribute to super or potential Age Pension entitlements. Investment properties can also help to further diversify your assets, but being such an expensive asset, it can quickly result in single asset risk too, so there are a number of things to weigh up. Some of the other potential benefits include:
- Tax incentives: Depreciation can help offset some of the costs involved in an investment property.
- Potential property value gains: Australia’s property prices have increased dramatically over the past decade.
- Residential property rental income is linked to the human need for shelter and can therefore provide a level of predictability that is uncorrelated to investment markets.
- Commercial property can provide higher than average income yields, though with the added risk of longer periods of being untenanted and typically lower capital growth.
- Infrastructure investments are usually high-yielding investments and offer a complimentary return towards retirement income needs.
We believe when investing in direct property, it is ideal that you can hold your asset for as long as possible. One of the biggest errors we see often is not thinking forward far enough on your property decision. Selling a property, after only a relatively short time of holding the asset, can lead to tax implications and transaction costs that may have otherwise been avoided if there had been adequate financial planning for your investment property.
One of the benefits of investing in listed property and infrastructure investments, is that it has a lot more liquidity and provides more flexibility to invest and divest as makes sense for your individual strategy and considerate of the investment cycle. You can also invest as little or as much as you like, which is an appealing alternative to direct property investment.
Investing in Shares
When you invest in shares, you’re purchasing a share of ownership in a company. As a shareholder, you are entitled to any dividend payment the company makes as a result of their profit.
You can invest in shares directly through a financial advisor, broker, or through a wide range of products including managed funds. It is important to be aware of the costs associated with buying and selling shares. Although when compared to alternative investments like property, the costs are typically a lot lower.
One of the great advantages of shares is that they are highly liquid and therefore your investment strategy can be iterated along the way to fit with your overall objectives and to respond to market opportunities and risks.
Shares can be a good long-term income producing investment for retirement and in particular in Australia where there are franking credits, because franking credits can add risk free return to your income yield and they are particularly beneficial to retirees.
Naturally though, it’s important to understand the risks. Shares are highly affected by things such as market volatility and unexpected events, because they are priced in real time. It is therefore important to have a well diversified portfolio that you can hold for the long term or change as is timely to do so, which are essential ingredients to consistently successful share investing.
Yield Financial Planning is Here to Help
Good fortune needs great planning, so if you have any further questions on any of the above income producing investments for retirement and which is right for you, get in contact with one of our financial advisors to discuss your options.