Spending in retirement and the taper rate

This latest Dialogue paper written by Andrew Boal, and published by the Actuaries Institute, argues that the current taper rate creates a potential ‘trap’ for retirees who don’t draw down and spend their retirement savings fast enough.

Australia has one of the best retirement systems in the world for accumulating savings. Yet, like many other countries, we continue to struggle with how to design an efficient retirement spending system.

Firstly, when planning for their retirement, there are a few key questions that people need to ask:

How much do I need (and can afford) to save for my retirement?
How do I invest my superannuation to improve my retirement outcome?
How do I safely draw down and spend my savings during retirement?

While the Age Pension is likely to provide enough certain lifetime income for low balance members, and high balance members won’t necessarily need to draw on as much of their capital anyway, the high proportion of Australians in the ‘middle’ could benefit greatly from more certainty.

This ‘middle’ group will be eligible for a part Age Pension for a substantial portion of their retirement and, as a result, the means test rules will be an important consideration for them. In particular, two recent changes:

Since 1 July 2019, only 60% of the purchase amount of a lifetime income stream will be an assessable asset and only 60% of the payments will be income for the means tests. These regulatory changes should, in time, promote the development of new longevity protection products such as deferred lifetime annuities (DLAs) or deferred group self-annuitisation (GSA) products which should help retirees plan their retirement spending with more confidence.
Since 1 January 2017, a retiree’s annual pension is reduced by $78 for each $1,000 of assets above the relevant lower thresholds of the assets test – before 2017, the taper rate was half that amount at $39. As the SG system matures, more and more people are expected to retire with higher superannuation balances and as a result of this change are expected to lose more of the Age Pension.

Based on the current taper rate of $78, retirees in the ‘middle’ group can be caught in a ‘trap’ whereby their total additional retirement payments could be lower than the accumulated reduction in the person’s net take home pay used to fund their higher retirement savings. This is particularly the case if they don’t draw down and spend their retirement savings fast enough.

It is worth noting that a higher taper rate should encourage retirees to spend their savings as quickly as possible until they become eligible for the full Age Pension, but there is little evidence that this occurs in practice. The fear of running out of money and the uncertainty about how long they will live cause many retirees to try and manage their own longevity risk by spending cautiously.

In addition to its favourable treatment under the means tests, a DLA partially solves that problem by providing a guaranteed amount of income for life once payments commence. This allows the retiree to draw down the remainder of their savings up to that point with more confidence, thereby enjoying a lifestyle that is better than would otherwise be the case during the early and more active years of retirement.

Unfortunately, while making the system fairer and more affordable, the means tests make the system more complex. Without assistance, it is near impossible for the lay person to know how much to withdraw and when a DLA might be a suitable product given their circumstances.

This ‘middle’ group of retirees would benefit from:

Encouragement to acquire longevity protection to give them more confidence to spend their savings during retirement;
A fairer taper rate that does not unduly encourage them to spend their retirement savings too quickly; and
Low cost access to information, guidance and advice to help them make better decisions about their retirement.

Given the interconnectedness of the system, it is important that the cohesion of all the relevant levers is considered, including how they impact the efficiency and effectiveness of any other changes such as increasing the SG to 12%.

Andrew’s Dialogue paper can be accessed here and the media release here.