Further superannuation changes coming
The federal government is taking its next steps in improving the efficiency of superannuation.
The Treasury has released a paper “Development of the framework for Comprehensive Income Products for Retirement” and is seeking comments on it by 28 April 2017.
The paper builds on the MySuper base. MySuper is the simplified default superannuation process used while one is building towards retirement. The Treasury paper, likely to result in something called “MyRetirement”, addresses the retirement stage.
MySuper was a response to the cost and complexity of superannuation offerings and the complexity of financial advice regulations. To understand its genesis, it is necessary to look at those regulations.
The advice regulations distinguish between “general” advice and “personal” advice. Personal advice can only be provided by a financial planner and must take into account the particular circumstances of the person being advised. General advice is essentially limited to the provision of facts. Against these definitions, it was hard for superannuation funds to suggest what their members should do.
Under the compulsory superannuation regime, employers are required to contribute to their employees’ superannuation funds.
The first question that arises from that requirement is what fund? The obvious answer is that specified by the member. But, what if the member does not specify a fund? This raises the concept of the default fund. The default fund is either chosen by the employer or specified by an industrial award and is used when a new employee does not nominate the superannuation fund into which mandated employer contributions shall be paid.
However, once in a default fund, the member faced further choices about investment strategy and insurance arrangements. Funds, within themselves, generally set up default investment options, but these varied across funds. Some took the view that the default investment could not lose any money and so was very low risk and low return. Others took the view that superannuation is a long term investment and went for growth at the expense of short term volatility.
In the absence of any statement from the member, they joined the default investment option of the employer’s default fund. The absence of a statement may well have been a reasoned decision that the default was the best for the person concerned.
Many people entered default options, giving rise to concerns that people were “unengaged” in and “disengaged” from their superannuation.
Combining the disengagement and the inability of superannuation funds to give advice lead to the oxymoronic concept of “mass customisation”. MySuper is the culmination of this. It is each superannuation fund’s idea of the accumulation and insurance arrangements that best suit most members.
Three major reports touching on superannuation this century, Cooper, the Henry Tax Review and the Murray Financial System Inquiry identified the fact that superannuation could do better in the retirement phase.
Many people invest their superannuation lump sums in an account based pension and draw the minimum possible pension. This is understandable, as they do not know how long they will live and whether their money will last. This often leads to a frugal lifestyle and a large inheritance for the children.
A consequence of this drawdown strategy is leakage out of the superannuation environment. Mutual Pensions Pty Ltd has published that a couple both aged 67 following that strategy could expect that 63% of the payments made by the fund be directed to children, 6% back to the government in taxation and 31% to their estate. So a third of the money saved using tax concessions for retirement funding is not used for its intended purpose. It is used as a tax efficient intergenerational transfer tool.
There is consensus in the three reports and the superannuation industry generally that some sort of longevity insurance will increase the efficiency of the system. Longevity insurance works by people committing to forfeit all or part of their superannuation on death in return for a share in the distribution of the forfeitures of those who die before them.
There a two main types of longevity insurance – annuities and Mutual Pension® (also known as Group Self Annuitisation schemes).
Annuities are a promise by an institution to pay a pension while ever the nominated person or people are alive. They are effectively a bet that pays off if one dies before the institution paying the pension goes broke. In the Australian regulatory context, that is unlikely, so an annuity can be regarded as a guaranteed income. To provide this guarantee, the institution prices the annuity conservatively and invests conservatively. This makes the annuity low risk and low return.
In contrast, a Mutual Pension® is not guaranteed but can adopt more appropriate investment strategies. The participant in a Mutual Pension® is making a bet that pays off if other participants die earlier.
In both cases, one has greater certainty of income in old age and one can be less frugal in retirement.
The next stage of the government’s superannuation progress is to encourage the use of longevity protection. There are two strands to this, removing barriers to providing this protection and removing barriers to marketing and distributing it.
Mutual Pensions® are possible under present law, but could be made more efficient with some changes. The government intends to do this. Annuities starting now are possible and from July this year, funds set aside for annuities deferred to a later age will not suffer income tax.
The final barriers to address are those to the efficient distribution of longevity protection. This is the reason for the latest government paper.
The problem the paper seeks to address the conundrum into which the advice legislation puts trustees of superannuation funds. They cannot currently explain and recommend longevity to their members except in the context of giving “personal advice”. Many funds are not equipped to give personal advice. It is costly and many fund members do not seek it.
The government’s approach is to say that any superannuation offering approved longevity protection (currently called a “Comprehensive Income Product for Retirement (CIPR)” and likely to be called “MyRetirement”) to its members will not be prosecuted for giving “personal advice”. Treasury uses the term “safe harbour” from prosecution.
In current contemplation is the voluntary provision by funds of longevity protection for which the safe harbour from prosecution may be available. The paper however hints that this may only be a first step.
The 57 page paper seeks comment on 40 particular questions covering the definition of a CIPR, how trustees will be regulated in connection with the CIPR, making sure the CIPR meets minimum requirements, helping trustees offer CIPRs, other longevity protection arrangements not covered by the CIPR system and other matters.
The paper suggests a CIPR should provide an income higher than the minimum drawdown account based pension, provide a broadly constant inflation adjusted income for life and have flexibility for lump sums and bequests. Clearly, any arrangement that involves forfeiture will meet the higher income test. The other two tests however are mutually exclusive. The more flexibility, the less forfeiture and therefore the lower the income of survivors.
The paper canvasses the issues of exact definition and who will decide if a CIPR is within the definition. This is likely to be a complex matter given the wide range of possible options and the fundamental differences between annuities and Mutual Pension®. It is to be hoped that the rules and processes are flexible and not overly prescriptive.
Paradoxically, the paper considers competition between CIPRs. This is strange as it is mainly about an off the shelf product to which the “disengaged” can be directed. One wonders whether the disengaged will bother to compare the options.
It is likely that longevity protection will grow up outside the CIPR system. It is in this area that the competition will occur. The “engaged” will evaluate and seek advice on what a number of funds offer.
There is clearly an appetite for longevity protection amongst some retirees. Otherwise, no annuity would be sold. The development of Mutual Pensions® will provide an alternative to annuities giving rise to greater participation in longevity protection. However, without a significant cultural change, longevity protection will not appeal to all retired people.
This raises questions about the take up of CIPRs. Default superannuation has been welcomed and used in the accumulation phase. However there is little at risk when one starts one’s career. How people view default options when they are considering their second largest asset is yet to be tested.
The Government has said that further consultation may be necessary once it considers the public submissions.
Dennis Barton is founding director of Andep Investment Consultancy with experience as a superannuation fund trustee and consulting actuary. He is a director of Mutual Pensions Pty Ltd. Mutual Pensions is a registered trademark of Mutual Pensions Pty Ltd.