If Australians are not to live unnecessarily frugally in retirement and the government is to reduce dependence of retirees on the public purse, upcoming decisions on the means testing of longevity products will be critical, writes Patricia Pascuzzo.
Those decisions hang on a just completed public consultation by the Department of Social Services (DSS) on the rules around social security means testing to ensure they are compatible with the creation of new retirement income products.
The willingness of retirees to take up such products depends on the implications of doing so for their pension entitlement and that in turn will influence the ability of the industry to offer such products.
But the department’s proposals, if enacted, could end up working against retirees with lower superannuation balances, the very people who stand to benefit most from longevity protection.
This is a highly complex issue that requires a balancing of conflicting policy considerations, as well as a clear understanding of the broader policy context and the problem we are seeking to solve.
The call for new longevity products arose out of the Murray financial system inquiry in 2014. Murray noted that these solutions could significantly increase retirement incomes while providing security of income for life. As well, a more efficient retirement phase would lead to significant benefits for the economy and taxpayers.
But despite this logic, little progress has been made since. With the Commonwealth still bearing the lion’s share of the risk of population aging, there simply is little scope currently for the financial services industry to step up and provide solutions.
The DSS review could change that. One precondition for innovation is that the age pension means test needs to be neutral in its treatment of longevity risk products as compared with other forms of retirement income.
The lifetime nature of retirement income products means the focus should be on the cumulative effect of the rules over time. In contrast, an excessive focus on targeting payments at a single point may have the undesirable effect of further encouraging dependency on the public purse.
Recognising this, DSS is proposing that 70% of the income would be assessed in the income test and 70 per cent of the purchase price of a longevity product would be counted towards the assets test (dropping to 35 per cent once the retiree has passed their life expectancy).
Under the DSS proposal, retirees with superannuation balances around $300,000 or couples with $400,000 would face a penalty for taking up pooled products.
This is problematic as these are the retirees who are most likely to be at risk of outliving their savings and for whom pooled products would offer a better solution.
At the same time, the proposal offers those with higher balances, who are unlikely to ever be dependent on the age pension, the potential to receive further concessions, on top of superannuation tax concessions already received, secure in the knowledge that they will live long enough to receive the benefits of longevity pooling by virtue of their higher socio-economic status.
Part of the problem is that current deeming rules are biased in favour of account-based pensions (ABPs) against other forms of income, hence the dominance of these products in the retirement market.
While DSS is not currently contemplating changes to the means test rules for ABPs, their favourable treatment under the existing deeming arrangements needs to be reconsidered to ensure neutrality if the means testing of longevity products are to have their intended effect.
Changing the deeming rules for ABPs is not without its complications. At the same time, relying on older Australians to live frugally in retirement for fear of outliving their savings is not an adequate approach to managing longevity risk.
Overcoming Design Issues
While our three-pillar retirement income system of the age pension, compulsory super and voluntary savings has much to commend it, its design has created unintended consequences.
First, it encourages excessive risk-taking in the asset allocation of superannuation funds because the Commonwealth, in its provision of the age pension, is effectively underwriting investment risk.
Second, the nature of super as a defined contribution system emphasises maximising the pot at retirement rather than the income generated. This encourages retirees to rank accessibility of capital over security of income.
If the private sector did more to pick up the burden of managing longevity risk, this would help address the sustainability of the budget and improve the welfare of people in retirement with broader benefits to the economy.
Yes, this is a complex challenge. But the fact is if we get the policy settings for the retirement phase right, we will meet the challenge of an aging population by delivering better retirement outcomes, while ensuring the sustainability of the system for generations to come.
Patricia Pascuzzo is founder and executive director of the independent, non-profit think tank the Centre for Sustainable Retirement Incomes (CSRI).