Wrestling with retirement risks

Recent policy changes have made preparation – and the role of planners – more critical than ever in the post-retirement space. However, even for planners, it’s not an easy system to navigate, with innovation barriers still shackling client choice, Kate Cowling writes.

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In many ways, Australia’s current retirees are the nation’s guinea pigs. 

As the first generation to retire with generally high balances, early Baby Boomers are setting the benchmark for their children and grandchildren, showing them how much they need to comfortably retire as the age of pension reliance fades into obscurity.

However, given the youth of the superannuation system, it’s often too risky to leave the journey to trial and error – something that makes the role of planners more crucial. 

Retirees have rapidly become the single largest market for financial advice and it’s a trend that looks unlikely to abate. 

Recent DEXX&R research shows the total retirement incomes market is set to grow at around 7.1 per cent a year over the 10 years to 2023. 

In March this year, the retail retirement incomes segment of the market held more than $148 billion in funds under management or administration, according to the research group. 

As the growing cohort of retirees learns that the age pension is a much smaller part of the puzzle than perhaps initially conceived, the best strategies to accrue and manage personal savings become a key concern.    

“The situation we’re seeing now hasn’t happened before,” the Association of Superannuation Funds of Australia’s (ASFA’s) CEO Pauline Vamos said. 

“So now it’s time to ask how we can enable people to convert those lump sums into income streams at the best possible value.”

While it’s certainly a burgeoning space for planners, it’s also one that is littered with challenges. How can we break the pension reliance? What’s the best strategy to encourage retirement saving? What products work best? And what role do annuities play?

Planners must initiate those conversations as early as possible, both to instil good habits and build up the asset, according to MLC’s general manager of retirement solutions Andrew Barrett. 

Barrett said research shows retirees want four things in retirement – liquidity, access to growth assets, capital certainty and longevity protection. 

But achieving the four is a near impossible pursuit and one that can be unravelled by poor planning, particularly in downward economic cycles. 

“We only have one chance at a successful retirement… And if another global financial crisis (GFC) hits us, the chance of us exhausting our pension increases from very little to a lot,” he said.

Challenger Life’s chief executive Richard Howes said unpredictability places the onus on planners to drive home the message that there are many elements of a successful retirement. 

“There needs to be mindset shift and advisers are the ones who can make that happen,” Howes said. 

Policy practicalities

A significant hurdle for retirees in the coming decades will involve breaking down reliance on the age pension and promoting it as a mere component of a far more intricate retirement system, Vamos said. 

With the qualifying age already set to rise to 67 by 2023, the recent Federal Budget also floated the idea of increasing it to 70. 

“With the ageing population, instead of five people working for every person retired, it’s going to go down to 2.7 people, so there just isn’t going to be the tax breaks,” Vamos said. 

“You cannot rely on the Government to provide you, and everybody, a large pension in retirement.”

However, if the Government wants to increase the qualifying age, it has to establish a framework to encourage retirement savings, she added. 

“If you increase access age to the pension but you don’t put more flexibility in the industrial relations framework, if you don’t look at how you can enable older workers to be productive, if you don’t have some sort of funding for retraining of older workers … they’re going to have some real issues there,” she said. “You’re gonna have people on unemployment benefits and not going to get the policy result you intended.”

Challenger’s Howes said the age pension needs to be reframed as a last resort. 

“The age pension basically covers poverty,” he said. 

“The next layer is private pension and guaranteed income stream, then beyond that you move into more aspirational terrain.”

From a policy perspective, ASFA and the Australian Institute of Superannuation Trustees (AIST), have been loud advocates of lifting the superannuation guarantee (SG) from 9 per cent to 12 per cent.  

“We still need to have a conversation with the Australian public that super is not a tax,” AIST CEO Tom Garcia said. 

“It’s part of that money you’re saving for your future and there’s a good reason why,” he said. 

MLC’s Barrett said due to the immaturity of the superannuation system uptake, in terms of voluntary contributions, has been both attitudinally and fiscally slow. 

“It was only several years ago that the SG rate was lifted to nine per cent, so for the vast majority of individuals, they haven’t been contributing at a robust rate throughout the course of their career,” he said. 

As a consequence, there’s a significant shortfall in retirement savings. 

NAB’s recent Wealth Sentiment survey found almost a third of surveyed Australians expected a large shortfall of savings at retirement, while a quarter expected some shortfall. 

However, AllianceBerstein’s executive director, Ross Kent, said longevity risk is a more severe, unaddressed problem.

“The issue is less about severe shortfall in savings immediately on reaching retirement and more a question of ensuring that the savings can last long enough,” he said. 

Innovation barriers

When it comes to the product landscape, and issues like longevity risk, stakeholders agree that innovation is crucial, but often not supported by the current regulatory framework. 

BT Investment Management’s CEO Emilio Gonzalez recently said the space is “primed for innovation” given the unwillingness of retirees to take on high levels of risk. 

MLC’s Barrett agreed, but said growth products still had an important role. 

“If you dial down your exposure to growth assets, there’s an opportunity cost to that,” he said. 

“While you might be reducing your market risk, you’re increasing your longevity risk. You’ve got a more stable portfolio, but it’s not generating the returns you need for an adequate income.”

As Vamos points out, there are “significant impediments” to product innovation in the post-retirement space, making it difficult for providers to handle longevity risk, liquidity and capital preservation simultaneously.  

“You can’t innovate,” she said. 

“At the moment, there are tax rulings and social security rulings that only deem certain types of income streams to be treated in certain ways.

“You’ve got to deal with about four different regulators to get a post-retirement product through, the capital product requirements are very high and there’s no financial advice framework.”

The impact of the impediments is the removal of choice, according to Vamos, who said she just wants “a real conversation about it”. 

These systematic impediments have skewed the post-retirement space towards wealth accumulation, over guaranteed income streams, according to Howes. 

“It’s just a lot cheaper and easier,” he said. 

“It’s expensive to guarantee income and there are onerous capital requirements.”

The annuities answer

One often talked-about solution to the lump sum dilemma is annuities, a product that offers compensation for longevity risk. 

The Australian lifetime annuities market is forecast to increase by an annualised 8.2 per cent over the next 10 years to $8.9 billion by 2023, according to DEXX&R data. 

“Challenger Life has been the undisputed leader in the annuity market for some years and continues to consolidate its position as the dominant company in the immediate annuity market,” DEXX&R’s managing director Mark Karchor said. 

However, the dominance of one company in the space presents a series of challenges, even for the leading company itself. 

Howes said Challenger would like to encourage more players to get involved in the Australian annuities space, if it meant a smaller market share of a much larger market. 

He said from a policy changing the restrictions around deferred lifetime annuities are a “no brainer”. 

ASFA’s Vamos agreed:  “the tax structures for deferred annuities are laughable”. 

And it seems advisers are getting on board with annuities and are keen to continue to integrate the product into clients’ portfolios. 

Research from Investment Trends showed around a third of planners (32 per cent) reported using annuities in the calendar year to 2013, up from 26 per cent the previous year. 

In 2013, planners used an average 1.6 types of annuities, with a preference for long-term solutions, the same report showed. 

When asked about their intentions for 2014, 37 per cent said they would like to use annuities in some capacity. 

The attitudes of surveyed planners were a clear signal that there’s a mindset shift around combatting longevity risk, Investment Trends senior analyst Recep Peker said. 

“Generally what you’ll find is that only 20 per cent of financial planners are currently using products that mitigate longevity risk,” Peker said. 

“But we do find that it’s an area that a lot more planners would like address, so annuities, and especially lifetime annuities, are plugging that gap.”

Planners’ role

Despite divergent opinions in the best products for retirement adequacy, most analysts agree planners have a critical responsibility in steering retirees towards the most suitable solutions for their individual circumstances. 

For the majority of retirees, it’s not a transition that can be adequately managed without advice, according to MLC’s Barrett. 

“It’s really about lifting the understanding of the risks in retirement,” he said. 

“The inflation risk, the sequence of return risk, the market risk, the investment risk, the longevity risk – these are complicated variables to understand and there’s an interplay between them. To that end, there’s a role for products that have effectively-embedded advice.”

The desire for advice around retirement is further solidified by Investment Trends research showing more than four-fifths (82 per cent) of financial advice funds under advice are now held by are retirees or pre-retirees. 

“In 2013, for the first time, retirees held half of all planner funds under advice, up from 46 per cent just 12 months earlier,” Peker said. 

“And that’s just the tip of the iceberg. With the first wave of baby boomers only just reaching retirement age, retirees and pre-retirees will continue to demand higher levels of planning support for decades to come.” 

However, a key challenge for planners in the coming years will be encouraging people to seek financial advice in the pre-retirement years. 

“Most advised clients are 50 plus, but we would encourage earlier preparation. The best conversations are objective and goals-based,” Challenger’s Howes said. 

Given the different needs throughout different stages of retirement, planners also have a key role in guiding clients through the several transitions that they may be unprepared for, AllianceBerstein’s Kent said. 

“In particular, it’s critical for investors to begin to think about the different phases of retirement and begin to understand their longevity.

“It’s never too early to start a conversation about retirement,” he said.

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