Redesigning retirement incomes policy - from the ground up
In recent years retirement income products have been a subject of the Cooper and Henry reviews.
Now they are being addressed in the Financial System Inquiry (FSI) and the Government’s review of retirement income stream regulation.
Further, appropriate retirement income regulatory design is very much driven by tax and social security expenditure settings, so the practical outcomes of these reviews may be dependent on the outcomes of new year’s Tax White Paper. If, for example, one outcome of that was Government adoption of the Henry proposal to tax super fund earnings at the same rate in both accumulation and pension phases then there would be no need for the prescriptive rules being examined in the current reviews.
Let’s assume, however, that the Government ultimately accepts that tax exemption should continue to be given for deserving pension products and various issues raised in the current reviews remain relevant. The broad question could be said to be: should we stick with the current rules or could they be improved to better meet the purpose of super?
The FSI interim report contemplates whether the Government should impose what could be called a “mandating approach” to access to benefits. This could embrace some or all of the following:
- a limit on maximum lump sum withdrawal
- a requirement to take an acceptable type of pension with some or all of super savings
- re-introduction of maximum drawdowns on account-based pensions
- a requirement to take some or all in the form of a particular pension product type.
The report canvasses the possible compulsory use of a longevity-based pension:
- for part or all of a retiree’s super
- immediately or on a deferred basis (eg at age 85) or
- for those retirees who do not actively choose a particular solution (eg a default pension for MySuper product members).
There is big difference between a mandating approach and our current system, which caters for the fact that needs of retirees are diverse and change over time. Is there a more moderate approach? What if retirees were instead just “nudged” towards suitable drawdown patterns? That is, the rules would be appropriate tax or social security incentives and disincentives structured around appropriate minimum and maximum drawdown levels.
If a nudging approach is to be preferred over mandating, the question arises as to how the drawdown parameters apply to different income stream products or arrangements. The Government’s current review has a product-by-product approach. One of its key focuses is on whether or not deferred lifetime annuities (DLAs) should be enshrined in legislation as products which could be acquired by a retiree with super savings and would attract tax and social security advantages. The broad idea is that DLAs would be purchased during the earlier phases of retirement and start producing income stream at a mature age – such as age 85 – which is guaranteed to last until death.
New set of rules?
The question is: does it make sense to create a new set of rules around a stand-alone DLA product? Does it make sense to have immediate minimum drawdown requirements for some products but not others? Would we be better off with a universal set or drawdown rules (or no minima at all) so that innovative hybrid income stream arrangements can be developed without falling foul of rules which entrench different product silos?
In the event that stand-alone DLAs are to be allowed, specific questions about product features need to be worked through, such as:
- Should a DLA be able to be commuted and/or provide residual capital on death?
- Should the DLA be purchased with a single up-front payment or by instalments?
- Should income levels be guaranteed, or could returns be market-linked?
You could be forgiven for being confused about the inter-relationship the various reviews of the retirement income system and for being left with the impression that radical change is afoot. You could also be forgiven for forgetting that many commentators regard our system as one of the most desirable in the world. It compels and encourages appropriate superannuation savings and provides flexibility to manage them to meet individual circumstances in retirement.
The current system does lack longevity risk pooling and better tools for market risk management. Enabling innovation and removing barriers in this direction is well-aligned to reduced government costs relative to the current environment. Perhaps the solution here could entail developing a universal set of drawdown rules which nudge – rather than force – people towards an appropriate arrangement.
And perhaps we could be looking beyond incentive-driven product competition and focus on ensuring availability of suitable underlying investments to meet retirement needs, supported by effective advice on selection and management of those investments and well-targeted means testing of government support.
August 27th, 2014
Source: Professional Planner www.professionalplanner.com.au