Is the Retirement Income Covenant really the right answer?

In July 2020, Michael Callaghan, Deborah Ralston and Carolyn Kay presented the final report of the Retirement Income Review. In brief, this government-initiated review found that Australia’s retirement income system was working for most retirees and that, with a few tweaks and more concentration on certain vulnerable groups, it was fit for purpose.

But the Review also found that the move from the accumulation phase to decumulation was ‘underdone’, and that it was up to the trustees to ensure that their super funds would more pro-actively guide members towards more secure retirement funding outcomes.

Enter the Retirement Income Covenant (RIC), which was enacted in legislation taking effect on 1 July 2022. Since then, regulators ASIC and APRA have issued a series of negative report cards on the progress of this requirement, accompanied by much hand wringing about the funds’ commitment to the Covenant.

But there have been no real consequences, which begs the question how patient the regulators will be with the slow delivery of this reform. How long should it take? How much latitude will the funds continue to be given? Why so much carrot and so little stick?

This leads one to question the whole point of the RIC and ask if it was a good idea, poorly executed or just a poor idea with little chance of success, regardless of how it was executed.

Or maybe something else entirely.

A lot has changed in the two and a half years since the RIC became law. Such changes include:

• Continued growth in the combined funds under management for the superannuation sector. This was $3.3 trillion in June 2022 – it is now $4 trillion, growing at nearly 10% per annum according to APRA.
• The rate at which Australians are retiring has increased, largely due to the spike in population represented by baby boomers in their 60s. Estimates vary, but at least 700 people are retiring on a daily basis.
• There is a rapidly shrinking pool of financial advisers to cover the needs of those entering retirement. Adviser numbers are down to about 15,000 nationally compared to a peak of 26,000. The ratio of advisers to retirees in cities is low, but it’s even worse in the regional towns and rural areas.
• Economic shocks such as those experienced during the pandemic have undermined confidence in long term returns on retirement savings.
• Ongoing economic volatility, evidenced by increased cost of living and higher interest rates further reduce retirement planning confidence.
• A sharp increase in the proportion of Australians carrying a mortgage into retirement means that more than 50% of those aged 55-59 are doing so.

There is also an entirely different sentiment toward industry super funds, which hold the lion’s share of the nation’s retirement savings.

When mandatory super was introduced in 1992, industry funds were the poor cousins to the more glamorous, strongly marketed retail funds, many owned by major banks. But over time poor performance by retail funds means that the lower fee, better performing industry funds have gained strength and membership.

More recently, industry funds have attracted so many assets that they have needed to head offshore to find suitable scale investment opportunities. The union origins of industry funds have tended to invite ongoing scrutiny of trustees, board makeup and marketing funds by conservative politicians. The slow processing by CBUS of death benefit claims has now resulted in Federal court proceedings by ASIC - and perhaps a class action.

It’s clear that the industry funds are no longer the darlings of the sector that they were in 2022. This is likely to further exacerbate a general lack of confidence in retirement planning.

Another less easily recognised change, but arguably one with far higher consequences, is the significant growth in the complexity of retirement funding, which relies on not one, two or three, but now five pillars:

• the Age Pension,
• superannuation,
• private investments,
• work income and
• home equity.

Some retirees will be restricted to only one or two, others three or four, while some will utilise all five pillars. But here’s the challenge: each pillar interacts with each of the others, and changing a setting on one pillar changes your options with another. Consider the following example of using some super to pay off your mortgage.

In one move you’ve changed your super balance, so your expected drawdowns will be lower and longer-term earnings will compound at a lower rate. You’ve also potentially improved your Age Pension entitlements because funds have moved to a means-tested asset to a non-means tested asset, namely your home. And you have increased the value of your home, thus changing the potential equity access opportunities.

Phew! If it feels like a game of snakes and ladders, that’s because it is. How does the average Australian cope with the complexity of these diverse but interconnected rules? Most don’t.

Retirement income literacy is not sufficiently entrenched to enable a majority of them to tackle the intricacies of retirement income planning. A recent survey finding revealed that fewer than 50% of retirees understood what preservation age was. Given it is when (subject to meeting certain conditions) one can access super, this basic lack of knowledge is a poor start to the necessary further financial decision-making.

What does this all mean for the RIC?

The legislative requirement for funds to take responsibility for guiding and supporting ‘retirees to have the confidence to spend their hard-earned savings, while enabling choice and competition’ is a huge ask. One which raises some important questions:

• Super funds are being asked to do the heavy lifting – all of it, basically, on behalf of the four other pillars of retirement income. Why?
• Despite the RIC being a legislated requirement since 2022, the funds’ response to date seems to be to devote time, money and resources into developing or white labelling products (typically lifetime income streams) as opposed (with the exception of one or two larger funds) to creating a customer journey with the intention to educate, inform and support. Is this evidence that they prefer a financially rewarding strategy over one that helps members?
• Is there a fundamental conflict of interests inherent in the RIC? Do super funds really want most of their members to withdraw more money, earlier and more regularly, than they have been? Or would they prefer to have a higher level of funds under management?

If an RIC isn’t the solution, then what is?

It appears to be both unfair and unproductive to expect the funds alone to solve the problem of retiree engagement, timely decumulation and productive management of their savings and resources.

Part of the responsibility for this program is that of the Federal Government. Yet successive governments have abdicated this responsibility for decades. A few dollars now being thrown at the Moneysmart website to supplement its retirement section is hardly going to help solve such a huge problem. So what will?

Let’s go back to the five pillars of retirement funding. What if each pillar ‘owned’ a share of the responsibility, and therefore the actions needed to support the transition from work to retirement. Here’s how it might work:

1. The Age Pension is the foundation of most Australian retirements – about 65% of retirees from age 67 and about 80% of retirees in their 80s. This pillar needs to be better explained and serviced by the provider, the Federal Government. This could include information on how pension payments combine with super to form a higher income stream and public education programs, targeted to different ages and retirement stages, sharing specific explainers about options, actions and outcomes are needed. An expansion of Centrelink’s Financial Information Service (FIS) would also help, particularly in rural and regional areas – a regular nationwide roadshow would also reach those in need.
2. Superannuation will mature from its current status as a ‘top up’ to the Age Pension and become a main income stream in a decade or two. The education and information about transitioning from accumulation to decumulation should rightly be offered by all funds. But they don’t need to reinvent the wheel – nationally approved templates could be used by all super funds (including SMSFs) for this purpose, saving time and resources and avoiding multiple compliance checks.
3. Private savings and investments are not ‘owned’ by any one group. Here there is a role for the entity which sets many of the rules – the ATO. Additionally it is incumbent upon individuals to step up and educate themselves on this form of retirement income, with perhaps a minor role for the ASX and other investment institutions.
4. Work income in retirement is becoming more prevalent. Education about transitioning to retirement could be provided by HR departments, with Centrelink needing to do a better job of explaining Work Bonus credit rules. Workplaces could do a far better job of ensuring that departing employees are aware of the fundamentals of retirement income.
5. Home equity can be accessed by using the government’s Home Equity Access Scheme (HEAS) or a reverse mortgage. Both the Federal Government and private mortgage providers need to explain these schemes in plain English (and other languages) so retirees can consider this ‘under the radar’ fifth pillar.

And if there is one Age Pension reform worth pondering – one suggested by financial experts such as David Knox at Mercer and Greg Jericho from The Australia Institute - it’s a serious consideration of whether the income test should just be removed.

This could reduce Age Pension complexity while encouraging more older workers to remain healthily engaged in the workplace. Tax would be paid on extra work income, thus ameliorating some of the costs.

Not all of these ideas will work, but what they might achieve is two things.

First, they would share the load of providing support for retirees across the five main pillars of retirement income in a much more equitable way. It is not just the job of the super funds.

Second, spreading the huge responsibility outlined above could result in quicker and more efficient progress towards the RIC’s original goal: to help Australians face their retirement journeys with a far higher degree of retirement income literacy and confidence.

Kaye Fallick is Founder of STAYINGconnected website and SuperConnected enews. She has been a commentator on retirement income and ageing demographics since 1999. This article is general information and does not consider the circumstances of any person.