A better understanding of new approaches for retirement planning will benefit your clients.
Parts one and two of this series examined the retirement landscape and the myriad of risks that face clients prior to and during retirement. In this third and final of the series, Allianz Retire+ examines the new approach to retirement planning so badly needed by Australia’s retirees.
The $3.5 trillion Australian retirement system has deservedly garnered world acclaim. Superannuation continues to provide workers with a growing pool of tax-effective savings set aside to finance their life in retirement.
However, it can be challenging to plan for the future when there’s uncertainty around how long clients will need a regular income to fund their lifestyle. What if they need access to capital to meet unplanned health or aged care needs, or fund other ‘lumpy’ expenses? How could drawing on this capital affect their future income?
Unfortunately, the investment strategies and products that have served so well to accumulate assets via superannuation don’t necessarily provide the kind of financial certainty Australians expect for their retirement years. As Australia’s demographics shift, today’s retirees face unique challenges. The tools, products and strategies that retirees have relied on for decades need to be optimised for a future in which people live longer and every dollar has to be stretched further.
The permanent threat of market volatility poses additional difficulties for Australians who rely on positive returns to maintain their nest egg as they draw down income. However, traditional retirement strategies are struggling to adequately mitigate these well documented risks, which are discussed in the second part of this series.
The 2020 Retirement Income Review recommended “guiding people towards products that deliver an income stream and provide protection against market fluctuations and outliving savings.” While this is a sound recommendation, it’s a challenge for advisers. Most existing products do not deliver a fit-for-purpose solution to provide retirees with the capital protection, flexibility and income certainty they need.
In a landscape devoid of real innovation for many years, a new approach to retirement planning is required, one that promises to revolutionise the way retirees navigate their future. With the ageing population and unpredictable economic climates, the need to manage risk and provide a secure and stable retirement income has never been greater.
Traditional retirement products
The current range of super-based retirement income strategies is limited. The options generally don’t fully address the financial fears held by retirees and while traditional income stream products are designed to protect retirees, they have failed to gain much traction with the target market[1].
At one end of the spectrum, Account Based Pensions alone provide flexibility, but can leave retirees shouldering significant investment risk, especially when used in isolation. At the other end, traditional lifetime Annuities are poorly understood and generally perceived as an expensive and inflexible solution. The Age Pension, meanwhile, barely provides enough income to sustain a subsistence level retirement.
Somehow, as well as providing for the future, retirement funds need to allow for the unexpected, the myriad of circumstances that can interrupt the best laid plans. Illness, accident or an unexpected redundancy can all lead to an unplanned early retirement and throw plans into disarray. Similarly, retirement can be interrupted by unexpected health issues, some of which might require access to money over and above the retirement ‘pay cheque.’
Account Based Pensions
Most Australian retirees manage their income needs via traditional asset allocation strategies within an Account Based Pension. While a common choice – and one that generally works well in a bull market – they leave retirees exposed to multiple risks.
Fear and uncertainty come to the fore when concerns about fluctuating, market-linked account balances can often see retirees forego holidays, family visits and other comforts to cushion the impact of future, unknown, investment downturns or unexpected personal costs[2].
Pros and cons
Annuities
Traditional annuities have not been used by many retirees. While the product transfers longevity risk (and in some cases investment risk) to an insurer, standard lifetime annuities have not been popular.
Pros and cons
While an annuity can theoretically provide a lifetime income, the product’s drawbacks and complexities have thwarted its take up by many retirees.
Solving for capital protection and income certainty
Traditional retirement income products involve tough trade-offs between income certainty and flexibility, putting often unpalatable limits for how retirees invest, withdraw, or use their money. Yet regardless of the perennial unpopularity of products such as lifetime annuities, retirees face a pressing need to protect their growth capital from market downturns, particularly in those critical years leading up to and immediately after retirement.
And as life expectancies increase and living costs rise, other strategies and tools currently available (notably, Account Based Pensions) are becoming less effective in managing the growing risks. With the retirements of 4.2 million Australians[3] at stake, new and innovative income solutions are urgently needed to complement the industry’s existing products and strategies.
A 2022 Actuaries Institute report noted that combining these traditional products with innovative solutions could lead to a remarkable 30 percent increase in retirement income. Further, the report noted that methods such as using investment-linked lifetime income streams have been shown to lift retirement income without increasing longevity risk: a win-win outcome that would see Australian retirees benefit from larger payments and a better quality of life without increasing the likelihood of outliving their savings[4].
While the existing limited range of retirement strategies can be adapted to help Australians through the changing and high-risk environment, financial product providers must also create new solutions that satisfy retirees’ need for capital protection and income certainty.
Certainty breeds confidence and confidence in retirement is good for the individual, good for their community and good for the economy; rather than living frugally, confident retirees will spend in their community, support business and live the retirement lifestyle they’ve looked forward to. Confident retirees also make for good clients; they are less likely to make poor decisions based on market conditions and behavioural biases.
A new approach to retirement planning
The 2020 Retirement Income Review found Australian retirees want longevity protection and guaranteed lifetime income products to protect their quality of life well into their twilight years[5]. The Retirement Income Covenant, which emerged out of the Review and came into force on 1 July 2022, requires superannuation funds to deliver member retirement solutions (decumulation) in addition to the historical focus on accumulating assets, inevitably spurring demand and supply.
More recent research highlighted by the Review showed that retirees were interested in incorporating guaranteed lifetime income products into their retirement strategies but found it difficult to select a suitable product.
The ongoing body of evidence indicates that Australians will need the support of trusted financial advisers and institutions to review and implement an appropriate retirement income strategy as the new solutions come online.
Imagining the retirement products of the future
While superannuation funds and other financial services firms have focused primarily on the accumulation phase, the development of innovative retirement income products has been slow.
However, the next generation of retirement products will improve further on the earlier efforts with outcome oriented solutions designed around core features including:
Over time, it is expected that guaranteed lifetime incomes will form the foundation of future retirement strategies but without sacrificing retirees’ ability to make withdrawals. Retirees and financial advisers will also have to consider new questions when selecting lifetime income products with due diligence likely to cover:
- the product provider’s legal obligation and ability to honour their long-term commitments
- whether the income stream is guaranteed
- how easily capital can be accessed should personal circumstances change
- the regulatory regime that covers these products, and
- the product’s underlying investment structure.
Australians close to retirement are increasingly wary of the risks posed by longer life expectancies and market volatility. And as this new wave of retirees – flush with ever-larger superannuation balances – rolls into the post-work phase, they need products and strategies that address their concerns.
Accordingly, retirement strategies must adapt in line with markets and demographics trends. Retirees need more innovative solutions that provide for longevity without sacrificing financial flexibility; retirement strategies need to incorporate a more comprehensive suite of features including guaranteed lifetime income, market-linked returns, downside protection and the ability to make withdrawals.
Australians look to the financial services industry not just for investment products and advice but for the peace of mind that comes from knowing, with a degree of certainty, they can enjoy a good lifestyle in retirement without running out of money.
Financial services providers have a duty to formulate solutions that give retirees a more accurate idea of what their retirement will look like. The next generation of retirement income products will help Australians make informed and confident spending decisions so that ultimately they can really live, thrive and flourish in retirement.
Read Part one: Getting older, living longer – Australia’s retirement landscape (part one)
Read Part two: Risky business – Australia’s retirement landscape (part two)
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