With recent speculation that the pension age is going to keep rising and constant reminders from finance experts that Australians are approaching retirement woefully underprepared, many people are wondering how they can take control of their financial future.
Australians are increasingly realising they are unlikely to be able to rely on the government for financial assistance in their old age. Indeed, director of wHeregroup Todd Hunter says it’s time for a wake-up call.
“For people our age, there won’t be a pension,” he says. “It’s a mathematical impossibility for there to be a pension on a growing, expanding and ageing population, with only a limited income coming in. It just won’t be there. You will have to support your own retirement.”
Many people recognise this inevitability but don’t know what to do about it. In fact, Mr Hunter says a vast number of people in the workforce at the moment are relying on death to fund their retirement life.
“There is a tonne of people out there who are expecting an inheritance and they think that will be their retirement,” he says. “There is also a lot of ignorance out there that will catch up with people later in life. People turn a blind eye and assume it will all be okay, but it doesn’t work that way.”
Ben Kingsley, director of Empower Wealth and chair of the Property Investment Professionals of Australia (PIPA), says most people don’t realise they have a problem until it’s too late. In addition, projections about the future value of money, changing economies and inflation can confuse and frustrate people, he says.
Despite the confusion, Mr Kingsley says investors who want to live a stress-free retirement need to take control now.
So the experts (and the figures) are telling us we need to do more. We need to take control. We need to build wealth. We need to be prepared. But where do you even start?
It’s a mathematical impossibility for there to be a pension on a growing, expanding and ageing population, with only a limited income coming in.
Building a passive income through property
The calculations around how much money you’ll need in order to retire can be overwhelming, but Philippe Brach, CEO of Multifocus Properties & Finance, says you just have to work backwards.
In today’s dollars, you establish how much you’d like at your disposal per annum.
He says if someone wants to retire on $100,000 per year, this is the equivalent to having $2 million sitting in the bank generating five per cent interest every year.
“So if you don’t have the money in the bank, you need to translate that into properties and the value of your portfolio. So you’d be looking at having a minimum of $2 million in equity in your portfolio after you’ve paid the capital gains on the sale of your properties,” he explains.
In order to have $2 million after selling costs and taxes, Mr Brach says investors should be aiming for $3 million in equity in their portfolio when they approach retirement.
“The actual size of your portfolio, in terms of number of properties, doesn’t matter – you need to focus on how much equity you can build today,” he says.
Mr Brach says an alternative approach is to hang on to some properties and generate a passive income from a combination of rental earnings and the sales proceeds of the rest of your portfolio.
Mr Hunter says, realistically, if investors want to have a passive income when they reach retirement, they can do this through income in the form of rent payments or they can live off the proceeds of selling their portfolio. Either way though, he says investors need to be debt free when they stop working.
The approach investors end up taking will largely depend on how much time they have, according to Mr Kingsley.
“The reality is if we have enough time then we go through what we call an accumulation phase. This is where we use debt to build our asset base much more quickly than we could without that leverage. That’s why property is such a powerful consideration for people who are looking to build wealth and income for retirement – because you’re able to borrow to control a bigger asset,” he says.
To simplify the numbers, Mr Kingsley gives the example of two investments, both returning 10 per cent per annum.
“Person one invests that $100,000 and they get a $10,000 return that year,” he explains. “The other person has $100,000 but they buy a property at $500,000 by borrowing $400,000. Now they get their 10 per cent return on $500,000 – so it’s a $50,000 gross return. Of course, we do have to cover the debt that we’ve just borrowed. If we assume that the interest on that $400,000 is at six per cent, then that would cost $24,000. So you take the $24,000 from your $50,000 gross return and you’re left with $26,000. So your cash-on-cash return is 26 per cent – as opposed to person one who got 10 per cent.
“You’re accelerating your position by taking on a debt or leverage position.”
Damian Collins, managing director of Momentum Wealth, agrees that property offers investors unique opportunities to create wealth for retirement, particularly because they can manufacture growth.
“Building a property investment portfolio is a great way to get to your retirement goals,” he says.
“You need to look at your current situation, your long-term objectives and your timeframe and then from there develop a specific property investment strategy that will enable you to reach your goals. There’s not a one-strategy-fits-all.”
Mr Collins says if you’re getting started early – in your 20s or 30s – you should focus on growth “because growth is what gives you the equity”.
“Most people can’t save another deposit once they’ve bought their first investment property, so they’re relying on equity from their home or investment. So you’ve really got to focus on growth and getting those high performance properties that are going to outperform the market,” he says.
Once you get closer to retirement, Mr Collins recommends investors look at bigger deals and projects.
“As you get towards that 10-year period from retirement, you start focusing more on the cash flow from the properties. You’re no longer buying the properties for the growth – you’re buying them for the yield,” he explains.
“So start looking at things you can do, like granny flats or commercial property. A lot of people don’t think about commercial property, but even if you can’t do it on your own, you could do it through a syndicate and get very strong yields. I think a lot of investors get caught up in a residential mentality. Commercial, as part of a larger portfolio, definitely has a place.”
The actual size of your portfolio, in terms of number of properties, doesn’t matter – you need to focus on how much equity you can build today.
$60,000 a year
A passive income of $60,000 a year may be less than your current income – but it’s far more than most Australians get per year once they stop working.
Mr Collins says most property investors can aim even higher than $60,000 a year, but if you achieved this number, you’d be doing better than most.
“We work on a blended net yield of five per cent,” he explains. “Your standard city higher-growth properties are only going to get you roughly net three per cent. Hopefully though you’ll be able to add to those through redevelopment or granny flats and get those yields up to maybe sixes and sevens. So it’s about blending your portfolio.
“If you want $60,000 on a five per cent net yield, then you need $1.2 million in your portfolio, free and clear of debt. So you need $1.2 million straight out.”
Mr Collins says this could be achieved with as little as three properties – a realistic goal for many non-professional investors.
Mr Kingsley says doing calculations to establish future figures can be complicated, but investors are able to simplify the sums to plan for their future.
“The reason most people can’t do these calculations is because the calculations are very complex when you bring in all the moving parts. You’ve got to bring in inflation, you’ve got to bring in taxation, you’ve got to bring in the actual income scales – that’s why projections of capital gains and also the rental yield you’re going to get aren’t easy projections,” he says.
“Looking at it in today’s dollar terms, a nice, simple way of looking at it is to assume property can return a 4.5 per cent longer-term yielding average. So that would mean if we wanted to get to $60,000, we’d need around $1.3 million worth of property.”
So despite the complexities in the numbers, both Mr Collins and Mr Kingsley calculated that around $1.2 million to $1.3 million in property would help generate a $60,000 passive income, which could then of course be supplemented by superannuation.
Adrian Rivish, head coach for South Australia and Western Australia at Positive Real Estate, says a passive income of between $60,000 and $70,000 through property can be achieved two ways – “neither of which is right or wrong”.
The first option is to accumulate six properties, which he says can be done in as little as six years. Over time, these properties will become positively geared (even if they didn’t start out that way) and retiring investors can then live off the proceeds of the rental income.
The alternative is to start at the cheaper end of the property market and “trade up”. This involves building your portfolio aggressively and then selling down parts of it to fund bigger purchases.
“So you start with the cheaper end because your financial position won’t allow you to go to the nicer blue-chip ones,” he says. “You build and you build, then you sell, you build, you build, then you sell. Then by the time you retire you don’t necessarily have to hang on to all of your properties. You could even sell down until you’re left with just three.”
Mr Rivish says if investors end up with three debt-free properties at the end, you can safely assume they will generate around $25,000 in rent each – a total of $75,000. There is, of course, going to be tax payable on this income, which Mr Rivish said would ultimately leave investors with around $60,000 to $65,000.
You’ve really got to focus on growth and getting those high performance properties that are going to outperform the market.
Is it too late?
One of the greatest concerns for people approaching retirement with insufficient savings or non-existent portfolios is: do I have time?
Even if your savings seems insignificant, you don’t want to lose it all in a desperate scramble to build last-minute wealth.
Mr Kingsley, however, says if you’re in your mid-50s it’s not too late to take control of your own future.
“If you want to be at the mercy of getting government assistance in retirement, then you don’t need to do anything,” he says. “But if you want to be in control of your own destiny, then the reality is you’ve got to start looking at the future. You’ve got to start planning for tomorrow.”
Mr Kingsley says for people in their mid-50s with no retirement plan, inaction can be the easiest option, but it’s not going to yield any results.
“If you don’t do anything, the situation is going to be even worse. But at the same time, you don’t want to risk the farm. Some people, especially when they’re in their mid-50s, get caught up in get-rich-quick schemes or high-risk investments that can potentially backfire. They panic and think they need to do an accelerated activity when in reality it might not have been the most sensible approach for them,” he says.
Mr Brach says older investors may need to be more aggressive and make fewer mistakes, but with the right advice and astute purchases, they can build a healthy, last-minute retirement.
“I started when I was 36 because that’s when I got into Australia and realised what negative gearing was all about,” he says.
“If you start later, you just need to be cleverer. When you’re younger you’ve got plenty of time. When you’re in your mid-40s though, you have less time to rely on property value growth so you can’t really afford to make a mistake.
“I started when I was 36 and I now have about $3 million in equity in my portfolio and I’m 52. So it’s definitely doable.”
Resi’s finance specialist and consumer advocate, Lisa Montgomery, says if the shrinking timeframe between now and your inevitable retirement has reduced your risk appetite, even a small action is better than nothing at all.
“The one thing that I like to say to people who are considering investing in property is: whatever you do, do something. A lot of the time we fall foul to procrastination; we look for the perfect property in the perfect place.
“In building a portfolio, you’re going to have some properties that are going to be better investments for you than others – but whatever you do, do something.”
You build and you build, then you sell, you build, you build, then you sell … by the time you retire you don’t necessarily have to hang on to all of your properties.
Number crunch: The shortfall
We hear a lot about how Australians are significantly underprepared for retirement, but just how big is the deficit?
The Australian Securities and Investments Commission’s (ASIC) MoneySmart guide says that for a single person to have a ‘comfortable’ retirement they would require $41,830 in annual living costs. If they retire at 65 and live to be 85, MoneySmart recommends a superannuation lump sum payment of $544,000.
For a couple, MoneySmart estimates ‘comfortable’ living expenses at $57,195 per year, requiring a lump sum payment of $744,000.
MoneySmart says that this is a generic guide and individuals can work out how much they will require in retirement by assuming they need 67 per cent of their current income each year during their non-working life in order to maintain the same lifestyle.
Many money experts and financial planners contend that in reality, the amount required will be much higher – and that most Australians are falling woefully short of this goal.
Indeed, figures from the Australian Bureau of Statistics (ABS) show that in 2010, males aged 55-59 had an average superannuation balance of $166,298. For women, the picture was even grimmer, with the average female aged 55-59 having just $90,783 in superannuation.
The ABS figures show men and women in all age brackets are falling short of their retirement requirements, with females aged 45-49 having just $46,315 in their super on average. Men in the same age bracket had an average of $89,047.
People in this age bracket likely haven’t been receiving employer contributions to their superannuation for their entire working lives, but the fact remains that most Australians won’t have enough when they retire to maintain their current lifestyles.
If soon-to-be retirees are hoping to supplement their superannuation with government assistance (in the form of the Age Pension), Australian Super points out that, as at March 2014, this is only $21,912 per annum for a single person and $33,035 for couples.
Philippe Brach, CEO of Multifocus Properties & Finance, says these figures are concerning, but hardly surprising.
“Around 84 per cent of people in Australia will actually retire on less than $21,000 a year. It’s pretty frightening,” he says. “Nobody thinks about retirement until it’s too late.”
Even if your savings seems insignificant, you don’t want to lose it all in a desperate scramble to build last-minute wealth.
Paying down your debt
One of the easiest ways to ensure you’re debt free at retirement age, or at least approaching financial freedom, is by taking control of your loans.
Resi’s finance specialist and consumer advocate, Lisa Montgomery, says paying down your home loans ahead of time will help you accelerate your wealth creation – and it doesn’t need to break the bank.
“It’s amazing. Once you start to do the calculations and understand what accelerated payments can do, you’ll wonder why you didn’t do it before,” she says.
Ms Montgomery says a greater number of Australians are heeding this advice and taking advantage of the current economic climate.
“It’s encouraging that since we’ve been in this interest rate cycle from November 2011, where the cash rate has dropped by 2.25 per cent – and about 1.85 per cent of that has been passed onto borrowers – we’ve seen a change in borrower behaviour,” she explains.
Ms Montgomery says recent statistics indicate over 70 per cent of borrowers are currently in front of their mortgage repayments, and around 20 per cent are in front by two years.
“Just by paying an extra $10 a week you can take years and thousands off your loan. Just $10 a week,” she says.
“My tip to borrowers it to have a look at some of these calculators on websites to see what accelerated payments can do.
“Borrowers should also recognise that a mortgage is the lowest interest rate and most flexible credit account that you have. You might have other debt that is at a higher interest rate. If that’s the case, use your mortgage to consolidate that debt and pay off the higher interest debt.
“You’ll be amazed at what you can achieve.”
A super option
Investors who are using property to build their wealth for retirement and help supplement the shortfall in their superannuation shouldn’t overlook the possibility of combining the two forces – property and super – according to wHeregroup’s Todd Hunter.
If nothing else he says, it’s a tax-effective way to build your retirement portfolio.
“People who are building an income outside of super will continue to pay tax on that money. Money generated by your super, as it stands in the legislation now, will be tax free when you retire,” he explains.
“So even if you have a $60,000 passive income from property outside of your super fund, that won’t equate to $1,200 a week. It will actually be far less because you will be paying tax on that money. You need to consider the tax implications.”
Mr Hunter has his own property portfolio but also one inside his self-managed super fund (SMSF), which will help fund his retirement.
“I own my office in my super fund, a block of land and two houses in the US,” he says.
“My office is a commercial building so there is very little wear and tear and the shop fit-out is relatively easy to upgrade. So I’ll obtain a really nice income when I retire from the rent that comes in from the office.
“Then there are the US properties that are paying fantastic yields – around 20 per cent. It’s not huge dollars though. As a dollar figure it won’t set the world on fire, but by combining it with my external portfolio, I’m building towards a solid retirement.”