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Since 1 January 2017, many retirees need to grapple with managing a reduction in their Age Pension following the rebalancing of the Social Security Assets Test. This means many people will now have the sustainability of their retirement income strategies tested. “As a result, your clients may be drawing down from their account-based pensions which in turn has been affecting the longevity of their capital,” McLean said.
Since 1 July 2017, several changes have made it more challenging for people to save toward their retirement. The eligibility for the age pension increased from 65 to 65 and a half years’ old, “meaning your clients may have the choice to work longer or start spending their retirement capital earlier”.
There is also less potential for clients to boost their superannuation balances under changes such as the reduction in non-concessional caps to $100,000 per annum from $180,000 per annum, and the $1.6 million “transfer balance cap” on tax-free super income streams. Earnings on Transition-to-Retirement (TRR) pensions are now subject to the super accumulation tax rate.
“All in all, these changes are affecting your clients’ ability to save and grow their retirement,” McLean acknowledged.
At the same time, the Government has moved to enhance retirement income streams by introducing an additional set of income stream rules, where retirees can qualify for tax-free earnings without the requirement to satisfy the SIS minimum payment rules. While the new definition limits lump sum commutations and death benefits, it does not restrict income payments. These changes see the recent availability of new products like Deferred Lifetime Annuities (DLAs).
Besides legislation, the Government is also looking at setting up a new framework to improve the retirement income landscape in recognition that the population is ageing and living longer. The Government is currently looking at introducing new products that will support retirement incomes such as MyRetirement, previously referred to as Comprehensive Income Products for Retirement (CIPRs).
MyRetirement is based on number of principled-based requirements including:
- Income - To provide minimum level of income that exceeds account-based pension drawn at minimum rates
- Longevity - To provide a stream of broadly constant real income for life – to manage longevity risk
- Flexibility - To include a component that provides flexibility to access lump sums and/or leave a bequest
MyRetirement products are likely to be a composite of different types of income streams, including account-based pensions, immediate and deferred annuities. McLean highlighted that no one current product can meet all three of the Government’s requirements.
For example, an account-based pension is flexible, but does not cover against longevity risk.
Using a case study, he offered a solution to addressing both the legislative challenges as well as the current retirement income product constraints.
Meet Mike and Carol. They are both aged 70, are a couple and own their home. They have $250,000 each in account-based pensions (deemed). Their investor risk profile is 50% defensive and 50% growth. They have $20,000 in personal assets and $50,000 in cash and TDs. They also qualify the Age Pension which is currently $20,277 a year.
Their main goal is cash flow certainty in retirement. While they want a retirement income of $60,000 per annum, they need $42,000 a year to meet essentials.
The graph below shows a projection of Mike and Carol’s account-based pensions. By drawing $60,000 per annum (indexed by CPI) from all sources (including their account-based pensions and Age Pension) Mike and Carol see their account-based pension assets fully depleted by age 93.
Source: Challenger Retirement Illustrator (10/10/2017). Amounts shown are in today’s dollars. Investment return sourced from Willis Towers Watson data. Assumes returns of 3.7% p.a. for defensive assets before investment fee 0.6% and platform fee 0.5%, returns of 7.7% p.a. for growth assets before investment fee 0.8% and platform fee 0.5%. CPI of 2.5% p.a. Cash and term deposits return 4% p.a. Centrelink rates and thresholds as at 20 September 2017. Account-based pension 50% defensive/50% growth.
Depending on the actual investment earnings they are exposed to over time their assets could be depleted earlier or later than this. From the point where their assets are fully depleted they will be reliant on the Age Pension alone to meet all of their income requirements. As Mike and Carol require $42,000 per annum to meet their essential income requirements the Age Pension alone (maximum rate currently $35,058 per annum combined) will be insufficient.
One way that Mike and Carol could ensure that they have income for life, irrespective of how long they live or the performance of investment markets, is through the implementation of an “income layering” approach including a partial allocation of investment assets to a lifetime annuity.
The graph below shows the effect on their Mike and Carol’s retirement income through a 25% allocation of investment assets to lifetime annuities.
Source: Challenger Retirement Illustrator (10/10/2017). Amounts shown are in today’s dollars. Investment return sourced from Willis Towers Watson data. Assumes returns of 3.7% p.a. for defensive assets before investment fee 0.6% and platform fee 0.5%, returns of 7.7% p.a. for growth assets before investment fee 0.8% and platform fee 0.5%. CPI of 2.5% p.a. Cash and term deposits return 4% p.a. Centrelink rates and thresholds as at 20 September 2017. Account-based pension 33% defensive/67% growth and when combined with the 25% allocation to lifetime annuities from defensive assets maintains these clients’ assets allocation of 50% defensive/50% growth. 25% allocation to Challenger Guaranteed (Liquid Lifetime) Annuity (Flexible income option, full CPI and maximum withdrawal periods).
The effect of this partial allocation in this case is significant. Irrespective of when their remaining assets in account-based pensions are depleted, when this happens Mike and Carol will not be dependent on the Age Pension alone. Their 25% allocation to lifetime annuities guarantees additional income for life to supplement their Age Pension and in this case, their $42,000 per annum income requirement is met, through a combination of annuity payments and Age Pension for as long as they live.
The 25% allocation to lifetime annuities also has the effect in this case of extending the projected longevity of their account-based pensions. The lifetime annuities make their account-based pensions last longer in this illustration due to a combination of the attractive level of payments made from the annuities, reduced drawdowns on the account-based pensions and some increased Age Pension payments made.
Introducing the new Challenger Retirement Illustrator
The new Challenger Retirement Illustrator shows how blending both an account-based pension and lifetime annuity can change retirement outcomes. Help ensure your clients' retirement objectives can be met by using it today.