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How to close the retirement income gap

Emma Rapaport  |  24 Sep 2018Text size  Decrease  Increase  |  
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Retirement schroders global investor survey

An account-based income stream blended with a deferred annuity could be the solution to Australia's retirement income shortfall, says Schroders global head of retirement Lesley-Ann Morgan.

Working Australians expect living expenses will take up just 39 per cent of their retirement income, according to a Schroders study published earlier this year.

However, living expenses in retirement account for around 58 per cent of expenditure, a gap of almost 20 per cent.

The Schroders Investor Study surveyed more than 22,000 people across 30 countries, including Australia, the US, Hong Kong.

Schroders' Morgan recently visited Australia to explore various ideas to help Australians close the gap between their expected retirement income and their actual income. In one scenario, an Australian retiree could establish an account-based income stream by starting with a deferred annuity at age 65, before transitioning to an income annuity at age 85. 

These products combine both investment and distribution components, and can help protect against "longevity risk" – the risk of outliving your assets. This type of annuity would span two phases – a saving phase where retirees invest and draw down their pre-retirement savings; and an income phase where retirees receive a guaranteed income from the annuity provider.

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To ensure the success of a deferred annuity program, Morgan says Australian retirees adopting this type of strategy need to take on more efficient risk in retirement if they are to "live long and prosper".

In another scenario, Morgan warns that a retiree purchasing an account-based income stream with a deferred annuity, which holds a 100 per cent investment in bonds, could result in a shortfall of between two and six years even before the annuity starts to pay out.

Alternatively, a 100 per cent investment in equities during this period could work well for the average retiree - but with the added equities market risk, some unlucky investors could fall more than seven years short.

"Bonds don't have enough juice and equities can be too scary," Morgan says.
Schroders instead favours retirees employing an above-inflation objective-based investment approach, striking a balance between bonds and equities. It projects this strategy would successfully close the gap for the average retiree, and in a worst-case scenario leave a gap of less than three years.

To avoid a gap, Morgan says Australians will also be forced to rethink their “wants” and “needs” in retirement, and focus on the balance between securing a smooth retirement and the culture of providing inheritance to family members.

While Morgan took note of an account-based income and delayed annuity solution – one in which retirees would purchase an annuity at 80-85 years of age - she raised several concerns including the risk of overspending in the early years (thereby not having enough in savings to purchase an annuity at 80), the risk of family interference, and the risk of cognitive decline.

"The issue is that you’re asking someone to make a decision about whether or not an annuity is a reasonable investment in their 80s but the US evidence is that cognitive decline starts at age 53,” Morgan said. “By the time you're 85 its going to be quite hard for you to make that decision.”

Schroders' latest comments coincide with the Federal Government's ongoing consultation with industry and the public around its Retirement Income Framework.

Having opened up to public consultation in 2016, further stages were announced in mid-2017 and following the 2018-19 Federal Budget. This includes plans for a national retirement income strategy anchored around a comprehensive income product for retirement.

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is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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