CPD: Retirement Income Covenant – background, adviser implications and trustee checklist

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The RIC legislation represents a watershed moment for governments, product providers, financial advisers and retirees.

Introduction

As the ageing of our population continues to accelerate, the shortcomings of our national retirement incomes policy framework become magnified. A historically disproportionate focus by policy makers and product providers on the accumulation – rather than decumulation – phase of retirement savings, combined with entrenched cultural beliefs about the sanctity of home ownership, have conspired to create a retirement income framework that is no longer fit for purpose.

In 2019, against this background, and following a recommendation by the Productivity Commission (made in its 2018 Report on Superannuation[2]), the Federal Government announced[1] a comprehensive review of the retirement income system.

The scope of the review included an examination of how the retirement income system supports retirees, the appropriateness of current policy settings, and the role of each of the three ‘pillars’ of the retirement income system (those being the Age Pension, compulsory superannuation, and voluntary savings).

In November 2020, the three-person review panel – led by economist Mike Callaghan – handed down an extensive report[3], containing a number of key observations:

  • the potential for superannuation increases to dampen future wages growth
  • the tendency for many retirees to bequeath the majority of their retirement wealth (despite the tax concessions that exist for the purpose of superannuation decumulation, not just accumulation)
  • the lack of focus, by policy makers, on helping retirees optimise their retirement incomes
  • the idea that more efficient use of retirement savings could have a bigger impact on retirement incomes than increases in the superannuation guarantee
  • the quantum of tax benefits enjoyed by those with large superannuation balances
  • the extent to which people relied on their home as a key plank in their retirement savings.

Whilst these observations were not accompanied by any formal recommendations as such, the Government was quick to use the report to further its policy agenda on a number of fronts. The most obvious example of this was seen in their narrative leading up to the recent increase in the Superannuation Guarantee rate[4].

Most recently, and perhaps most significantly, this policy agenda has been further accelerated through the release (in September 2021) of draft legislation relating to a Retirement Income Covenant[5] (RIC).

Premised on the delivery of improved retirement income outcomes for superannuation fund members, this legislation will also have significant and far-reaching implications for superannuation fund trustees, product providers, and financial advisers.

What is the Retirement Income Covenant?

The retirement income covenant, which will form part of the SIS Act – will oblige trustees of super funds trustees (excluding SMSFs) to formulate, regularly review and give effect to a retirement income strategy.

The legislation is scheduled to take effect from July 2022.

At the heart of the RIC is the Strategy, a document which must be made publicly available, and which must articulate how the fund trustees will help those fund members who are retired, or near retirement, to achieve the following outcomes:

  • maximising their retirement income (considering the Age Pension and any other relevant income support payments such as veteran entitlements)
  • managing the risks to the sustainability and stability of their retirement income, which could include outliving their savings, future inflation, and the uncertainties inherent in investment markets; and
  • ensuring flexible access to savings during retirement (for example, to meet large costs such as medical bills, home repairs, or replacing a car).

To the extent these objectives compete with one another, the Strategy should also identify how members will be assisted to make these ‘trade-offs’, and the potential consequences on their retirement income of making certain choices.

The Trustees are required to review the Fund’s Retirement Income Strategy once every three years. The individual Fund’s performance against the strategy will need to be reviewed at least annually.

What does this mean in practical terms?

At a high level, trustees will find themselves needing to get more engaged with their members, more active in providing guidance and tools, and more collaborative and creative in their product offerings, pre and post retirement.

The Explanatory Documents accompanying the draft legislation suggests a Trustee’s strategy could provide a range of assistance, including:

  • developing/and or offering specific retirement income products
  • developing specific drawdown patterns that provide higher incomes throughout retirement
  • providing tools such as expenditure calculators to identify income and capital needs over time
  • providing factual information about key retirement topics, such as eligibility for the Age Pension, the concept of drawing down capital as a form of income, or the different types of income streams available, and
  • providing guidance to beneficiaries early in accumulation about potential income in retirement through superannuation calculators or retirement estimates.

What is the NOT intended by the Retirement Income Covenant?

There is no stipulation for all superannuation funds to develop their own suite of retirement products – use of third-party products will be permitted – and as will be discussed below, it is likely that introduction of the RIC will act as the catalyst for a long overdue wave of innovation in the retirement product space.

The Position Paper[6] released by Treasury, prior to drafting the legislation, also made clear that the formulation of Retirement Income Strategy is not considered to be:

  • Financial advice – The development of a retirement income strategy by a trustee does not, in and of itself, constitute the provision of financial advice to their members. The retirement income strategy expresses the broad actions the trustee will take to assist their members to balance key retirement income objectives. It does not consider the specific circumstances of individual members. However, any assistance provided by the trustee to give effect to their retirement income strategy needs to comply with existing financial advice rules.
  • A requirement to offer a default product – Whether a trustee gives effect to their retirement income strategy by offering a particular retirement income product is at the discretion of the trustee. There is no requirement for trustees to offer a particular retirement income product to members. If a trustee’s strategy identifies that specific retirement income products are needed to assist their members, it is not a requirement for members to consider or take-up those products.
  • A mandatory ‘one-size fits all’ approach – A retirement income strategy outlines a trustee’s plan to assist all their members, or cohorts of their members, in generality. This does not preclude the trustee from assisting their members to meet their individual needs through tailored advice or guidance.

Member cohorts

Peruse the extensive public commentary about the RIC and you will almost certainly encounter the expression ‘member cohort’. Notwithstanding the point above about personal advice, there is a recognition that different strategies will suit different groups of members, which is why funds are required to conduct cohort analysis of their members. Examples of factors that funds may use to determine these cohorts (or sub-classes) include superannuation balance amount, expected Age Pension eligibility, relationship status, home ownership, gender (to the extent it affects morbidity and mortality), and likely retirement age.

Central to defining such cohorts will be access to comprehensive data, and funds will, initially at least, be able to choose between actual membership data (gleaned through surveying members about their assessable income and assets, home ownership and relationship status), or broad demographic data from publicly available sources such as the ABS.

Until the RIC is well bedded down, and widely understood, those funds who choose to survey their members about the value of their homes and other sources of income should be prepared for plenty of member queries/complaints and low response rates!

SMSFs and the RIC

Although the RIC was originally intended to apply to SMSFs, by the time the draft legislation was released in September 2021, they had been made exempt from the requirements[7].

This exemption was welcomed by the SMSF Association, amid concerns about the additional cost and red tape for small funds where the members and trustees are typically one and the same.

Notwithstanding their stance, Association CEO John Maroney cautioned the sector on the perils of not properly addressing the expected risks associated with maximising a member’s expected retirement income.

“Just because the law doesn’t require you to have a retirement income strategy, doesn’t mean you shouldn’t have one,” he said.

“It is still important for SMSF trustees to ensure members are covered by a strategy that balances the objectives of maximising a member’s expected retirement income, managing the expected risks, and providing flexibility to access capital required during retirement.”[8]

Implications for advisers

The introduction of the Retirement Incomes Covenant, and the increased focus on retirement incomes policy and products more generally, has significant implications for financial advisers.

New product solutions

The RIC is likely to herald a new wave of product innovation, more focused on the decumulation phase of retirement. Whilst some larger funds may choose to partner with providers to develop in-house offerings, many will undoubtedly rely on solutions developed for the whole market, the same solutions advisers will be recommending to their individual clients.

These new solutions will hopefully find a way of addressing the problematic reliance by many retirees on their family home as the main store of wealth in retirement.

Research suggests around three quarters Australians over the age of 65 own their own home[9]. In many cases – courtesy of booming real estate prices and generous exemptions in means testing, it represents the largest part of their retirement savings.

Aside from the emotional attachment many of us have to the family home, more and more of us have an outstanding mortgage at retirement, requiring us to use other savings (including super) to pay off a very illiquid asset.

This means, in many cases, the funds needed for major contingencies such as medical costs or aged care are stored in our real estate.

Current product offerings have been limited in effectiveness, either through lack of choice, or lack of consumer take up (think reverse mortgages), and a proliferation of creative, contemporary solutions, provided by fund managers and insurance companies, will be welcomed by advisers and consumers alike. (We are already starting to see some movement in the area of products addressing longevity risk.)

The Review Panel Report specifically suggest that CIPRs (Comprehensive Income Products for Retirement) could lead to a better drawdown strategy and greater take-up of products that efficiently manage risks (such as longevity risk), lending support in favour of the advancement of these products.

Products in focus: Annuities and CIPRs

The Retirement Income Review noted the following[10] in relation to retirement income product solutions:

“Despite the potential for annuities to provide a stable income for life, and more efficient use of retirement income, the take-up of annuities in Australia is very low. Of pension phase accounts, around 6 per cent are invested in annuities. Attractive structuring of these products is challenging in a low interest rate environment.

Low take-up of annuities is not unique to Australia. Economists call the fact that people invest very little in annuities, even though they facilitate consumption smoothing, the ‘annuity puzzle’. It has led to many countries (such as Austria, Iceland, Ireland, Italy, the Netherlands, Norway, Sweden, and Switzerland) mandating at least partial annuitisation at retirement.

Australian research shows that people would take up Comprehensive Income Products for Retirement (CIPRs), products that combine income, risk management (e.g., longevity risk management) and flexibility (e.g., to access a lump sum) if these products were offered.

Streamlined platform access to such solutions is also likely to be a focus.

More collaboration between advisers and superannuation funds

The in-house advice offerings of many large funds continue to founder (the recent billion-dollar write-down by Aware Super of the advice arm it acquired from First State Super is just the latest example[11]).

On this basis we can expect to see more opportunities for independent advisers to collaborate with funds on the provision of advice to their members.

SMSFs

Although, as discussed above, SMSFs are currently exempt from the requirements of the RIC, optimising retirement incomes remains as critical for members of SMSFs as it is for members of APRA regulated funds.

Advisers working with SMSF trustees are likely to see increasing demand for solutions and strategies around decumulation.

Advice regulations

Whilst the immediate obligations of the RIC fall upon fund trustees, Treasury did flag in its Positions Paper[12] that further reform may be needed to assist trustees manage the risks to sustainable retirement incomes. The Paper refers to ASIC’s consultation on the delivery of good quality personal advice and the proposed Quality of Advice Review[13], slated for 2022. Those reviews will provide input to future policy direction, which will aim to improve access to appropriate guidance in retirement.

One suspects that other changes to superannuation laws are also likely to follow.

Trustee checklist

With the July 2022 implementation date rapidly approaching, trustees have a lot on their plate to meet their obligations, including:

  • taking reasonable steps to gather information necessary to inform the formulation and review of their strategy
  • recording their strategy in writing
  • recording specific actions and decisions relating to the strategy, and
  • make a summary of the strategy publicly available on their fund’s website.

Practical areas they will likely be working on already include:

  • approach to cohorts
  • surveying their members
  • product strategy
  • member communication and web-based tools.

Advisers should expect client enquiries related to this work to ramp up over the coming months.

The magic pudding

The introduction of the Retirement Income Covenant, and the increasing focus on retirement incomes policy more generally, represents a watershed moment for governments, product providers, financial advisers, and of course, retirees.

The solution ultimately being sought by policy makers is like the fabled ‘magic pudding’, where our ageing population becomes increasingly able to be entirely self-funded in retirement, in a way which reduces the future burden on the social security (thus maintaining downward pressure on taxes) and which doesn’t force employers to stifle wage growth in order to afford their SG obligations.

How successful the government will be in achieving this balance remains to be seen. In the meantime, there is much change afoot, change for which advisers need to prepare themselves, and their clients, now.

 

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References
[1] https://treasury.gov.au/review/retirement-income-review
[2] https://www.pc.gov.au/inquiries/completed/superannuation
[3] https://treasury.gov.au/publication/p2020-100554
[4] https://www.afr.com/politics/federal/frydenberg-hints-at-delay-to-super-guarantee-increase-20201120-p56gcj
[5] https://treasury.gov.au/consultation/c2021-209553
[6] https://treasury.gov.au/consultation/c2021-188347
[7] https://www.accountantsdaily.com.au/smsf/16210-smsfs-spared-from-retirement-income-covenant
[8] https://www.accountantsdaily.com.au/smsf/16214-smsfs-urged-to-focus-on-retirement-income-strategy-despite-covenant-exclusion
[9] https://www.firstlinks.com.au/stop-treating-family-home-retirement-sacred-cow
[10] https://treasury.gov.au/sites/default/files/2021-02/p2020-100554-udcomplete-report.pdf
[11] https://www.afr.com/companies/financial-services/aware-super-admits-defeat-on-1-1b-stateplus-purchase-20211104-p59623
[12] https://treasury.gov.au/sites/default/files/2021-02/p2020-100554-udcomplete-report.pdf
[13] https://www.ifa.com.au/news/29466-government-to-combine-lif-advice-reviews

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