A pathway for fund members to follow into retirement
One of the challenges for a super fund is to help every member find an appropriate retirement income solution and guide them. Previous Challenger research has highlighted that many members are left in the accumulation phase, even after they retire, potentially paying unnecessary tax on their investment earnings.1 APRA data indicates that as at June 2022 there were more than 1.3 million member accounts with more than $225 billion in accumulation accounts for members aged over 65.2 Some of this will be by choice (or because of the transfer balance cap) but most of these accounts will be paying tax members don’t need to pay. There will also be accounts of members aged 60-64 who could also have their money in the pension phase but don’t.
The proportion of super funds that belongs to members over 65 has been increasing in recent years, but this has not been matched by the super pension portion. The figure below presents data on large APRA funds showing the recent trends in pension balances. The age 65+ balances (as a condition of release) provide the basis for the $225bn estimate.
While members of the large super funds have more than $556 billion in the pension phase, it should be higher as members would be taxed less on investment earnings. There are a significant number of members that are missing out on the core purpose of super: a better retirement outcome. The aim is getting members to their best retirement outcome. This requires:
• Existence - the best retirement option for the member needs to exist;
• Accessibility - the member needs to be able to easily locate and access the right retirement option for their needs.
The retirement income covenant, introduced from July 2022, requires super funds to have a strategy that addresses both issues for members in, or approaching retirement. This has kickstarted improvements for members in retirement, but more work remains outstanding.
Figure 1: Proportion of super FUM age and pension phase
Optimal retirement strategies
The first challenge in making the best retirement option available for members is to know what the best option is. While an account-based pension (ABP) provides flexibility for members and a way to access their savings, it does not do everything a member needs in retirement. This was noted in the Financial System Inquiry by David Murray in 2014 which included the proposal for super funds to offer a ‘Comprehensive Income Product for Retirement’.3 Other reviews have reached similar conclusions about the need for a better solution in retirement, including the 2021 Retirement Income Review.4 The retirement income covenant provides guidance on a preferred solution and it goes beyond the flexibility of the account-based pension to include maximising retirement income and managing key retirement risks, such as longevity, investment and inflation risks.
Finding an optimal solution is not always straightforward. ANU academics (Butt et al.) have published a paper that demonstrates that the optimal strategy varies for different retirees.5 Their range of allocations between the account- based pension, an immediate lifetime annuity and a deferred lifetime annuity are provided in Figure 2. This shows a possible range of product allocations for different risk profiles for people with different balances at retirement. These variations across members are likely to be present in most super funds and are consistent with the range of outcomes modelled in previous Challenger research.6
Figure 2: Optimal allocations from Butt, Khemka & Warren (2022)
One solution to the growing advice gap is to leave it for the members to solve. In some ways, this is the natural extension of a defined contribution system where all the investment risk rests with the member. There is evidence of this approach in the implementation of the retirement income covenant. The explanatory memo to the legislation refers to education and guidance as a way to assist members choose their retirement income solution.
While this sounds reasonable, there is one significant flaw.
Over time, a fund will need to have a range of solutions available to provide the best outcomes for each member to choose and, as the research indicates, a wide range of solutions can be produced from a small range of options. The difference in the combination of the options can help meet the needs of the member. At a minimum, a solution should be constructed for different identifiable cohorts of members. The means testing of the Australian Age Pension provides a natural base as the secure income stream differs across retiree cohorts. To match the requirement for a range of retired members, super funds will need products in addition to an account-based pension. Butt et al. note that lifetime annuities and deferred lifetime annuities are components of the optimal bundle for many of the likely retiree cohorts they considered. Other innovative income stream products, which were not modelled in this paper, could also be included to help provide optimal retirement solutions.
The good news is that there are signs that funds are responding with some funds expanding their retirement offer and a majority (57%) intending to review and update their retirement offer.7 This will improve the availability over time of retirement income solutions for members.
A bigger challenge for the funds will be in providing practical access for members to the appropriate solution. While funds can develop solutions for a range of member cohorts it does not guarantee that the members will find their way into the appropriate solution for them. Many members will not necessarily know which cohort they belong to. One solution is for each member to work with a financial adviser who will be able to determine the needs of the member and the appropriate retirement income solution. However, this is a costly exercise and with the number of Australians approaching retirement increasing,8 and the number of financial advisers decreasing,9 for most members a traditional advised strategy and its costs will not be an option.
An alternative for a super fund that can set up cohort- based solutions is to provide guidance so that members can make an informed choice to find the retirement income solution that could potentially best suit them. Under current regulations, this will be difficult to scale. As noted in the Quality of Advice Review by Michelle Levy, this would be personal advice that super funds do not tend to provide currently to their members.10 The government has accepted in principle her recommendation to help super funds to provide more advice for their members. The potential changes could enable the provision of advice at scale that is necessary for retired members to find their optimal solution.
At a minimum it could be used to help members identify the appropriate cohort to select the funds pre-defined retirement income solution for that cohort.
The more guidance that a fund can provide, the easier it can be for members to navigate their transition from accumulating savings into drawing income in retirement. Adopted fully, this could be the provision of a tailored pre-set option for each member. Conceptually, the tailored pre-set is a pre-packaged option that the member can take up on their transition to retirement that has been designed to meet the general (assumed) profile of the cohort for that member. Broadening the way that funds can provide advice to members can potentially assist here, but the form will depend on the implementation of the government’s response to the Quality of Advice Review. Having tailored pre-set range of options will provide a ready starting point that most members will be able to stay with but retains the flexibility to make some changes if required.
Figure 3: The pathway to and through retirement
The objective of super is to provide income for members in retirement. Members are different and what they need from their super fund in retirement will vary but funds can do more to help members. Super funds are expected by ASIC and APRA to provide assistance to members to meet the retirement income covenant.11 As part of their member engagement, an effective retirement income strategy for a super fund should find a way to guide members into a retirement income solution that is suitable for their needs, improving outcomes for members.