What’s next for income streams? DAVID C. ORFORD discusses the current problems with income stream products and proposes a new type of income stream.
The word retirement often invokes thoughts of stress-free days: holidays, gardening and perhaps visits from the grandkids. The reality, however, is often very different. Concerns over money, how long funds will last and what happens if they don’t fill the minds of many.Our current system may be the envy of others, but does that mean we should sit back and declare the job done? Or can we do better, much better?
What if Australia’s objective was to provide every citizen with an income stream that lasted for the rest of their life and it generally kept pace with inflation, to ensure their income does not decrease in real terms? There are many that hold the view that the income-stream products available on the Australian marketplace cannot efficiently fulfil this objective of paying an indexed lifetime income stream.
Australia’s current batch of products suffer from the extremely strong guarantees of investment and mortality. These costly guarantees are built into the price, making them unattractive. The result is that people simply do not buy them in significant numbers. The fact people cannot ‘see’ the money with an annuity, and that people will often forfeit any remaining balance at death, also weighs heavily on those considering a retirement product.
A new type of lifetime income stream is needed: one with different features and lesser guarantees, making the product more attractive and fairly priced so people will not be put off.
But what about account-based pensions? It is true account-based pensions are more attractive to Australians, as they can see the money and have comfort they won’t lose it upon death. However, it is also well known that there is yet to be an individual who has ‘taken it with them’, nor apparently is there any need to do so.
It’s also true there are no solvency reserves required, as there are no guarantees. The pension may even last for life, although the income normally reduces in real terms until the holder is receiving relatively low amounts of pension at older ages. It is then that the burden falls back to the rest of the community, as these retirees turn to the social security safety net. Some quick calculations on longevity and ageing demographics show the societal cost going forward. Evidence of this is noted in projections contained in the Australian Government’s Intergenerational Reports with some of the reading sure to cause subsequent nightmares.
Rather than discuss the merits of different options, let’s do what actuaries love to do and get to the numbers, challenge conventional thinking and provide some thought-provoking discussion. The graph below aims to show the pension achievable with an account-based pension compared to what might be achieved with the type of ’Real Lifetime’ Income Stream I propose – both shown in real terms, that is, after inflation.