Sophisticated pension products from financial services organisations and government, and investor awareness of properly managing withdrawal rates are key to securing Australian retirement incomes.

Australia needs a world-class retirement income system with high quality products, improved fund governance and targeted financial advice.

That’s the view of ASX-listed wealth manager Challenger, which believes the financial services industry needs to act now to support an increasing number of retirees moving into the drawdown phase.

“Super is doing the first part of its job; it is allowing people to accumulate assets for retirement,” the company argues in a new position paper.

“However, there is no structure to the drawdown phase in our defined contribution model – flexibility is prioritised at the expense of risk management and income certainty and sustainability.”

Australian Bureau of Statistics figures show 51 per cent of national wealth is held by the 45-64-year-old cohort, and about 700 Australians are retiring every day. The ability for Australians to self-provide in retirement is increasing, Challenger says, with almost 60 per cent of retirees reducing or eliminating their reliance on government income support.

Echoing the recommendations of the 2014 Financial System Inquiry, the Challenger paper describes the need for products designed to deliver regular and stable income streams in retirement as “critical”. .

The paper also backs a government initiative for tighter fund governance around retirement income, which would among other things, require trustees to consider the retirement needs of their members when developing and offering retirement income products.

“This new governance initiative could form a major plank in the drive to improve the market for high quality retirement income products,” the paper said.

But improving the retirement phase is not just about product, Challenger says. It also requires specialist training of financial advisers to ensure they have a strong understanding of retiree behaviour, expenditure and life expectancies -- including mortality rates, mortality improvements, and the deviation of actual life spans from the mean.

“It is essential that [retirees] get sound financial advice before and during retirement, and that the financial products available to them meet their needs in retirement,” the paper says.

Challenger hopes its concerns about the future of Australia’s retirement income system will be addressed by the federal government’s development of a framework for Comprehensive Income Products for Retirement (CIPRs), or a 'MyRetirement' product, and consultations run by Financial Adviser Standards and Ethics Authority (FASEA).

Morningstar Australasia's managing director of research strategy, Anthony Serhan has covered this topic in detail--including the implications of the government’s $1.6 million cap on concessionally-taxed money held in pension products--as introduced last year.

Safe withdrawal rates

A 2016 Morningstar paper Serhan co-authored addressed the need for a broad response from government and players such as Challenger, the banks and other financial services companies. This centred on “safe withdrawal rates” for retirees: how much they can withdraw post-retirement without running out of money.

Serhan explains how, in assessing the implications for Australians, "the first thing was to address one of the practicalities of life: fees".
"Whether you are paying somebody to manage your portfolio...there are costs. "So what we did first of all was introduce a fee of 1 per cent per annum into our analysis. And secondly, we looked at the Australian returns as opposed to US returns.

"So if you do a similar thing: Assume a 30-year period, 50 per cent Australian shares/50 per cent Australian bond rates with the fee level, the 4 per cent number drops to around 2.5 per cent."

Taken a step further, the paper looks at projected returns in the context of current equity markets and interest rates, and also within more diversified portfolios that also include a mix of Australian and international assets.
Get used to lower returns
"Our safe withdrawal rates are similar to what we've seen in the past, but they are lower and importantly, these withdrawal rates will be even lower if, as the data shows us, people keep living longer.

"That's good news, isn't it? We are going to live longer. Well, maybe you've got to take that into account when you are thinking about how much you are spending today," he says.
Serhan also emphasises another finding in the report that is particularly relevant for retirees living off an allocated pension.

"If you want more certainty about your money lasting for the full duration of your life, you may need to save money outside of the allocated pension, or more importantly, you may need to put aside some of your annual payments from your allocated pension to another investment that you can draw upon," he says.

"The reality is we are all different and we need to look at this stuff one by one, and reviewing and this taking into account your own requirements, your own preferences, is still going to be the best way of working your way through retirement."

 

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Emma Rapaport is a Morningstar reporter, based in Sydney.

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