Government is currently framing a Retirement Income Covenant.
Reforms could force super funds and trustees to formalise retirement income strategies.
Could impact on member super knowledge and engagement.
Last week in Connect, we looked at a Commonwealth Treasury's position paper, 'Retirement income covenant'. It canvasses encouraging retirees to spend their super and not leave a huge nest egg when they die, on the basis that around 90% of retirement savings are left behind.
This extract of a longer article that appeared inauthored by Dr Geoff Warren and David Bell, looks further into the likely reforms and what they may mean for retirees.
Developing retirement solutions is the next big challenge facing the superannuation industry and it’s about to get serious. The government is currently framing a Retirement Income Covenant (RIC), expected to come into operation on 1 July 2022. Treasury recently released a Position Paper that states the intent of the RIC is to:
“codify the requirements and obligations of superannuation trustees to improve the retirement outcomes for individuals”.
The RIC will require trustees:
“to formulate, review regularly, and give effect to a retirement income strategy”.
The impending codification will act as a catalyst for the major super funds to move from navel-gazing, to taking action over their retirement offerings. The focus of this article is how the framework might work for these funds. The RIC will also cover SMSF trustees who will need to consider whether their retirement strategy should be more formalised.
Rather than prescribing a retirement product, the RIC Position Paper focuses on the principles for strategy design. It discusses how funds might develop retirement strategies to balance the provision of income, management of risk (specifically investment and longevity risk), and flexible access to some funds.
The government has intimated they want member choice to sit at the foundation of the retirement system. Indications are that they envisage individuals selecting a retirement strategy for themselves. This might occur through accessing information and decision support tools such as interactive financial calculators, which could be made available by their fund or other providers (perhaps ASIC MoneySmart).
Or it could occur under the guidance of financial advisers. Eventually, robo-advice might even play a role. Basically, members would be expected to directly exercise choice over their retirement solution, including the products making up the strategies and their providers.
An important concern is the willingness and capacity of members to engage with financial decisions. Research finds that most individuals have relatively low financial literacy. They can also be subject to various behavioural influences that may lead to sub-optimal decisions. This includes difficulties in processing information, anchoring on obvious choices, myopia and cognitive decline with age – just to name a few.
Managing finances in retirement requires deciding where to invest and how much to draw over a few decades, while accounting for other assets and income sources such as the age pension. Market returns are uncertain, and people don’t know how long they will live. The difficulty will only be further exacerbated by a likely proliferation of available retirement products, which the Government seems keen to encourage in order to spur innovation and create competitive tension.
The hurdles to effective self-choice might be overcome if people were willing to seek professional financial advice. Unfortunately, this is not likely to provide a solution for the masses. A full Statement of Advice reportedly costs $3,000 to $4,000, a price many retirees are not willing to pay. Further, the financial planning community is constrained in providing advice at scale. Personal advice is time-consuming, and adviser numbers have fallen sharply post the Royal Commission.
There is another way of matching retirees with suitable retirement solutions apart from relying on either financial advice or making a self-directed choice. Retiring members could also be given an option to request that their super fund selects a retirement solution on their behalf. We call this ‘fund-guided choice’.
The selection could be framed as a recommended retirement solution that the member can decide to accept or not. Alternatively, the member might choose to ask their fund to assign them to a solution, followed by sign-off to confirm acceptance.
We suspect that many retirees might welcome the opportunity to ask their fund to make a selection for them. Research indicates that a substantial portion of fund members are willing to trust their fund and are content to accept options put in front of them, due to a lack of confidence to decide for themselves.
The question arises as to what happens when members don’t make a choice, perhaps because they are heavily disengaged. At a minimum, the fund might continue to attempt engagement. It might also be helpful for funds to have the scope to assign members to a retirement option under certain conditions, although this would run counter to a purely choice-based system.
The RIC offers an opportunity to establish a framework that caters for various types of retirees according to how they prefer to engage with choosing a retirement solution. This could be achieved through placing an obligation on fund trustees to engage with members at retirement to establish their preferred mode for choosing a suitable retirement solution and giving effect to their choice.
Dr Geoff Warren is an Associate Professor at the Australian National University's College of Business and Economics and sits on a number of advisory boards. David Bell is Executive Director of The Conexus Institute, a not-for-profit research institution focused on improving retirement outcomes for Australians. This article does not constitute financial advice.