Best products to fund a comfortable retirement

While retirees are wary of locking up their savings in an annuity, mixing and matching products could provide a higher regular income

Should the federal government be telling retirees how to invest their super and spend their savings? Its Retirement Income Review noted with concern that retirees are being too parsimonious with their savings and leaving bequests to their kids. The government wants to ensure super’s generous tax concessions aren’t being used for estate planning, but rather for their intended purpose: providing income in retirement.

As the super system matures and shifts its focus from the accumulation phase to pension phase, the spotlight has focused sharply on which types of products serve retirees best and whether longevity products should play a greater role.

The idea is to put a stop to “leakage” in the $3 trillion system, with some players calling for super fund members to be defaulted into lifetime annuity type products.

But research undertaken by the Association of Superannuation Funds of Australia (ASFA), using data from the tax office, the Australian Prudential Regulation Authority and other sources, found the vast majority of retirees exhaust their savings and leave no super behind when they die.

“We don’t have a systemic problem with retirees underspending or bequeathing their super – quite the opposite. The majority of Australian retirees run out of super well before the end of their lives,” says ASFA chief executive Martin Fahy.

The research showed 90% of retirees aged over 80 had no super in their final years. Among women, 85% who passed away aged 60 and over had nothing left.

“The main challenge for the system is to deliver higher superannuation balances at retirement. The solution for ensuring adequacy of retirement incomes is moving the superannuation guarantee to 12%,” says Fahy.

So why all the attention on retirement products when account-based pensions have served retirees well? Their balanced option has given super fund members returns of more than 7% a year over the past 10 years.

The product also gives retirees the control, flexibility and transparency they need to manage life’s unexpected twists and turns. And while they might worry about outlasting their super, the age pension is there as a safety net.

Consumers often bristle at the thought that the government might take a “Big Brother” approach and foist annuities on them. As far as they are concerned, it’s not only their money, it’s deferred pay and they should use it as they see fit.

Means test changes

Currently, 35% of Australians retire with balances of $250,000 or more. Over the next 40 years this proportion is expected to double, with around 70% of balances expected to reach that amount or more, says the Actuaries Institute’s Andrew Boal in the paper “Spending in Retirement and the Taper Rate”. By then about 40% of super balances at retirement are expected to reach $500,000 or more.

At present a homeowning retiree with assets, including super, below $268,000 is entitled to a full age pension for most, if not all, their retirement. Those with over $800,000 have the capacity to live off investments earnings and not have to eat into the capital.

But it’s the high proportion of people in the middle who could benefit from more income certainty, says Boal.

They will be eligible for a part age pension for a substantial portion of their retirement and “as a result, the means test rules will be important to them”.

Changes made to the rules for the age pension on July 1, 2019, now make annuity or lifetime products a more attractive proposition. Under the new rules only 60% of the purchase amount of a lifetime income stream and only 60% of the income payments will be an assessable asset.

Boal says such favourable treatment will be important to this large middle group and will also promote the development of new products.

How annuities work

Annuities pay a guaranteed level of income, either for a fixed period or for the rest of your life, in return for a lump sum investment. The income is paid regardless of how markets perform, providing retirees with certainty.

The downside is that an annuity is sensitive to interest rates, which means its risk-free income comes at the expense of higher growth and higher returns.

Alex Dunnin, executive director of research and compliance at the Rainmaker Group, publisher of Money magazine, says a fixed 15-year annuity currently returns about 3% in annual income payments.

“To get $50,000 a year in income from this you’d need to put $1.7 million into these annuities. That’s a big amount of money to put away for such a long time.

“That’s twice as much as you’d need to invest in a balanced investment in a plain vanilla account-based pension. Annuities are paying much higher rates than traditional bank term deposits. But compared to regular retirement superannuation accounts, they’re not so compelling.

“It’s part of why annuities, regardless of how compelling they are as a way to get guaranteed retirement income, have struggled to capture the imagination of today’s retirees.”

APRA figures show annuity payments have stayed at $4 billion a year since 2015. “Given income payments paid through super funds have risen 32% from $28 billion to $37 billion through this time, it means the annuity share has fallen from 14% to 11%,” says Dunnin.

“When you look at the broader trends, when people retire they are increasingly leaving their money in the super system in an account-based pension or an equivalent product and drawing down a pension or regular payment from their super.”

The generous age pension incentives may be their “secret sauce”, says Dunnin, but it doesn’t get over the hurdle of retirees’ reluctance to lock in their savings and not being able to pass on the residual to their estate. “That makes them unattractive to a lot of people.”

However, an annuity can complement other retirement investments and sources of income such as super and the age pension.

Take a layered approach

Ben Marshan, head of policy, strategy and innovation at the Financial Planning Association, agrees there isn’t a lot of demand for annuity products. “In a market-based society, if there was a lot of demand for annuities you would’ve seen more companies providing them.” People are not comfortable with the idea of locking up their money.

However, annuities do have strategic benefits if used well in combination with other income streams, such as

“To get an income of $50k a year for 15 years, $1.7m is a big amount to put away for such a long tme”

account-based pensions and the age pension. For starters, they offer higher returns than term deposits. “If you were to invest $100,000 in a term deposit you would probably be getting somewhere between 1%-2.5% returns, but because they pool all of the money, you tend to be able to get 4.5%-6%-type interest rates or annuity payments off the investment,” says Marshan.

“When you combine the guaranteed payments, and you combine the age pension benefit you get from an annuity product, there’s a strong argument as to why – within certain profile bands – they are attractive to help acquire certainty around retirement.”

Financial planners typically use a layering approach to maximise retirees’ income. “They will typically look at allocating about 20% to annuities. It will cover the client’s essential living expenses so no matter what happens with your other investments it’s going to be covered,” says Marshan.

“It means you can take a slightly more aggressive investment approach with your account-based pension than you otherwise might do because you have a guaranteed source of income from the annuity. Over longer periods of time you will get a better outcome from that. It provides some additional flexibility for you if you’ve got this guaranteed income that is sitting there.”

Deferred lifetime annuities are another product that can give people peace of mind if they fear running out of money later in life. The income stream can be purchased but deferred to a later date.

“If you’re just a bit over the Centrelink assets test you can lock away a portion of your money that will be available later in life and doesn’t count for Centrelink purposes. It allows you to get age pension benefits but you know you’ll get your money back later in life,” says Marshan.

He dismisses out of hand calls to make annuities and lifetime pensions compulsory. “Australians want control over their own money. They also want to know they have the option of helping their kids when they pass away. The only people that are pushing it are the ones who stand to make significant amounts of money and benefit from it.”

Independent financial adviser Mark Berry, of Berry Actuarial Planning, agrees that making such products compulsory has little appeal. “The environment in which retirees operate must allow optimum flexibility to respond to their changing needs and circumstances,” he says.

“Products like annuities compromise their ability to respond to change and should not be compulsory. They may need to access capital for aged care needs or to assist family members with unforeseen medical expenses, and if funds are trapped in annuities then the ability to respond is compromised.”

John McCallum, CEO of National Seniors Australia, says the retirement system as it stands is far too complex. “What’s needed is consistency and a lack of complexity, particularly in that zone between having eligibility to a part pension and managing your own money – that’s a very complex zone.”

He favours fund members being offered a default lifetime product, but it should not be compulsory – they should be able to opt out.

Pioneering product

QSuper, the third largest super fund in the country with $120 billion under administration, is the first super fund to launch a lifetime product.

The lifetime pension is linked to QSuper’s balanced investment option, enabling it to offer much higher rates of income than traditional annuities.

Unlike annuities, the lifetime pension payments are investment-linked. This means amounts are not guaranteed and may be adjusted up or down annually based on the investment performance and mortality of the pool.

The product is designed to support increasing payments over time to assist with rising costs of living.

As a lifetime pension it qualifies for the pension

benefits referred to above: retirees may receive higher pension payments than they may otherwise have qualified for, or potentially be eligible for the age pension and commonwealth pensioners concession card.

Ben Hillier, head of product and services at QSuper, says unlike a traditional annuity that needs to invest conservatively in cash and bonds, QSuper’s product is market-linked and invests 100% in the fund’s balanced option.

“As a result, the rates of income are substantially higher. But because its market-linked there is some variability to the income. It will go up and will go down annually based on a fairly simplistic, or transparent, formula that we communicate to members.” The benchmark for the pool’s financial result is set at 5%.

Brnic Van Wyk, head of asset and liability management at QSuper, says there are two components to adjusting the pension annually. “The dominant one is investment returns. So, you could phrase it in a way to say we have an investment return assumption of 5% and the adjustment will be a deviation from that assumption.

“That assumption is prudent, it’s conservative. We would expect to get investment returns in our balanced fund in excess of that 5%, which means we expect pensions will increase over time.

“Our balanced option returns for the last 20 years is almost 9% a year, so that would’ve given people in the last 20 years effectively a 4% increase a year on average. Some years it goes up and some years it goes down, but that broadly keeps pace with inflation.

“It doesn’t guarantee it will increase every year with inflation, but it creates that expectation over time. And that will dominate. But there is also a mortality assumption because it is effectively a pooling of lives.”

In addition, Hillier points to the product’s low fees. “Effectively there are no extra fees. QSuper has a standard percentage-based admin fee of 0.16% a year and an investment management fee on the balanced option of 0.38%. They are just our standard fees that apply to this product.”

The lifetime pension has money-back protection, which assures members if they die before receiving their purchase price back as income their beneficiaries will get the difference. “If you put in $300,000 and you and your spouse die after 10 years or so and had $200,000 in income, the remaining $100,000 will be paid to your beneficiaries.”

There’s a six-month cooling off period so retirees can decide whether the product is right for them. It can be used alongside an account-based pension.

Finally, when it comes to setting yourself up for retirement, it pays to get professional help. It’s a complex and difficult landscape to navigate alone.