Disrupting retirement: What needs to happen

While super’s best brains search for a golden goose of retirement income products, just stay focussed on building your nest egg.

We are nearly three years into the search for new ways of delivering better superannuation income streams to retirees.

And so far, we’ve had almost nothing. Product innovation is virtually non-existent. People are waiting for a miracle solution – a golden goose with low fees and the flexibility of an octopus.

According to “experts”, Australia needs to redesign its retirement income streams. They say current products aren’t good enough, not flexible enough, too risky, too simplistic. The current solultions don’t deal with longevity risk adequately, or certainly not cost, or tax, effectively.

So, in the background for the last three years, there has been a running debate in Australia about what what is being referred to as CIPRs (pronounced “sippers”), which stands for “comprehensive income products for retirement”.

The CIPRs concept came out of David Murray’s Financial System Inquiry (FSI), released in December 2014. Mr Murray was trying to stimulate innovation in the retirement incomes sector, to come up with new products that would allow Australians to have more options than the two incumbents.

Those two existing options are, essentially, “account-based pensions” and “annuities”.

ABPs are seen as risky, because they don’t have longevity risk protection – that is, the money can run out before you die. Partly because you can withdraw it all once you have hit a “condition of release”.

But they’re safe and “fair”. That is, if you hit retirement with $500,000 in your super, you will get to spend that, plus or minus whatever it earns according to your investment decisions, and when you’ve pulled out your last dollar, you know that you’ve spent your money.

Annuities (which come in many forms) aren’t well embraced, because they are inflexible, generally come with high fees and are seen as risky if you die too soon. If you pass away too early, an insurance company wins and your heirs lose.

If you take an annuity and die too soon, the terms of the contract might determine your estate gets nothing. And taking lifetime annuities, particularly with current interest rates, can lead to what would be considered pitiful ongoing income streams.

So, where is the debate going?

It hasn’t moved far in the past three years. Some issues have been regulatory. Others have been on the product-manufacturing side.

But in order to expand away from the ABP and lifetime annuity products, there are two main product innovations that seem to be open to manufacturers. Both will require governments and government instrumentalities, to change laws to allow them to work efficiently and get support in a super system tax environment..

Deferred lifetime annuity (DLA)

The first of these is a deferred lifetime annuity. That is, you purchase at a certain age (usually something like 65) a guaranteed income stream that doesn’t start immediately.

A DLA would normally be purchased to start at say life expectancy, or from age 85, and be paid through until death. If the purchaser (annuitant) dies before the DLA starts, it might pay something to the estate, but this would increase the cost of the annuity itself.

The point of this is that some annuitants will start their pension at, say, 85, then die a few years later. In that case, the insurance company wins. But others will last beyond 95 or 100, in which case the insurance company loses. It comes down to insurance companies being able to manage that risk on behalf of their shareholders to earn a reasonable return for the risk being taken.

But the problem for individuals is taking that punt and losing. And also that, currently, governments don’t treat these sorts of products as they do other superannuatoin-based products. And this needs to change.

Group self-annuitisation (GSA)

This is about pooling mortality risk. Large numbers add to the pool and the pool pays out to surviving members.

The argument is that this will deliver a higher income in retirement than an ABP. But there is no surety of income, as it will fluctuate with market returns and, well, the number of people who pop their corks. The main downside risk, again, is that if you die, you can’t leave what should be your share to anyone.

Singapore’s compulsory state super system runs an example of a GSA, with some twists. If your super fund balance is above a certain threshold, you have to participate in the program. At which time, you have two choices.

The first choice is a lower payout figure, but a higher amount that can be left to beneficiaries. The second is a higher income stream, but a lower amount that can be left to beneficiaries.

Where to for Australians?

I don’t think this is on the radar in the short term – and it would be horrendously unpopular politically, unless backed by all parties – but some thought will be given eventually to making some sort of annuity product compulsory.

Like Singapore’s example, you can take and spend retirement savings up to a certain amount. But over that, you have to sink an amount into an annuity product, deferred or immediate.

Something that would provide you with an income over and above any government age pension, for life.

What they need to develop is the choice for the annuity products. (It will still, somewhat sadly, come down to a punt on your life expectancy.)

Another option, of course, is access to equity in the home – most notably known as “reverse mortgages”. I have covered this at other times. But this will, undoubtedly, become a larger part of retirement income stream considerations into the future.

But in the three years since Murray’s FSI, little has happened. There has been no rush of products to market. Government does not appear to have backed anything, or made major regulatory changes to assist in product development.

So, for the time being, that only leaves Australians with one option.

Continue to build you super pot as large as you can, while you’re in control of it. The bigger it is, the more options you have … when some realistic choices for longer-term income streams become available. 

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The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is managing director of Bruce Brammall Financial and is both a licensed financial adviser and mortgage broker. E: bruce@brucebrammallfinancial.com.au . Bruce’s new book, Mortgages Made Easy, is available now.