Retirement income used to be a simple proposition for the relatively small number of Australians who had superannuation before the mandatory Superannuation Guarantee commenced in the early 1990s.
In the old days, when defined benefit (DB) schemes were prevalent, retirement income came in a monthly cheque, typically with an annual inflation adjustment.
A diminishing few enjoy such guaranteed payments in today's overwhelmingly defined contribution (DC) environment. Instead, most people accumulate their own "pot" of money, an account-based pension from which to generate income alongside any age pension payments they may receive.
Financial advisers can provide value by helping clients create a plan to generate income throughout retirement. This section is intended to provide advisers with relevant background and insights to do so.
An investor doesn't need to be engaged to accumulate assets within Australia's retirement system—although it never hurts for them to make additional contributions, and there are various incentives to do so. The level of employer contributions is mandated by the Superannuation Guarantee. The employer supplies these contributions.
If the worker isn't sure which investments to choose, they can simply have their super contributions invested by default with the super fund of their employer's choice and in that fund's low-cost, diversified MySuperopens new window option.
For many, the process unfortunately invites plan members to pay little attention to their superannuation accounts. Then, at retirement, when it's time to turn a career's worth of savings into a stream of lifetime income, the member faces a series of crucial and potentially irrevocable choices. Perhaps having rarely been engaged while accumulating assets for retirement, investors must become fully engaged when it's time to start accessing their money.
In this context, the government is developing to enact a retirement income policy framework that governs superannuation funds to pay specific attention to the needs of their retiree members.
One part of this framework is a concept of a Comprehensive Income Products for Retirementopens new window (CIPR), which would be designed to efficiently turn accumulated DC savings into retirement income. Specifically, they would provide broadly constant income while mitigating the risk that an individual would outlive his or her money. They'd also allow individuals to maintain some access to capital for unexpected expenditures including home maintenance and health-care costs.
However and wherever CIPRs are implemented, advisers have abundant opportunity to help clients, including how they maximise the age pension.opens new window Recent Vanguard researchopens new window found that the areas where individuals felt least competent in their planning abilities were related to retirement income topics such as how to manage administration of a self-managed super fund and how to draw down from a DC plan.
Most Australians draw their retirement income from two sources: the age pension and their own superannuation accounts.
The age pension serves as a valuable safety net that pays an inflation-adjusted income stream for life. But because it's means-tested for both income and assets, determining how much someone receives can be complicated.
As clients receive less — or perhaps nothing — from the age pension, uncertainty grows about how to structure account drawdowns and make savings last. The financial adviser's role becomes vital for clients who need to consider longevity risk and how to access varied assets in retirement.
The age pension can be a meaningful portion of retirement incomeopens new window for many singles and couples. But its benefits can be reduced by an assets test and an income test; the level of pension received is based on whichever test produces the lower result.
The assets test considers the value of assets that an individual or a couple owns, including home contents, financial assets such as shares and bank accounts, and investment properties. The assets test includesopens new window a threshold over which the amount of age pension received is reduced by $3 for every $1,000 of assets, up to a higher threshold above which no age pension is received at all.
The income test considers both income received — from employment and rental properties, for example — and income assumed, or "deemed," from financial assets. Such deeming applies to assets including shares, bonds, cash and superannuation balances. Each dollar above an income test thresholdopens new window reduces the age pension by $0.50.
You can learn more about the role of the age pension in retirement planning.opens new window
Account-based pensions (ABPs) from superannuation represent the dominant form of retirement income in Australia. They're fully accessible once an individual is retired and reaches preservation age, and they provide a full tax exemption after age 60 (provided the retiree's account balance is below $1.6 million).
Individuals who have begun to draw down their super accounts must make annual withdrawals at minimum rates set by the government. The age-based minimum drawdown rules are designed to provide a reasonable level of income stability (assuming annual returns of about 2% to 4%) beyond Australians' average life expectancy.
However, no maximum annual withdrawals have been established, so ABP holders can withdraw higher proportions of their savings to finance higher spending in retirement and/or to meet unanticipated expenses. In doing so, of course, they risk exhausting their assets prematurely.
Still, research shows that ABP holders tend to behave conservatively, keeping their annual drawdowns close to the minimum payment levels amid uncertainty around longevity and future expenses.1 The behavioural guidance that you as a financial adviser are in position to offer can be invaluable in such circumstances.
Apart from ABPs, and with some limited exceptions, the only other type of retirement income product that has historically been eligible for tax exemption after age 60 is a traditional lifetime annuity. However, in Australia and in other countries, annuities have been unpopular from a consumer perspective because they require investors to give up a capital lump sum in return for a guaranteed income stream. Further, that stream has been limited in the low-interest-rate environment of recent years.
Reverse mortgages represent another strategy that can provide retirement income, but they can be complex and expensive and can carry long-term risks.opens new window
Individuals can always work in retirement, or retire partially while accessing superannuation benefits. Under the "Transition to retirement" rulesopens new window, workers can top up their income with regular payments from their superannuation account without needing to retire or necessarily even reducing their working hours, once they have reached their preservation age.
And many individuals take retirement income from sources such as investment properties. They may look to you for guidance around taxation, which can be complex in the context of non-super income sources.
1 Superannuation Drawdown Behaviour: An Analysis of Longitudinal Data, Reeson et al. (CSIRO-Monash Superannuation Research Cluster, May 2016.)
As the superannuation system matures and, for many, reliance on the government's age pension decreases, people entering retirement may seek less traditional vehicles for securing lifetime income.
Lifetime annuities have experienced some renewed interest amid market volatility in recent years. For the most part, however, they've been unpopular with consumers reluctant to part with lump sums of cash in return for a lifelong guaranteed income stream.
A new generation of vehicles seeks to balance the seemingly contradictory desires for certainty and access to capital.
Many products discussed in the context of retirement income provision seek to ensure that individuals don't outlive their savings. Some are specific to the individual, while others are meant to benefit individuals through pooled mechanisms.
Deferred life annuities are a form of annuity through which regular, rest-of-life payments are delayed until an individual reaches a certain age (85, for example) or for a set length of time after the individual purchases the annuity.
Variable deferred annuities are similar to deferred life annuities except that, rather than fixed payments, individuals' eventual payments vary based on the market performance of the underlying investments.
Group self-annuitisation is the pooling of a portion of super fund members' assets to produce payments that fluctuate based on investment performance and the longevity of group members. The early demise of some members provides for the continued payments to surviving members. However, such products are not guaranteed for life.
The Australian government requires super funds to have a retirement income strategy in place by July 2020 and a Comprehensive Income Product for Retirement (CIPR) available by July 2022.
The impetus for such a requirement is a stated objective for the superannuation system to provide income to supplement or substitute for the age pension.
The Treasury aims to add a retirement income covenant to the Superannuation Industry (Supervision) Act 1993. It advanced a retirement income covenant position paperopens new window that, while product agnostic in its characterisation of a suitable CIPR, provided as its typical example a deferred life annuity alongside drawdown from an account-based pension. It emphasised that an account-based pension wouldn't mitigate longevity risk without an annuitised component.
In many ways, retirement savers are alike. They need to save as much as they can, for as long as they can, at the lowest cost possible to garner sufficient assets for what could be decades in retirement.
Conversely, people planning for how they can spend in retirement are different. Their assets, their spending needs and, most important, their goals set them apart dramatically.
It's a challenge for advisers and an opportunity too. Putting a retirement income discussion in terms of the individual not only bodes well for outcomes, it builds your clients' trust.
Longevity is a useful word for actuaries, policymakers and financial advisers. For people planning their retirement, it's just a euphemism for when they're going to die. People who don't like to think about when they're going to die similarly don't think about how long they might live.
So make your retirement income conversations about the prospect that your clients might run out of money. Everyone will exhaust their longevity; those who enjoy more of it are at greater risk of depleting their retirement savings. And no one wants that.
To help balance multiple considerations, including whether a client should purchase an annuity, we've constructed a retirement-planning frameworkopens new window that allows retirees to capture their priorities and use their financial resources in a way that best aligns with achieving their goals and mitigating their risks.
The age pension comprises a meaningful portion of most Australians' retirement income. But because it was designed as a safety net, its income and assets tests may disqualify some, especially early in a retirement when the need to draw on a career's worth of accumulated wealth has only just begun. But it can be an important planning toolopens new window even for those who may not be able to access it until well into retirement.
Vanguard has espoused for years that, all else being equal (all underlying investments, all holding periods, for example), a low-cost fund outperforms a high-cost fund every time. We've shown illustrations in materials for investors all over the world depicting the vast differences between high- and low-cost funds in amounts that could be accumulated for retirement.
The concept works the other way, too. All else being equal in an individual's plan for retirement, a low-cost fund allows for more spending than a high-cost fund.
This chart illustrates the difference in the amount a single retiree with a $400,000 superannuation balance and a couple with an $800,000 super balance could spend each year during a 30-year retirement were they to select a low-cost or high-cost investment product.
Note: The income levels shown are based on a constant real spending amount over a 30-year horizon with a 95% probability of success. See “The role of the age pension in your retirement plan” for further discussions on the age pension. Retirees are homeowners with a balanced (50% equity/50% bond) portfolio. The model incorporates the age pension as at September 2018 and only considers financial wealth and therefore does not consider assets that would not be deemed to earn an income (i.e. home contents) or additional income (i.e. employment income) which would shift eligibility. The model treats superannuation and non-superannuation assets as one pool of financial assets and therefore we have assumed that any minimum withdrawals from super that exceed the retirement income targeted are reinvested in a non-super account. All values are in real terms. The examples used here are general only and do not consider any personal information. Actual age pension received may differ from that represented by the analysis due to a range of legislative and personal factors.
Source: Vanguard Capital Markets Model (VCMM) simulation as at June 2018
IMPORTANT: The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class in AUD. Results from the model may vary with each use and over time.