The role of the superannuation system is continuing to transition from a focus on accumulating for retirement to helping retired members draw down income from those savings, presenting a unique opportunity for financial advisers.
The Federal Government brought this transition into sharp focus by legislating that from 1 July 2022, super funds have to comply with the Retirement Income Covenant (RIC), which includes a requirement to disclose their retirement income strategy and how it will help members achieve and balance the following objectives:
- To maximise expected retirement income over the period of retirement
- To manage risks to the sustainability and stability of retirement income over the period of retirement including longevity, investment and inflation and other risks
- To have flexible access to expected funds over the period of retirement.
This has presented an opportunity for advisers to emphasise these elements within their advice in the post-Covenant world. Often, and where appropriate, this advice has included a partial allocation of retirement savings to a lifetime income stream.
Quantifying the benefit of including a lifetime income stream in a client portfolio can be challenging but, using typical client scenarios, it is possible to measure and understand its value and contribution to improve client outcomes.
A worked example like the one below can highlight the value of an adviser’s recommendation of such a product.
This example evaluates how including a CPI-linked lifetime income stream can improve financial retirement outcomes for a typical couple, Dora and Bryce.
Both are aged 67 and they each have $500,000 invested in super. They own their home and are debt free. They are considering transferring their super into account-based pensions to fund their retirement income. Their super is invested in accordance with their 50/50 growth/defensive risk profile. They have $50,000 in cash and term deposits and $20,000 worth of personal assets.
The couple say they would like to live comfortably for as long as possible and estimate that $70,482 per annum (equal to the ASFA March 2023 quarter ‘Comfortable’ retirement standard) indexed annually with inflation would be sufficient to meet this goal.
As part of their total intended annual spend in retirement, Dora and Bryce have established they require at least $45,808 per annum (equal to the ASFA March 2023 ‘Modest’ retirement standard) indexed each year with inflation, to meet essential spending needs.
Base case modelling for Dora and Bryce if they roll their super into account-based pensions invested in accordance with their 50/50 risk profile and drawing $70,482 per annum (adjusted for inflation) from all sources projects their account-based pensions will last until age 100 and well beyond their couple life expectancy of age 94 (when one of both is expected to be alive).
This is a strong outlook for Dora and Bryce. However, it is a simple analysis which fails to address the likely volatility of investment returns over time. We know, for example, that whilst we might achieve the projected rates of return over time, variation in the actual returns from year to year could significantly change retirement outcomes.
We used the Challenger Retirement Income Illustrator, available online to advisers, to stress test this strategy for Dora and Bryce. The tool can stress test both an account-based-pension-only portfolio and a comprehensive retirement income portfolio, including a partial allocation to a lifetime income stream, using returns that change over time. The result showed a high likelihood that both their income ‘needs’ and their income ‘needs and wants’
will be met over their life expectancy.
While the account-based pension strategy is not broken for Dora and Bryce, the question is: can we do better to provide them with more certainty around their retirement income?
An enhanced strategy model for Dora and Bryce involves a blend of both account-based pensions and a 20% allocation to guaranteed CPI-linked lifetime annuities. This requires re-balancing of the asset allocation of their account-based pensions to ensure that the allocation to the CPI-linked lifetime annuity does not ‘de-risk’ Dora and Bryce’s investments.
Modelling this for Dora and Bryce shows that a 20 per cent partial allocation to a lifetime income
stream could provide:
- Lifetime income, fully indexed for inflation, for as long as they live. The lifetime income amount in the first year is $10,326.
- A 100% chance of meeting income ‘needs’ (an increase of 13 per cent over the non-lifetime portfolio).
- A 93% chance of meeting desired ‘needs and wants’ (an increase of 10 per cent over the non-lifetime portfolio).
- Total retirement income paid over 27 years increased by $80,256 (in today’s dollars).
- The estate value at the end of 27 years increased by $75,919 (in today’s dollars).
From an estate value perspective, the modelling shows that at different points, both the account-based pension and the enhanced strategies might provide a higher estate value but at life expectancy, for example, the strategy allocating 20 per cent of assets to the lifetime income stream would result in a higher estate value.
The general conclusions from this worked example show that a partial allocation to a lifetime income stream within a retirement portfolio can:
- Directly help manage longevity risk with payments that will continue no matter how long a client lives
- Help improve the likelihood of a client meeting their income goals
- Improve confidence to spend in retirement
- Help to improve estate outcomes for clients and their beneficiaries;
Andrew Lowe is head of technical services at Challenger.
