Retirement savings, interest rates, and inflation — these three terms are often discussed in the same breath, especially at the moment. Soaring inflation, followed by the first interest rate hikes in well over a year, has impacted retirement savings, and Australians are understandably concerned.
So what is going on exactly? And, perhaps more importantly, what is the solution? Let’s take a look at the current confusion gripping the retirement savings landscape in Australia as we examine what the future holds for savers.
Inflation is always going to be a serious concern when it comes to retirement planning because it has such an impact on the purchasing power of your money. For instance, if you have $20,000 in saved cash stowed away in a safety deposit box, and you don’t touch it, you will still have $20,000 in cash this time next year. However, the real value of this cash reserve would not be the same. If inflation tracks at 2% a year, hypothetically, you would need $20,400 next year just to keep the value of your retirement savings at the same level. If inflation drives the cost of goods and services up too quickly, the purchasing power of your savings will quickly be reduced.
In earlier articles, we discussed the idea that retirees should be able to access around 70% of their annual pre-retirement income in order to live comfortably when they are no longer working. This is likely to be sufficient as a rule of thumb, but it is dependent upon inflation — it’s critical that inflation remains stable to ensure that purchasing power remains strong.
This has caused some alarm among Australians saving for retirement. In 2022, inflation in Australia has grown by 6.5% on the previous year — the sort of rise that has not been seen in the country for more than three decades. If this dramatic rise continues, it would threaten the real value of retirement savings in superannuation funds and other savings accounts.
We’ve touched upon an important word above — confusion. This confusion is arising because retirement planners are receiving mixed messages in the market. On the one hand, there are the thirty-year highs in inflation we have seen this year. On the other, there are the measures being put in place by the Reserve Bank of Australia (RBA) to bring this inflation under control.
In Q4 2020, the RBA dropped the cash rate to an all-time low of 0.1%, where it remained until early 2022. This historic low was great news for those seeking to take out a fixed-rate mortgage, as they were able to lock in this rock-bottom interest rate in the long term. It was less good news for people planning for retirement, as it meant slow growth for their capital reserves. Currently, 76% of Australians own their own home at retirement age, and the average value of these homes is $1.1 million — well above the median home price across the country. For those with retirement savings low interest rates do not help to ensure that these savings will be sufficient to support their desired lifestyle, post-work.
In Q2 2022, however, all this changed. In an effort to bring inflation under control, the RBA began raising the target cash rate. As of 4 July 2023, the cash rate sits at 4.1% — a significant increase on the 0.1% last seen in May last year. This is what we mean by confusion. Retirees — and those approaching retirement — are unsure of what the future holds. Are we looking at a longer period of increasing interest rates, growing the value of retirement savings? Or will spiralling inflation prevail, eroding the true-to-life purchasing power of capital?
It’s likely that neither of the two situations listed above will continue indefinitely. The RBA remains in the driving seat when it comes to interest target rates, and will not permit these rates to keep on rising forever. There are also other options at the RBA’s disposal, such as bond buying, should extreme action be required to curb inflation.
At the same time, it’s likely that the RBA’s actions will be successful in the long run i.e. higher interest rates will curb rising inflation. Inflation is projected to remain high across the next year, before falling back to within the RBA’s ‘acceptable band’ of between 2% and 3%. However, retirees — and those approaching retirement — still need a way to eliminate this uncertainty and unreliability. Investments in stocks and shares are vulnerable to market volatility, while the risk of high inflation will continue to make Australians nervous as they move towards or into retirement.
So what is the solution? Rather than moving away from traditional superannuation funds and retirement savings altogether (these methods will always have an important role to play in the post-work funding landscape), a more diverse approach is required. As we’ve noted above, the issue is not a lack of wealth, but rather a lack of access to liquid funds.
Australian retirees generally have significant amounts of capital tied up in property, and this is an asset class that is largely unaffected by fluctuations in inflation and interest rates. If Australian retirees can tap into this capital without eroding their home equity or losing control of property assets, they can achieve greater financial security once they finish working.
Futureproof is currently developing the Equity Preservation Mortgage® a fiscally responsible means for homeowners to access the capital currently tied up in their homes or in other properties. With the Equity Preservation Mortgage®, retirees will be able to achieve retirement income that is tax-free while maintaining the level of equity they have already built up. The idea is to optimise levels of return while reducing risk and retaining full control of assets.
The Equity Preservation Mortgage® is scheduled for release in 2024.