Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 304

Lifetime income tackles retirement timebomb

A typical household has two or three sources of income in retirement including the age pension, income from superannuation and income from non-super investments. Running out of savings means living solely on the age pension which is $24,081 per annum for singles or $36,301 per annum for couples.

For those wanting a lifestyle that’s higher than the age pension, a complex balance needs to be met between how much we want to spend now and how we preserve some assets for spending later in life.

Typical use of a retirement account

The superannuation product we typically use today to manage the balance between spending and capital preservation is the Account Based Pension (ABP).

ABPs, and their predecessor the ‘allocated pension’, were designed around 1992, with the purpose of providing an income that is similar to a CPI-linked lifetime pension up to life expectation around age 80. After this they have a declining real income, when greater amounts of the age pension will likely be payable by the Australian Government.

However, it is not usually sufficient to provide a total (ABP plus age pension) income that keeps pace with inflation. Therefore, for many of us, depending on rates of investment return and inflation, an ABP plus age pension may not deliver anything like a CPI-linked income for the whole of our lifetime.

The market risk of an Account Based Pension

As we saw in the GFC in 2008, investment returns above inflation can be very uncertain. The following chart shows the projected income (in today’s purchasing power) from an ABP invested in a balanced portfolio using the recommended assumptions in ASIC’s MoneySmart retirement calculator. This assumes a rate of return of just 4.8% per annum, less fees of 1.1% per annum and a 3.2% allowance for cost of living increases throughout retirement. Presumably ASIC is being conservative to allow for the fact that ABPs carry significant investment market risks.

You can see from the blue line that in the earlier years of this person’s retirement only a part pension is received (due to means testing). The retiree relies more on consuming their own savings for their income until the full age pension applies from their mid-70’s onward.

By age 95, the spending power of the income from the ABP under this scenario has dropped to around one-third of what it was at age 66. This is a far cry from the product’s objective when it was designed in 1992 – to provide a CPI-linked pension – even if only to life expectation.

Longevity risk is increasing

Longevity is increasing, which is a benefit to each of us, but creates two financing problems:

  1. Have we each saved enough to avoid poverty in retirement?
  2. How can we spread our savings over longer periods in retirement?

More of us are living well into our 80’s and 90’s now and are often running low on savings. As an indication, a healthier 65-year-old female today has a 50% chance of dying between age 92 and 110. Taking into account that most retired households have a female member, it’s a fair question to ask: has Australia outlived the ABP?

Making sure your retirement income lasts for life

The options we have for retirement income now include:

  1. Account Based Pension (ABP)
  2. Traditional Lifetime Annuity
  3. Real Lifetime Pension

A Real Lifetime Pension is an investment-linked lifetime income stream that’s guaranteed to last for life but where the payment level is linked to the performance of the professionally-managed investment option selected. It means when you reach age 65, you can secure an income in retirement that, depending on how long you live, is 20% - 30% in aggregate higher than the aggregate account-based pension minimums (with the same investment choice). It removes the worry of running out of savings if markets perform poorly or if you live well beyond your life expectancy, and who doesn’t want to do that?

The Real Lifetime Pension lets superannuation funds insure mortality risk whilst still offering members investment choice, providing the retiree with an income no matter how they long they live. It gives the ability to switch between different investment options and can be offered as both an immediate or deferred pension. In our product, the longevity risk is underwritten by the world’s third-largest reinsurer, Hannover Re.

For those impacted by Centrelink means testing, options (2) and (3) will also result in a higher age pension than option (1) from 1 July 2019.

Trustees must tackle the retirement time bomb

We are able to access our super once we have reached preservation age. Our individual preservation age is between 55 and 60 depending upon our date of birth. The following chart shows how many of us are increasingly approaching preservation age.

Australian population by preservation age, 30 June 2017

Many super funds find it challenging to retain us as members when we retire. Failure to provide effective solutions that are in our best interests as we age may potentially result in a range of challenges for super funds:

  • loss of members to other institutions and SMSFs which promise better retirement services and products. This includes pooled lifetime income products which are scheduled to receive preferential Centrelink means testing from 1 July 2019 that will result in higher age pensions for many retirees
  • trustees potentially failing to act in the best interests of their retired members. Medical advancements will continue to increase life expectancies. One in three retired households will see at least one spouse live into their late 90s. It could be argued that trustees are negligent if the only retirement product they offer fails to meet its desired outcome for at least one-third of its members
  • funds failing to retain adequate amounts of their retirees’ money to remain sustainable and maintain economies of scale
  • increased demand on cashflow that causes more assets to be invested in liquid assets that could skew the available investment strategies, potentially reducing returns for all members.

This potential demographic time bomb can severely affect the long-term viability of super funds – and our retirement - and it is already ticking.

For each of us, including SMSF members, the investment linked-lifetime pension option (including a deferred version) can reduce or eliminate longevity risk and still allow the use of professional investment managers and switching between investment options.

 

David Orford is the Founder and Managing Director of Optimum Pensions. Optimum Pensions was launched in late 2017 with the objective of providing innovative sustainable retirement income solutions.

4 Comments
David Orford
May 18, 2020

The full investment return under a Real Lifetime Pension is passed back to pensioners less costs for investment and other expenses and the longevity costs. Smoothing of investment returns is available and cash accounts in order to reduce the impact of lower than average investment returns for a period.
Lifetime products also benefit from survivorship (or mortality) credits - which is where the 30% extra income is derived.
Whatever income an investment manager can deliver is enhanced by these credits - so out-performing that manager as far as income is concerned - and income provides lifestyle.

Peter Rowe
May 02, 2019

At present retirees are faced with two extremes:

(1) Traditional annuities (SPIA as you've called them) which guarantee the risks of both investment performance and from living too long. These guarantees come at a cost.

or

(2) Account based pensions. With these you wear the investment risk and the risk of living too long. If the market does poorly you get less money and if you live too long your income will fall or run out.


J.D. You are right to combine more than one product to fill the middle ground between them - in a way that suits your personal objectives and preferences.

The Real Lifetime Pension is another option to fill that middle ground. It suits people who are happy to use some growth assets in retirement (with potential upside but also some downside risk) but who do not want the fear of seeing their account balance reducing further and further as they get older. The costs are lower due to the insurer not having to offer investment guarantees which lock in at today's low interest rates.

Jim
May 02, 2019

I saw a client today who is planning for retirement. She was intending to design her retirement in a way where she lives off investment returns only - ring fencing her capital so that it never runs out. This is due to witnessing her own parents increasing terror as their ABP fell and fell over the course of retirement.

My client was delighted to hear that there are products that can provide higher income than just living on investment returns - without fear of ever running out.

J.D.
May 02, 2019

> and who doesn’t want to do that?

Me.

So for a Real Lifetime Pension, if the market does poorly, you get less certainty than an annuity, but if the market does well, you get less money than investing directly?
Sounds great ... for the insurance company.

I'd much rather a SPIA (single premium immediate annuity) to guarantee basic cost of living at around 70 years of age, and direct investment for the rest.

 

Leave a Comment:

     

RELATED ARTICLES

Protect retirement savings from longevity risk by pooling

Achieving a sufficient retirement income portfolio

Schemes designed to deal with longevity risk

banner

Most viewed in recent weeks

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

Latest Updates

Economy

The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.

Shares

Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.

Shares

The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.

Property

The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.