How Long Will Your Pension Last?
Many working expatriates dream of the day when they can throw in the towel and retire on their savings, beginning to enjoy the benefits that an international lifestyle can bring without the added hassle of having to work. But how do you know if you have enough to retire? How long would your money last if you retired today? Is there anything you can do to help stretch your savings over the course of your retirement? To help answer these questions, consider the following case study.
Case Study: How Long Will This Expat Couple's Savings Last in Retirement?
Situation: Jan is an expat considering early retirement. He is 52 years old, married and lives in Southeast Asia. He and his wife Linde, also 52, have two grown children. They have saved over the years and have an estimated net worth of EUR2.0M, and no debt. Their financial assets include the following:
- A new investment condo with a market value of MYR2.0M (EUR430K), rented out with a gross yield of 5% and producing net annual cash flow after all expenses of MYR83K (EUR16.6K).
- An investment portfolio worth EUR1.5M. Overall, the portfolio is invested 55% in stocks, 30% in cash and fixed income, and 15% in gold. Total portfolio expenses average 1.5% per year.
- Dutch Social Security benefits (Jan and Linde together) worth about EUR6,000 per year in current euros when they are 67 years old.
Jan and Linde estimate that their lifestyle costs approximately EUR80K per year, including living expenses, housing, medical costs, gifts and charitable donations, and travel. They plan to keep the investment condo for about 10 years for its cash flow, and then hope to sell it at an expected small profit.
Analysis: Although EUR2.0M is not an insignificant amount of savings, unfortunately it may not be enough to support Jan and Linde in their expected lifestyle for the rest of their lives. Even assuming the rent on their condo investment grows by 4.5% per year, they can clear EUR600K from the condo sale in 10 years after closing costs, and their other investments generally grow by 8.5% per year before portfolio costs, they stand a good chance of running out of money around the time Jan and Linde turn 82, leaving them only with a small income from the Dutch Social Security program.
In the early years of retirement, Jan and Linde may not realise that they do not have enough savings for their planned retirement, or at least as they have structured it currently. Rather deceptively, at first their net worth may continue to increase, giving them a false sense of security. However, due to inflation, the costs of their current lifestyle will also increase. In their current situation, the rate of increase of their costs is likely to be greater than the rate of increase in their net worth (which will be negatively impacted by their need to live off their investments). Eventually, their net worth will begin to fall in nominal terms as well. This could be a problem, as Jan and Linde may live far past age 82. For example, at least half (50%) of healthy nonsmokers of their age live to be 84 (men) and 88 (women), and 30% live to be 90 (men) and 92 (women).
Solution: So, how can Jan and Linde improve their chances of not outliving their savings without sacrificing their lifestyle?
1. Revamp their investment portfolio.
Jan and Linde could improve their investment portfolio in a number of areas to help it last longer. Right now, the historic long-term return of their portfolio averaged a real rate of return of just 2.8% per year after inflation and fees (8.68% nominal return -4.38% inflation - 1.5% annual fees). In particular, they could consider an asset allocation with a better expected return per unit of risk (annual volatility), use funds with no entry/exist charges to cut the 1.5% running costs. These simple moves alone would greatly raise their expected real rate of return after inflation to perhaps 4.35% per year (9.03% nominal return - 4.38% inflation - 0.5% annual fees), lower the annual volatility of the portfolio (risk), which could help their saving last an additional eight or more years.
2. Consider selling the condo now
The expected net yield and future appreciation of the condo may not be great enough to compensate Jan and Linde for the risk they are taking in having so much of their savings tied up in a single illiquid asset with an uncertain future cash flow stream and valuation. Jan and Linde may be able to improve on the longevity of their savings if they sell their condo and reallocate the proceeds to the revamped investment portfolio described in #1.
This is because based on their estimated net rental yield and future expected sales price, the condo investment might achieve an Internal Rate of Return (IRR) of just 6.1% (nominal) per year on average
3. At some point in the future, consider purchasing a low-cost immediate fixed income annuity
An immediate fixed income annuity would require Jan and Linde to make an initial upfront payment to an insurance company, in exchange for which they would receive a stream of guaranteed income. The amount received will depend on the size of the initial payment, their age at the time of purchase, the interest rate level, and the income option that they choose (example: joint life income).
This type of annuity is different from the typical offshore pension schemes sold in that it is much lower in cost (the purchaser receives a larger payment), the payments are received immediately following the purchase, and there is no investment risk as the insurance company is contractually obligated to make fixed payments which are not linked to stock market performance. However, there can be counter party risk if the insurance company runs into financial difficulty.
Jan and Linde are relatively young and interest rates are at the low end of the cycle, so it may make sense to wait to purchase a low-cost immediate fixed income annuity until they are a bit older and they can lock in a higher interest rate.
If in the future they do decide to purchase a low-cost immediate fixed income annuity, to maintain flexibility and hedge against inflation they'll want to be sure to use only a portion of their savings. They'll also want to be sure they purchase the annuity from a financially strong insurance company in a well-regulated jurisdiction.
4. Supplement retirement costs with part-time income.
Jan and Linde are relatively young and hopefully have many more years ahead of them. There are a number benefits to continuing to work part-time, and not all of them are financial. Working part-time in retirement may be a great way for Jan and Linde to continue to stay active, keep engaged, and in the meantime serve to stretch their savings further.
The above case study is intended to illustrate the type of analysis and decision-making that goes into considering whether you have saved enough to fully retire. Additionally, regardless of when and how much you have to retire, reorganising your financial assets may allow you to add years to your savings expected life in retirement. Alternatively, planning to work part-time in retirement may provide you with unexpected non-financial as well as financial benefits.
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