Retirement looks different for everyone, yet one thing remains certain, everyone wants the confidence to live the best lifestyle they can. Both financial planners and superannuation funds are tasked with a critical responsibility – to provide access to retirement products that can maximise income, keep pace with inflation, and sustain a lifetime of financial security. However, uncertainty surrounding life expectancy poses a challenge. How can retirement income be made to last?
This article explores why super funds must include longevity insurance within superannuation offerings for sustainable and confident retirement planning.
Longevity complexities
Life expectancy varies for each individual and a myriad of factors, including lifestyle choices and health considerations will have an impact on each person’s life expectancy. However, ‘life expectancy’ figures should not be seen as a prediction of when you’ll die. Instead, it is a statistical representation, an average derived from a group’s longevity patterns, and understanding this distinction is important when planning for retirement.
The thought of running out of savings at average life expectancy is unsettling, given the 50/50 chance of still being alive and active at that point, yet with no financial cushion left. As a result, many individuals tend to lean towards a more prudent approach, planning a careful retirement to last beyond the expected timeframe, providing peace of mind- just in case.
This has been evident in the majority of people using the Optimum Pensions Lifespan Calculator choosing to focus on the result that gives them at least 90% confidence that the suggested planning horizon can cover their actual lifespan. For couples, this often means their plan needs to be able to last to around age 100!
Chart: Range of projected lifespans – Confidence levels for 10,000 couples entering retirement
- Source: Chart created by Optimum Pensions using the Australian Life Tables with 25-year improvement rates. This example has used a male/female couple for illustrative purposes, but the same principle applies to same sex couples.
However, if individuals need their retirement savings to last until age 100, the current approach adopted by most super funds means they can only withdraw a limited amount from their superannuation each year.
Unfortunately, this often leaves members facing an uncomfortable dilemma:
(a) withdraw a higher income annually, depleting their savings sooner, or
(b) opt for smaller withdrawals each year to ensure longevity of funds if they live well into old age.
If members want confidence that they won’t outlive their superannuation, they have to be frugal, carefully managing their retirement income, just in case they have a longer lifespan.
Reserving money for a scenario that is unlikely to occur is an incredibly inefficient system. Recognising this, the government has encouraged super funds to enhance their retirement products by incorporating longevity insurance to provide members with improved options that effectively safeguard against the possibility of outliving their savings.
Using insurance to protect retirement income
In various areas of life where people face risks that carry a low probability of occurring, but pose a high financial cost if they do happen, the solution is straightforward – insurance. Whether it’s the possibility of a car accident, or a devastating house fire, insurance protects against uncertainty, effectively transferring the associated risk to an insurer who assumes the burden of these potential financial losses. This system eliminates the need for every customer to set aside the full amount of money needed to cover potential claims.
When it comes to retirement income, the insurer takes on the responsibility of covering the expenses associated with providing additional funds to pay the retirement income to individuals who live longer.
By recognising that only a portion of members will reach the age of 100, for example, insurers can handle this task more efficiently than if every individual were to set aside funds to last until age 100 “just in case”. From an insurance perspective, it’s relatively straightforward for their actuary to predict how many people will live to reach each age, but it remains impossible to predict which specific individuals will live to each age.
People insure their homes and their cars in retirement, so why not their income?
Members wanting confidence that their superannuation income in retirement will last as long as they live face two options:
(a) Set aside a sufficient amount of money to cover their projected lifespan, typically extending beyond age 100 for a couple to ensure a 90% confidence level. This means a conservative withdrawal strategy to make sure their retirement savings last the distance; or
(b) Allocate a portion of their savings to a retirement product that offers longevity insurance. The cost of the insurance is based on the probability they live to each age, plus associated expenses, and a margin for the insurer in taking on the uncertainty and risk.
Retirement Products with Longevity Insurance
There is a new a range of potential designs for retirement products in Australia that offer longevity insurance and more confidence in retirement. A simple example, that’s popular overseas, and now available is an investment-linked lifetime annuity (ILA). This is a hybrid product that sits between account-based pensions and traditional lifetime annuities. Under this approach, individuals receive a lifetime annual income, albeit with fluctuating levels of income based on the performance of their chosen investments supporting their income stream. This dynamic structure provides peace of mind that they will not run out of money later in life, and also has the potential for higher investment returns and income (subject to investment risks) over the long term.
Combining an Investment Linked Annuity with an Account Based Pension will ensure members still have access to cash and enjoy the freedom to manage their investments while safeguarding their retirement income stream providing both flexibility and security.
How can superannuation funds provide an ILA for their members?
There are three basic ways for funds to offer an ILA:
- Add an ILA to their product list
- White Label an existing ILA (that can be customised to the fund’s membership)
- Manufacture the ILA (but they will still need an insurer).
Each of these options is available now, but each one has a different level of cost and complexity.
Insurance plays a crucial role in retirement, instilling confidence, and security among retirees by providing a lifelong income. Superannuation funds can offer these new retirement products to members to dramatically transform the retirement phase and simultaneously address the requirements of the Retirement Income Covenant. With the potential to improve retirees’ financial well-being and pave the way for a more prosperous and worry-free retirement journey, what are the super funds waiting for?
For more information, please contact Peter at peter@optimumpensions.com.au