What comes after the accumulation phase
Australians are getting older and every year more of us are thinking about ways to draw down on our super, rather than building it up.
But until recently all the attention was on accumulating super, with what actually happens in retirement something of an afterthought.
Most retirees have either taken a lump sum and tried to figure out how best to manage that money themselves, or have been sold an account-based pension, which has its advantages.
But with around 95% of pension assets invested in account-based pensions, we need to ask whether one size really fits all.
Account-based pensions: the good and the bad
The main selling point of account-based pensions is their flexibility. They’re a lot like accumulation funds.
Your money is invested in an option of your choice and its value goes up or down depending on investment earnings and how much you withdraw (with minimum withdrawals set by the government). You can switch funds or investment options easily and withdraw your lump sum for its current value.
But that means retirees are left fully exposed to the two biggest risks to their income: investment risk and longevity risk, or the chance that their money will run out before they die.
The Financial System Inquiry in 2014 found most retirees worry a lot about the latter and try to reduce their longevity risk by living more frugally and drawing down the minimum allowed.
So they are effectively self-insuring against longevity risk and paying for it with a lower standard of living. There have been estimates that retirement incomes could be as much as 15% to 30% higher if better retirement income products were designed.
The alternative is to buy an annuity that provides a known income for life or a fixed period, but these have traditionally been seen as expensive (in terms of the income generated) and less flexible.
In December, the government released a consultation paper on developing comprehensive income products for retirement (CIPRs), or MyRetirement products as they may more sensibly be called.
The idea is that super funds will be required to offer a retirement product with minimum standards, though members will be able to choose whether or not they take it up.
According to the consultation paper, CIPRs would meet three main requirements:
• They will need to provide a minimum level of income that would generally exceed what a retiree would get taking the minimum from an account-based pension, with recognition of the benefit of a guaranteed level of income where relevant.
• They will provide broadly constant real income for life.
• And they will allow flexibility to access a lump sum (for example, via an account-based pension) and/or leave a bequest.
In effect, this might mean a hybrid product that takes some of the best features of current products such as account-based pensions and deferred annuities.
Because super funds would offer the products, they would need to be tailored for the fund’s membership and would allow the pooling of longevity risk.
Just how this would work is yet to be established but the idea is that instead of an individual having to plan for the possibility that they might live longer than the average life expectancy, the fund could plan for average life expectancies with the risks of living longer spread across all members.
Members will still be able to get their own financial advice and make other choices if they decide the CIPR is not for them, but it would make the transition to retirement simpler for most people.
Of course, all of this is easier said than done. The consultation paper recognises how complex developing new retirement products can be and suggests mid-2018 as the earliest potential start date.