Retirement products: the next wave

With the baby boomer generation now entering retirement, or certainly looking down the gun barrel at it, the focus on retirement income streams, by both the government and financial providers, is at a peak.

Unfortunately, this generation was born too late to take full advantage of the Superannuation Guarantee, and estimates show that in 15 years there will only be three taxpayers for every pensioner. Increased longevity, and unfunded government pension liabilities, are only adding to the pressure to find a means of ensuring retirees have enough money to live on.

Changing attitudes

In recent years, the superannuation regulatory environment has been positioned to encourage more individuals into structured income streams, in an attempt to change the ‘lump sum’ mentality of Australians.

According to Peter Nicholas, director of savings and retirement at AMP: “I think the lump sum mentality to a certain extent is going — the ‘take it and spend it’ scenario — and people are starting to think ‘I need to be generating an income stream’.

“They [baby boomers] are a big spending generation, and they now realise that they are going to live longer than their parents. People have moved beyond the fact that they are just going to have fixed interest investments, a lump sum or a fixed interest investment out of super, and just run down their cash in retirement.”

In addition, the reduction of the asset test exemption for annuities last year provided many with a wake-up call that Centrelink benefits could not be relied on as a method of funding retirement for the majority.

Andy Polson, head of product at IOOF Investment Management, says: “I think the Government will get more and more strict on how people get access to their social security benefits because, obviously, it’s the taxpayers that pay for it. That’s a critical component for advisers and clients.”

Nicholas adds: “There’s a mass of people coming through who don’t really have enough money to live on. The Government says ‘we can’t fund them; we don’t have enough people in the workforce to fund them’ and therefore we are seeing a proliferation of products and strategies to accommodate them.”

According to Bronwyn Speed, chief financial adviser at Mercer Wealth Solutions: “Over the course of time, the past five years in particular, the Government has made it completely clear that super is the way to go.”

Allocated pensions

By far the most successful of all retirement income stream products is the allocated pension.

Following the announcement last year that term life expectancy pensions, also known as complying pensions, would only benefit from a 50 per cent asset test exemption, rather than 100 per cent, allocated pensions have become the number one retirement income option. Although not before thousands of Australians brought forward their retirement before the due date of September 29.

Peter Hogan, head of technical services at Colonial First State, says: “They sold hundreds of millions of annuities. A whole year’s worth of budgets in a month, sort of stuff, because of that change in social security treatment.”

Hogan estimates the sales of allocated pensions currently reap in around $7 billion a year, significantly more than lifetime annuities at $150 million per annum, and term life expectancy pensions, which generate around half a billion yearly.

He believes the popularity of allocated pensions is because “they are market-linked, and you have full access to capital”, adding “we are still seeing that perhaps a large reason for the sales of products in the market still has something to do with easy access to capital”.

So while it seems more Australians are realising the benefits of a structured income stream, access to that all-important lump sum is still an incentive.

Speed adds: “While I’ve not seen many people access their capital as a lump sum once they’ve commenced an allocated pension, the fact that the flexibility is there, and the availability is there, is peace of mind.”

Polson believes the simplicity of the product, and the fact they are one of the best-understood pension vehicles, is also in their favour.

“Obviously, you’ve always had the choice of a full range of investments in any product you choose, but they [allocated pensions] were the first transition into full choice in a pension environment, from an annuity-type product set,” he says.

“Effectively, you can have growth assets in an allocated pension, it’s just that they are a slightly different structure.”

The benefits of allocated pensions, according to Nicholas, are two-fold.

“At the medium to lower end, it gives you that asset test protection. In other words, it hides some of the assets so you can qualify for the pension. At the other end, where you’ve got the RBL [reasonable benefit limit] issues, it enables you to qualify for the pension RBL,” he says.

New and improved

Following the release of the Transition to Retirement regulations, allocated pensions have been adapted to suit those individuals who wish to continue working past retirement date, while also beginning to draw down their super savings.

The non-commutable allocated pension (NCAP), does not allow access to lump sums in the early phase, although capital can be accessed at a later date.

Hogan explains: “It’s a way of starting your allocated pension sooner than what you normally would have, and you’re not locking it into being non-commutable forever.

“As soon as you satisfy a condition of release, it becomes commutable again. So for example, as soon as you turn 65, or full retire, or work less than 10 hours a week, you get full access to your capital again.”

A number of providers, including AMP and MLC, have already launched NCAPs, and more products are anticipated.

Polson says: “We have just written all our technical specifications for that. I definitely think it is going to be a trend in the community. People will want to work through their retirement rather than just retire at one point and disappear.”

AMP launched its NCAP on September 3, and while it is too early to estimate take-up levels, Nicholas says that following a series of retirement seminars held around the country, it is obvious that advisers are interested in the product.

“It certainly created more interest from a financial planning point of view than any other products which have come onto the market in the last couple of years,” he says.

While being an ideal retirement option for those aged 55 who are examining their future options, Nicholas also believes it helps cement the relationship advisers have with their clients.

“I think it really helps them to lock in their client relationship as they get to eventual full retirement.”

Speed is also positive.

“I think they are going to be a very popular vehicle. As an adviser, it is part of your role, in my view, to coach or help the retiree with lifestyle issues.”

The future for TAPs

Term allocated pensions (TAPS) were launched to much fanfare in September 2004.

Marketed as growth pensions, Hogan says there was concern they would “cannibalise the allocated pension market, because a lot of people have a rebateable allocated pension up to the lump sum RBL, and then buy another allocated pension which is not rebateable with any excess benefit money they had”.

Despite the 50 per cent asset test exemption, which is not available for allocated pensions, sales have been slow. Many believe this is due to the market being sucked dry when people rushed to buy 100 per cent asset text exempt annuities last year, but the fact that TAPs don’t allow access to capital may also be a disincentive.

Still, many believe these products will prove more popular in the future, as individuals try to access Centrelink pension benefits.

Nicholas says: “For me, it was a product that was going to grow very slowly. Where I see TAPs becoming increasingly important going forward is when people look at how they can maximise social security. Therefore it becomes a fairly compelling opportunity to use as a financial planning strategy.”

Nicholas believes that TAPs work particularly well when used in conjunction with an allocated pension.

“You’ve got the TAP to reduce your assets, to get your dollar of pension, and the flexibility when you use an allocated pension alongside it. We took that position with the original design of the product, giving fee discounts to people who used both together.”

Government proposals

Sam Rubin, technical manager at IOOF Investment Management, believes that TAPs are currently too restrictive, which has limited sales.

However, he is hopeful that recent proposals by the Minister for Revenue, Mal Brough, to enhance the flexibility of income streams could work in their favour.

This includes allowing clients to choose a term that extends to their 100th birthday, or their spouse’s 100th birthday, whichever is longer.

“What they are looking at providing is greater flexibility from a term perspective. Just basing it [the term] on your age meant it wasn’t very clear,” Rubin says.

Speed also believes the current term period for TAPs poses a risk for clients.

“The longevity risk is quite real, because they are designed to run out. So are allocated pensions, but they are designed to run out over a petering of time, whereas TAPs are designed to run out at a specific point.”

In addition, TAP customers will be able to vary their annual income payments by plus or minus 10 per cent of the amount determined each year at July 1.

Rubin says: “The income you will be able to take out will be more in line with an allocated pension, the only difference will be that the income you take out will be closer to a minimum or maximum of 10 per cent, and you won’t be able to get access to capital.”

Rubin also hopes the Government will consider allowing non-super monies to be invested in a TAP.

“The original intention was to have a TAP that was available for non-super money as well, because a lot of clients get to 65, get a large lump sum, and can’t get money into super, so how do they provide themselves with an income stream? And the Government would rather them have an income stream they can lock up, so they don’t go and blow the lump sum.”

Alternative investments

In addition to super products, more individuals are looking at non-super investments to generate an income stream in retirement.

“There are also products outside the legislative environment, which is something that people don’t always think of,” Nicholas says.

For instance, he says AMP offers unit trust-style investments, including a monthly income fund that enables investors to set their own income levels.

“You actually dial up your income retirement. So you can say ‘I want 7 per cent income return, and then it will give you a combination. Obviously, if the investment markets are above that it will be all investment return, or you can have it dialable to give you investment return and return of capital,” Nicholas says.

However, new product development in the super space is limited as it is driven by Government regulation.

Hogan says: “Treasury and, to a large extent, social security have to come to the party. So I guess the process is a little more difficult now in terms of product development. So I can’t see a lot more products at this stage, certainly no one’s asking for much more than what we currently have.

However, he adds: “It is interesting that perhaps people have made their own flexibility with self-managed super funds, and perhaps that may be where the development continues to come along.”