A potential solution to one of the Australian superannuation industry’s biggest challenges—helping plan members make the transition to retirement—may lie partly in designing a process to enable members to effect the change in three stages, global asset manager AllianceBernstein (AB) said yesterday.
Instead of moving directly from the accumulation phase to the final income stage by purchasing an annuity immediately on retirement, many plan members would benefit from the option of an intermediate “initial income” stage, according to David Hutchins, AB’s London-based Portfolio Manager, Multi-Asset Solutions.
“One of the main challenges facing retirees is longevity risk, or the risk that they could outlive their savings,” said Hutchins during a visit to Australia. “One way of addressing this is to consider when would be the best time for retirees, generally speaking, to purchase an annuity.
“We’ve researched what a number of countries around the world are doing in this area, and we’ve concluded that there are basically three choices: retirees can purchase an annuity as soon as they turn 65, or they can keep investing for growth and some income and delay purchasing an annuity until they turn, say, 75, or buy a deferred annuity at 85.
“Our research has consistently come down in favour of the second option.”
Hutchins said there are a number of negatives with the first option.
“They include the fact that the insurance value of an annuity is minimal from the age of 65 to 75, although it increases thereafter. In the current low interest-rate environment, annuities are expensive. Also, locking yourself into an annuity early could expose you to rising inflation and the frustration of being subject to an inflexible arrangement.”
At the other extreme—purchasing a deferred annuity at age 85—there are cost, complexity and inflation risks.
“With the second option, the main risk is that of spending too much money before buying the annuity at age 75, but this can and should be managed. The other advantage of buying at that age is that the decline in cognitive ability increases after 75, which is likely to result in more retirees becoming disengaged from their financial affairs.”
According to AB research, drawdown from a A$100,000 investment portfolio from 65 and the delayed purchase of an annuity at 75 could result in income of A$4,900 a year on average, compared to A$4,550 for a deferred annuity purchase at 85. These amounts are respectively 11.4% and 3.5% higher than the A$4,400 a year available on average from an annuity bought at age 65.
This suggests a simple three-stage approach to retirement saving consisting of, say, a target date fund (TDF) during accumulation, an income-paying TDF in the initial income stage between 65 and 75 and, finally, an annuity.
“As we all know, however, reality isn’t that simple,” said Hutchins. “We need to consider individual savers’ needs and it’s pretty clear that one size won’t fit all. But it’s possible to fine-tune the approach to some extent according to the size of retirees’ nest-eggs.
“For example, a retiree with a relatively small amount saved would probably use a rapid drawdown TDF in the initial income stage and forgo any later life income, relying instead on the State.
“At the other end of the spectrum, a saver with a large enough nest egg may not even need an annuity, being able to live off the interest they earn alone, moving at age 65 into a multi-asset income-paying fund and remaining there.”
Hutchins added: “The Australian superannuation industry, like its counterparts globally, is debating over the best design template for a retirement product—whether, for example, it should be generic, individualised or somewhere between the two.
“While we believe the debate has some way to run, our research suggests that a three-stage approach based on a delayed annuity purchase offers a framework for developing solutions that may suit a meaningful proportion of retirees and provide significant cost and flexibility advantages.”