The days of a long, uninterrupted accumulation phase followed by a 30-year retirement might be over
Retirement planning used to go like this.
Once people start work, they embark on the so-called accumulation phase. Over 30 to 40 years, they maximise their earnings potential and save up their nest egg. Then they retire and the drawdown phase begins. On average, people have roughly 20 to 30 years to spend their savings before they die.
In the drawdown phase, retirement planners have traditionally assumed a 4 per cent withdrawal rate. This describes the proportion of your retirement assets you can safely withdraw in your first year of retirement.
To put this rule into practice, if you project that you need S$40,000 a year when you retire in the year 2020, you will aim to have S$1 million in retirement assets then. The 4 per cent number was first devised in 1994 by former US financial planner Bill Bengen.
Mr Bengen stress-tested withdrawal rates to see how long portfolios will last before they are exhausted. He took into account the volatility of the stock market and major events in financial markets such as the inflationary recession of 1973-1974 and the Great Depression of 1929. He concluded that abiding by the 4 per cent rule ensures retirement portfolios last for at least 33 years and in most cases, 50 years or more. To deal with inflation worries throughout retirement, one’s portfolio will be fully invested. Mr Bengen’s study had assumed one’s money was 50 per cent invested in stocks and 50 per cent in US government bonds.
Common sense dictates that with such a portfolio, you initially live on dividends and coupon payments, liquidating some assets as necessary as you get older and as costs of living go up. The amount you can withdraw in the second year and beyond is the 4 per cent of your initial portfolio adjusted for inflation.
The 4 per cent withdrawal rule is just a starting point. It has its flaws.
Begin your retirement at a time of market crashes and you cannot withdraw too much, too fast. You will run the risk of your portfolio running out before you die.
Start your retirement with a stock market boom, meanwhile, and you can probably treat yourself to more than 4 per cent. Otherwise, there could be too much left, and you will have deprived yourself unnecessarily. Other factors threaten the viability of the model. People are living longer, increasing the risk of their savings running out. Healthcare costs continue to go up. Most people will incur substantial healthcare expenses in their final few years of life.
Sometimes, people cannot manage their retirement assets in a disciplined way. They might be tempted to use the money to try to flip properties in a bull market. Children might need help to buy a property or to study. So while the 4 per cent rule implies a fixed spending schedule, reality will be anything but that.
When retirement plans fail
More significantly, in a time of slow growth, bond yields around the developed world, including in Singapore, have plummeted.
In 1994, investors could seek refuge in US 10-year Treasuries yielding 7 per cent. Today, they yield around 2.5 per cent. Last July, they were at a frighteningly low 1.4 per cent. Lower interest rates lead to lower retirement plan returns. The money might run out faster than people think.
For those who recently joined the workforce, a bigger worry is the uncertain economy. Their questions become: How long is the accumulation phase? Can we still gather assets till we are 60 like our parents did?
Contract jobs are on the rise. Cushy jobs are no longer guaranteed for life. Technology continues to disrupt every industry. People will face episodes of retrenchment. If they are in their 40s when this happens, it can take a while before they can get back on their feet.
All this is scaremongering, you might say. Singapore’s resident unemployment rate is still under 3 per cent as at September 2016. But people who are out of work are taking a longer time to find new jobs, according to the latest figures. Moreover, unemployed people continue to outnumber job openings.
A rethink is needed
Savers young and old thus need to question traditional assumptions around planning for retirement. The idea that you can make steady deposits into your nest egg over an accumulation phase of 30 to 40 years is unrealistic. Similarly, one’s withdrawal phase need not consist of fixed withdrawals over 30 years.
After all, some people might take a break in between careers. There might be years of retraining needed for a new industry, either because your old industry was rendered obsolete, or because you find the new one offers more meaningful work.
You might have shorter accumulation periods, interspersed with withdrawal periods. Perhaps you have already worked for 10 years, but your firm gives you a two-year break to recharge and spend time with your children. You then go back to work for five years, before taking a year off to volunteer at a local charity.
Savings schemes have been designed for these situations. In the Netherlands, the government once tried out a “life course savings scheme” to encourage employees to save or invest to fund periods of unpaid leave. The scheme was merged into another one, which was not introduced due to funding concerns.
In Singapore, a scheme that has the potential to benefit people through periods of unemployment is the Supplementary Retirement Scheme (SRS), though it was not specifically designed for this purpose. In the SRS, contributions are tax-deductible but taxed as income upon withdrawal. Incentives are skewed to promote withdrawal after retirement, such as a 5 per cent penalty on early withdrawal before retirement age.
But if you contribute in your 20s and 30s from a tax bracket of above 5 per cent, you can still viably use SRS savings before retirement as a backup source of basic income if you become unemployed in your 40s or 50s. While there is scope for the early withdrawal penalty to be tweaked, I am not a fan of the idea of expanding the scheme Dutch-style yet. This is due to excess bureaucracy concerns.
The idea, as some tax specialists have recommended, of increasing the SRS contribution limit or allowing people to contribute to the SRS of family members should also be shot down. Such suggestions mostly benefit high earners, who already use the SRS as a tax shelter. As it is, the government will already be spending more in the years ahead due to the needs of an ageing population. Everybody needs to pay their fair share of taxes.
A new model of work
And Singaporeans arguably don’t need to be further encouraged to save. Rather, they need to be prodded to keep learning to stay relevant to the world. The SkillsFuture account introduced recently works towards this philosophical aim. As people practise lifetime learning, the traditional retirement age of 62 or 65 might no longer apply. One might continue doing part-time work one enjoys long after “retiring” from full-time work at age 50, all the way till one’s 80s.
A new model of work, education and leisure will have profound implications for people planning their personal finance journeys. For starters, if people can indeed find work in their 60s and 70s – a very big if – a retirement “number” in the millions one needs to hit before 62 becomes less relevant.
Secondly, one cannot just invest in stocks, even though their returns are superior to bonds going by past performance. Bonds of shorter-term tenures will rise in importance as people buy them to get some returns while possibly liquidating them in a few years’ time to pursue other goals.
Finally, the role of the Central Provident Fund (CPF) can evolve further. Its original purpose of providing for a basic retirement might change to providing for basic needs during periods when one is without income.
The need to draw from one’s CPF can arise when one is 40, 60 or 80.
Retirement doesn’t have to begin from 62. Neither should retirement be a permanent condition.
Whatever people do, the crux is to stay healthy in body, mind and spirit. One’s retirement security will then take care of itself.
Source: The Business Times © Singapore Press Holdings Limited. Permission required for reproduction