In each of the SPAA conferences in recent years there has been at least one session on turning retirement assets into retirement income. It is fascinating to watch the evolution of thought and collective wisdom progression. Here is a summary of the good (and not so good) comments which were presented this year.
There is a very clear awareness of the sequence of return risks with drawdowns via an ABP. The probabilities of outcomes – other than averages on the mortality side – are being well articulated. SMSFs have an additional issue in that members tend to be more “white collar”, better educated and wealthier and this correlates to longer life expectancy than the average for the population – even allowing for trend improvements. Presenting longevity as the opposite to mortality risk is neat. Life insurance hedges against mortality risk. Lifetime annuities hedge against longevity risk. Life insurance becomes more expensive as you get older, while lifetime annuities become cheaper.
What is poor in these presentations are examples that don’t take the Age Pension entitlement into account. This presents totally erroneous values of the level of income that is sustainable. Even couples with considerable assets now, will have substantial Age Pension entitlement at some stage and the potential offset should be incorporated in a realistic plan.
The other aspect that I find most unfortunate is the lack of benchmarks in advisors’ heads about how future income will vary if you need to rebalance to longer payment durations for survivors. If you start early and make small, frequent adjustments you can get a smooth appropriate income run in most cases.
How the mighty immediate annuity has fallen! From talk of compulsory annuitisation some time back, there is now discussion on the problems of annuities regarding both the demand and supply sides. On the demand side, the perceived shortfalls are:
- The risk of failure of the issuing organisation at some stage over a 20-30 year risk horizon – even if well regulated;
- Perceived poor value in the terms offered from a market with virtually no supplies;
- Lack of flexibility to deal with flexible retirement patterns;
- Social security and tax issues; and
- Loss of capital to bequest.
On the supply side the insurers have problems with:
- Capital adequacy requirements;
- The lack of long dated assets;
- High distribution costs; and
- Virtually no reinsurance available.
Personally, I think the pendulum has swung too far. It is worthwhile (for example) to use an immediate annuity for some portion of the monies at some stage of the life of the member. Annuities are suffering from the inability of consumers to establish quickly and easily what sort of return they are being offered. They can’t separate what is return of capital and net earnings in each payment, or what is the internal rate of return. This is an issue that NetActuary will solve for potential consumers with a complimentary and simple calculator to be available soon.
OK. What is the next practical step to helping clients in this area? There are quite a few steps that are necessary. The first is to prepare more technical notes and other material to explain to retirees what longevity, market and inflation loss dangers they face. The next step is to enhance the models so that all three risks can be consolidated into one plan. The solutions will be different for each individual and will have a solution that has Age Pension, possibly some product, and certainly some process/strategy solutions.
For myself personally, I have another challenge. I need increasingly to take the step beyond helping a small group of advisers to developing the tools and processes which bring this to a wider audience.
The NetActuary Team