Australia has one of the best retirement systems in the world for accumulating savings. Yet, like many other countries, we continue to struggle with how to design an efficient retirement spending system. To some extent, this can be attributed to the absence of a clear purpose as to what we are trying to achieve.
Following a recommendation by the Financial System Inquiry, the Superannuation (Objective) Bill was introduced to Parliament in 2016 to establish the primary objective of super: “to provide income in retirement to substitute or supplement the Age Pension”.
While it is a start, it does not provide a lot of direction. The Explanatory Memorandum provided more guidance, and two of the proposed subsidiary objectives noted at the time were to facilitate consumption smoothing over the course of an individual’s life, and to manage risks in retirement. Unfortunately, these objectives have lapsed in Parliament, so we still have some uncertainty about the overall pathway to better retirement outcomes.
More recently, in September 2019, Treasurer Josh Frydenberg announced a review into the retirement income system as recommended by the Productivity Commission in its report, Superannuation: Assessing Efficiency and Competitiveness.
The panel appointed to run this important review, released on 20 November, was given the task of identifying the facts that would help improve understanding of how the retirement income system operates and the outcomes it is delivering for Australians. The terms of reference for the review stated: “It is important that the system allows Australians to achieve adequate retirement incomes, is fiscally sustainable and provides appropriate incentives for self provision in retirement.”
In this context, the panel identified four principles to assess the performance of Australia’s retirement income system: adequacy, equity, sustainability and cohesion. This latter one, cohesion, is particularly important. How do the various parts of the system work together to improve retirement outcomes in Australia?
Retirees in ‘the middle’
It is only recently that a significant number of Australians began retiring with material retirement savings, with around 35 per cent of superannuation balances at retirement reaching $250,000 or more. Over the next 20 years, this is set to change with almost 65 per cent reaching that level. While around 15 per cent of superannuation balances will exceed $750,000 in 20 years’ time, as a proportion, retirees in ‘the middle’ will double from around 25 per cent to 50 per cent.
Retirees in this ‘middle’ group are likely to be eligible for a part Age Pension for a substantial portion of their retirement and, as a result, the means test rules will be an important consideration for them.
As we all know, the means tests are targeted to help keep the cost of the Age Pension at an affordable level as Australia’s population ages. But this also makes them complicated and more difficult for retirees to navigate.
It is also worth noting that legislation was passed in February 2019 to amend the means test rules that apply to longevity protection products with effect from 1 July 2019. Under the new rules, only 60 per cent of the purchase amount of a lifetime income stream will be an assessable asset and only 60 per cent of the payments will be income for the means tests.
These regulatory changes should, in time, promote the development of new longevity protection products such as deferred lifetime annuities (DLAs) or deferred group self-annuitisation (GSA) products, which should help retirees plan their retirement spending with more confidence. However, they add further complexity.
By way of example, consider a person who is a homeowner, who retires at age 67 with a superannuation account balance of $500,000 and who uses $50,000 to purchase a DLA. With 40 per cent of the purchase price (or $20,000) no longer counting for the assets test, this person will be entitled to $1560 per annum more in Age Pension payments for around 10 years.
The confidence to spend
Longevity risk is one of the major risks faced by retirees. The fear of running out of money and the uncertainty about how long a retiree might live causes many to try to manage their own longevity risk by spending cautiously. In addition to its favourable treatment under the means tests, a DLA partially solves that problem by providing a guaranteed amount of income for life once payments commence.
This allows retirees to more safely draw down the remainder of their savings up to that point, thereby enjoying a lifestyle that is better than would otherwise be the case during the early and more active years of retirement.
Unfortunately, DLAs and other annuity products are often criticised as being ‘expensive’. The question is: compared to what? This is often because people undervalue the insurance component of the product, but also because of the conservative nature of the investments typically backing these products. Retirees who want to leave a bequest to their family also prefer to add a death benefit to the product, which also makes them more ‘expensive’.
Maybe it’s time to go ‘back to the future’, where the annuity is a form of ‘with profits’ or unit-linked policy so that the policyholder shares the investment return (and risk). The number of units paid each year until death would remain the same, but the dollar amount would vary depending on the performance of the underlying investments selected by the retiree.
Unit-linked DLAs would have two distinct advantages over traditional annuities.
First, these products could remain invested in more growth assets during the deferral period, much like an account-based pension (ABP), with retirees able to dial down the risk profile of the investments as they get older, either by choice or automatically, via a form of life cycle investment.
Second, they would be more attractive to advisers who understand investment risk and return and can assist their clients with their choices. As annuities are not well understood in the general community, some form of guidance and/or advice will be needed to help retirees understand how DLAs and other retirement products can help them manage the various risks they will face in retirement.
Retirement Income Covenant
One of the announcements in the 2020 Federal Budget was the deferral of the Retirement Income Covenant to July 2022, to allow the findings of the Retirement Income Review to inform the discussions and any further consultation.
According to Treasury, the covenant will codify the requirements and obligations for superannuation trustees to consider the retirement income needs of their members, expanding individuals’ choice of retirement income products and improving standards of living in retirement.
The covenant is supported by a number of principles, key among them that:
- Trustees should develop a retirement income strategy for members.
- Trustees should offer all members a comprehensive income product for retirement (CIPR), which, by design, would provide longevity protection and some access to capital.
- Trustees should provide guidance to help members understand and make choices about the retirement products offered by the fund.
With the release of the Retirement Income Review report and ensuing consultation on the covenant, we look forward to the introduction of new retirement income products, and the development of affordable access to better information, guidance and advice.
Together, we will then be better able to help more members secure a better retirement, where they can spend more of their savings safely, especially in the early years of retirement when they are healthier and more able to enjoy it.
Do you have confidence in your spending in retirement or your plan when you get to retirement? Are there sufficient products available? Do you understand what is available?
Andrew Boal is head of the Actuaries Institute’s Retirement Strategy Group and CEO at Rice Warner.
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Disclaimer: All content in the Retirement Affordability Index is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.