There was almost unanimous agreement recently that the objective of superannuation is to provide income when you retire (i.e. to replace your salary). This definition is expected to be enshrined in legislation – to make sure future governments and policymakers have a concrete goal when making legislative changes.
But how much income will you get when you retire?
How do you even find out?
This is a major problem that the government is striving hard to fix.
Last December the Australian Prudential Regulation Authority (APRA) released a package of new prudential requirements to strengthen superannuation fund trustees focus on delivering quality outcomes for their members. There is a dedicated page about the new requirements on APRA’s website “Strengthening superannuation member outcomes”.
There are two main layers to these new requirements:
- Fund must decide what metrics are suitable to measure whether members get good outcomes; and
- Superannuation trustees must have a business plan in place to improve these outcomes and must measure whether their actions are effective in improving member outcomes
This is potentially great news for Australians. But it requires super funds (and commentators) to stop focusing purely on your balance and focus on the metrics that help give you confidence about what income you will get to live on when your salary stops.
The math to do this is hard!
Generating retirement income means taking the balance you have when you retire and spreading it across your whole future retirement as income. Most people don’t have a best friend who is an actuary and so struggle to make these decisions in light of uncertainty around how long they might live, what returns they might get and how the price of their weekly shopping bill will increase over the next 20 – 40 years (yes, some people will live to age 105!). Because of this they have no idea of what income they can rely on once their salary stops.
One approach is to take your money to an annuity provider and purchase a guaranteed income for the rest of your life called an annuity. The amount of income you’ll get is about 3.5% to 4.5% of your balance at 65 – payable as a regular income for the rest of your life and indexed to inflation.
But in the past, most retirees have tried to do it themselves – to convert their own balance into income by just drawing down on their superannuation balance using a product called an account-based pension. This is sometimes referred to as ‘self-annuitisation’. The Financial System Inquiry (and other major reviews) have recognized that this is generally a poor approach for many people and that better options are needed.
Many retirees have run out of savings by their 70s and 80s and others are living far too frugally out of fear that theirs will run out too. Imagine you’re 85 and still healthy but your balance is down to $25,000. Would you feel confident to keep drawing $5,000 per year but possibly living to age 95? What happens when the money runs out?
APRA’s ‘Strengthening superannuation member outcomes’ package will hopefully help.
Examples of the metrics that superannuation funds can use to measure and manage your outcome in terms of retirement income are:
- The level of income the fund gives you as a percentage of your balance when you retire
- Metrics to compare how secure that income will be going forward:
- Probability it will keep pace with inflation
- Probability it will last for life
- Probability your income may reduce in any particular year
- Assessment of how long members are likely to live, and the range of how long particular groups of members will live
- Measures to assess the pricing / inherent charges of any longevity products used (i.e. external insurance arrangements to help ensure incomes last for life):
- Investment and admin fees and charges
- Internal rate of return calculations (these assess what investment return you’d need to invest your own money and ‘match’ the income from your super fund)
- Credit risk of any external providers
- Metrics to assess the cost of different features you may want such as:
- Ongoing income for your spouse if you die before they do
- Death benefit to protect your estate or to pass on to your children
- The ability to access your capital again
The Australian Government Actuary and Treasury are working hard to create good metrics like the above. Some superannuation rating agencies are creating methods and frameworks for measuring which funds are doing a good job against these type metrics.
As the amount of super in the retirement phase heads towards $1 trillion, superannuation trustees have an enormous responsibility to ensure they turn balances into retirement incomes in a ‘super’ efficient way.
This is an area where, with the right strategies, super funds will be able to deliver “best in show” retirement outcomes and easily outshine the others. Members will need to carefully watch the evolution in this space to get the best outcomes.
With over 200,000 Australians entering retirement every year, super funds know their members need a lot of help deciding what choices to make and with setting up their broader retirement income plans taking into account all assets and income sources the member and their spouse have (including the Age Pension and sometimes loans against property).
It’s an area where I expect to see some specialist retirement advice firms emerging – to help retirees on a national scale.