The Annuity Ambiguity

Advisers may be eager to use annuities but until rigid product definitions and the inconsistent tax treatment of annuity products are removed, innovation will be shackled.

As a system that came into being in 1992, superannuation has been proficient in accumulating a large pool of money, but as Challenger's Howes pointed out, the industry had so far failed to convert it into retirement income.

"The industry has a lump sum mentality. It often talks about its role of growing wealth so I think there is an over-arching challenge for the industry to provide retirement income and reduce the reliance on the age pension," he said.

The Financial System Inquiry said tax concessions in the super system were not conducive to boosting retirement income, which meant it increased the cost to taxpayers, resulting in higher levels of taxation in other areas of the economy due to differences in the way other savings tools were taxed.

The Inquiry called for improved use of risk pooling, and tearing down barriers to new product development.

VIEW ALL

View all

ASFA's Vamos said the biggest challenge in retirement income was that income stream product definitions were very narrow, especially for social security and pension purposes.

According to a 2013 ASFA paper, the Superannuation Industry (Supervision) (SIS) regulations focused only on current post-retirement products, leaving little wiggle room for new products and innovation.

Regulations have stringently relied on individual product definitions (for example, account based, lifetime, residual capital value), instead of consistent principles for income streams such as regular drawdowns irrespective of whether payments started now or in the future.

This made it impossible for legislation to treat different types of income stream consistently.

"This issue is clearly demonstrated through the classification (or lack thereof) of deferred and variable annuities in the context of SIS legislation and regulations of the law," ASFA director of research, Ross Clare, wrote.

Vamos argued deferred lifetime annuities (DLA) did not fit the structure of the Australian Prudential Regulation Authority's requirement for a minimum surrender value of longevity products when a policy holder wanted to cease a pension or annuity product.

"The owner of the product, the retiree, under the life insurance act, has certain rights, and those rights go against what an annuity product is about. It just doesn't fit," she said.

"The easy answer is to design the superannuation system so these types of income stream products are seen as within the system, not outside the system. Once we bring them within the system, then we can ensure that they do start to get that scale and accessibility that we need."

Product development handcuffed

With 83 per cent of retirement planners open to using DLAs, and 96 per cent of those who had positive experiences with annuities willing to use it, there clearly is appetite for it.

But more than half of planners wanted liquidity access, while 40 per cent wanted the availability of DLAs in super.

In its review of retirement income stream regulation in July last year, the Treasury proposed extending the same concessional tax treatment to DLAs as those on investment earnings on assets supporting super income streams.

ASFA's response said there should be a tax exemption in the deferral period for DLAs to make them attractive in Australia.

SSFS' Monaghan said loosening up some of the distinctions around allocated pensions and annuities would be useful, along with freeing up requirements around allocated pensions and minimum payment levels.

"At the moment if you retire from full time work and start an allocated pension, which is a logical thing to do once you've turned 60, you can move your super into an effectively tax-free environment, and you're required to take out a minimum amount.

"Now, these days, lots of people don't just sort of retire and don't do anything. Many people will take on other work and another job.

"The easy answer is to design the superannuation system so these types of income stream products are seen as within the system, not outside the system.

"Maybe they therefore don't need in their early years to draw so much from their pension. It might be better if they could draw a little bit less from their pension and defer that expenditure to later in their life."

Lend a hand

Investment Trends' Peker noted a knowledge gap among advisers who had not used annuities, with 63 per cent rating their understanding as unsatisfactory.

"Advisers want more help from product providers in the form of educational material, marketing material to use with their clients to educate themselves, educate their clients, products that are a bit more flexible," he said.

With 84 per cent of planners wanting to use Challenger annuity products, an Actuaries Institute paper in the Australian Journal of Actuarial Practice argued lack of competition in the annuities market resulted in monopolistic behaviour, meaning consumers did not have choices, and were reluctant to purchase annuities.

Vamos also said providers needed to cut through red tape to get approval for longevity products, which pushed up costs.

"You've got four regulators: ATO, APRA, ASIC and Centrelink. The cost of developing the product is very high, which means if you don't succeed in the product, and you're using retirement member balances to develop that product, then that's a real concern for many trustees," she said.

Read part one of Malavika Santhebennur's report: Riding out the retirement storm
Read part three of Malavika Santhebennur's report: The Proof is in the Portfolio