Half of all Australian superannuation is taken as one of these single payments. Now, as policymakers look for the next big economic reform, the Great Australian Lump Sum has begun to come under real scrutiny. Its time may be up.
Lump sum: case against
The attacks come from all over. Leading economists and actuaries have long criticised the lump sum; in 2014, the Murray Inquiry into Australia’s financial system has made it a major target; and a new paper for the IPA by Deakin University School of Accounting, Economics and Finance senior lecturer Dr Adrian Raftery has now added to the case for change.
Raftery cites Australian Bureau of Statistics data showing 60 per cent of retirees from 2007 took out a partial or total lump sum. Of that group, only 40 per cent invested in a pension product – for example, an annuity or life pension. Around one in three retirees used the lump sum to pay off a mortgage, while 16 per cent of males purchased a new car.
“It is the Institute’s view that the use of retirement funds in this manner is not always appropriate and does little to diminish the future pension burden faced by a shrinking workforce and ageing population,” writes Raftery, adding that the IPA “is particularly concerned with the current ability to withdraw benefits in full as a lump sum”.
Income stream: case for
The alternative to the lump sum is the income stream – gradual payments that appear in your bank account each month just as your income did when you were working. They offer less temptation for a giant spend-up, and they reduce the government’s Age Pension costs. The best-known product delivering such a stream is the annuity.
Raftery writes in his paper that income streams have several benefits.
They reduce longevity risk, where the retiree lives so long that they run out of money and must turn to the government – a risk that is growing as more and more retirees live into their eighties and nineties. They reduce the risk that retirees will be surprised by changes in the cost of living. And they also reduce the high-liquidity risk that product providers face when retirees can take all their money out of their account at once.
As the Murray Inquiry notes, Australia is unusual in doing nothing to encourage income streams. Indeed, the Centre of Excellence in Population Ageing Research says Australia is the only developed economy with mandatory retirement saving that has no real system to shape how funds are drawn down.
Leaving the lump sum
The question, then, is whether we should work to eliminate these lump sum payouts, or whether we should just change the balance by reducing lump sums’ size and frequency.
Mercer’s David Knox, one of Australia’s most respected retirement incomes experts, says his firm is a big supporter of a better balance between lump sums and income streaming.
“About 80 to 85 per cent of retirement dollars are now converted into an account-based pension,” says Knox. “The accountbased pension is a fairly flexible product. People can draw down on that as a lump sum if and when they need it, and, of course, you have to recognise that in retirement, people sometimes do need lump sum payouts, [for things like] medical or dental treatment. I think a combination of income streams and access to capital is the ideal system.”
The IPA paper supports choice in superannuation decision-making, but it also argues for suitable incentives that encourage retirees to invest in pension and annuity products. Annuities will generally better provide for the longerterm needs of retirees, it says, and are also more closely aligned with the policy intentions of the superannuation system.
The paper also makes the case for maximum and minimum drawdown rates that control the size of the stream. It says the Institute prefers “soft inducement rather than compulsion” and goes on to suggest tax law changes.
One change would modify the tax rules on superannuation income stream products that don’t satisfy the current earnings tax exemption, such as deferred lifetime annuities. These products, suggests the paper, could receive the same concessional tax treatment that applies to income derived from superannuation assets supporting income streams. This is now the challenge for governments to tackle. With the Murray Inquiry’s final report and its recommendations also fuelling public discussion, the argument about Australia’s superannuation and pension future is set to become even more intense.
