Advice key to navigating retirement incomes

The Government has moved further to facilitate the development of post-retirement products but, as Hope William-Smith reports, the provision of good advice will remain the key.

Financial advisers are faced with a myriad of challenges in the retirement income space with an increased focus on balancing the longevity risks of an ageing population with policy changes in the superannuation and taxation sectors.

Re-evaluating advice around retirement income strategy is the key priority for advisers who need to navigate the best path forward for Australia’s largest cohort of retirees. 

The 2017/18 Federal Budget delivered last month did not hold any controversies, but reaffirmed the complex regulatory issues unveiled in the 2016 Budget which shed light on the increasingly convoluted concerns of how an ageing population can be financially supported.

Between 2006 and 2016, the proportion of the population aged 65 years and over increased from 12 per cent to 15.3 per cent, or 3.7 million people. Australian Bureau of Statistics (ABS) data also showed the population over 85 had expanded by 141.2 per cent in the same period.

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With the government still consulting on the development of Comprehensive Income Products for Retirement (CIPRs) to build new income streams and assist the 65 per cent of older Australians solely reliant on the Age Pension, Australia’s $2.2 trillion superannuation system is set to be riddled with changes come 1 July. Advisers will be relying on retirement income product manufacturers to come up with new products to help meet the needs of those exiting the workforce.

The offering of various retirement income products, their legislative framework and accompanying structure and requirements are yet to be fully developed, but experts agree that staying safe with investments, securing multiple income streams, and progressive goal tracking from the accumulation phase through the transition to retirement and to retirement will be fundamental to decision-making over the next 12-24 months.

RETIREMENT SENTIMENT

According to the Australian Securities and Investments Commission (ASIC) Moneysmart website, a modest retirement lifestyle, assuming a life expectancy of 20 years after retirement, would cost a single $23,996 per year, while couples required $34,560. A ‘comfortable’ retirement lifestyle required a total $43,372 and $59,619 respectively.

The Association of Superannuation Funds of Australia (ASFA), put this figure slightly higher in its March quarter figures at $43,665 for a comfortable retirement for a single, and $59,971 for a couple.

While mortgages and debt were the most prominent causes of Australia’s low accumulation of funds, ASFA data showed product providers would also now have to account for new long-term challenges including guaranteed price hikes in the cost of power, health care, food and rates.

Investment Trends senior analyst, King Loong Choi said that while statistics showed an obvious issue, they also caused misconceptions for pre-retirees in dire need of professional advice to understand their financial position.

“There is a mismatch between how much people actually need in retirement and how much they may think they need,” he said.

“There is an opportunity here for advisers as well as super funds and the like to really just educate Australians about how much they actually do need for retirement.”

Research from Investment Trends showed only 44 per cent of Australians over the age of 40 feel prepared for retirement, down from 49 per cent in 2015.

“Australians’ confidence about their retirement has deteriorated significantly over the past few years,” Choi said.

“The ability to accumulate sufficient wealth, potential falls in the share market and regulatory changes to the superannuation rules are all contributing to Australians’ growing angst.”

Choi said advisers should step up and demonstrate to clients how well their savings had progressed at various points in the accumulation phase, and should integrate goals-based financial planning methods to assist pre-retirees to prepare for later life.

“What advisers need to keep in mind is that one of the top things clients look for at the moment is just about setting a goal and demonstrating to clients exactly how they can go about achieving that,” he said.

“A lot of the doubt comes from a general misunderstanding on the consumers end, regulatory uncertainty, as well as the general pressure on the market.”

POLICY DEVELOPMENT

Findings in the HSBC 2015 Future of Retirement Report showed 65 per cent of people globally who did not prepare adequately for retirement did not realize this was the case until it was too late. The same report ranked Australia fourth in the world when it came to lack of confidence in retirement, with 46 per cent in fear of financial hardship. 

The government opened its discussion paper to explore the key issues in developing more efficient retirement income products in December, with the framework set in place to reform crucial longevity and sequential risks caused by financing a growing and population with high life expectancy.

Choi said retirees and advisers had similar goals in mind when it came to what Australia needed from CIPRs.

“Every client wants a product that is easy to understand, something that is tax effective, low cost, and compatible with social security entitlements,” he said. “The main things (advisers) need to look at is what the clients themselves are looking for in a product and then really just trying to hone in on that.”

In a May 2017 review on CIPRs, the Committee for Sustainable Retirement Incomes (CSRI) said that while most retirees preferred to not rely on expensive personal financial planning advice, they needed iterative engagement as they considered when they intended to retire, or transitioned to retirement, and whether to vary their voluntary contributions to achieve their target retirement income.

The report drew attention to pitfalls in the framework for CIPRs which had the potential to compromise overall effectiveness and sustainability. 

“The absence of a clear overarching objective for the retirement income system that can support a consistent set of policies across the different parts of the system has been identified as a significant impediment to the development of good public policy,” the report said.

“Of particular relevance has been the tendency to consider public pension, taxation and superannuation regulatory reforms in separate domains, resulting in poor system integration, [and] excessive complexity.”

Vanguard senior manager, superannuation policy, Paul Murphy said product providers and advisers were waiting to see how much tailoring of the CIPR product can be made for particular retiree segments.

“Trustees should be conversant enough with members’ circumstances and needs to arrive at a reasonable ‘soft default’ structure and personal advice will still play a critical role,” he said.

Murphy noted the traditional focus in Australia was on account-based pensions for retirement, but 1 January changes to the Age Pension assets test meant retirees could no longer rely on a strong level of government support.

“The expansion of the post age-60 earning tax exemption to a broader range of retirement income streams from 1 July this year [will] see a range of new products like deferred annuities and group self-annuitisation products brought to market, expanding the options for retirees,” he said.

“There is no silver bullet that delivers all of these desired features in a single product – the retirement planning story will always be about trade-offs and prioritization and for a financial planner, it comes down to trying to optimise the situation for each client.” 

KnowIT Group technical manager, Rob Lavery said while it was clear the government had tried to build flexibility in the system to allow CIPRs, there was little conclusive evidence to support any likelihood of its success and that negative client sentiment was rife which placed the adviser in a difficult position.

“Australians are cost sensitive and the cost comes into these things,” he said.

“Australia is not a huge market. The more options people have the better but I’m not sure how [CIPRs] will assist or how popular that will be.”

INTEGRATING AGED CARE

Another blip ahead for Baby Boomers and the calculated expectation of their 20-30 years of life after retirement was the lack of integration between the retirement and aged care life phases, according to Bravura Solutions research.

According to the financial software provider’s Superannuation Megatrends: 10 Trends Reshaping the Industry report, those aged 65 face a 54 per cent chance (females) or 37 per cent chance (males) that they will enter permanent residential aged and the framework for CIPRs should include dedicated investment products for insurance for health and aged care, as well as mechanisms from equity release products to income continent loans.

“While the CIPR space promises to be fertile ground for Australian super funds in the years ahead, the funds who prepare their operating environments now will reap the greatest rewards,” said product manager superannuation APAC, Scott Kendall.

“To deliver these benefits super funds need to develop new offerings and ready themselves operationally to deliver these new innovative retirement income solutions to retirees.”

Kendall said streams already in place which included a combined pension and annuity product, the combination of an account-based pension with a pooled investment, and the use of an investment bucket strategy which separated their members’ account balances into buckets based on pre-set investment models had all been tried and tested successfully.

“As super funds take up the challenge of delivering greater certainty around income and longevity risk there are likely to be many more variations on these approaches,” he said.

“To deliver these new products super funds will need modern agile administration solutions and operational capabilities to manage far greater complexity in the form of add-ons to allocated pension products, multifaceted product suites and/or standalone products that bundle together desirable features. 

“Systems must allow for flexibility in product design and mix, simplicity in administration, efficiencies in service delivery and adaptability as products evolve.”

UTILISING ANNUITIES

Annuities have long been a popular choice for investors who want to receive a steady income stream in retirement and were an adviser-approved wise choice, according to King.

“Forty three per cent of advisers have been recommending annuities to their clients…up from 27 per cent in 2012,” he said.

“There is this growing use of annuities amongst advisers and there remains this strong appetite from advisers to continue using annuities in the future as well.”

Choi said the basic benefits of annuities including guaranteed income regardless of market performance, tax-free investment earnings, and the 15 per cent offset for annuities purchased with super money before age 60 would continue to grow in popularity as clients looked for safe and simple options free from regulatory and policy complexities.

The hurdle for product providers to overcome now was changing client sentiment toward certain retirement products. Investment Trends proprietary Point of Failure Analysis showed allocated pensions and annuities appealed to just 11 per cent of Australians approaching retirement and at November 2015, annuities accounted for just 2 per cent of Australia’s retirement income market, according to research house DEXX&R. 

Benefits from annuities could be considered by more, as a deferred annuity used in combination with account-based products allowed retirees to utilise the account-based component with confidence, as there was a fall back for outliving the pension component, according to Murphy.

Lavery agreed annuities were a safe and logical mitigator for longevity risk, but said the difficulty for advisers winning clients over when recommending them could persist unless the client demonstrated high-level understanding of products and strategies on offer.

“Annuities are excellent but the client has to understand them, so if you have a highly sophisticated client, you can deal with an extremely sophisticated product,” he said.

“If it becomes too complicated or too hard to unwind in the clients’ mind, then you don’t get a lot of traction with the products themselves.”

SHARES, BONDS, AND DEPOSITS

A capital preservation solution that delivered a predictable outcome and high security is what advisers should be navigating clients towards, according to Omega Global Investors senior portfolio manager, John Moore.

Different income strategies including the use of Australian shares to balance a portfolio were touted as a strong portfolio diversifier and helped retirees feel secure, with money staying close to home away from geopolitical market threats. 

“Retirees are risk-averse and taking those things into account and then looking at how you can use a share portfolio shows people are needing to diversify away from term deposits and traditional bond accounts because they are not as attractive as they have been in the past,” Moore said.

“Create a fund to provide investors with regular income and some capital protection by reducing the exposure to volatility in the equities markets and…aim to generate a tax-effective and regular income stream.”

Moore said that the best way for advisers to compare income products or funds was to assess and restructure around their draw down.

“Put in place a hedge or buy some insurance to protect it from market fall so we have a strategy to reduce the investor’s share market exposure,” he said.

“Having a lower volatility portfolio is paramount for retirees, so risk-adjusted returns are extremely important and how you look at risk adjusted returns will protect you from longevity risk.”

While Australians remained hesitant about planning for post-work life, the responsibility of navigating the accumulation phase and ensuring Baby Boomers passed into the retirement phase with a supportive financial base would be dependent on the willingness of the sectors responsible to work in tandem.

“As an industry, we must address Australians’ lack of engagement on the topic,” Choi said.

“This will require further action from super funds, financial advisers and product providers.”