The retirement income paradox
Matt Drennan - Group Head of Research and Portfolio Construction
Australia’s ageing population has thrown up a myriad of challenges. Society faces the challenges of meeting increased demand for expensive medical services and retirement villages, as well as funding public services with a declining ratio of taxpayers. Retirees face the challenge of having enough income to live comfortably whilst balancing their desire to leave an inheritance for future generations.
For the superannuation industry, a key challenge is designing and delivering genuine retirement products. Our industry has been very slow to recognise this need and move its sights from the accumulation phase to the retirement phase.
Advisers have been left with little choice other than relatively expensive annuity products that offer modest income in the current low interest rate environment. Many have simply continued using a similar mix of investment funds to those employed during the accumulation phase, but with a more conservative asset tilt, and holding two to three years of income in cash to avoid having to sell assets during periods of market weakness.
Surely product providers can do better.
To make a start in the right direction product providers need to understand the key needs of retirees. At first glance, three key retirement objectives appear to be:
A regular (preferably monthly) and predictable income stream. This needs to meet the age based legislated minimum drawdowns as far as possible. Clearly this is difficult to achieve in the current low return environment.
Minimising capital drawdown and protecting against market risk. Protection against market risk, including tail risk caused by GFC type events, is an important objective. Clearly this is difficult to achieve in an environment where most clients require some ongoing exposure to growth assets which are subject to the vagaries of the market. What’s more, the cost and complexity of most forms of protection can be prohibitive if not managed carefully.
Managing longevity risk. The Government’s attempts to design a My Retirement regime (formerly known as CIPRs) suggests there is an increasing focus on longevity risk. While this has some merit, the jury remains out on how best to manage this risk. Running out of money is one of the key concerns of lower balance clients. These clients have traditionally used the age pension as their longevity insurance and this is likely to continue. There is mixed evidence about whether high balance clients actually face this challenge in any meaningful way.
Let’s not shy away from increased sophistication
Increased sophistication in financial products would allow us to offer better retirement outcomes for our clients. Yet our industry tends to shy away from it. So how do we overcome this paradox? Perhaps we should follow the example of other industries, such as the automobile industry.
Think about the sophistication of the average family car 10 years ago and compare it with what are regarded as ‘standard’ features today. Cruise control, ABS, automatic mirrors, even automatic parking. What makes these sophisticated features work behind the scenes? I have absolutely no idea. I’m not even sure what ABS stands for. The point is I don’t care. I am interested in the benefits, not the electronic specs.
The automobile industry understands that customers don’t want complexity. They emphasise benefits and explain sophisticated features in simple, easy-to-understand terms. Product providers in our industry would do well to embrace a similar approach – not avoid sophistication but explain it in a way that is engaging, and emphasises benefits over technical specs so it is easily understood.
IOOF’s open architecture approach to product solutions makes us well placed to grapple with these retirement income challenges. By drawing on the expertise of our product partners, and focusing on what really matters to advisers and their clients, we will be able to design and develop the next generation of retirement products.
In fact, a multidisciplinary team at IOOF has already begun tackling these important issues. Our end goal is to provide better retirement products and solutions that will help advisers deliver the best outcomes to their clients. Watch this space.