Overdue retirement reform

In a few weeks, the Retirement Income Review will provide its voluminous report to the Treasurer.  The report will be a catalyst for setting and implementing a sensible framework for retirement incomes.

Since the Financial System Inquiry recommended the introduction of Comprehensive Income Products for Retirement (CIPRs), there has already been significant consultation with the superannuation industry.  However, progress has stalled:

• The (primary) Objective of Superannuation was debated but never passed in Parliament. Arguably, the definition tabled, to provide income in retirement to substitute or supplement the age pension, is now too narrow as it does not allow for life insurance nor early release schemes (though subsidiary objectives could be framed to allow for these).
• In November 2018, the introduction of CIPRs was deferred until 1 July 2022, and there is still debate about whether these should be part of a default retirement product/strategy for members or not.
• The Retirement Income Framework, which requires trustees to develop a retirement solution for their members, has not been finalised. Indeed, the introduction of a Retirement Income Covenant, which was scheduled to commence from 1 July 2020, has been deferred to a future date still to be determined after further consultation.

There is no doubt that this legislation is overdue.  Half of the bulging baby-boomer generation has already retired, and the majority did so without receiving any formal financial advice.  Further, very few have built a longevity product into their retirement portfolio.  Most funds still run simple account-based pensions where all risks are borne by members.

Learning from SMSFs

One segment of the industry which does cater well for retirees is the Self-Managed Superannuation Fund (SMSF) Segment. Well over half of all Australia’s retirement assets are in this segment, as it is structured sensibly to allow retirees to manage their finances appropriately.

Despite their small size, these funds have advantages in three key areas:

• Administration including fund and tax structure
• Financial advice
• Investments

Administration

The key advantage of SMSFs is that they pool family superannuation – more than 85% of these funds have been set up for couples.  A couple at retirement often requires four linked accounts, being an accumulation and a pension account for each partner.  Even when retired, an accumulation account is needed to take future contributions from any ongoing part-time work, or to hold assets exceeding the Pension Transfer Balance cap.

This contrasts to APRA funds where the partners are usually not in the same fund, and where their accounts cannot be linked due to outdated administration platforms.  Further, shifting from MySuper into a retirement product is tedious with cumbersome paperwork.

Financial Advice

As APRA funds look to providing advice for their members, they are hampered by holding only a part of a member’s financial assets, so any intra-fund advice does not capture enough information to do more than recommend moving out of accumulation into pension phase.

Some APRA funds provide comprehensive financial advice, but they struggle to offer this cost-effectively, and at a price which members will pay.  It was no surprise to see QSuper withdraw from this service recently.  The problem facing funds is the cost of delivery of this service and the heavy compliance risks.  These costs usually exceed any revenue from the service which means they are subsidised by other members.  Despite that, members still baulk at paying for the advice even when it is delivered at lower than full cost.  This is an industry-wide problem which reflects poorly on the legislative and compliance regime for financial advice.

Even where a full pre-retirement plan is prepared for a couple, the member is simply moved into an account-based pension, but the partner is often left in their current fund’s retirement product.  One of the reasons for this is the compliance cost of comparing the partner’s fund with the member’s fund – and the embarrassment if it is rated better!  However, leaving the members in separate funds does makes it more complex to review strategies in future years.

Holding the superannuation assets of a couple within the same fund, such as an SMSF, materially improves the ability to facilitate the delivery of better financial advice.

Investments

Most APRA funds have a single diversified (balanced) fund shaped around MySuper.

Some funds have introduced lifecycle investments and/or bucketing solutions to help members to manage sequencing risk, including sudden downturns in investment markets leading into and during retirement.   However, the absence of longevity products means that members still take on the risk of living beyond life expectancy as well as taking all investment market risks.

A balanced fund is ideal for those saving for retirement, but it is not optimum for retirement where people need several accounts for different purposes.  For example, this could include one account for making regular pension payments, a diversified fund to cater for the longer-term spending needs, and a separate allocation for longevity protection.

Once again, this is easier to structure for a couple with all their pension assets held in one place.  It is also easier to manage the tax situation.  It is well known that moving from accumulation to pension phase is not considered to be a CGT event, so deferred tax liabilities are released on retirement.  Some APRA funds now pay a pension transfer bonus to partly compensate their members, but it is not as efficient as an SMSF.

Many SMSFs also benefit heavily from franking credits and from company buy-backs.  Many funds have a higher after-tax than pre-tax investment return.

Like APRA funds, SMSFs lack longevity protection, apart from the safety net of the Age Pension for those who spend all their retirement benefits before they die.

Retirement Solution

As APRA funds contemplate the changes needed for the forthcoming Retirement Framework, they should think further about building a viable retirement service for their members.  After all, if a highly fragmented segment can deliver something efficient, it should not be beyond the ability of those managing hundreds of thousands of members and tens of billions of assets.