Time to rethink retirement income streams

Tony Greco

Much has been said and debated in Australia about the need to improve the regulatory framework to enable the further development of retirement income products, such as annuities. In other countries the market appears to be more developed, with more retirees opting for retirement income streams than may be the case in Australia. Treasury has recently undertaken consultation on this issue. The Institute of Public Accountants (IPA) put forward its views and recommendations, some of which appear below.

One of the main issues is around the types of income stream products that would enable retirees to better manage risk in the retirement phase, in particular, longevity risk and investment risk.

As we all know, lifetime income streams insure the holder against both investment and longevity risk while the holders of account-based income streams bear all the investment risk themselves.

The IPA is concerned these income streams will not suit the investment risk profiles for all individuals and we encouraged Treasury to allow holders some flexibility with their investment choices, like they currently enjoy in the accumulation phase.

The IPA believes the longevity risk of account-based income streams could be managed by the setting of a maximum drawdown rate, that is, not 100 per cent of funds can be withdrawn immediately when all conditions of release are satisfied, together with a taxation inducement to draw down closer to the minimum rate. The IPA would encourage soft inducement rather than compulsion.

In terms of the development of new products, the IPA contends the annuity and pension rules constitute an impediment and we are particularly concerned with the current ability to withdraw benefits in full as a lump sum.

This imposition creates high liquidity risk for product providers who already have high set-up costs in establishing and marketing new products.

In order to promote the development of a wider range of income stream products, the IPA believes changes are needed. For instance, we recommend the consideration of the reintroduction of maximum drawdown payments for pensions.

As already stated, the IPA prefers soft inducement rather than compulsion and hence would encourage amendment to existing taxation laws that would encourage individuals to receive a pension rather than take benefits as a lump sum.

As such, the IPA recommends the age threshold of 60, whereby any lump sum withdrawn under this age is tax free up to a cap, currently $180,000, be removed.

In other words, any lump sum in excess of a member’s lifetime low-rate cap, irrespective of their age, will be taxed at the same rate (currently 16.5 per cent) as anyone under 60.

The IPA recommends tax rules around superannuation income stream products that don’t satisfy the current earnings tax exemption, such as deferred lifetime annuities (DLA), could be modified so these products could receive concessional tax treatment that applies to income derived from superannuation assets supporting income streams.

The IPA would encourage the removal of these impediments to developing viable annuities and other long-term retirement income streams. It would be expected the introduction of some of these changes would lead to new products being brought onto the market.

It is our view that it would be appropriate that people should only be able to purchase a DLA with superannuation money once a condition of release has been met.

The IPA believes the ability to purchase DLAs with non-superannuation money would be counterproductive to current policy intentions of the superannuation system by encouraging individuals to keep money outside of the system in the accumulation phase.

In order to achieve the policy objective, we are also of the view there should be an upper limit on the amount that can be invested in a DLA. The IPA recommends the upper limit be the time that will elapse from the commencement of the DLA to the end of the maximum deferral period expressed as a percentage of the maximum deferral period.

For example, if a DLA is invested to commence in 10 years and the maximum deferral period is calculated as 25 years, then the upper limit on the amount that can be invested in a DLA should be 15/25, that is 60 per cent, of the total superannuation money available at date of purchase.

A minimum deferral period for a DLA should be added and we recommend this period be expressed as the shorter of 20 years or the number of years to the person’s life expectancy (as determined by reference to the Australian Life Tables).

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