As the baby boomers enter retirement, the superannuation industry is being swamped by the growing numbers of new retirees. Funds are struggling to communicate complex issues to the large numbers of their members who are approaching retirement. This year, we can expect 250,000 new retirees, with combined benefits of $35 billion. Only about 10 per cent of these members will see a financial adviser, so the rest have to struggle to cope with superannuation rules, taxation and social security (age pension).
Superannuation funds tend to offer a “preferred” product in retirement, which is an account-based pension using a variation of the MySuper investment strategy. If members want to join the pension, they need to apply, as there is no automatic shift from accumulation to pension phase. Effectively, they exit the fund (crystallising all capital gains taxes) and then re-join as a pension member using their retirement benefit as the base for the pension. So, funds need to communicate with their existing older members if they want them to place their retirement benefit with them.
Some members will have taken advice and started a transition to retirement pension. They will end up with an accumulation account, into which future contributions are made, and a pension account, which will be free of tax on earnings. These pensioners are no different to any other – they simply start their pension before they have ceased working, and the pension benefit will be taxed until they attain age 60.
No default pension products
Unlike accumulation – where there is a default investment strategy (MySuper) – there is no default structure for pensions. Many funds use the MySuper investment strategy as one of the pension options so it is a de-facto default structure. It takes one of three forms:
- A diversified portfolio with an emphasis on achieving high real returns over the long term, reflecting that most new retirees have a life expectancy of at least 20 years. Several industry funds simply replicate their pre-retirement balanced investment option
- Lifecycle products that reduce the exposure to growth assets with age. Most have no more than 50 per cent of growth assets at the time of retirement and they fall further at advanced ages. These products were created to avoid the sequencing risk associated with drawing a full benefit at the point of retirement. They are inappropriate for anyone who intends to take a pension as they reduce retirement income without any other redeeming feature
- A bucketing approach which separates the money needed for pension payments from the assets needed to provide longevity and inflation protection.
None of these defaults have any form of mortality pooling. Several funds offer lifetime annuities (hard guarantees) or group annuitisation (soft guarantees) but all are little-used options. The poor take-up rates suggest that many of these longevity solutions appear to have been developed without thinking of the needs of retirees.
In reality, despite the wide variations in personal circumstances, members seem to fit into three behavioural groups when they retire:
- Those who take a lump sum. Typically, they have assets less than $150,000. Feedback from super funds and their financial advisers suggests that many of this group first takes a reward, such as an overseas holiday, buying new a car or upgrading their kitchen/bathroom; others will pay off debt. Most of the lump sum – which constitutes about $5 billion a year for all new retirees – is then saved in a bank term deposit. These retirees then live off the interest that supplements their age pension. The capital is rolled over and only used in emergencies.
- Most of those with more than $100,000 in superannuation convert it into an account-based pension. And most draw the minimum legal amount as a pension each year. This is a percentage of the account balance at the start of the financial year, being 4 per cent to age 65 years, then 5 per cent to age 75 before increasing to 6 per cent from age 75. Effectively, much of this group also lives off their earnings for the first decade or so in retirement.
- A small group of those who take an account-based pension set a living standard and live to this recognising that their money will probably run out before they die.
Funds don’t yet have different plans for each of these member strategies. Surely, it would not be difficult to build a fixed interest product that had a capital guarantee and paid a higher return than a bank term deposit?
The Australian Catholic Superannuation Retirement Fund has developed a retirement product which acts like a distributing trust and deposits all earnings into a cash account each quarter. These payments are close to the minimum pension withdrawal rates, so the retirees are also living off their income and not spending their capital. The separation of income also protects it from market risk while maximising growth of the underlying capital.
Planning for longevity
The Financial System Inquiry (FSI) recommended that all funds offer a comprehensive income product in retirement (CIPR), with the minimum features of this product to be set by the government. These features would include “a regular and stable income stream, longevity risk management and flexibility”.
Treasury is currently reviewing the requirements for a CIPR. It recognised that it will not be possible to meet all the required features with a single product, so the CIPR strategy will need to have some form of bucketing, perhaps an account-based pension with some form of longevity risk protection. The retiree’s needs will also vary by the size of their superannuation account, their marital status and possibly their health.
The personal characteristics of retirees make it difficult to set up a default structure. Consequently, it is improbable that the government will prescribe a specific product; we are more likely to see a set of rules for retirement saving beyond life expectancy.
If we recognise that those couples retiring with less than $300,000 will usually receive a full age pension throughout retirement, there seems little point in telling them how to spend their retirement savings. Similarly, those members with balances above $1,000,000 should be able to make up their own minds as to whether they want any longevity protection.
So, could we see a rule that those with balances above (say) $250,000 must allocate a minimum amount (maybe 15 per cent of their retirement benefit) into longevity-oriented products? This could be set up as a default – and members could still opt out if they so choose. The longevity product could be:
- A lifetime annuity payable from an advanced age (bought by the retiree when they reach that age)
- A deferred annuity
- Some form of group annuitisation
- A non-vested bucket in an account-based pension which becomes available in 20 years. While the bucket does not have any mortality pooling, it does spread the retirement benefit over a longer period.
The weight of money in pensions now exceeds $630 billion. That ought to be large enough for funds to spend time thinking about appropriate strategies for retirees!