The recent publication of the Retirement Income Review Final Report intended to give a snapshot of the current Australian retirement income system in the hope of stirring the industry into action to ensure better retirement outcomes for Australians.
Some important themes were identified by the Retirement Income Review panel concerning the best use of retirement savings to fund life after full-time work ends including:
- The need to change the focus from saving for retirement to spending in retirement.
- The complexity of Australia’s retirement income system;
- The lack of understanding of life expectancy and managing longevity risk; and
- The importance of introducing the proposed Retirement Income Covenant.
Changing the focus
As the panel suggests, the focus of the Retirement Income System needs to change from saving for retirement to spending in retirement.
Many Australians retire after a lifetime of working and look forward to enjoying their retirement. However the hurdle that lies between successfully transitioning between these two phases of life, is working out how to effectively convert hard-earned savings, including superannuation, into an adequate retirement income. A task that challenges even the most educated and financially literate.
The panel calls out the complexity of the retirement income system and acknowledges that it prevents people from optimising their retirement income.
Various submissions to the review proposed different options to simplify the system, and these should be considered as a priority. We need to accept that retirement is complex—certainly more complex than the pre-retirement phase – and involves many risks and uncertainties including longevity risk.
‘Voluminous research has been dedicated towards understanding the accumulation phase of superannuation … In contrast, little attention has been allocated to the retirement phase.”
Griffith Centre for Personal Finance and Superannuation, Retirement Income Review Submission.
The system is complex
Complexity, combined with fear and uncertainty, can result in people making poor choices. One of the unfortunate results of the intricacy of the retirement income system, is that retirement planning can become so overwhelming that people avoid it altogether and end up not using their superannuation balances effectively in retirement.
Adding to the complexity is the interaction with other regulated systems that can be difficult to navigate such as aged care and tax.
The panel suggests (because it can’t recommend) that a solution to this could be better access to low-cost, accessible financial advice. Giving superannuation funds the confidence to provide some financial advice to members without needing to comply with associated legal obligations, could advance member retirement outcomes.
Life expectancy and longevity risk
The fear of retirees outliving their savings is a real one and the panel reported that some submissions argued longevity risk was a major deterrent to spending in retirement. The lack of accessibility to retirement income products that provide longevity risk protection further compounds this issue.
- Firstly, a better understanding of the concept of life expectancy is important for retirement planning and managing longevity risk.
- Secondly, superannuation funds need to offer longevity products to help manage this risk.
- And finally, retirement product providers need to understand and address the behavioural barriers to the take-up of such annuity products.
The panel acknowledges the low take up of annuities despite their advantages is not unique to Australia, and something that is often called the ‘annuity puzzle’. There is no shortage of research publications attempting to explain this dichotomy, many listed in the references section of the report.
Rationales for the annuity puzzle include people tending to underestimate their longevity, but also the way product providers present them to the consumer.
In an important paper by Jeffrey R. Brown et al, “Why don’t people insure late-life consumption? A framing explanation of the under-annuitization puzzle”, the authors present evidence that when consumers evaluate annuity products using a “consumption frame” that considers the consequences for lifelong consumption rather than a narrow “investment frame” that focuses on risk and return then they are more likely to buy them.
The Retirement Income Covenant
None of these themes outlined are new. The Government proposed Retirement Income Covenant (2018‑19 Budget) addresses many of these issues, and the panel appears to support the implementation of the Retirement Income Covenant to provide a decision-making framework to assist people at retirement. The modelling included in the review illustrates what the covenant could achieve.
The covenant would require superannuation funds to reconsider the retirement income products they offer to members and to make sure that they are appropriate and in their best interest for improved retirement outcomes.
Superannuation fund trustees need to consider member needs in retirement and develop an appropriate retirement income strategy. Yes, who would have thought that superannuation funds would need legislation to do this …
The terms of reference for the Retirement Income Review precluded it from making recommendations. The panel was asked to “establish a fact base of the current retirement income system that will improve understanding of its operation and the outcomes it is delivering for Australians.”
Retirement income review chairman Mike Callaghan said,
“The best use of the review is if it makes people think, question, have a better understanding, get a better debate. We’ve laid out the facts and people looking at them can come to [their own] conclusions of what should be done.”
We hope that with informed debate, considered research and a focus on consumer outcomes, work can be done together towards achieving the objective for Australia’s retirement income system, that the panel boldly proposed was: “to deliver adequate standards of living in retirement in an equitable, sustainable and cohesive way.”