In December 2014, the government released the final report of the Financial System Inquiry (FSI). It made a number of recommendations around superannuation including the need to set clear objectives for the superannuation system itself.
The FSI suggested the primary objective of superannuation be “to provide income in retirement to substitute or supplement the age pension”. Following a brief period of consultation with industry – where there were several suggestions for amendments – the government announced at this year’s budget that it would enshrine this objective unchanged into legislation.
The budget changes to superannuation effectively frame retirement income for a new retiree between the age pension (about $22,500) and four times that amount ($90,000). Those with little super will get a small income to supplement the age pension and those with the maximum $1.6 million in their pension account will substitute it with payments of about $90,000 a year.
Many are confused about the buying-power of the proposed $1.6m pension cap. The chair of the Future Fund, Peter Costello, claimed retirees would need to earn 5.5 per cent on $1.6m to be able to draw a pension of four times the age pension. However, pension payments include some capital as well as income so the $90,000 withdrawal is sustainable even if earnings are lower.
Wealthy Australians will be able to draw more than $90,000 if they have built up a further benefit (which will be kept in an accumulation account following the budget changes). Further, there is a generous tax-free threshold for those over age 65, the Senior Australian and Pensioner Tax Offset (SAPTO), so more retirees are going to spread their investment over three tax structures – tax-free pensions, tax-concessional accumulation (15 per cent) and personal investments. This environment is likely to drive superannuation funds to expand their financial planning services.
CIPR already nicknamed ‘MyPension’
Sometime after the election, the government will announce its response to the FSI’s recommendation that there be a default retirement strategy – a comprehensive income product for retirement (CIPR). This product (which is already colloquially known as MyPension) is to provide a regular and stable income stream, longevity risk management and flexibility.
In time, members of superannuation funds (with their partner) will end up in one of four categories:
- Full Age Pensioners – a smaller group over time
- Part Pensioners – a growing cohort
- Self-funded retirees – not eligible for the Age Pension, at least early in retirement
- Wealthy retirees – self-sufficient throughout retirement with investments on top of the $1.6m pension cap.
Rather than maintain a single product suitable for a homogenous cohort, superannuation funds will need to develop different retirement strategies to suit each group of members.
Full age pensioners
At present, most people retiring with small account balances draw all their super as a lump sum and place most of it in a bank term deposit – collectively, about $5 billion a year is rolled into these products. These people are risk-averse and keep the capital as a nest egg. Effectively, they live off the interest, which is likely to be low for many years.
Superannuation funds should be able to develop pension products that pay a higher interest rate than a term deposit while also preserving the retiree’s capital. Future retirees will have higher balances and members with accounts of up to $250,000 will fall into this category.
These members will retire with account balances between $250,000 and $700,000. Many will live a frugal retirement by living off their income and trying to preserve their capital.
However, if they adopt some form of retirement pooling, they will be able to spend their capital with more certainty. Funds can use CIPRs as the vehicle to build these pools – they won’t gain the membership required if they are voluntary.
This group will need financial advice at the time of retirement and reassurance periodically through retirement. Retirement is complex but the strategies can be quite simple. While they will need cash to cover pension payments, they will be more concerned with the investment earnings over an extended retirement of twenty years or more. Growth will be more important than mortality pooling for these members.
Michael Rice is the chief executive officer at Rice Warner