Retirement savings are currently invested via account-based pensions (ABPs) that perform multiple functions including funding income and acting as a store of wealth to draw on if needed. One problem is that retirees can be reluctant to draw on their savings due to fear their savings might run out. We think dividing retirement savings into two pots – accounts to generate income and ‘contingency’ or ‘rainy day’ accounts – might help retirees to better utilise their savings while providing peace of mind through knowing that they have something set aside ‘just in case’. Contingency accounts would also cater for low balance members who prefer to use their super as savings they can access when needed while relying on the Age Pension for income, rather than for generating a small amount of income.
In effect, a two-account structure would amount to a form of bucketing. Income accounts would be directed at generating income. Contingency accounts would provide a pot of funds that retirees may draw upon to meet occasional spending needs such as holidays or renovations, while providing a backstop in times of need, i.e. as ‘precautionary savings’. Two accounts can simplify matters over having one account to cover everything.
We explored the idea of contingency accounts in a recent paper (available here). In essence, they would involve a retirement account that retirees can draw from as and when they desire which is not subject to the minimum drawdown rules (MDRs) applied to ABPs. While determining the maximum contingency account size requires further work, we notionally suggested and modelled $100,000 as an amount that provides a meaningful backstop with an eye on the type of expenditure envisaged.
The mechanics of how contingency accounts could operate
Super funds might offer contingency accounts within retirement solutions as a way of providing members with ‘flexible access to funds’ as required under the Retirement Income Covenant. Contingency accounts could be set up a few different ways:
(A) Virtual accounts sitting within an ABP under existing rules – The super fund notionally divides the ABP into income and contingency accounts. Regular income is reported to the member as being drawn from the income account, while irregular drawdowns are taken from the contingency account. This structure could become messy, as the MDRs would still apply to the overall ABP balance.
(B) Functionally separate options within an ABP – The MDR schedule is adjusted so that minimum drawdown requirements apply only above a certain threshold, which in turn equates to the maximum contingency account size. This allows super funds to create contingency accounts sitting within an ABP structure that are quarantined from the MDR. The remainder is allocated to an income account to which the MDRs directly apply.
(C) Functionally separate products – A new retirement product is created to which MDRs do not apply. Retirees could allocate between an ABP as their income account and the new product as a contingency account up to a certain limit.
Structures B and C both require policy change, which would probably involve resetting the MDRs applying to income accounts at a higher level to ensure an appropriate overall level of drawdowns. Both these structures bring additional complexity. So the net benefits need to be worthwhile.
Identified benefits for retirees
We believe there are a range of benefits including:
- Provide confidence to draw income and spend – Retirees may have more confidence to spend income and to draw down from other assets knowing that they have something set aside ‘just in case’. Indeed, carving out some assets that are available when needed may help overcome any reluctance retirees may have to draw down from other savings (including non-super savings).
- Provide confidence to take an appropriate level of investment risk – Generally, more investment risk creates an expectation of higher outcomes (in this case income) with some risk of a poor outcome (lower income or in the worst-case exhausting retirement savings). Having savings set aside through a contingency account may provide retirees comfort to take an appropriate level of investment risk.
- Accommodating retirees with low balances – Our understanding is that some retirees with low balances prefer to treat their super as a resource they can draw on if required (i.e. a type of savings account), rather than use it to generate regular income (which may primarily come from the Age Pension). A contingency account would accommodate these preferences. Currently, low-balance retirees are required by the MDRs to take what might be a minimal amount of income. Super funds tell us this requirement contributes to some retirees remaining in accumulation to avoid being forced to draw down, and therefore continuing to pay tax on investment earnings.
- Understandable for retirees – Retirees might find it more intuitive to have separate asset pools to address income and precautionary savings. This might better align with how households run their finances.
- Simplifying retirement solution design – Initially carving out some assets into a contingency account to address flexible access to funds and directing the remaining assets towards providing retirement income enables addressing differing objectives through distinct mechanisms. It would reduce the need to worry about whether sufficient accessible funds are being left in place within ABPs.
There are some downsides
Nearly every policy idea comes with shortcomings.
- The size of unintended bequests could be boosted – This outcome would be inconsistent with the government’s policy intent for superannuation as a tax-incentivised savings vehicle designed to fund retirement income. Bequests might be boosted and less spent in retirement if retirees fail to access their contingency account. However, this is far from a foregone conclusion and partly depends on the implementation and level of MDRs (if reviewed).
- Cost and complexity may increase – Managing contingency accounts and their inclusion within retirement solutions could add governance and operational cost and complexity to super funds, depending on how these accounts are structured. Some of these costs may flow back to retirees. It would be important for funds to present and communicate effectively to their members, otherwise it also adds more complexity for retirees.
What value do contingency accounts offer retirees?
We’re interested in your thoughts.
Our experience is that whenever the concept of contingency accounts is raised during discussion, a typical response is ‘that makes a lot of sense’. It is not a new idea. Treasury proposed the idea in their Retirement phase of super discussion paper (2023). Some major super funds, including Cbus and Rest, have been strong advocates.
We’d like to hear from you. To what degree:
- would you view the availability of contingency accounts as a welcome development?
- would a formalised account structure with different buckets for income and unexpected expenses change how you structure your retirement finances?
- would the existence of a contingency account impact on your willingness to draw income?
- would the existence of a contingency account impact on your willingness to invest more aggressively to grow your income-producing asset pool?
- if you have a lower level of retirement savings and are receiving a full Age Pension, would a contingency account better suit your needs than an ABP that ‘pushes’ income out to you?
Please provide any thoughts either in the comments section or privately to [email protected].
David Bell is the Executive Director of the Conexus Institute. Geoff Warren is a Research Fellow at the Conexus Institute and an Honorary Associate Professor at the Australian National University. This article is based on Conexus Institute research linked here.