The retirement income covenant: what happens now?
The retirement income covenant (RIC) passed through Parliament on 10 Feb 2022. The RIC comes into force on 1 July 2022 and requires super trustees to develop a retirement income strategy for their members, improving the financial outcomes for Australian retirees.
The RIC has been evolving since the 2014 Financial System Inquiry recommended that super funds offer comprehensive income products for retirement. The RIC is principles-based, so there is no requirement to offer any particular product, but super funds need to comply with the RIC from 1 July.
So, what is needed by July 2022?
The requirement is to have their retirement income strategy developed and recorded, with a summary publicly available on the fund’s website. There is no specific requirement to have all elements of the strategy in place for every retired member by July, but the expectation is that the strategy will become deliverable over time. This will deliver the improved retirement outcomes the RIC is seeking to achieve. APRA has listed consultation with the industry in 2023 in their policy priorities so it won’t be long before they scrutinise individual fund strategies to measure them against the objectives of the RIC.
Retirement income strategy principles
At the strategic level, funds need to maximise the (expected) retirement income of their members while managing risks and providing flexible access to funds. The retirement income strategy needs to apply to all members who are retired or approaching retirement. With the sole purpose of super to provide income for retirement, the strategy will ultimately be relevant for every member of the fund.
While the RIC is principles-based, there are some important elements that are called out in the legislation:
- Retirement income must include funds drawn from super as well as Age Pension payments and may include other appropriate income (such as a spouse’s income, if known). Trustees cannot factor in a potential bequest as part of the strategy.
- The expected income must be calculated over the ‘period of retirement’. Trustees have discretion to define this period, but retirement income needs to be sustained over the long term.
- Longevity, inflation and investment risks are specifically called out and funds will need to address each of these risks in their retirement income strategies.
- Funds can define cohorts (sub-classes of beneficiaries) with a different retirement strategy for different cohorts. Every retired member needs to be included (but not necessarily identified) in a cohort with an applicable retirement income strategy.
- Flexible access to funds is required over the period of retirement.
Super funds have demonstrated capabilities in delivering performance and managing investment risks. Funds manage inflation risks in the accumulation phase already. Managing longevity risk is different and existing approaches have been limited in addressing longevity risk. The Age Pension is helpful in providing longevity risk management for some members, but the majority of super fund members in the pension phase do not receive a full Age Pension. As recent APRA data show the average balance for a member in pension account was over $330,000 in June 2021. This is above the threshold to receive a full Age Pension and these members will need something else to manage longevity risk and reduce the majority’s fears of running out of money.