Are annuities the answer to the fear of running out?
By Tom Watson
Many Australians aren't effectively tapping into their superannuation and enjoying retirement due to their fear of running out of money.
That's part of the argument put forward by the Grattan Institute in a new report that recommends a host of reforms aimed at simplifying the retirement side of the superannuation system.
Most prominent among the measures proposed by the Melbourne-based think tank is for lifetime annuities to play a much larger role in the superannuation product mix in order to provide retirees with greater certainty around their retirement income.
The think tank is recommending that retirees should be encouraged to place 80% of their super balances above $250,000 into lifetime annuities - a move which it says could not only boost incomes, but provide a guaranteed income stream during retirement.
"For most people, we go through our working lives budgeting around a regular pay cheque, but superannuation is pretty different," says Joey Moloney, deputy program director of the housing and economic security program at the Grattan Institute.
"You get handed a pile of assets and you're left to figure out how to spend it, invest it and make it last when you really have no idea how long you're going to live."
Retirement income and the benefits of balance
Moloney makes clear that the major issue at play isn't the account-based pensions from which many retirees currently draw a regular income. Instead, the challenge is more fundamental.
"When the Nobel laureate William Sharpe called drawing down savings for retirement income the hardest, nastiest problem in finance, he wasn't kidding.
"It's just impossible to use your assets efficiently when you don't know what the future is going to hold - when you don't know what investment returns are going to be or how long you're going to live."
What Moloney and his fellow report authors do argue is that this uncertainty appears to be holding back retirees who rely on account-based pensions from using their superannuation more confidently.
For instance, the report highlights research that half of all retirees who use account-based pensions only draw down their super at the minimum legislated rates.
Furthermore, modelling produced by the Grattan Institute itself found that Australians who draw down at the legislated minimums during their retirement will leave the equivalent of 65% of their original super balance unspent by the age of 92.
Account-based pensions do provide retirees with a number of benefits though, such as the flexibility to withdraw lump sums, which is why the think tank isn't proposing to do away with them.
"We think a more balanced system would provide people with an easy way to spread their money across a flexible account based pension, but also a lifetime income product that provides them a guaranteed income for life," Moloney says.
Could annuities help soothe uncertainty?
In the most basic sense, a lifetime annuity is a product that allows consumers to hand over a lump sum in exchange for a guaranteed income over their lifetime.
As Moloney explains, these can be structured in various ways to suit the needs and risk appetites of different retirees.
"That income can be held at a particular level by indexing it to inflation - and a that of people will see value in that inflation protection.
"But we also think it should be easier for people to access investment-linked annuities where you get guaranteed payments for as long as you live, but those payments will vary with investment returns."
Of course, annuities and other similar fixed-income products are already offered by a handful of insurers and super funds - but not at the scale that Moloney believes is helpful.
"If one of the fundamental problems is people being cautious about spending their super because they're uncertain about the future, regardless of the form that it takes we need something that delivers that at scale - something that gives people the confidence to spend their retirement income."
Government-backed annuities
So who should offer annuities to retirees on a mass scale? The Grattan Institute proposes that - like many other countries - this role should be taken on by the federal government in conjunction with an independent agency to administer the scheme.
Several reasons are outlined in the report in support of this idea, including the government's ability to take on the scale involved, to offer competitive and transparent pricing, to provide access for retirees across the income spectrum and to integrate offerings with the age pension.
Adding to this, Moloney notes that the superannuation industry as a whole hasn't shown much interest in annuities in the past, and that the rollout of annuities from private providers hasn't always provided great outcomes for consumers.
For instance, he cities one example from United Kingdom where, until 2015, many retirees were compelled to purchase annuities through the private market.
A series of reviews conducted by the UK's Financial Conduct Authority found that retirees didn't shop around and tended to take out annuities with their existing providers though, meaning that more than 80% of people were worse off than they could have been.
"I'm happy to be proven wrong, but those two issues together make a pretty strong case to me that it's just easier for the government to deliver this at scale," Moloney says.
"I'm not against the private provision of annuities. If we could confidently design a market that delivers annuities that scale, via super funds, then I'd be a really happy, full-throated supporter."
Get stories like this in our newsletters.