Maintaining a healthy income in retirement

With the oldest of the baby boomer generation now pushing 60, the Government is making a concerted push to keep older workers in the workforce to lessen the burden on the public purse.

In recent years, several new measures have been introduced to encourage people to delay retirement, including allowing those working reduced hours to supplement a lower salary by accessing super, introducing the Age Discrimination Act and offering pension bonuses for those working past 65.

But according to the latest AMP.NATSEM Income and Wealth Report, a large proportion of workers are continuing to take early retirement when they cannot afford to do so.

Of those surveyed, some 24 per cent of people aged 45 to 64 had completely retired, 9 per cent were partly retired and 2 per cent had never worked.

Alarmingly, 44 per cent of retirees said they were pressured into retiring, highlighting the importance of the Government’s campaign to change the way employers view mature workers.

The survey also showed that pre-retirees interviewed in 2003 were still grossly over-estimating how far their super would stretch. When asked how they expected to fund their retirement, only 29.2 per cent said Government pension, 42.4 per cent said they would use their superannuation and 13 per cent planned to rely on savings, with the rest counting on income from a business or other sources.

These figures were in marked contrast to the actual principal source of income of retirees in 2003, with 74.2 per cent relying on the Government pension or allowance, 10.4 per cent using super, 8.7 per cent using savings and the remainder relying on other sources. Clearly there is a considerable gap between expectation and reality.

Empty nest egg

According to Centric Wealth chief investment strategist Robert Keavney, part of the problem is that many Australians do not know how to quantify the income their super will generate in retirement.

“Those in the top income bracket tend to be well-provided for and those with very little know they can rely on Centrelink. But those in the middle who may have $200,000 to $800,000 often don’t realise they don’t have enough.

“They think half a million is a lot of money, but in reality it will only fund a cost of living of $25,000 to $30,000, which could not be classed as comfortable.”

He believes Australians are still failing to put enough aside for retirement, with many who should be in the wealth accumulation stage funding a lavish lifestyle by drawing down on their mortgages.

“We are seeing more and more people in their 40s who have treated flexible lending facilities like a checking account and have not considered that they need to pay down that debt before they retire. We need to encourage people to increase their capacity to save,” Keavney says.

MLC technical services manager Andrew Lawless says many Australians are now realising they may be underfunded for their retirement, but it may be too late for those who are about to retire.

“Some people may not have had the opportunity to make adequate provisions for their retirement, but we are certainly seeing more people actively seeking financial advice and realising that they need to put a bit more money away,” he says.

Reverse mortgages are viewed by some as a way to top up retirement income and Lawless says these products are continuing to grow in popularity.

“There are 20-odd providers in a market that is worth just half a billion per annum because there is an expectation that the market will get a lot bigger. From my point of view this is almost like a last resort because you run the risk of eroding the capital value of your property,” he says.

Delaying retirement

There are, however, some more attractive retirement options on offer than putting the family home at stake.

In July 2005, Australians aged over 55 and under 60 were offered a way to ease into retirement by reducing their working hours and using super to supplement their income through a non-commutable income stream, under the Government’s new ‘Transition to Retirement’ rules.

This provides the double benefit of keeping employees in the workplace for longer, stretching their super further and providing the opportunity to salary sacrifice back into super.

Previously, anyone wanting to leave work early had to sign a declaration that they had ceased employment to claim some of the super and, if aged over 55 but under 60, they needed to state they had no intention to return to paid work for more than 10 hours per week.

The recent Budget also delivered sweeping changes to the superannuation environment, abolishing RBLs, removing tax on lump sums and pension income taken after age 60 and abolishing compulsory cashing of superannuation at age 65 — allowing older people to keep their money in super, regardless of whether they are still working.

Term allocated pensions (TAPs) were introduced in 2004, but have not been popular because investors must take an income stream rather than a lump sum.

As a result, the Government will be removing the current 50 per cent asset test exemption on TAPs in favour of a reduction in the taper rate for assets exceeding the lower threshold. Instead of excess assets reducing age pension entitlement by $3 per fortnight for every $1,000 of assets, this rate will reduce to $1.50 per fortnight from September 20, 2007.

The Government has also raised the maximum age for contributing to super to 75.

Navigator’s distribution development manager, investment, Maria Mazur says the reforms to the superannuation system in recent years have been the most significant in the history of super.

“The main outcome of the new rules is the flexibility provided to individuals when they plan their retirement.

“Any of the existing income stream products can be used — allocated pension, term allocated/growth pension, fixed term or lifetime pension or annuity, as long as the product has, or the product provider sets up, the required ‘non-commutable’ restrictions,” she says.

Non-commutable products

According to MLC’s Lawless, many advisers are currently favouring a blend of guaranteed products and more aggressive portfolios — for example, placing clients in two growth pensions with different terms of, say, 20 and 40 years to ensure the client’s variable retirement income levels needs are met.

As long as 50 per cent of total funds are invested in a TAP, members have been able to access the asset test exemption and the rest can be invested in a more flexible allocated pension.

Currently, MLC offers a range of products including lifetime and fixed term annuities, allocated pensions and TAPs, as well as a non-commutable version of the allocated pension.

Lawless says allocated pensions are proving to be the most popular products, while annuities are the worst sellers.

“There are a few clients who like the guaranteed returns, but most prefer exposure to growth assets to reduce the risk of outliving their superannuation,” he says.

Turn on the TAPs

IOOF technical manager Sam Rubin says annuities can offer advantages for some clients who need to roll in non-super money such as an inheritance after they reach the cut-off age of 65 for superannuation contributions.

However, he agrees with Lawless that allocated pensions are the most popular products.

They offer advantages from an estate planning perspective because when the member passes away, the remainder of the funds can transfer to a beneficiary as a lump sum, or an income stream in the case of TAPs, whereas with some annuities the balance is lost.

Since the introduction of TAPs, there have been yet further changes to provide retirees with a more stable annual income for a longer period of time.

From July 1 this year, allocated pensions will be calculated using updated minimum and maximum factors that are approximately 10 per cent lower than the factors applying to allocated pensions started before December 31, 2005.

For TAPs, retirees will be able to choose the term of the pension from a range starting at life expectancy and going through to age 100, based on either the retiree or their reversionary spouse, if nominated.

Each year TAP holders will also be able to increase or decrease the annual income taken by 10 per cent to smooth out cash flow and existing TAP holders may also be able to adjust their annual income within this range without having to start a new account.

“Some people in the market are calling TAPs mini allocated pensions because you can still vary the income slightly but not fully,” Rubin says.

It still remains to be seen, however, whether clients will take up the amended products.

“We will be issuing a non-commutable TAP, but so far there has not been a great deal of demand because clients do not necessarily want to lock that much away, especially prior to retirement,” Lawless says.

“The sales figures show that overwhelmingly people like to have the option to draw down a lump sum in case they need to do home renovations, pay for healthcare or take an overseas trip.”

Centric Wealth’s Keavney says his dealer group is treading carefully when it comes to recommending TAPs.

“People have to realise that they can’t change their mind and access the capital later if they want to buy a new house. We have not opened the floodgates into TAPs because you have to weigh up that loss of flexibility against the tax benefit.”

The biggest sellers

According to industry analyst Dexx&r, around 80 per cent of assets under management in the whole market are invested through allocated pensions or term allocated pensions and around 20 per cent are invested through fixed term annuities or lifetime annuities.

The recent Pension and Annuity Report by Victorian researchers Plan for Life bears out the changing demand for retirement income products. The study shows that in the fourth quarter of 2005, sales of immediate annuities, which comprise term, term plus residual capital value (RCV) and lifetime annuities, made up 9.8 per cent of the inflow, allocated pensions 86.4 per cent, term allocated pensions 3.3 per cent and allocated annuities 0.5 per cent.

Sales of term certain products increased to $148 million and inflow into combined allocated pensions rose significantly to $3.3 billion. Sales of lifetime annuities dipped to just $6.84 million.

Total sales over the quarter reached $3.7 billion, with Comminsure/Colonial dominating with product sales of $796 million, followed by BT/Westpac with $393 million, AMP/Hillross with $274 million, MLC/NAB with $269 million and ING/Optimix with $247 million. Metlife, AXA, Challenger, Macquarie Bank, Aviva/Navigator and Suncorp also made the top 10.

Navigator’s Mazur believes that despite the growth in non-commutable pension products, the market has still not seen the end of lump-sum pensions.

“Retirees will always have loans to pay off and capital expenditure. However, the relative ‘leakage’ of lump sums will decrease over time. Twenty, or even 10 years ago, $20,000 to $30,000 of superannuation benefits was above the average, and amounts up to this level were commonly all taken in cash to meet immediate requirements.

“Greater awareness of the value of financial advice, together with the introduction of the Superannuation Guarantee, the abolishment of surcharge, superannuation splitting and other superannuation concessions, mean that more Australians will be entitled to substantial superannuation entitlements, with a substantial amount left after these initial bill payments, to leave in income stream products,” she says.