How to fix the retirement mess

Here’s a proposal for solving Australia’s retirement system mess that is both brilliantly simple and blindingly obvious.

The government should sell increases in the old age pension

I have a modest proposal for solving the mess that is Australia’s retirement system, as exposed by the royal commission into misconduct in banking, financial services and superannuation.

It is, if I do say so myself, both brilliantly simple and blindingly obvious: the government should sell increases in the old age pension.

It would be a form of government-guaranteed annuity, without the risk or fees of private operators, and it would be a way to turn the current superannuation lottery into more of a defined benefit scheme, although not entirely of course.

It would solve longevity risk, since the old-age pension is for life, and also solve the problem of the financial advice industry, which remains deeply conflicted after Kenneth Hayne decide not to recommend the structural separation of advice and wealth products. Let me explain my reasoning.

It’s not so much Hayne’s decision, although as discussed here before, it was a shocker, but the failure to deal effectively with the problems of financial advice in general. Nevertheless regulators and policymakers will need to focus on this soon.

Hayne’s most controversial recommendation, later rejected by the government, was that mortgage brokers should be paid by borrowers not banks. With financial advice, that happened a while ago when Labor’s Future of Financial Advice legislation banned trailing commissions.

That did not mean the end of financial planning as an industry, as it would do for mortgage broking, because advisers get to hang onto their clients’ money and can painlessly deduct large percentage fees. Trailing commissions simply became “fee for service” and life went on.

But it’s becoming clear to all now that financial advice is too expensive, and as compliance grows ever more onerous, especially after the royal commission, it will only get more so.

Also the rapid increase in educational requirements are going to result in a big exodus of people from the industry. Fewer advisers and more education and compliance mean only one thing: skyrocketing price — of something that’s already far too expensive.

An initial Statement of Advice can cost $5000 to $6000 and ongoing fees can deduct 1 per cent and more from the account. It’s not so much the fact this is $833 per month on a $1 million retirement balance, which is a lot of money, but the fact that it compounds because it’s a percentage rather than a fixed dollar sum, and can up costing far more than the number years times the amount.

The policy imperative is to look after retirees better. Most of them still get a lump sum from their super fund and hand it over to a financial adviser, saying: “Here, can you look after this for us please, and pay us something every now and again until we die, if there’s any left by then.”

Apart from a small minority of true SMSF operators who invest their own retirement capital, the management of self-funded retirement in Australia is in the hands of financial advisers who are on the whole, with honourable exceptions, insufficiently qualified and too expensive, and they provide an unfairly wide variety of experiences for retirees, from great to horrible.

What’s more they are about to become harder to find and more expensive as many of them retire or quit.

So if advisers are not going to be stopped from being employed by wealth managers because Hayne didn’t recommend that, what, if anything, is going to be done to ensure Australians who have saved 9.5 per cent of their salary for 40 years get a secure and comfortable retirement without being ripped off?

My suggestion: the government should sell increases in the old age pension.

At the moment the pension — which you get for nothing — is $24,081 per year for a single and $36,301 for a couple. There could be a menu of increases in that amount — payable for life of course — for a range of prices.

It would reduce the need for means testing because instead of reducing the pension, extra assets could be used to increase it by handing them over to the government.

The prices of the various pension increases would have to be worked out actuarially, and in a sense it would represent a bet against longevity. If someone lives a long time, they win; if they die quickly, other taxpayers win.

That makes it sound a little frivolous, but I think it might be the best way for the government to run a serious government annuity operation: instead of sending retirees off, perhaps with tax incentives, to buy annuities from private operators who charge whopping fees, simply build it into the aged pension system.

And the best thing would be that there would be no risk at all — the amount would be government-guaranteed for life.

The money would have to be invested by the government, but that could be done by the Future Fund, which is mandated to fund fixed commonwealth pensions. In a way, increases in the old age pension bought with retirement savings would just be an extension of what it does already.

Those who want to leave some money for their descendants could use only part of their retirement lump sum to buy extra pension, and invest some separately. But I reckon the time to give that money to the children is when you retire, which is when they need it, if not before.

I have previously suggested that there should a single government-run default super fund, so that savers don’t get ripped off by poorly-performing industry funds and high fee retail funds, but that’s never going to happen.

Selling increases in the pension would leave the super industry intact, and leave it up to retirees to decide whether either to a buy bigger government pension with zero risk and no fees, give the money to a financial adviser to invest for income and plenty of risk (and fees) or buy a private annuity, also with risk and fees.

Alan Kohler is Editor in Chief of InvestSMART