Death by complexity

Alex Burke,  Senior Writer,  No More Practice Education

COVID-19 may have shaken up Australia’s economy, but there’s one enduring challenge advisers will have to face with their clients - and no particular product can solve it.

In the middle of the previous decade, the adequacy of Australia's retirement income system definitely had a "moment". 

There were several reasons for this: one was the flow-on discussions following the 2014 release of the Financial System Inquiry's final report, which argued that the super system was not "operationally efficient" and that assets in super funds were not being "efficiently converted into retirement incomes due to a lack of risk-pooling and over-reliance on individual account-based pensions." 

Another reason was the growing consensus that despite representing around half of all super fund benefits, retirees and pre-retirees were underserved by their funds' retirement income offerings. And even though people in that age bracket were coming to represent a much larger share of the total Australian population - APRA projects nearly 20% of Australians will be 65 and older by 2030 - the super system appeared primarily geared towards those in the accumulation stage. 

A Challenger whitepaper from 2016 summed up the challenge thus: "The superannuation industry is currently very good at the first part of retirement savings – investing the money in accumulation and building it up. The second part – giving members’ money back to them in a way that meets their needs and deals with the unique risks and challenges they face in retirement, needs a lot more work." 

The paper covered numerous issues and suggested multiple criteria for "success" when it came to retirement income, including liquidity, retirees' potential risk aversion, optimisation of Age Pension benefits and the ways in which retirement investments could be "bucketed" to suit different time horizons. Some of these, Challenger noted, were "potentially in conflict with each other," which highlighted "how many moving parts an optimal retirement income plan must address." 

Treasury’s perspective

It would take four years before Treasury would release the findings of its review into these concerns. The Retirement Income Review aimed to assess the efficacy of Australia's retirement system across three pillars: the Age Pension, compulsory super and home ownership. Similar to the post-FSI discussions, the final RIR report suggested there was still "insufficient attention on assisting people to optimise their retirement income through the efficient use of savings." 

This lack of attention, the report argued, was compounded by a lack of understanding in the general population regarding Australia's "complex" retirement income system. This complexity (along with low financial literacy) led to misconceptions among pre- and post-retirees, which in turn "[has] resulted in people not adequately planning for their retirement or making the most of their assets when in retirement." 

Two years ago, APRA highlighted a potential strain on the super sector given that lump sum payments to retirees had jumped over 50% in the previous five years. And last year, the COVID-19 early release scheme saw super members withdraw nearly $40 billion in savings; while APRA data from late 2020 shows that users of the scheme skewed young (the majority being 25-44), there was still a considerable number Australian retirees and pre-retirees applying for COVID-related financial hardship. 

The pandemic may have slowed down in Australia, but the economic effects have lingered and will likely stick around for quite some time. In this new environment, what needs to be done to ensure Australia's retirement system is up to task? Do our priorities need to change? Are traditional retirement investments no longer relevant? 

Most importantly: what can be done to address the lack of understanding regarding retirement income highlighted in the Retirement Income Review? 

The more things change

Despite the challenges Australia (and indeed the world) has faced over the past year, Story Wealth Management CEO and senior financial planner Anne Graham believes the principles of retirement investment strategies haven't changed. "Whether pre- or post-COVID," she says, "there's always going to be volatility in the market. What matters most is the client's needs: from that starting point you can build the strategy, which could cover contributions, drawdowns and the investment element." 

If anything, Anne thinks the market volatility last year is a timely reminder of how important it is to educate people about the purpose of saving (and investing) for retirement. "Moving into the retirement stage," she says, "is a huge transition. People need to be reminded that the money they have might have to last them for 30 years, which has a lot of implications in terms of their spending, lifestyle and how they invest that money." 

This reflects arguably the biggest challenge of any retirement investing strategy: the inherent balancing act between sequencing risk (how short-term market movements and the timing of withdrawals affect one's retirement balance) and longevity risk, which in the simplest terms is the danger of one outliving the money they've accumulated. 

This balance is an integral part of Australia's super system and the investment philosophies that underpin it, but it's also an inevitable consideration for any individual approaching or in retirement. Which is why Anne thinks it's so critical that clients understand it. 

"Unfortunately, a lot of people think their savings are a bottomless pit," she says. "Clients need to understand their own actions have a big impact on how long their money will last. Are they too generous? Are they helping their children financially without understanding the impact that has on their retirement? Do I help my child buy a house? Making these decisions without really appreciating the impact not having that money might have on their future can significantly reduce a client’s retirement options." 

The flipside of this "bottomless pit" thinking, of course, is the danger of being too cautious with how your retirement savings are invested (or not invested, as the case may be). "You have to realise that you are taking on some risk to get a higher return over 20-30 years," Anne says, "but alternatively, if you're really cautious with investments, your money might not last nearly that long." 

There will always be potentialities in this equation - no one predicted the arrival of COVID-19 nor its associated economic downturn, for example - which is why Anne prefers to stick to gradients when discussing retirement with clients. 

"You can make numbers tell any story you want them to tell," she says, "so I try to avoid exact figures in these conversations. It's more about presenting trends and scenarios - your best-case and worst-case outcomes. I wouldn't trust any prediction that someone's money is going to run out when they turn, say, exactly 73 years and two months old." 

The role of products

The importance of presenting scenarios rather than exact figures is also why Anne doesn't think the "retirement challenge" is primarily an issue of getting better retirement products in the market. Which isn't to say she thinks there's no room for improvement in the retirement product sphere - she cites using home equity, pension loan schemes and annuity products as areas where there could be a broader range of options - but there's no "killer app" that's going to solve this problem. 

"It comes back to the numbers issue," she says. "It’s more about the strategy and the best-case scenario than whatever marginal benefit is offered between two different products. Getting another 0.5% per annum isn’t that compelling when you’re drawing down over 30 or even 40 years. There’s also trade-offs that need to be considered and they are often intangible" 

What's far more compelling, Anne says, is developing an understanding of one's options and adjusting expectations accordingly. "People need to rethink their expectations," she says. "It’s unrealistic to think that most people can retire at 60 and not have a change in their lifestyles.

“Lots of people don't wholly own their homes and a lot of people still have dependents; it’s a long time to be self-funded or to retire on the Government. The biggest change needs to be how we think about work and possibly working longer - which might not be working as we know it. It could be part-time, contract work, a portfolio of consulting work or something else."

If there is one thing Anne thinks retirement products could do really well, it's incorporating and facilitating this kind of understanding. "It would be quite useful if they had some behavioural finance concepts and education built into them," she says. 

Why advice must be accessible

Anne’s comments reflect RIR analysis from Deloitte, which argues that for most Australians, “adequate comprehension of [the retirement] system is beyond them.” To fix this, the Deloitte report recommends simplification of the system but also - crucially - points out that an immediate opportunity “is to make it easier to access help at an individual level.”

“As the home ownership/SG dilemma suggests,” the Deloitte report continues, “this assistance should incorporate decisions inside and outside superannuation … There has been insufficient attention on assisting people to optimise their retirement incomes through the efficient use of their savings. 

“When individuals are engaging with financial services professionals, it is important that we do not promote legislative and industry-led complications (e.g. superannuation only vs holistic conversations) that frustrate and hinder … It must be easy to access simple help that takes into account personal financial circumstances. We should make it easy for those who are asked to provide help to do so.”

While Deloitte notes that advisers are only one part of this equation, they are vital to the project of improving retirement outcomes for all Australians. If anything has become clear since the RIR concluded, it’s that the solution won’t be product-led; it will come down to the individual conversations advisers have with their clients as part of a broader adjustment of expectations in society and more comprehensive education about the options available to those planning for retirement. 

Even if there are sweeping changes on the horizon aimed at addressing the complexity of our retirement system, the immediate opportunity is access to the kind of “simple help” to which the Deloitte report is referring. With Treasury’s recently-merged Quality of Advice review now underway, there’s no better opportunity to address the systemic risks inherent to having a large percentage of Australian pre- and post-retirees not being able to afford (or otherwise not having access to) the advice they need. 

"There's nothing worse than sitting in front of a client and telling them they're going to run out of money," Anne says. "But if you can give them some confidence that they can improve their situation by doing x, y and z, that’s a satisfying outcome." 

Whatever challenges the Australian economy may face over the next few years or decades, people will continue entering retirement and will need to understand what that means. If there's one thing Australia's retirement system must get right from here, it's helping them do just that. 


The opinions expressed in this content are those of the author shown, and do not necessarily represent those of No More Practice Education Pty Ltd or its related entities. All content is intended for a professional financial adviser audience only and does not constitute financial advice. To view our full terms and conditions, click here

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