Annuities could be the solution to horizon risk, according to State Street Global Advisors’ (SSgA’s) head of global defined contribution Kristi Mitchem – but some of the more sophisticated products will require changes to tax laws in Australia.
Horizon risk (i.e., not knowing how long you will live for) is one of the major stumbling blocks for people who are planning their retirement, according to Mitchem. If you’re too pessimistic about your life expectancy you could run out of money, and if you’re too optimistic you could end up missing out on consumption.
“One way you can bridge that gap is by using annuitisation. ‘Annuity’ is kind of a scary word because it requires you to give up a big bundle coming into retirement,” Mitchem said.
An advanced life annuity is one useful and relatively cheap tool that can provide a guaranteed income if a retiree lives to a very old age, Mitchem said.
Towers Watson managing director Andrew Boal said there were also investment-driven ways to deal with horizon risk. Age-based lifecycle options are useful, and they also remove ‘behavioural’ risk since people can’t withdraw all the money and convert it to cash after a bad year, he said.
Dynamic lifecycling works by operating in a ‘band’ between an upper limit income and lower limit income, Boal said. If the upper limit is reached, some risk is taken off the table to maintain the target income. Risk is also reduced if the lower limit is approached.
Laddered bonds are the preferred solution of SSgA, according to Mitchem, which use zero-coupon bond and contain an advanced life annuity.
“A lot of these concepts would require some tax reform in Australia – specifically laddered bonds, in the form of zero-coupon bonds – and also advanced life annuities, which are a form of deferred cash flow,” she said.
Boal joined Mitchem in encouraging those in the superannuation industry to lobby for reforms to make annuity products such as laddered bonds available to Australians.
“A deferred annuity doesn’t comply with the SIS regulation definition of a pension because you’re not drawing any income for the first 20 years … the same thing happens in the tax side of things … so we need to get the Government to change that,” said Boal.
