Turning super into income: inquiry opens retirement funding debate

The focus is shifting to how Australians access their super to fund retirement. Wendy House/Flickr, CC BY-NC-ND

A good proportion of the Financial System Inquiry’s 460-page interim report is dedicated to a discussion of superannuation and, in particular, to making the financial system better at facilitating the conversion of super into retirement income.

Currently, the system does poorly. It does not meet the risk management needs of retirees. They have few options if they want a stable income after retirement that is insured against longevity, investment and inflation risk.

Indeed, existing rules impede the development of such products. It may make sense in principle for a retiree to insure against outliving her savings by buying a “deferred annuity” consisting of an income stream that only starts paying out in 20 years’ time. But this would not be a wise move if (as is currently the case) the Age Pension means test deems that she is receiving that income in the intervening 20 years, and lowers her interim pension as a result.

The inquiry correctly identifies these issues as part of a wider problem of policy inconsistency: on the one hand, tax-advantaged retirement savings and default fund and portfolio allocations are mandated because we recognise we are subject to under-saving and behavioural biases. The majority never have to interact actively with superannuation during their working lives. On the other hand, retirement income decisions and risks are left entirely with individuals at the moment of retirement.

Four options to tackle the problem

The report puts forward four options, some of which are expected to become solid recommendations when the inquiry submits its final report in November 2014. These range from the full flexibility but limited risk management of the status quo (where individuals use super savings as they see fit, with some improvement in financial information, advice and education) to the limited flexibility but full risk management of compulsion (where some savings must be used to buy a longevity-protected product).

In between these extremes are two other options. The inquiry flags the possibility of incentivising longevity-protected products via tax or the Age Pension means test. But benefits from super are already tax-advantaged so incentivising longevity-protected products may require raising taxes on other income streams and lump sums.

This could tie in with addressing another concern noted by the inquiry: that the tax arrangements within the superannuation system are being used for estate planning rather than for providing retirement incomes. Super taxes may be an area that the government’s proposed tax review will also look at.

Finally, the inquiry opens the door to a full discussion of instituting a default for decumulation of super. A single default would not suit everyone and there are fiduciary concerns about automatically committing individuals to a given decumulation product, but an opt-out would be available and elements tailored to individual circumstances could be included.

Also only a proportion of savings above a certain threshold may be subject to the longevity-protected product default. These can guide those who are less engaged and offer flexibility to those wanting to make their own decision.

We know from research that defaults have a strong behavioural effect – often more so than financial incentives. A recent online experiment, led by the Centre of Excellence in Population Ageing Research, showed that in a decision to allocate assets between an account-based pension and an immediate annuity individuals were most likely to choose the default (see figure).

Proportion of assets taken as an annuity with different defaults. Bateman, H, Eckert, C, Iskhakov, F, Louviere, J, Satchell, S and Thorp, S 2013, ‘Default and 1/N Heuristics in Annuity Choice’, School of Risk and Actuarial Studies Working Paper 2014/1, UNSW

Such products, perhaps combined with a tendering process (seen in countries such as Chile and Singapore) for the most competitively priced, may yet provide value for money with the right mix of flexibility and risk management, regardless of a person’s level of financial capacity, engagement or superannuation balance.