Whilst we now have a prudential standard from APRA on how superannuation funds need to assess the outcomes they deliver to their members, most of the discussion and activity by the industry has been on the accumulation phase and the point of retirement. This begs the question: how should superannuation funds assess outcomes in the retirement phase? After all, isn’t that what saving for retirement is all about?
Most retired households will have a mix of assets at retirement with the most common being superannuation, home, and savings outside of superannuation. To complicate matters, retirees face two huge unknowns:
- What investment returns will be during their retirement; and
- How long they, and their spouse, might live.
This uncertainty makes turning capital into lifetime income incredibly hard. And for those subject to means testing, the income from the Age Pension is highly erratic too.
Retirees are faced with some incredibly difficult mathematics to convert these assets into a lifestyle over and above the Age Pension.
A common approach used by superannuation funds and financial advisers is to consider average returns and average life expectancies. However, a member is not an average but an individual so a better approach is required.
Considering a range of scenarios
One approach to determining how robust a retirement outcome will be is to test every possible scenario the retiree could face. In Figure 1, the horizontal axis indicates the range of possible demographic scenarios a household can experience. The vertical axis indicates the range of long term investment performance that retirees will experience over time. The red shading indicates which scenarios are most likely, and the white and blue indicates scenarios that are less likely but can still happen but will still happen over time. It is vital that superannuation trustees acknowledge the long term nature of this. All of these scenarios will happen to some cohorts of retiree over the generations. In my presentation I demonstrated the reality of this by showing a number of historic outcomes that Australia has witnessed over the past 100 years.
Figure 2 shows 100 carefully constructed scenarios for income (in today’s money) from an investment of $200,000 in a balanced account-based pension drawing the minimum. The red line shows the Year 1 income (in today’s money).
Using this approach then allows us to talk about the robustness of a retirement outcome in a meaningful way. We can assess the likelihood of any particular outcome – such a maintaining a your desired lifestyle for life, or not outliving your savings. The approach also allows for testing the impact of using different combinations of retirement products and using different investment mixes.
Similar techniques were proposed in Treasury’s Retirement Income Disclosure Consultation earlier this year.
Common member objectives
Typical financial objectives of retirees are:
- High income (e.g. SKI-ers – spending the kids’ inheritance)
- Income lasting for life
- Stable income each year (keep pace with living costs)
- Enough access to capital
- Leave a bequest
Each retiree will weigh the importance of each of these differently. By understanding these weightings, superannuation funds can combine products to deliver on each of these objectives to deliver robust retirement outcomes for their members.