by Tony Kaye
WHEN it comes to the development of a robust framework for lifetime retirement income stream products, it seems there is still a fair way to go.
In everyday language, what we're talking about here are annuities, products especially designed for retirees that deliver a guaranteed set income for life. In the finance industry, they're often being referred to as Comprehensive Income Products for Retirement - and there is a strong push being led by the Federal Government to make them a more attractive investment option.
Indeed, the Turnbull Government used its 2016-17 Budget to announce it planned to remove many of the tax and other legislative obstacles standing in the way of the development of better retirement income products.
On the surface that announcement was a step in the right direction, and retirement product providers have been working closely with the government ever since to develop a preferred structure and rules that will encourage individuals into lifetime income products in retirement.
In January the Department of Social Services released a position paper setting out proposed new social security means test rules for pooled lifetime retirement income stream products.
But it hasn't drawn favourable reviews. A follow-up report from the Actuaries Institute that reviewed the DSS paper has found the department lacking.
For one thing, it notes that the DSS has not recognised the obvious fact that retirees who invest in a lifestyle retirement income product (annuity) will generally lose access to some or all of their capital. This carries a liquidity cost, because an annuity prevents individuals from accessing their funds as a lump sum.
The institute also notes that the modelled scenarios by the DSS assume that retirees draw down from account-based income streams at minimum drawdown rates. But the reality is different, because those with lower assets, who are more likely to be impacted by means testing, actually tend to draw down at higher rates.
The list goes on. The DSS analysis has made no allowance for the impacts of risk, with only central estimate outcomes being considered.
Most importantly, when the DSS total outcomes are considered, including bequests, the proposals result in a significant disincentive to lifetime retirement income streams.
For example, a single homeowner with $300,000 in superannuation and no other assessable assets will have their total outcome reduced by around $40,000, or 6 per cent of total outcome, under a lifetime annuity or group self-annuity product compared to an account-based income stream.
The Actuaries Institute notes that the DSS proposals have a great adverse impact on those with lower means. A single homeowner with $600,000 in superannuation and no other assessable assets has around the same outcome between an account-based income stream and a lifetime annuity compared to the 6 per cent detriment for the single homeowner with $300,000 in assets.
"This is particularly important for the future development of CIPRS considering the current (and future medium term) average balances at retirement are below $300,000,” the Actuaries Institute says.
There are other potential problems with the DSS position paper. The DSS has suggested that 70 per cent of the purchase price of an annuity product be counted towards the age pension assets test, dropping to 35 per cent once the retiree has passed their life expectancy, as calculated at the time of purchasing the product.
But the Actuaries Institute believes that the income test will likely be used more often if annuity products are adopted widely, and 70 per cent of all pension payments from annuity products will be counted in the means testing of the pension.
It recommends changes to both the assets test and the income test to cater for the growing use of annuity products, which will help level the playing field with those choosing to stick with other conventional retirement products.
The lesson for retirees? Watch the CIPRS space. There is a lot more work to do by the Government and industry to create a system that will make annuities more attractive.
Tony Kaye is the editor of Eureka Report, which is owned by financial services group InvestSMART. www.investsmart.com.au