A ‘mix and match’ approach to advice is replacing one-dimensional thinking around retirement income.

Based on their attractive tax treatment, other than the Age Pension, account-based pensions (ABPs) remain a retirees’ primary and often only source of retirement income. However, given that the likes of ABPs and term deposits are agnostic to the individual objectives of retirees, there is a growing appetite by financial planners and their clients for ‘out-of-the-box’ thinking on retirement income planning. 

According to the 2015 Intergenerational Report, Australians now enjoy one of the world’s longest life expectancies, and this should be a blessing. However, the current low interest rate environment, which is pushing clients up the risk curve, plus the downside risk from an over-heated equities market, is fuelling retiree dread of running out of money. This is typically referred to as longevity risk. 

Unsurprisingly, the latest research from National Seniors Australia found that having a reliable source of income for life, is a key factor for worrying less. Based on research by retirement solutions provider, Allianz Retire+, 61 per cent of Australian retirees are more worried about outliving their finances than the fear of dying. 

Despite these fears, income streams like ABPs and term deposits remain the predominant go-to products in the post-retirement space. As a result, retirees tend to manage their longevity risk by simply underspending, which is often unnecessary.

Changes to retirement income solutions

While by no means regarded as a game-changer, the Social Services and Other Legislation Amendment (Supporting Retirement Incomes) Bill 2018, which was passed in early 2019, is making the uptake of annuities a more attractive proposition. 

For example, from 1 July 2019, means test rules for these products will see the income test assess 60 per cent of all product payments as income and the assets test would assess 60 per cent of the nominal purchase price until the person reaches the life expectancy of a 65-year-old male (currently age 84) – or a minimum of five years – and then 30 per cent of the purchase price thereafter for the rest of the person’s life. 

It’s early days, but there is emerging evidence that the clawback is helping to boost the uptake of annuities. Under the recent changes, those on the full Age Pension receive no additional benefit. However, those receiving a partial Age Pension, who invest $100,000 into a lifetime annuity, will reduce their assessable assets by $40,000 and this could increase their Age Pension by $3,120 in the first year.

Non-traditional strategies

It’s the quality of new thinking around retirement solutions, says Caitriona Wortley, Head of Distribution at Allianz Retire+, that’s doing more to offset client concerns around sequencing and longevity risk. 

Caitriona urges the industry to do more to support financial planners to explore options, beyond one-dimensional retirement solutions, by providing more portfolio tools and frameworks to support the implementation of retirement advice. 

 “There’s no doubt that planners need these tools to better combine the likes of ABPs and term deposits with retirement solutions, and other options to help overcome retirement risk,” says Caitriona.

 Given that they have the data at their fingertips, David Orford – the Managing Director at Optimum Pensions – agrees product providers should play a stronger role in equipping planners with the right tools. He cites retirement calculators as one example. 

 “People don’t like to contemplate when they’re going to die,” he says. “So, it’s better for financial planners to start talking about guaranteed income for life than trying to explain complex concepts like sequencing risk.” 

Modelling for better retirement outcomes

 Meantime, Challenger’s Head of Technical Services, Andrew Lowe, has witnessed greater planner uptake of stochastic modelling tools to get more colour around a range of outcomes, based on different markets. By tweaking the income level to match the likely spending, planners are using these and other modelling tools to help address longevity risk.

 “The confidence of spending more in retirement comes from solving longevity risk,” says Andrew. “The broader uptake of annuities is less a response to a ‘one-size-fits-all’ approach, and more about an asset allocation strategy focused on buying a guaranteed level of income.”

 In the U.S., where there are considerably more retirement solutions available, Caitriona says it’s not uncommon for financial planners to recommend up to a quarter of a (defensive) portfolio to be exposed to innovative annuity-style products.   

 “Based on our research into optimisation, in conjunction with Pimco, a 30 per cent exposure funded from the equities component of a balanced portfolio, into a Future Safe policy, reduces tail risk by up to 59 per cent. This is based on selection of a Future Safe zero per cent protected option (floor),” says Caitriona.

What’s new in retirement products

 With planners focusing more on longevity risk, David Orford is witnessing a corresponding uptick in lifetime annuities, which offer greater certainty and security than term annuities. Included within the handful of providers currently offering lifetime annuities are Challenger and CommInsure. 

 In addition, Optimum Pensions offers a white label lifetime pension, which gives people control over the investment options they can select, and change periodically. Orford expects to see greater diversity within the annuity product range going forward. 

 However to its credit, the retirement solutions market has responded with product solutions that overcome retiree fear that if they die tomorrow, they would risk losing their capital. It’s this fear, adds Caitriona that has typically made annuities unattractive.

 Then there’s the Allianz Retire+ retirement solution, Future Safe, which plays in the middle ground between annuities (low risk, low return) and equities (high risk, high return) markets by removing the lingering uncertainty over bad outcomes. As a shares-based retirement solution, Future Safe lets retirees continue to grow their retirement savings, while enabling retirees to limit any potential share market losses to 0 per cent of their investment. 

Since launching early in 2019, Caitriona says a lot of the interest in Future Safe is coming from planners whose clients haven’t used annuities before. Given the current equities and interest rate environment, she suspects retirees see Future Safe as an innovative way to mitigate sequencing risk, offering peace of mind on the downside and the potential for good returns.

The starting point when creating Future Safe, says Caitriona, was to create a product that provides some of the key elements people liked in the old defined benefit scheme – security and certainty to offer retirees the confidence they crave. As a result, she says Future Safe is focused on certainty on the downside, while participating in growth, without taking on more risk.

“We’ve been encouraged by the interest in Future Safe from dealer groups that have been open to a unique offering at a challenging time for advice,” says Caitriona. “We regard Future Safe as appropriate for anyone approaching retirement, up to the age of 80.”

A combo-approach to advice solutions

While it’s impossible to imagine retirement solutions without ABPs, Wayne Leggett CFP® – Marketing Director and Client Adviser of Paramount Financial Solutions – says financial planners are now increasingly willing to take an ‘ABP with combos’ approach. 

Given that they exchange access to capital for reduced market risk, and enhance Centrelink entitlements, he says annuities represent a great option for those desiring either one (or both) of these outcomes. 

“But by far, the most untapped, and easiest source of retirement income would be in the form of a reverse mortgage, yet very few people know about them or how they work,” Wayne says.

He claims that annuities best apply to those whose assets put them in the realm of possibly obtaining some Age Pension. But if this is an unlikely scenario, at least in the early years, Wayne suggests retirees are better off attempting to maximise their assets within an ABP-based solution. 

“We recommend using a combination of asset allocation and risk mitigation provisions that most of the better ABPs offer to minimise market risk,” Wayne says. “After all, the average retiree will see another two to four market cycles in their lifetime. So, providing they adequately manage sequencing risk, exposure to share markets should hold no great fear for them.”

Wayne says improved outcomes for both clients and an advice practice typically come from having the right conversations early around retirement income. 

“However, most of my clients are in transition to retirement (TTR) mode and not looking at Centrelink,” he says. “One of our planner’s has a number of clients with annuities, but anything ‘new’ has been largely about improvements to the existing suite.”

Practical advice 

Despite having looked at different approaches to retirement income planning over the years, Anne Graham CFP® – CEO and Senior Financial Planner with Story Wealth Management – typically finds herself gravitating back to more traditional solutions, which still deliver the right client outcomes. However, she says it’s important for planners to regularly stand back from their advice, and question if it remains appropriate.

 While ABPs are hard to ignore, Graham says it’s important to remember they can be structured in different ways to deliver on stated outcomes. For example, she says there could be merit in a couple having an ABP each, particularly if one has a tax-free component, while the other partner might have a defined benefit scheme, a share portfolio, and/or Age Pension considerations.

“Generally, clients don’t ask for annuities unless they need a guaranteed income, whereas some clients may be interested in investment bonds for estate planning purposes,” Anne says. “The bigger part of the retirement income planning challenge is less about product selection, and more about managing the behaviour of clients, which could mean increasing or reducing exposure to markets.”

Create unique client solutions

Anne recommends all financial planners broach the retirement income planning journey with clients by tabling the problems they have to solve. 

For starters, she suggests asking if the level of income is going to fund a client’s life expectancy. Anne says there could be good reasons for a client having half their money in their own name (i.e. outside super), rather than in an ABP or an annuity. 

“The tipping point is the tax-free element and what other investments they may have,” she says. “They could have exactly the same portfolio within a wrap, without a death benefits tax, or there could be valid reasons why a family trust might be another appropriate option.”

While financial planners may indeed end up recommending ABPs to their clients, Anne says they can’t afford to be in default mode. Assuming they know their clients well enough, she suspects most planners will know intuitively what’s likely to work for them.

Anne suggests the trick for planners is to stress-test their own intuition by creating a few scenarios, then going through them before committing them to a statement of advice. For example, instead of drawing down a pension from an ABP, drawing down lump sums when needed could be a preferred option. 

“While sequencing risk is more difficult for clients to get their head around, it’s possible with an ABP to build a portfolio that helps manage longevity risk using a bucket approach.” 

Retirement income framework

Another potential game-changer for superannuation funds is the Government’s recently introduced Retirement Income Framework. Accompanying the framework is a retirement income covenant. 

This convent requires super trustees to help members reach their retirement income objectives by offering – under the Comprehensive Income Products for Retirement (CIPR) initiative – longevity products (like annuities and pooling products) within their portfolio. However, funds do not have to offer a CIPR until July 1, 2022. 

Given that CIPR is yet to be bedded down, there’s little incentive for super funds to team up with a life office or established providers to offer retirement products (including annuities) to comply with the CIPR. 

What’s proposed under CIPR… 

While the specifics on how the Comprehensive Income Products for Retirement (CIPR) initiative will be structured remain unclear, three minimum requirements for CIPRs proposed by the Government include:

* A minimum level of income that would generally exceed an equivalent amount invested fully in an ABP, drawn down at minimum rates, with recognition of the benefit of a guaranteed level of income where relevant. 

* Provide a stream of broadly constant real income for life. 

* Include a component to provide flexibility to access a lump sum and/or leave a bequest.

Money & Life, Financial Planning Association