“The retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees.”
~ Any guesses as to who said this and when?
Could it have been in the Final report for the Retirement Income Review, released in November 2020? Or was it said by the Government when the Retirement Income Covenant was implemented in 2022? Was it something that APRA and ASIC raised in their report on the findings from the joint APRA and ASIC thematic review into the implementation of the covenant?
If none of the above, then surely it’s from the discussion paper on the retirement phase of superannuation that the Government released in December.
Wrong again.
This quote is from the July 2014 Interim Report of the Financial Services Inquiry, also known as the Murray Inquiry.
Yes, a decade ago.
Consultation on the retirement phase of superannuation
In the latest December 2023 Treasury Discussion Paper that considers the retirement phase of superannuation. Treasurer Dr Jim Chalmers said that the Government is looking at how to improve the retirement phase of superannuation so that the system delivers a better retirement for more Australians.
The Discussion Paper points out that one of the highest priorities for older Australians is having a source of income that will last for life and that lifetime income products are a great way to insure against this risk. Yet very few Australians use lifetime income products at retirement. This is a puzzle. Or more precisely – the annuity puzzle.
The Paper invites feedback on the opportunities, barriers and challenges to improve the experience and outcomes of members in the retirement phase with a focus on:
- Supporting members to navigate the retirement income system,
- Supporting funds to deliver better retirement income products and services, and
- Making lifetime income products more accessible.
Optimum Pensions contributed a submission to this Discussion Paper, which sets out a possible solution, how it can be achieved, and how problems and objections can be addressed.
Submission Summary – A soft-default retirement product solution
How many Australians would have a healthy retirement balance today if the Government had not made it compulsory in 1992? One reason Australia’s retirement system consistently rates highly on international comparisons is that it is mandatory.
Thinking about retirement income products with a similar form of compulsion could make them more accessible to more Australians.
Why is only half of our retirement income system based on compulsion? From an economic point of view, it simply may not make sense to have a compulsory retirement system that switches to voluntary at the point of retirement. The behavioural and market inefficiencies that required compulsion in the first place persist into the retirement phase.
At Optimum Pensions, we propose extending an element of compulsion beyond retirement. The main difference is that we propose using a soft default, one that members can opt out of if they wish, rather than the hard default used in the accumulation phase.
Many of the submissions raise concerns about introducing a default retirement income product, even a soft default one. They point out that the cashflow needs of Australian households are likely to be very different to each other. Our submission acknowledges those concerns and lists some of the reasons for this need for flexibility and personalisation.
However, in our view, once retirees enter their 70s, many of these issues are reduced significantly. So, to address many of the concerns, our solution splits the retirement phase into two parts.
During the first part, from retirement until five years past the Age Pension age, the soft-default product is a fully flexible product. During this period, the member needs greater flexibility and personalisation.
For Australians who are five years beyond the age pension age, which is currently 67, the financial issues they face become more stable, and, as a group, their needs become more homogeneous again
For members in this second part of retirement, we propose a blended product mix of an account-based pension and a lifetime income product. For all but the most cautious retirees, we suggest using one of the innovative lifetime income product types now available in the Australian market. These allow retirees to benefit from the equity risk premium and don’t require providers to set aside high capital reserves.
The modelling included in our submission echoes the original modelling for the Financial System Inquiry—that a blended retirement product can deliver between 15% and 30% more income than a traditional retirement product, with the income continuing for life.
Disclosure, tools and advice
Any product solution must be supported by appropriate disclosure and tools to help members navigate the complexity of retirement planning. Several of the submissions raise the risk of a default mechanism steering a member to an inappropriate product.
The Government introduced the Design and Distribution Obligations to require firms to design financial products that meet the needs of particular groups of consumers and distribute their products in a more targeted manner. That sounds like what we are trying to do with retirement income products, doesn’t it?
We recommend ASIC use this existing regulation to require trustees to take a more diligent approach when producing their Target Market Determination (TMD) documents for their retirement income products, including the specific retiree needs that each product addresses and, just as importantly, doesn’t address. For example, an account-based pension does not protect against longevity risk. Nor does it allow means-tested retirees to benefit from the Age Pension incentives that can apply to lifetime income products. Rather than being silent on this, we propose the TMD for an account-based pension explicitly call this out.
In addition, a ‘red flag’ system for new retirement products can help members and advisers identify when a product is unsafe or unsuitable for their circumstances. This will reduce the risk of a member ending up with an inappropriate product for their circumstances. This approach is used with lifetime annuities in the UK.
Superannuation is different
Superannuation is not a typical industry, such as food or consumer goods. The laws of supply and demand work differently in superannuation. The superannuation guarantee system was introduced in 1992 to overcome many of the demand-side issues with saving for retirement.
Similarly, the commencement of the MySuper regime in 2014 was partly an acknowledgement that not all superannuation members have the necessary skills to comprehend complex financial information or are investment experts.
In the same way, we should not expect all superannuation members to have the skills necessary to comprehend complex financial information and be investment experts in retirement. Without defaults in place, each member needs to become their own defined benefit actuary, able to assess all the variables and unknowns and work out how to efficiently and effectively utilise their superannuation savings to fund their retirements, no matter how long they live.
It is now time for the next step in the evolution of Australia’s retirement income system.