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Financial planning, Investment and Self Managed Super Fund Article
Financial Literacy and Retirement Readiness - Part 1
By Lester Wills
1st December 2006
This article may be out of date.
Mercer Wealth Solutions recently released its Financial Literacy and Retirement Readiness Study 2006. Studies on financial literacy are not new. The ANZ undertook such an exercise in 2003 in which they claimed that:
…financial literacy is all about enabling people to make informed and confident decisions regarding all aspects of their budgeting, spending and saving, and their use of financial products and services, from everyday banking through to borrowing, investing and planning for the future.
Further, ANZ argued that financial literacy has become an increasingly important requirement for functioning in modern society, and trends in work patterns, demography and service delivery suggest that it will become even more important in the years ahead. Mercer suggests that the benefits of a financially literate society include:
- reduced dependence on the government for economic assistance
- reduced risk of falling victim to unscrupulous financial schemes
- confidence for individuals to take control of their finances and make decisions which help grow their savings
- increased employee confidence in making sound financial decisions for their employers
- increased knowledge about financial matters providing greater opportunity for individuals to grow their savings for retirement.
As Mercer rightly points out, numerous surveys have found glaring holes in Australia’s level of financial literacy and preparedness for retirement. However, Australia is not alone.
The 2004 Prudential Retirement Index in the UK found that when people were asked if they had considered how much money they needed to save to provide them with the income they wanted in retirement, 50% had no idea.
They also found that two thirds of those surveyed had not taken any financial advice before they retired. When they asked people currently in the workforce about their expected lifestyle and income in retirement, the report described respondents as “living in a fantasy land”.
The Citibank Retirement Index 2005 investigated confidence in having enough money in retirement and found that approximately 30% of the total sample considered they do not have enough savings to get by on, a figure that rose to 42% for those aged 55-64.
Almost two thirds of those surveyed as part of a global research project by HSBC also in 2005 said that they had begun to prepare for retirement, but most of this was restricted to reading up on the subject and discussions with family and friends. They also reported that Canada was the country best prepared, yet even there, when people were asked whether they thought they would have enough money to fund their retirement, less than 25% stated they equated later life with financial independence.
As a result, Mercer set out to determine:
- How financially literate working Australians are in their understanding of superannuation and retirement planning issues?
- What gap exists in current versus desired levels of knowledge about superannuation and investments?
- What working Australians are doing today to prepare for retirement tomorrow?
Mercer extended the research beyond these parameters and also sought to investigate whose responsibility it is to educate the public on issues relating to financial wellbeing. In this regard they sought to establish what role employers, the government and individuals play. In a very welcome twist, they also asked retirees what they wish they had known before they retired.
The first part of the research reported on how well prepared working Australians are for retirement. Their answer: “in short, not well prepared”.
Mercer found that 50% of the respondents had given, at best, some thought to retirement, but made very little (if any) preparation for it. They found that this was correlated with age with 70% of 18 to 34 year olds having made very few preparations. However, more than a quarter of those aged over 55 also revealed that they had made little preparation for retirement. They also found the classic situation regarding women, with almost 60% stating they had made little or no preparation.
When Mercer cross-checked with recent retirees, they found that the degree to which such people were prepared depended on several factors:
- their employer
- when they started contributing to a superannuation fund
- events immediately preceding retirement, such as redundancy or illness.
They also found that those in government and financial sectors who had compulsory superannuation at an early age were able to significantly increase their end superannuation balance compared to those who had adopted superannuation later in life.
I find the influence of the employer particularly interesting. I have long been an advocate of workplace marketing/education. I have visited a number of US companies who as part of their 401k plan have regular educational seminars and/or information available to their employees. The nature of the US system is different to that in Australia and employment is often a package that includes a range of benefits. The retirement savings plan is one of those and the type of benefits within that are all used to attract (and retain) staff. This may, or may not include the matching of employee contributions to the savings plan by the company (note that it is not the government, as is the case here). I suspect that we may be heading more towards the US retirement savings approach.
Whether the government will ever allow employer matching is another matter altogether.
Next, Mercer asked what level of financial comfort working Australians predicted they would have in retirement.
The results revealed that almost 20% expect they will lead a retirement lifestyle that is a lot less comfortable than they lead now. A further one in three (30%) anticipate they will be a little less comfortable in retirement. Just over a quarter felt their lives would not really change. Meanwhile just under 20% thought their lives would improve, whilst the remaining 4% had no idea at all.
In terms of when people will retire, once again Mercer showed a very interesting approach.
They not only asked when people would like to retire, they also asked when people thought it was likely they would actually retire. The found that the median age people would like to retire is 53. Almost a third said they would like to retire before they turned 55, whilst 11% stated they would like to retire at 65 or over.
Mercer found that the median age of when people expect they will retire was actually 64 (11 years further on from when they would like to retire) and 11% stated they would like to retire at age 70 or older (which I believe is a more realistic age).
Mercer commented that interestingly, almost 205 respondents did not have a specific age in mind for when they anticipated retiring. Mercer suggested that they may be adopting a ‘wait and see’ approach. In other words, they were perhaps unable to provide an estimate of their retirement age as they were unclear about their true financial situation.
My experience has been that this is closer to the truth than Mercer may realise. I have repeatedly found that many do not know how much they have, how much they will need, or how long it is supposed to last, yet they still expect a great lifestyle in retirement.
Looking at what is likely to fund retirement, Mercer projected that superannuation is likely to account for 43% of all retirement funding for working Australians. A further 20% will be made up by investments (shares, investment property, bonds, debentures); 21% was by other assets (such as the home and other savings); and 13% by government assistance and the aged pension. Inheritance was projected to contribute very little (3%) to overall retirement funding for today’s working Australians.
As superannuation is likely to be a substantial proportion of overall retirement funding, it is crucial that people have at least some understanding of how the system operates in this country. Not surprisingly, they found some differences in the way people choose to fund their retirement.
Mercer found that those who expect to be a lot less comfortable in retirement than they are now anticipate that they will rely far more heavily on the government (government assistance accounts for 27% of total retirement funding for this group).
This is compared to those who think they will be as comfortable (or even more so) in retirement as they are now. Among those respondents who anticipate being a lot more comfortable, only 2% of their funding is anticipated to be from the government.
Previous research that I have conducted in this area found a significant lack of knowledge of just what the aged pension is and how it operates. When the actual amounts were revealed to people, the normal reaction was one of shock and horror! My findings are not dissimilar to those of this research.
Mercer asked all respondents for their understanding of the government aged pension. They found knowledge of the qualification criteria for the pension to be sketchy at best. People were aware that they needed to be over a certain age, but eligibility criteria and extent of benefits were generally not known.
Mercer add a rider: aged pension regulations change constantly, therefore it is quite reasonable to suggest participants do not take note of them as they expect the rules to have changed by the time they near retirement. Nevertheless, the fact that 30% claimed to have “no idea” suggests that it is important for the very limited nature of the pension to be more effectively communicated, a proposition I totally agree with.
When Mercer asked about how much people expect to have accumulated by the time they retire, they found that many had little idea. Mercer offer a potential explanation by suggesting (not unreasonably) that it is impossible to predict market fluctuations let alone how superannuation will be taxed.
They did find, however, that almost 40% projected they would have $100,000 to $500,000 in their superannuation at retirement. One in ten (10%) predicted they would have more than $750,000 in their superannuation.
As Mercer point out, while the trend towards longer life expectancy and medical advances is expected to continue, the funds Australians have available at retirement will need to last many more years than it had to last for previous generations.
In terms of how much people expected they would need to live comfortably in retirement, Mercer found that on average, respondents predicted they would need approximately $2600 a month (after tax).
They did not comment on how realistic they considered this estimate to be. However, given that the median retirement age was 64, and the average life expectancy is likely to be in the region of 80, that means (in crude terms) the eventual account balance would need to be able to generate in excess of $400,000 of income. I suspect this is a conservative estimate.
Next edition I will examine the report’s findings on financial literacy levels.
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