Redesigning retirement: The case for soft defaults

Great article Stephen, and great discussion. I don't mind the idea of a soft default - but also understand why this would be called a nanny state solution when it really is up to the individual retiree. I wonder if we might soft default to another type of income stream? And don't mind the idea of a government backed income stream - that would give many people the confidence to think about it. The elephant in the room, of course, is complexity. How many regular retirees can do the sums across all levers of retirement funding and confidently come up with an answer without some professional input? And then there's the issue of trust in advice, cost of advice, and how few advisers are left in the industry. Oh dear ... a lot to solve, but good to have this debate.

Annuities are promoted as a way of dealing with the major risks in retirement. They are paid for life so they eliminate longevity risk and they also eliminate inflation risk and market risk. But annuities introduce counterparty risk. The retiree needs to be confident that the entity promising to pay this regular income will actually be around in 30 years time to honour that promise.

From a counterparty point of view, the safest annuity is actually the age pension. It is paid for life and indexed to inflation and unaffected by market conditions and we can be fairly confident that the government will still be around in 30 years to pay that pension. So maybe the answer is for retirees to be able to buy more age pension from the government to supplement their retirement income.

That introduces legislative risk. We would need to be confident that the pension rules won’t change over the next 30 years. Given the track record with changes to superannuation over the past 30 years, that is a substantial risk.

Clearly there is no such thing as a risk-free retirement, so I feel more comfortable managing my own risks, thanks very much.

Compulsory annuity, I feel it should be part of the income tax system, we've paid income tax during our work lives, retirement should be the time we get that money back as annuities.

It's my money. Government and the financial industry can just keep their hands off. No nanny state thanks.

The annuity is part of the tax system,it is called the pension.Then you go through the income and assets test to get the annuity.

Other countries give the tax a different name,NICS in the UK, I forget the German name but it will probably have versicherung in the title. The USA gives it a long and weird name ,along the lines of old age,dependants and survivors pension.Shortened to social security taxes.They all do the same thing.

The UK at the moment is providing good entertainment through a word salad. People should not be taxed twice,you pay 20% tax and then you pay 10% tax ( might be 8% now),we always called it NICS but if we abolish this tax ( as we call it now) you will only be taxed once.Hopefully you will not notice that tax rates have gone up to 28 or 30%,all rolled into one,just concentrate on the fact that you will only be taxed once,not twice.

Don't mention fuel taxes, alcohol taxes, VAT ( GST) and many other taxes.If anybody mentions them they are not taxes,they are levies,there is no way they are taxes.

The Ponzi scheme is over,Keating told you that around 1986 under the accord.Give up a 3% pay rise to kick off superannuation.

You live longer,your health care costs are higher as you live longer.Your pension costs are higher as you live longer. You will retire later because you live longer.The other plan is die younger,oh hang on,bit of a dumb plan that one.

Responsibility has been moved to you.Try to keep healthy to reduce health care costs,try as hard as you can to understand financial matters. It is all down to you with govts being there as the safety net. Believe or not.

I wouldn't be thinking that complication makes things better. I get along great knowing my 2x table.I think that is called a superpower in financial jargon

Use a DRP,,lump it in all at once,the DRP will take care of $ cost averaging.

1,000 shares each in CBA and NAB.Sit on your hands for 33 years. Cost then 12K call it $13K if you want.

Today say 6,500 shares in each of them,the company web sites will give you the cost of every share bought in the DRP. 6500 is getting it roughly right. Round it down to 6000 if you want.

6000 X $4.50 plus franking credits for CBA.

6000 X $1.80 ? for NAB,plus franking credits.

Would that be where the dumb money outsmarts the smart money.?

I'd be paying the financial industry to keep away from me.

I've often wondered if they believe their own B/S

You're quite welcome to see if simple things work well.Retired for quite a while now.We can stop the clock today. The rest of your life that is it .Dividends from 2 companies. You can buy more of them,or you can sell the lot,each to their own. See how it goes.

Strap yourself in and buy some noise cancelling headphones The ride will be rough,but very quiet.

Presume you knew in 1991 that the maximum Assessable Assets of the Age Pension Assets Test for a Full Age Pension for a couple would be $451,500 in 2024. How much would a couple need to invest as a one time investment in 1991 to own $451,500 of CBA shares today. Assuming the couple are assiduous tax dodging home owners, each having individual taxable income less than $5,400 in 1991: https://www.ato.gov.au/tax-rates-and-codes/tax-rates-australian-residents#ato-Australianresidentstaxrates1990to1999 and less than $29,783 as SAPTOers today. They dodged capital gains tax by not realised any capital gains. The effect of capital gains and dividend reinvestment on ASX:CBA can be seen by clicking the ADJ button: https://www.marketindex.com.au/asx/cba/advanced-chart On 01/09/1991 CBA price $6.75; back adjusted for dividends $1.14. On 01/04/2024 CBA price $118.04. How much would the artful dodgers needed to invest in 1991 to have $451,500 today? Shares today = $451,500 / 118.04 = 3,825 Shares 1991 = 3,825 * $1.14 / $6.75 = 646 Value 1991 = $6.75 * 646 = $4,360.50 Value 2024 = $4,360.50 * $118.04 / $1.14 = $451,503 (to check arithmetic)

Prior reply de-paragraphed by Apple device?

The effect of capital gains and dividend reinvestment on ASX:CBA can be seen by clicking the ADJ button:
https://www.marketindex.com.au/asx/cba/advanced-chart

On 01/09/1991 CBA price $6.75; back adjusted for dividends $1.14.
On 01/04/2024 CBA price $118.04.

How much would the artful home owners needed to invest in 1991 to have $451,500 today?

Shares today = $451,500 / 118.04 = 3,825.
Shares 1991 = 3,825 * $1.14 / $6.75 = 646.
Value 1991 = $6.75 * 646 = $4,360.50.

[ Value 2024 = $4,360.50 * $118.04 / $1.14 = $451,503 (to check arithmetic) ]

Let's get real. An income stream of any description needs to be [or should be!!] backed by Capital Assets or Guarantees - does not matter who the provider is. The Govt Aged Pension is, in effect, an "annuity" without any asset backing at all, other than the Government's Balance Sheet and future taxation. Should the Government's Balance Sheet blow up with excessive debt, or spending out of control, the ability to pay the Aged Pension or cost of living adjustments, diminishes. There should be a Govt Asset backing these future pension liabilities - "a Future Fund for All" but there isn't. Not a problem for Australia "yet" but massive problem for many Western countries, swept under the rug.

Private providers locally are at least regulated and the Capital must be set aside. That Capital must be conservatively invested or the provider must carry more Capital to cover the risk - dilemma - to earn returns higher than the Bond rate, you have to add risk which requires Capital OR pass at least some of that risk off to the Client. That is the reason you are seeing some "hybrid" annuities - a fixed component plus a growth component - not always packaged that way but look under the hood!

Cut through the noise the "answer" is actually very simple - allow Australians to directly buy a Government Annuity - a "Parallel Future Fund" or "Pension Top Up" if you like. Money set to one side, not compulsory, next to no fees and choose what suits you. That would of course wipe out an Industry!

Spot on! Only governments can carry the risk for annuities.

'Chalmers said that the Government is looking at how to improve the retirement phase of superannuation so that the system delivers a better retirement for more Australians'

From recent experience with this government, this may simply (but duplicitously) signal their intention to further tax and reduce the higher super balances of the more self-provident savers for some form of redistribution to the less self-provident or improvident. A little 'better .. for more' may be achieved by making the outcome a lot poorer for some.

Scariest 10 words in any language: "I'm from the government and I'm here to help you!"

The problem I have with the annuities currently on offer is that they lock you in to fairly mediocre performance and require a pretty hefty balance to overcome this.

One could argue that the conservatism which causes this is essential when dealing with retirement funds, but there is also a convincing argument (albeit definitely not a consensus) that retirement is not the time to shut up shop. And not just because of nasty outcomes like the recent bond slump.

I've recently switched to the pension phase in my super so give me decent tax free income, although I have still have a considerable portfolio outside super.

Before doing so I played with a bunch of the calculators on various super sites to work my safe(ish) withdrawal rate.

The most eye opening was on Hostplus (from memory). It allowed one to compare withdrawal rates with expected returns from their various investment options.

The only ones that provided a comfortable margin over the assumed 30 years I have left were those that might be classed as growth or high growth.

This wasn't an outlier. I'm with Australian Super and their default offering when you switch to a pension is a 70/30 'balanced' fund for 88% of your portfolio and cash for the rest. The default withdrawal rate is 6%, which is much higher than the usual recommendation.

I may be the trusting type, but I assume they've done a lot of number-crunching.

I like the theory of a compulosry guaranteed annuity, but I worry that absent a government guarantee, the risk posed by 'safe' low returns is just as worrisome as the risk posed by maintaining a growth strategy.

"annuities currently on offer is that they lock you in to fairly mediocre performance":
Putting it mildly.

"require a pretty hefty balance to overcome this":
Rate of return and ratio of capital to expenditure required to avoid bankruptcy are related;
https://freeimage.host/i/image.JV1zXJp

Simple safe withdrawal rate with tax rate 0%:
Annual withdrawal payment, nominal investment returns 7% , inflation 3%, 30 years, capital normalised to 1 (- = capital in fund), 0 remainder;
= PMT((1 + 7%) / (1 + 3%) - 1, 30, -1, 0)
= 5.70% / y

Same real capital remainder:
= PMT((1 + 7%) / (1 + 3%) - 1, 30, -1, 1)
= 3.88% / y

Taking large risks might result in large returns and large terminal capital or bankruptcy. Small risk with small returns has the same outcome stretched over a larger time.

"calculators on various super sites to work my safe(ish) withdrawal rate":

This one has only one fault that I know:
https://www.mercer.com/en-au/insights/superannuation-and-retirement/future-of-superannuation/mercer-online-retirement-income-simulator/

Assumes that all withdrawals are all instantly disappear, presumed spent.
More realistically, withdrawals are added to capital outside super and may accumulate, adding to income outside super.

Reading this, I'm reminded of the Warren Buffett quote: "Don't ask the barber whether you need a haircut"

Ah yes! Back in the late 80's we were securing the future of clients with about 30% of their income from lifetime annuities with an estimated IRR of 12% (as I recall). This is about when interest rates were on the way to 17% and so were the Capital Guaranteed returns from life companies. The principles haven't changed much: the shareholders of the life companies were the ultimate providers of security for the annuitant, although back then the Government was not about having a life company go to the wall. As always, total certainty comes at a price too high for most, so a blended portfolio with a portion 'guaranteed' still looks like a smart option.

What I don't hear is much comment about the fact that a person has a lot of variables they can plan for if not always control them. Staying healthy past our out-of-date retirement age and continuing paid work is one, getting a double bonus of super lasting longer along with the extra income (and often a health boost). Adding value could include, say, grand-parenting, thus releasing children to add more value themselves. Volunteering and other socially important activities can add community value in response to the longevity bonus of longer healthy lives that a majority of older people will achieve. We really need a national longevity strategy to get the most of all older people have to offer. It is the only way we will achieve proper co-ordination of all the resources we could marshal to genuinely make the best of increasing longevity, rather than just trying to manage the much promoted 'longevity risk'. Along with the strategy, we need personal longevity planning that empowers each person to take more control of their life in seeking to make the best of it!

Lifetime annuities are a good part of any retirement portfolio. Certainty of some income.no management issues and Centrelink and tax benefits. Pretty scam proof and many annuitants live longer than there life expectancy as a challenge. Also a good thing for those who are prone to overspend.

"Lifetime annuities are a good part of any retirement portfolio.":

Model showing annuities outperforming government guaranteed term deposits?

I am an individual, with individual needs. I am not simply a member of a collective or group to whom a policy can be applied. I won't play nice with any system that forces me to buy an annuity simply due to being over a certain age.

Hear hear John

I agree, hear hear John

I am opposed to compulsion in any form which pretends to be for my good.

As you argue, compulsion helps disinterested or disengaged people who would never had done anything for themselves re super if it hadn't been compulsory. So why punish everyone with a compulsory annuity for goodness sake? I know you state that your model would be "opt out" but really, what is the point for someone who has the bare minimum super at age 65 (say $200k) - they might be able to better use those funds for a new car, caravan, trip, etc.? They will always qualify for the AP anyway. I can manage my own money quite sufficiently without further govt intervention thanks.

The heart of the problem with the multi trillion dollars super industry is that people want lifetime income but the industry is asset based.

Only a Government can take the actuarial risk for providing lifetime income annuity type products.

Do I see the super funds supporting this? No way.

So we will continue to have a dysfunctional system.

Why don't you see us supporting an income-based system? I know the fund I help govern has been working very hard on this for years. We do actually believe in supporting our members!

As for 'only the government' taking actuarial risk, that's not true either. If investors were willing to purchase lifetime annuities, which act like an insurance policy and only pay out while you're alive, then the industry could easily handle it. The problem is with the investors/retirees who on the whole are reluctant to consider investing in a product that might only pay out less than 100% to you if you die relatively young. The mentality that annuities are like reverse-life insurance policies needs to be developed. The government can help with that, but doesn't have to create suitable product.

The returns on the annuity are awful. I have had quotes which put me off (I also got them to run them for the equivalent of a Parliamentarian’s pension - unbelievable cost, an absolute scandal).

I can invest the cost of an annuity in a portfolio of shares and government debt and get a better return.
The bonus is I can leave the capital to my children or a charity.

It's because the industry is asset based that they want pensions to come in. 10 to 15 years will see all the Baby Boomers and GenX, whom have balances typically higher than Boomers) are reaching preservation age and retirement age. Now not all will start taking all their Super out pay property off, help the kids buy etc but a lot are going to.

That's a large exodus of funds. Pensions, slows that rate of withdrawal down.

Assets, be they infrastructure bonds or buildings, get interest, lease payments,. They'll want to balance the flow if funds in and out.

I agree the TMD is a good initiative but, the designers are taking a straight through the middle approach and the level of detail is insufficient for retirement income products. The TMD regime is a recognition that the PDS regime didn't achieve all its goals. The legalistic, too long, documents are possibly designed for the issuer (protection) rather than being an end consumer information document. So, a mash of the PDS and TMD is potentially what may be needed. The challenge is that, a lot of disclosure documents just become tomorrow's chip packet. So perhaps new delivery models are needed to engage the potential consumer and result is an outcome where the person has some useful information in order to make an informed decision.
Financial literacy is a conundrum. Some basics can be taught at school level - things such as how to compare between products such as phone plans, electricity contracts or streaming services, for example. Relatable and current day usability for the young ones (also imbeds some good maths skills, as well as research skills along with learning to distinguish between marketing and actual feature). Teaching super is probably best targeted at the 40+ and retirement, not until much later, into the 50s, for example. Point is, age relevancy is needed for any interest to be piqued.
So, this isn't just one for the government to solve, superfunds probably need to, not only consider their "life-stage products" offerings, but the associated fin lit that should accompany them. In the current form, PDS or TMD, the mark is well missed.
Couldn't agree more that the compulsion concept should be considered at the de-accumulation stage. This has been tightened up with death benefits with only a valid pension being permitted to stay in super following the death of a member. But prior to death, there is nothing.
For now, age 65 has remained a standing feature of super (maybe its too hard to amend all the references to it so it may be at the bottom of a to do list). The CSS - a government funded defined benefit scheme - requires a decision by age 65. The world doesn't stop turning but it certainly gets people engaged with their super. Making age 65, or 67 if there needs to be alignment with the state pension eligibility age, a decision point with tax (dis) incentives to direct behaviour, may be a part of a potential solution. It doesn't have to be about products and the need for innovation, it can be about legislative nudges that firstly gets member engagement and then incentives to take certain course of action.
The SISA is 30 years old and desperately needs revisiting.
And of course, the sacred cow of the home. Can anyone explain why, after a period of 12 or so months when the last of a couple has entered aged care, the full value of the previous home is not assessed in the means test? It is nothing other than an estate asset by the time someone enters residential aged care. Therefore, if super is being hammered as not being for estate accumulation, then why, should the home be carved out? (It seems to be a bridge too far.)
The Home Equity Access Scheme is one of the better government initiatives and, just perhaps, there should be compulsion in the utilisation in some cases where aged care funding is needed, for example.

"Relatable and current day usability for the young ones (also embed some good maths skills, as well as research skills along with learning to distinguish between marketing and actual feature). Teaching super is probably best targeted at the 40+ and retirement, not until much later, into the 50s, for example. Point is, age relevancy is needed for any interest to be piqued.":

Computer models will keep improving.

The citizenry need to know how to find age relevant ones.

We used to have a compulsory pension phase until Costello abolished it (another change to only benefit the well off). Why not simply stop people using super as a tax planning tool and requiring withdrawal after retirement age or pension age or 75. Just because you have to withdraw it doesn't mean you have to spend it, but it would stop super being used for purposes other than retirement income. Don't agree with compulsory need for anything other than current account based pensions - lifetime pensions should be individual choice (and what would happen if you already have an employer lifetime pension too).

I read your submission to the Treasury Discussion Paper that you refer to here and thought it was quite good. I think you should get it out more although it's hard to convince some people.

" cashflow they receive from the age pension is very irregular":

https://www.optimumpensions.com.au/wp-content/uploads/2024/03/Retirement-phase-of-superannuation-discussion-paper-Optimum-Pensions.pdf

Abolish Age Pension means tests, adjust tax rates.

Abolish Super, adjust tax rates.

Specifically no tax on imaginary ('inflationary') returns.

While waiting for Abolition, Self Abolish taxes through capital efficient Home Improvement to reduce Assessable Assets to less than $451,500 and deemed Assessable Income to less than $9,360 / y. Definitely avoid taxable work.

"based on an investment-linked lifetime annuity design by Generation Life":

Age at Start, Pay / y / $100,000, Years to 0% return:
80 $8,900 11.236 [ = NPER(0%, 8900, -100000, 0) ]
75 $7,200 13.889
70 $6,200 16.129
65 $5,500 18.182
60 $4,900 20.408

Talking own book. Too many Annuity products seem to suit the provider overly, at cost to the recipient.

Agree 100% with Dudley and Ray

Until the ability to contribute to super is lifted from the age 75 cut off (ignoring the clunky Super Home Downsizer) to age 100, and the current minimum pensions are halved, nothing much will improve.