How do we stop super becoming a trillion-dollar inheritance scheme?

Last week, Bec Wilson – writing for this masthead in response to our recent Grattan Institute report Simpler Super: Taking the stress out of retirement – posed the question: could annuities solve our retirement woes?

To which we respond with a resounding “yes”.

Australia’s multi-trillion-dollar compulsory superannuation system is turning into a massive inheritance scheme. That’s not how super was meant to work.Credit: Dominic Lorrimer

We agree with Bec on a lot: Australia’s superannuation system is far too complex and there is virtually no support to help people figure it out in retirement. We also agree that this means cautious retirees spend less than they could, and that more use of annuities could help fix this.

Our report argues that while superannuation offers the promise of a more comfortable retirement, too few retirees are enjoying the benefits of their super.

Most people find retirement planning stressful: four in five Australians approaching retirement find planning for it complicated, and three in five don’t think their retirement will be financially stress-free.

What’s more, few retirees draw down on their retirement savings as intended. In fact, many are actually net savers – their savings continue to grow for decades after they retire.

We propose that retirees be encouraged – but not forced – to allocate 80 per cent of any super balance above $250,000 to purchase an annuity.

Australia’s multi-trillion-dollar compulsory superannuation system is turning into a massive inheritance scheme. That’s not how super was meant to work.

Most Australians go through their working lives without making many big decisions about their super, such as how much to contribute or how it’s invested. But once they retire, the super system casts them adrift.

In many countries, new retirees are automatically given – or strongly encouraged to choose – an income guaranteed to last their entire lives. But in Australia, retirees get little guidance about how to use their super.

So it’s no surprise that Australians tend to stick with the default option: more than four in five retirees end up in account-based pensions and having to cautiously manage their spending to avoid outliving their savings.

However, while an Australian woman aged 65 today can expect to live until 88 on average, they also have a one-in-five chance of making it to 94. How can retirees plan what they can spend each year when faced with such uncertainty?

And half of those retirees who use an account-based pension draw their super at legislated minimum rates. Yet drawing at the minimum will leave the typical retiree with 65 per cent of their super unspent by the time they die.

To make the super system simpler, it needs to be easier for retirees to choose whether to buy an annuity: that is, using some of your super to “buy” a guaranteed income for life. The research shows that buying an annuity can reduce retirees’ stress and boost their spending.

That’s why we propose that retirees be encouraged – but not forced – to allocate 80 per cent of any super balance above $250,000 to purchase an annuity, with the rest to be drawn via an account-based pension that provides flexible access to capital.

Our modelling finds that retirees who follow this recommendation could boost their incomes by up to 25 per cent, compared to solely drawing on an account-based pension at legislated minimum rates.

And it would give retirees the certainty of knowing that the bulk of their incomes, irrespective of their super balances, would be guaranteed to last as long as they do.

But steering retirees into annuities offered via super funds is unlikely to work. Many people struggle to understand and compare annuities, and once you’ve signed up, you typically can’t switch to a better deal even if you can spot one.

Recent experience in the UK showed that when required to purchase an annuity, most people simply took what their fund was offering and often got a poor deal.

It’s true that a number of super funds now offer their members the option of investment-linked annuities, which offer an income for life, but where the level of that income varies with investment returns.

But many of these products are incredibly complex: even experts struggle to decipher what retirees are being charged in fees and other costs. The best option, therefore, is for the government to directly offer annuities.

Priced fairly, and with its investments managed by the Future Fund, a government annuity would build trust, since retirees could be confident that they’re getting a fair deal.

A government annuity could even offer a money-back guarantee, where if you die before receiving the purchase price back in fortnightly payments, what’s left goes to your beneficiaries once you pass away.

And if you didn’t want to buy an annuity off the government? You wouldn’t have to. But for many Australians, a government annuity would offer the promise of a more comfortable and stress-free retirement.

Brendan Coates and Joey Moloney are retirement income experts at the Grattan Institute.

• Advice given is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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