Jacqueline Barton

Interest rates are an important financial lever for world economies. They affect the cost of borrowing and the return on savings, and it makes them an integral part of the return on many investments. It can also affect the value of the currency, which has a further trickle-down effect on other investments.

So, when rates are low they can influence more business investment because it is cheaper to borrow. When rates are high or rising, economic activity slows. As a result, interest rate movements are also a useful tool to control inflation.

The cash rate or headline rate you hear mentioned regularly in the media is the interest rate on unsecured overnight loans between banks. The Reserve Bank of Australia (RBA) sets the rate and meets every month, except January, to consider whether it should move up, down or stay the same. This rate then usually flows through to market interest rates causing, for example, mortgage rates to rise or fall.

Rising steadily

For the past few years, interest rates have been close to zero or even in negative territory in some countries, but that all started to change in the last year or so.

Australia lagged other world economies when it came to increasing rates but since the rises began here last year, the RBA has introduced hikes on a fairly regular basis. Indeed, the base rate has risen 3.5 percent since June last year.

Australian Cash Rate Target

The key reason for the rise is the need to dampen inflation. The RBA has long aimed to keep inflation between the 2 and 3 percent mark. Clearly, that benchmark has been sharply breached and now the consumer price index is well over the 7 percent a year mark.

While interest rates are the key monetary policy weapon to control inflation and dampen the economy, there can be a risk of taking it too far and causing a recession. Economic growth is forecast to slow to around 1.5 percent this year as high inflation, low consumer confidence and rising rates take their toll.ⁱ

Winners and losers

There are two sides to rising interest rates. It hurts if you are a borrower, and it is generally welcomed if you are a saver.

But not all consequences of an interest rate rise are equal for investors and sometimes the extent of its impact may be more of a reflection of your approach to investment risk. If you are a conservative investor with cash making up a significant proportion of your portfolio, then rate rises may be welcome. On the other hand, if your portfolio is focused on growth with most investments in say, shares and property, higher rates may start to erode the total value of your holdings.

Clearly, this underlines the argument for diversity across your investments and an understanding of your goals in the short, medium, and long-term.

Shares take a hit

Higher interest rates tend to have a negative impact on share markets. While it may take time for the effect of higher rates to filter through to the economy, the share market often reacts instantly as investors downgrade their outlook for future company growth.

In addition, shares are viewed as a higher-risk investment than more conservative fixed-interest options. So, if low-risk fixed interest investments are delivering better returns, investors may switch to bonds.

But that does not mean stock prices fall across the board. Traditionally, value stocks such as banks, insurance companies and resources have performed better than growth stocks in this environment.ⁱⁱ Also investors prefer stocks earning money today rather than those with a promise of future earnings.

But there are a lot of jitters in the share market, particularly in the wake of the failure of a number of mid-tier US banks. As a result, the traditional better performers are also struggling.

Fixed interest options

Fixed interest investments include government and semi-government bonds and corporate bonds. If you are invested in long-term bonds, then the outlook is not so rosy because the recent interest rate increases mean your current investments have lost value.

At the moment, fixed interest is experiencing an inverted yield curve which means long-term rates are lower than short-term. Such a situation reflects investor uncertainty about potential economic growth and can be a key predictor of recession and deflation. Of course, this is not the only measure to determine the possibility of a recession and many commentators in Australia believe we may avoid this scenario.ⁱⁱⁱ

What about housing?

House prices have fallen from their peak in 2022, which is not surprising given the slackening demand as a result of higher mortgage rates.

Australian Bureau of Statistics data showed an annual 35 percent drop in new investment loans earlier this year.^iv The consequent reduction in available rental properties has put upward pressure on rents which is good news if you have no loan, a small loan, or a fixed interest loan on the property.

The changing times in Australia’s economic fortunes can lead to concern about whether you have the right investment mix. If you are unsure about your portfolio, then give us a call to discuss.

i https://www2.deloitte.com/au/en/pages/media-releases/articles/business-outlook.html
ii https://www.ig.com/au/trading-strategies/what-are-the-effects-of-interest-rates-on-the-stock-market-220705
iii https://www.macrobusiness.com.au/2023/02/inverted-yield-curve-predicts-australian-recession/e.
iv https://www.abs.gov.au/statistics/economy/finance/lending-indicators/latest-release

The concept of retirement is changing, with fewer people working towards a final retirement date and then clocking off for good.

Instead, those who have the flexibility to choose are often transitioning out of the workforce over several years, or even returning after a break.

Whether you simply want to wind back your working hours to explore other interests, or don’t want to cut your ties with work completely, to make it work you will need to plan ahead.

Choosing your retirement date

If you want to retire in the next few years, you need to work out how you will finance your living expenses once you no longer receive a regular wage or salary.

There is no set retirement age in Australia, but most people will not be eligible to receive an Age Pension until they reach age 67.ⁱ This means you will need enough savings to provide another income source if you hope to retire earlier.

Although most of us have super, you are not permitted to access it until you reach your preservation age, which is currently 59 and soon to increase to age 60 depending on when you were born.ⁱⁱ

Withdrawing your super also requires you to meet a condition of release. There are various conditions, but the most common one is reaching age 60 and permanently retiring from the workforce. Once you turn 65, you can access your super whether you are working or not.

Keep in mind, tax also affects your super, with different rates applying depending on whether you have reached your preservation age, or are aged 60 and over. Most people can access their super savings tax-free once they reach 60.

Paying for your retirement

Unfortunately, there is no simple answer to how much income you will need in retirement. It depends on your current lifestyle and planned retirement activities, but a good place to start is the ASFA Retirement Standard (see table).

For around 62% of the population aged 65 and over, the main source of retirement income is the Age Pension and government payments.ⁱⁱⁱ

Eligibility for an Age Pension is assessed using your age, residency status and personal income and assets. These determine whether you receive the full fortnightly payment rate, which is currently $1547.60 for a couple.

As part of your planning, check for other potential sources of income you can use if you retire fully, or decide to slowly transition. Possibilities could include income from investment assets, contract work, or rent from investment or Airbnb properties.

Using your super savings

While you may dream of retiring early, many of today’s retirees can expect to live well into their 80s so, your super may need to provide income for more than 20 years.

If you are unsure whether your super is on track, most super funds provide online calculators to give a rough estimate of your likely retirement balance and how much income it will provide.

ASIC’s MoneySmart Retirement Planner is another useful tool for working out your retirement income and potential Age Pension payments. It also illustrates how extra super contributions and changing investment options could affect your final balance.

Transition-to-retirement (TTR) pensions

If you would like to ease into retirement, it can be worth investigating a TTR pension. These allow you to cut back your working hours while using your super to supplement your income without compromising your lifestyle.

If you are aged 55 to 59 you will pay some tax on these pension payments, but they are tax-free once you reach age 60.^iv

TTR pensions also allow you to continue topping up your super through a salary sacrifice arrangement with your employer. You only pay 15% tax on these contributions, which may be lower than your marginal tax rate.

Giving super a late boost

If you have income to spare as you move towards retirement, perhaps from an inheritance or downsizing your home, there are now additional opportunities to continue adding to your super.

You can make personal after-tax contributions of up to $110,000 a year until you reach age 75, even if you are not working. You may even be eligible to use a bring-forward arrangement and add up to $330,000 in a single year.  in a single year.

Once you hit 60, if are planning to sell your current home you can also make a downsizer contribution of up to $300,000 ($600,000 for a couple) into your super account.

The role of home ownership

Despite falling levels of home ownership, most people still aspire to being debt-free free by the time they retire with a home fully paid for or close to it.

Your home could even be a source of retirement income, using a reverse mortgage or the government’s Home Equity Access Scheme.

When you are doing your retirement sums, don’t forget some of the concessions on offer to older Australians. If you are aged 60 and over and working less than 20 hours per week, your state’s Seniors Card can provide discounts on public transport and some goods and services.

You may also be eligible for the Commonwealth Seniors Health Card for cheaper prescriptions and medical appointments, or a Pensioners Concession Card for discounted public transport.

Estimating how much you are likely to need in retirement

As everyone’s financial position and retirement plans are different, it’s impossible to predict exactly how much you will need when you retire. But a useful starting point can be the Association of Superannuation Funds in Australia’s Retirement Standard, which estimates the income required to support two different retirement lifestyles.

Estimated total annual expenditure for households and living standards for people aged 65-84 (June quarter 2022)

Note: Budgets are based on detailed expenditure breakdowns for both lifestyles and are updated quarterly to reflect changes in the cost of living. Budgets assume you own your home outright and are relatively healthy.

Lump sum required to achieve ASFA’s two different retirement lifestyles

Note: Lump sum estimates take into account receipt of the Age Pension both immediately and into the future.

If you would like to discuss your retirement options and how to fund them, give us a call.

i https://www.servicesaustralia.gov.au/who-can-get-age-pension?context=22526
ii https://www.ato.gov.au/Individuals/Super/
iii https://www.aihw.gov.au/reports/australias-welfare/age-pension
iv https://moneysmart.gov.au/retirement-income/transition-to-retirement