CIPRs to redefine retirement planning

Financial advisers will need to be able to segment their client base to take full advantage of the CIPR regime, Paul Murphy writes.

We’ve come a long way since the mandatory superannuation guarantee (SG) was introduced in the early 1990s. Australia’s super system is now the world’s fourth largest private pension industry, with $2.1 trillion under management at June 2016.

But the super system is still immature. It took 20 years for the SG to reach 9.5 per cent, and will take until 2025 to get to 12 per cent, assuming policy continuity. So it will be well into the 2030s before Australians have spent their full working lives with SG coverage of at least nine per cent of their salaries.

This means that for most of today’s retirees, the Age Pension continues to be the main source of retirement income, with approximately 80 per cent coverage. 

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But future retirees will be much more dependent on their own super savings, with social security falling back to more of a ‘safety net’ function over time.

And this profound change in the dynamics of the super system is happening faster than many people expected.

Accumulators turn income generators

Until now, the primary focus for wealth providers has been maximising net investment returns through the accumulation phase. But things are changing, driven by the wave of Baby Boomers entering retirement.

As the super system matures and the population ages, the Government is looking to shift the industry’s focus from accumulating capital to generating income, from maximising returns to managing liabilities, and from building wealth to drawing down.

Key changes emanating from the Financial System (Murray) Inquiry and other policy reviews are now poised to produce policy outcomes that will transform the retirement product landscape in Australia.

ABPs dominate the current scene

Currently, retirement product selection is almost entirely driven by the tax-free status of eligible retirement income streams from age 60.

However, there is only a very limited range of products that qualify, with the vast majority of these (around 95 per cent) being account-based pensions (ABPs). While these offer great flexibility, investment choice, access to capital, and bequest benefits, they expose investors to investment, longevity, and sequencing risks.

Some recent research also suggests that ABPs often lead to unnecessarily frugal drawdown behaviours, with retirees being anxious about the risk of outliving their savings.

At an overall system level, the Government contends that super assets are not being efficiently converted into retirement incomes due to a lack of risk pooling and over-reliance on individual ABPs.

So the government has recently expanded the definition of products that can qualify for tax-concessions in the retirement drawdown phase, and is planning to introduce comprehensive income products for retirement (CIPRs).

The future and CIPRs

At the end of last year, the Government released its long-awaited discussion paper for the new CIPRs.

• While many critical details remain to be resolved, the overall direction of policy seems reasonably clear:
• An optional MyRetirement product category, along similar lines to MySuper in the pre-retirement phase;
• The MyRetirement products to be a ‘soft default’ option to be offered by trustees, providing an ‘anchor’ point for member selection decisions;
• Income efficiency with Government modelling suggesting a 15 to 30 per cent increase in income compared to ABPs drawn down at minimum rates; and
• Mass customisation with trustee assessment of suitability for the majority of members.

For APRA-regulated funds, the creation of CIPRs as soft defaults for retiring members will move much of the post-retirement ‘action’ away from individual product selection and tailored advice towards a mass-customised environment.

This is a significant shift in retirement planning. Until now most of the thinking has been at an individual member and client level, taking into account issues like age, account balance, health, marital status, and home ownership.

While individual advice will remain pivotal for many, Australians financial advisers are likely to get an expanded toolkit to build client drawdown strategies.

Together with the recent extension of earnings tax exemptions from age 60 to a broader range of retirement income stream products, we see the CIPR proposals leading to three broad categories of product development:

• Annuity-based solutions providing a guaranteed income in return for a fixed commitment of capital, and accessible either at commencement of retirement or on a deferred basis;
• Collective/pooling solutions that require access to large member pools, such as longevity risk pooling, collective defined contribution schemes and group self-annuitisation; and
• Portfolio-based solutions with no mortality pooling that use the existing ABP framework, like objective-based funds, managed drawdown funds, capital protected and lifecycle funds.

Customisation = innovation

While CIPRs will be a single product from the perspective of members and clients, behind the curtain they are likely to be a blend of products.

CIPRs will pave the way for product innovation across the industry. And as super funds come up with mass customised solutions, a new challenge for advisers will be to segment their client base to take full advantage of the new regime.

In this regard, we see CIPRs taking their place in a future product landscape as part of an income layering or ‘bucketing’ approach.

• Basic needs (food, shelter, health care, and utilities) – age pension, annuities, and term deposits;
• Nice to haves (holidays, hobbies, entertainment) – reverse mortgages, variable annuities, portfolio-based solutions, and investment properties; and
• Aspirations (bequests, supporting grandkids, philanthropy) – direct equities and ABPs.

But no matter which products are used to build portfolios, they require efficient execution.

The principles of investment success still apply in retirement – create appropriate investment goals, develop an asset allocation that suits your age/risk profile using well-diversified funds, minimise cost and maintain a long-term perspective.

Paul Murphy is senior manager – retirement policy at Vanguard.