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Ageing Australia: retirement income and you

Glenn Freeman  |  30 Jul 2019Text size  Decrease  Increase  |  
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The ballooning pension bill and fears about rising costs of living risk drowning out the importance of annuities, which can provide a steady income stream.

Australians are getting older - a fact that keeps cash-strapped governments up at night, not to the mention those facing retirement, who wonder how they're going to get by as life gets more expensive.

The government's "retirement income framework" is a bland name for a critical problem.

How does government reduce Australia's Age Pension bill and yet ensure older Australians can live with some modicum of comfort?

Those are pressing questions as Australia faces the fact that the number of people aged 65 and over in Australia is projected to more than double, to 8.8 million, over the next 40 years.

What’s more, the government spends more money on pensions and aged payments than any other type of welfare. More than $70.2 billion will go to aged welfare payments in the next financial year.

Since at least the end of 2017, the government has been talking to industry on ways to boost standards of living in retirement.

Good for individuals, good for government

Among the voices in the debate is Optimum Pensions, a provider of income products, whose mission is to help Australians retire in comfort.

Optimum Pensions founder and managing director David Orford says keeping up with the rising cost of living is critical and that the government is keen to address the retirement income challenge. Regular income streams such as annuities are an overlooked but key instrument in this, he says.

"Because if people receive income streams and they offset inflation, they'll get 30 per cent more financial benefit than they would with an account-based pension," Orford says.

This is a key distinction in the structure of pension incomes: in Australia, most retirees draw their income from their super fund, which transitions from the accumulation phase to draw-down phase.

Orford believes annuity income streams are "good for people because they get an income for life, while also saving the government an enormous amount of money."

Annuities are critical but misunderstood

As its name suggests, an annuity is a form of retirement income product, which ensures an annual income payment for those in retirement.

In this way, it is similar to superannuation or an account-based pension. Yet many people remain in the dark about annuities, how they work, and how they can be accessed. Orford estimates only around 1 per cent of Australian retirees currently use an annuity.

He cites a federal government survey of about 8,000 people conducted last year, which explained how annuities worked, and then asked whether they would buy one: "and 54 per cent of respondents said they would".

Also known as lifetime or fixed-term pensions, annuities are generally offered by super funds or life insurance pensions. Individuals establish them with a lump-sum from superannuation or other savings vehicles.

The income received is fixed when the annuity is initially purchased, and can be indexed annually either by a fixed percentage or in line with inflation.

Income payments are usually made either monthly, quarterly, half-yearly or yearly.
Operating similarly to insurance products, owners can nominate beneficiaries when starting an annuity – usually a spouse or another dependant. This enables income stream payments to be directed to them upon the death of the annuity owner.

Another alternative is to choose a "guaranteed period" - which means if the owner dies within this period, their beneficiary will receive the remaining income payments as an income stream or a lump sum.

‘Just like an insurance policy’

Orford describes annuities as a type of insurance product, citing the pooled nature of the investment as a key feature.

"It means that the payments will keep level in real terms, while income from an account-based pensions would be received to date,” he says.

"It's just like an insurance policy, but here you're insuring your longevity or your lifestyle rather than your life."

Orford says there is a major discrepancy in the retirement income structures employed in Australia versus the US, where lifetime pensions are much more common.

He points to the Teachers Insurance and Annuity Association of America - Collect Retirement Equities Fund – the world's largest pension fund, equivalent in many ways to UniSuper in Australia – as an example. Around 40 per cent of its member assets are held in lifetime pensions.

"The path that we're now on is to let funds get their own frameworks in place and then get the products up and running from inside the funds.

"The government's CIPR objective set too high a standard. It was a very altruistic, noble objective, but its' not necessarily what people will want," Orford says.

He highlights one of the key themes of the banking royal commission – member best interest – saying that the current system of account-based pensions "isn't in members' best interest".

But having spoken to about 40 Australian superannuation funds and seven insurers, Orford says interest is strong: "we haven't had a knock-back yet".

is senior editor for Morningstar Australia

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