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The "Principal" Issue - Running down Capital in Retirement

The "Return of Capital" Issue

A lot of column space in financial papers and magazines is regularly devoted to the issue of, "how much do I need to retire on?" Reference is often made to how much income you will need in retirement and the capital required to support that income. When it comes to calculating the capital, you will often find that financial experts will simply say something like, "if you need $60,000 a year and we guesstimate that returns on your portfolio will be around 6% per annum (let's forget about inflation for the moment) then you need a "lump sum of $1 million".

Traditionally then, letters to the column in the next week ask why no consideration was made to running down the capital in any calculation - so that each year you would receive income which was a combination of income and capital, and essentially more total income each year. Clear answers to that question are very rare, and largely concentrate on the fact that we never know exactly how long an individual will need to rely upon their lump sum ("longevity risk"). It is a complex issue and you can form a view that it suits the financial planning and superannuation industry to avoid it - they are also better off in the situation where "funds under management" and "superannuation balances" are maintained, rather than eroded.

In reality, the correct approach will depend very much upon your circumstances. There will often be a perceived need to maintain capital, or access to capital perhaps in the form of a main residence, to fund entry into nursing homes - although the actual percentage of Australians who will need nursing home care for long periods is small - or perhaps to assist family members who need continuing special care and help for medical reasons. Outside of these particular circumstances, we believe it is appropriate to include some element of capital draw-down during the period of retirement, calculated on a conservative basis appropriate for each individual or couple.

In short, there is no point in living like a pauper if the only objective is to pass on an inheritance to family members and the purpose of superannuation, particularly, is not inter-generational wealth planning but providing for you in retirement. This is particularly the case in a world where interest rates, and riskless rates of return seem to be trending to zero, or indeed negative on occasion.


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