The Australian Treasury has recently consulted with its citizens on how to oblige Trustees of its huge Super funds to provide them with retirement income.
There are parallels in the UK. Over the autumn and winter, the DWP will be talking with our master trusts about what they would need to offer in-house pensions (as part of the CDC initiative). Some DC schemes already offer investment pathways and some signpost pathways of other providers. However, there is no obligation for them to do so, and the discretion of trustees is often used to protect the scheme and sponsor from the liabilities arising when people get their later life finances wrong.
A Retirement Income Covenant
The Australian Retirement Income Covenant ; “will place a key obligation on trustees to formulate, review regularly and give effect to a retirement income strategy outlining how they plan to assist their members to balance key retirement income objectives.”
The strategy will be a strategic document developed by the trustee, outlining their plan to assist their members to achieve and balance the following objectives:
- maximise their retirement income
- manage risks to the sustainability and stability of their retirement income; and
- have some flexible access to savings during retirement.
In the UK , savers have access to 25% of their pot at any time after 55 as tax-free cash. However there is little obligation on trustees to maximise retirement income on a stable and sustainable basis.
There is a strong case for the UK following Australia down this route. Requiring trustees of the fast diminishing stock of sole-occupation and multi-employer DC schemes to spell out the service they offer their members will help determine whether the scheme is providing value for members. Trustees who cannot offer answers to the questions posed by a Covenant Assessment are the trustees that the Pensions Regulator should be asking to consider their and their scheme’s future.
Why does Australia need to introduce this measure?
Despite being held up as a model for other countries, the problems facing members of Aussie Super Schemes sound remarkably like those approaching the close of their working lives in the UK. They struggle with decisions on how to spend their savings
The long-term implications of these decisions, and their complex interactions with other systems like tax, social security, aged care and housing, make it very challenging for retirees to determine an optimal retirement income strategy on their own.
And as with their UK counterparts, Australians are reluctant to take advice
Yet most people do not seek financial advice at retirement to help navigate this complexity. Rather, in the face of this complexity, evidence shows that Australians currently follow others, disengage, or fall back on rules of thumb and defaults that are not fit‑for‑purpose
The consultation suggests that Aussie savers struggle to spend their pots (clearly as much a problem for the Treasury as for ageing Australians.
The ‘nest egg’ framing of superannuation compounds the complexities around deciding how to manage their superannuation in retirement. Partly because they have only ever been primed to save as large a lump sum as possible, retirees struggle with the concept that superannuation is to be consumed to fund their retirement.
Because retirees struggle to develop effective retirement income strategies on their own, much of the savings accrued by members through the superannuation system are not used to provide retirement income. Rather, they remain unspent and become part of the person’s bequest when they die. By 2060, it is projected that 1 in every 3 (Aussie) dollars paid out of the superannuation system will be a part of a bequest
All of this resonates with the UK experience of pension freedoms so far. Retirement living standards in the UK are requiring massively more than the average DC pot can bring, yet there is evidence that many DC savers are starving their lifestyle’s for fear of running out of money later on.
And of course there is the risk of doing quite the opposite and spending your savings too hard, which appears to be equally a problem
A new research paper from @asfaAUST makes it clear why we need retirement income products that help retirees manage longevity risk https://t.co/DBmTNoriyk #Superannuation #LongevityRisk #RedesigningRetirement #RealLifetimePension pic.twitter.com/GXOlLA2OWM
— Optimum Pensions (@OptimumPensions) April 7, 2021
So what will these strategies look like?
The consultation document makes it clear how a strategy should be created
In effect, the strategy is a strategic document developed by the trustee that:
- identifies and recognises the retirement income needs of the members of the fund; and
- presents a plan to build the fund’s capacity and capability to service those needs.
The retirement income needs of members, and the plan to service those needs, may be different from fund to fund, or from cohort to cohort within a fund. There is significant flexibility for trustees to identify the particular needs of their members and develop a retirement income strategy that is suited to those particular needs.
Knowing your members
The consultation makes it clear that trustees should not be getting involved in providing financial advice individually, introducing soft defaults (such as an option from which you have to opt-out) or a “one size fits all approach”.
Instead the Trustees of a Super Scheme are expected to gather data about their membership and organize them into cohorts who can be offered support as a group
The factors used to identify cohorts of their members are at the discretion of the trustee, but could include consideration of:
- the size of a member’s superannuation balance
- whether a member is expected to receive a full, part- or nil-rate Age Pension at retirement
- whether a member is partnered or single
- whether a member owns their own home outright, owns their home with a mortgage, or is renting at retirement;
- the age a member retires and/or starts to draw down from their superannuation.
Clearly some of this information is not available to UK trustees (and GDPR will make it hard to find it out without member consent).
However, there are interesting thoughts here for UK policymakers to consider. This is the kind of thing, I’d like Nest Insight to be pursuing.
Balancing three objectives – (returns, risk-reduction and flexibility)
The toughest decisions for trustees look like being around trade-offs between mazimising returns, minimizing the risk of money running out and providing the freedom to take cash when needed.
Frankly, this is where I start getting concerned. There are many good points made in the consultation, not least the recognition that on average income needs fall as people get into extreme old age, but can trustees really manage these trade offs without either financial advice , a soft default or a one size fits all approach?
It strikes me that a strategy that simply highlights the problems isn’t much of a strategy, more another guidance document that leaves members not much better off.
Even if the guidance documents are presented to different cohorts in different ways, this kind of approach still relies too much on members working out the trade-offs. Put simply, members cannot take financial decisions in four dimensions (time being the fourth).
The solutions being put forwards focus on “more products”.
Dominate in inevitable merger discussions by having greatest member retention and FUM increases and attractive products.
It is also a matter of survivorship strategy. “The early bird catches the worm” or the Early Adopter fund attracts FUM from other funds. https://t.co/TDzuNfHoKT
— David C Orford (@dcorford) March 1, 2021
I suspect that in the UK, “attractive products” will be slower to emerge and depend on a highly regulated approach to product development (see CDC regulations published earlier this week)
Does Britain need an Aussie Style Retirement Income Covenant?
My answer is “yes”. However I think that the Covenant needs to be better defined than in Australia, where the trustees are in danger of just adding to the noise with glorified decision trees.
Trustees may consider it perverse to be providing people with guidance towards pensions, but I consider trustees as perverse for running a pension plan where the pension option isn’t at least the soft default.
We have investment pathways but we have no soft option default and (other than Royal Mail) no one size fits all solution.
We should be thinking hard about what a Retirement Income Covenant could do in the UK and how it might be introduced. Put this on your shopping list Mr Opperman!
Absolutely right Henry.
The Romans used lifetime pensions 2,500 years ago – so have the British for centuries.
Apart from increased retiree happiness and a 30% increase in income, lifetime income (pensions or annuities) may result in an increase in the Australian Age Pension compared to a retiree effecting an Account Based Pension (a draw-down product), AND the overall cost to the Australian Government of the Age Pension will be lower over time. 1 plus 1 = 3 or more. QED
The problem in Australia is that “superannuation” is really a more tax efficient way to save and invest. Nothing in the legislations require super savings to be taken as an income in retirement. So, it’s not surprising that people have different views on the purposes of their super savings. Discussion on superannuation is hence often confusing when the underlying context is unclear. What might makes sense under a certain context could have a complete opposite effect under another.
Placing additional “obligations” to trustees to assist members in achieving and balancing “retirement income objectives” is like asking someone to solve a problem that may not even be relevant for many to start with.
Even for those want to use the savings to provide retirement income, in a complex system where retirement choices are many, “average retirees” are likely to struggle because many of them have neither the willingness nor capacity nor confidence to work out a better solution than the easiest pathways (either take the money or use the prevalence account-based pensions and withdraw only the minimum amounts set by the government).
The RIC is a good small step forward but it’s leaving too much discretion to trustees. It might not be very onerous – depending on the views held by different trustees – for trustees to fulfill their obligations. Whether any additional assistance would be meaningful for “average retirees” – especially when it comes to helping them identify a better retirement solution – is largely an unknown.
Forgive me Henry, but perhaps your readers might like to know about the origin of pensions – rewards for spying! This novel set in Elizabethan times brings to life an amazing period where spies entrapped folks like Mary Queen of Scots, no less. Love, intrigue and a plot as thick as London’s fog awaits the brave reader of this worthy tomb!