Page 5 - FWP Wealth Adviser Issue 109

ISSUE 109
APRIL 2025

Implications for Retirement Planning creating uncertainty around income sustainability.
Failing to account for these nuances can lead to two • Example: A retiree invested heavily in equities may
major risks: experience anxiety during periods of market turbulence,
1. Underestimating Longevity: Retirees may deplete their leading them to sell assets at a loss.
savings prematurely if they base their plans on average • Solution: Diversified portfolios combining equities, bonds,
life expectancy rather than individual probabilities. and cash can balance growth potential with stability.
2. Overestimating Longevity: Conversely, excessive caution
may lead retirees to underspend and miss out on enjoy- 4. Behavioural Biases
ing their savings. Emotional decision-making often leads retirees to make
To address these risks, financial advisers must educate suboptimal financial choices during periods of stress or
clients about the probabilistic nature of life expectancy uncertainty.
and incorporate personalised projections into retirement • Example: Panic-selling during market downturns or over-
plans. External tools such as actuarial tables provided by the confidence during bull markets can disrupt long-term
Australian Bureau of Statistics (ABS) can help refine these plans.
projections. • Solution: Working with professional advisers can help
retirees avoid impulsive decisions and stay focused on
Navigating Financial Risks in Retirement long-term goals.
Retirement introduces several financial risks that can
jeopardise long-term wealth preservation. These include: Lifetime Income Streams:
A Solution or Oversimplification?
1. Sequencing Risk Lifetime income streams are often marketed as a solution
Sequencing risk refers to the danger posed by poor to longevity risk because they provide guaranteed income
investment returns early in retirement. For example, if a for life. However, these products are not without limita-
retiree experiences significant portfolio losses immediately tions.
after retiring, they may be forced to withdraw funds at
depressed values, reducing their capital base and limiting Advantages of Lifetime Income Streams
future growth potential. • Predictability: Lifetime income streams offer consistent
• Example: Consider a retiree who begins withdrawing payments regardless of market conditions.
$50,000 annually from a $1 million portfolio during a • Simplicity: Retirees do not need to actively manage in-
market downturn that reduces their balance by 20%. vestments or worry about running out of money.
Their remaining balance after withdrawals would be • Peace of Mind: Knowing that income is guaranteed pro-
$750,000—substantially lower than if the downturn oc- vides emotional security.
curred later in retirement when withdrawals had already
reduced the portfolio size. For example, annuities and defined benefit pensions
• Solution: Strategies such as maintaining a cash reserve are popular options for retirees seeking predictable income
or adopting dynamic withdrawal rates can mitigate se- streams.
quencing risk.
Disadvantages of Lifetime Income Streams
2. Inflation Risk • Inflexibility: Funds allocated to lifetime income streams
Inflation erodes purchasing power over time, making it are often inaccessible for emergencies or bequests.
particularly dangerous for retirees who rely on fixed in- • Potential Underperformance: Returns may not keep pace
comes or conservative investments. with inflation or alternative investments.
• Example: A retiree receiving $40,000 annually from an • Complexity: Many retirees struggle to understand the
annuity may find that this income covers fewer expenses features and implications of these products without pro-
as inflation rises. Over 20 years at an average inflation fessional advice.
rate of 2%, their purchasing power would decline by As highlighted in “Are Lifetime Income Streams the
nearly 33%. Answer or Just the Easy Way Out?”, these products are best
• Solution: Incorporating growth-oriented assets such as suited for risk-averse retirees who value stability over flexi-
equities into portfolios can help offset inflation risks. bility. However, they should not be viewed as a one-size-fits-
all solution. Combining lifetime income streams with other
3. Market Volatility strategies—such as account-based pensions—can provide
Market fluctuations can destabilise retirement plans by greater flexibility while still addressing longevity risk.

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