Strategies to Facilitate Intergenerational Wealth Transfers #1 – Transcript

Vince Scully
Hello and welcome to this special XY advisor podcast mini series focused on retirement income and the related advice issues. I’m Vince Scully, veteran advisor and founder of life Sherpa, Australia’s most affordable financial advice service. 2022 marks 165 years since the Australian mutual provident society offered the first pension savings plans and 30 years since the introduction of compulsory super now total assets and superannuation total almost three and a half trillion dollars and benefit over 16 million Australians. 2022 also marks the introduction of the retirement income covenant for super funds. But more of that later, the history of superannuation in Australia has been marked by almost constant change super was either an attractive tax shelter for the wealthy and self employed or offered to a small proportion of the workforce, mostly the public service, or white collar private sector workers. By 1974, just under a third of the workforce benefit from employer provided superannuation and males received at a twice the rate of their female colleagues. Back then life was simple. There was no tax on contributions, no tax and fund earnings, and a 3% tax on the resulting lump sum benefit. 1983 saw the introduction of a 30% tax on retirement benefits and the birth of rollover funds, which allow these tax to be deferred indefinitely, or at least until death. Although readily avoided this tax prove hugely unpopular, and protests led to pre 1983 balances being grandfathered at the old rate. Older advisors will recognize this as the source of the old pre and post components, which created much complexity by 1988. Then treasurer Paul Keating cut this exit tax in half to 15% and levied a further 15% tax on contributions and fund earnings. Just five years later, compulsory super was born with 3% Superannuation Guarantee payments applying from July 1993. We’ve lifted super coverage to 8% of the workforce, and total super assets $269 billion contributions at the time were made to a fund chosen by the employer or nominated in an industrial relations instruments such as an award members weren’t given the choice of fundamental 2004 reasonable benefit limits were introduced in 1994, giving everyone a lump sum limit of $400,000 and a pension limit of $800,000. These in the relator transitional reasonable benefit limits granted to existing members created a range of strategies for advisors, looking eerily similar to the current section 293 surcharge, a short lived surcharge starting at 15% and later dropping to 12 and a half percent was introduced in 1996 and abolished in 2005. The Costello budget of 2006 changed everything and greatly simplified the system. This created a series of immediate opportunities for advisors and taxpayers alike. These measures abolished RBLS remove the requirement to draw benefits at 65 and eliminated tax and retirement benefits. This in effect replace limits on benefits with limits of contributions. 2017 saw the introduction of the transfer balance cap to limit the tax concessions on pensions. I’ll recap all of these to demonstrate that as advisors changes ever present, some of it good, some of it bad, but all of it creating opportunities for us to add value to our clients and improve our businesses. Those who embrace it will thrive, those who don’t will ultimately fail. And all of this brings us to today’s topics the retirement income covenant, specifically what it is and why it matters to both consumers and their advisors. The measure forces superfunds or more specifically the registerable superannuation entity or RSC to formulate a retirement income strategy and publish a summary on their website by the first of July 2020 To help us understand what this means in practice. I’m joined in the studio by Ruth Stringer, a leading superannuation lawyer. Ruth is a partner at Minter Ellison and a non executive director at ASX listed platform provider hub 24. She has previously worked at ASIC in their superannuation group, and was General Counsel at MLC shortly after NAB acquired it from LendLease. Welcome, Ruth.

Ruth Stringer
Thank you, Vince, nice to be here.

Vince Scully
Now, there’s a lot of being talked about the retirement income covenant, which sounds very strange. And as of July, this year, our super funds have had a whole bunch of new obligations added. Can you tell us a little about what the retirement income covenant is?

Ruth Stringer
Thanks, Vince. The covenant is a very strange sort of a word. But essentially, it’s a promise which is in the legislation and it follows the pattern of many obligations that are in this legislation that are that are expressed as a covenant. But if we leave that to one side, essentially, what it requires is for the trustees to formulate and develop a strategy, which has to do with the developing retirement income or reducing retirement income for members and advisors. You know, similar covenants exist now for investments. So there’s a covenant to have Have an investment strategy, covenant to have an insurance

Vince Scully
covenants are the promises to members?

Ruth Stringer
Yeah, essentially, it’s effectively as if this was a clause written into the funds deed. And therefore it means that it’s enforceable, I suppose, by members if, if there were no covenant, and it’s also enforceable under the superannuation legislation, as well that the trustee has to comply with the covenants. And if if it fails to do so then there are pennant penalties attaching.

Vince Scully
And so this covenant to have a strategy to deal with retirement income, what did they superfunds actually have to do on July one of this year?

Ruth Stringer
Well, on July one, they had to have formulated a strategy. And the strategy has to take account of a number of things. Predominantly, it’s about maximizing retirement income, while also balancing that against the risks of longevity risk, inflation risk, and various other prescribed matters. And so the strategy is really putting pen to paper and justifying what it is that you believe, you know, ought to happen to produce a good solid, reliable, stable retirement income. And not only that, you have to publish a summary of it on your website. So I think there’s a real transparency angle here, that’s, you know, very useful, because it’s requiring trustees to I guess, justify what they either do or don’t have, by way of retirement income products, and what thought they have given to their own membership base, what their needs might be, how to meet those needs, recognizing, I guess, really, for the first time that the retirement phase, the D cumulation. Phase is very different from the the accumulation phase, and really turning their minds to how to serve their members in providing good retirement income products.

Vince Scully
Because most of the publicity and media we see about super easy about that accumulation stage. And you know, I guess, compulsory, super 9093 is just coming up on its 30th anniversary. So if you were a wet EAD graduate in 1993, you’re still some way off retirement. So why do you think now?

Ruth Stringer
What is a great question? And I think, you know, I’ve been practicing super since before 1993, actually. And I think, you know, there was probably, I guess, a sense in which this was all very new. I mean, I think the, the, you know, the boomer generation, and had probably felt that we have a system of an old age pension in Australia. And that, you know, if you own your own home, and you’re gonna get the pension, you know, she’ll be right, essentially. But I guess having had the move into compulsory sleeper, which is clearly designed to augment the age pension, which is really not a luxurious lifestyle, from what I can gather, then there’s, there’s been a lot of focus on getting the account balances up. And so in the early days, you can imagine the balances were not terribly strong. But as the balances have been growing, I think that’s the impetus to look at what is actually happening, it’s a maturity thing, I think of our system, because, you know, well, it’s not until you have decent sized balances that you need to start thinking a little bit more strategically about how to how to use those to fund a retirement income that replaces your salary. And obviously, longevity has increased in that time as well. So the life expectancy for retirees is just a much longer period, and you’re therefore running out of money toward the end of life as becomes a bigger concern.

Vince Scully
So this is just a strategy. So there’s no requirement for the super wants to go and develop new products at this point. Correct. Is there a plan B, or Part B of this that will require them

Ruth Stringer
at this point? I mean, I think, you know, if we look at the genesis of how this came about, at an earlier point in time, the government was looking to be a little bit more directional in mandating what was going to be called a comprehensive income product for retirement, or a super bit of a mouthful. But the government’s walked back from that more prescriptive approach, and really is is looking at a light touch. And I guess, because we’ve got the president of the strategy for investment strategy, which is a really important trustee function. The idea is I think designed to allow bespoke solutions and not to place any requirements, but really to place the the asset on the trustee I suppose to to justify what they’re doing to look to the needs of their particular member base because you know, there’s could potentially be quite different depending on On account balances or demographics. And so therefore, to really take this further, but I think having said all of that, I think the reality is as, as funds develop an initial strategy, as they gather data, as they think about what those needs look like, and what we know what the longevity risk might be that they will, they will start to look at product, I think product will inevitably come into the equation, and product development will be part of what they’ll end up doing.

Vince Scully
So is this sort of subtle code that we really want you to get on and develop products? In the sense that, you know, the, the old requirement to consider that the investment strategy must consider insurance needs, for example, or which was generally became a part and parcel of a super fun that yours couldn’t have won without insurance?

Ruth Stringer
I think it is. I mean, I think it is a form of nudge. I mean, if you call that a nudge, and I think, you know, it, we talked a bit before about the history to this. And the last time I saw any statistics on this, something like 94% of the retired population, we’re in an account based pension. And, you know, I think for most people trying to manage an account based pension and work out how much can I safely withdraw? And how much should I withdraw? What’s the time horizon? How should I invest it? You know, that’s a pretty vexing problem for people. And so I think, to the extent product can be developed to to make life a bit easier for the retiree confronting that problem. You know, I think it’s probably overdue.

Vince Scully
I mean, certainly what’s often referred to as longevity risk, or for older folks like me on longevity opportunity, because I’d like to live a long and purposeful life for many years in retirement. So longevity, the length of time your pension has to last is probably a bigger risk, then what the market’s going to do tomorrow. And yet, with the demise of defined benefits, we actually haven’t really seeing anything more imaginative coming out of super funds, then account based pensions. That’s right. Are you seeing trustees looking to develop that sort of product?

Ruth Stringer
I think that it’s been very interesting, because if I look at the last 10 years, I’ve always had a lot of client trustees come to talk about these products. And very often, I think, they’ve been interested in doing it, but didn’t have the confidence, because the competitive landscape was not such that others were doing it. And so there’s only been very, very modest development to date. But I do think that the covenant is kind of a line in the sand. And not that there’s products all launched on the first of July. But I think the the kind of cycle we’re in now is a lot of a lot of funds have committed in writing in their strategies to at least consider expanding their product range and developing products that more explicitly address longevity risk. And so it feels like there’s now a momentum and a commitment. So I do believe there will be more product development in that area.

Vince Scully
And one of the things that I, after being asked to do this, I went and actually tried to find these on quite a few Superfund websites. It’s generally not an easy task. But most of them talk about longevity, and most talk about inflation. And of course, for anyone who wasn’t around in the 70s and 80s. Inflation right now is a bit of a novelty and potentially very scary thing. And many seem to talk about advice or what tools can be provided to help people work this out themselves. So I guess the question is, that doesn’t appear to be required by the actors, as I read it, so advise it if you were to advise a trustee or hypothetical trustee, obviously, you don’t want to have any real ones. What would you be advised them to do around dealing with the any other risks, which is a bit like the sixth step in the safe harbor for best interests? Do everything else you might think might be appropriate? What are the sorts of things that would spring to your mind in that space?

Ruth Stringer
Ah, well, I mean, you you’ve mentioned the longevity risk and the invasion risk, which are kind of explicit call outs, I suppose. I mean, I think this is probably more a question for a financial person in terms of, you know, what risks there might be, you know, in terms of the member, the member experience, you know, potentially I guess you Think about things like health risks. And I guess one of the difficulties in this area is if you were thinking about the risk of, for example, having to go into an aged care facility, you start to get into realms which are classically outside of superannuation. And yet very, very important to the members financial well being in retirement. And so I think it is a bit of an open question what that any other risks might mean, I think one thing I would just say is that, because the covenant is so new, and we’re really in the information gathering phase, I know a number of funds are going to survey their members, and ask the members what the members are concerned about. And we’ll also, I think, be looking at gathering a whole lot of data about, you know, for example, the age pension and the cost of living and trying to bring all of that information together, I suppose, before maybe changing the product mix or the way that they engage with retired members. So I think there’s work to be done in really, the trustees will need to go out and look to what those risks might be, and how they might be addressed within the construct of a fund. Yeah, I

Vince Scully
mean, all those issues about have health aged care. Dealing with kids and aging parents, at the same time, that so called sandwich generation, does make this a lot more complicated than it might have seen in 1993, where we had, as you say, most people relied on the page pension. The, what do we call the four pillars being the age pension, family home,

Ruth Stringer
the obviously supination and

Vince Scully
non super savings, and those other ones are becoming bigger and bigger. With inflation in our home prices, if you look at the family balance sheet, or the household balance sheets, the family home ranks right up there, it’s still ahead of our super, for our younger members, their super tends to be bigger than their home savings. But as we head towards retirement, the big family home in Pymble is still worth more than most people’s superannuation balance. And some of these seems to be working in a different direction or pulling in a different direction, then the recent changes about the transfer balance caps, and all those things. So there seems to be a whole bunch of different things happening here, which don’t all seem to be pulling their same direction.

Ruth Stringer
I think that right, and I mean, it’s well known, I think that superannuation has, has been a bit of a political football and getting a kind of really consistent position, particularly when you have the sole purpose test, and you know, different ways of interpreting that test. And, you know, financial well being in retirement, I’m speaking to the expert here, it is not just what you have in your super it’s, it’s the whole picture. And you know, health plays into it. And so it’s a little artificial, taking the super as a standalone. And I mean, super also has the constraint currently that each individual has their account into it’s not a mixed or a joint sausage hold as a household asset. So there’s some constraints around super that that mean, it doesn’t work seamlessly in the mix there. But I think the idea of focusing on I think, to me, it’s a little bit like really just focusing the mind of the trustee on the fact that, what are we doing this for, it’s not to sort of produce a really big number at 65. And then say, off you go, it’s really the the focus needs to be how am I going to assist in really providing retirement income, or assisting the member to achieve that retirement income? And I guess, coming back to the point about product, it’s one of the reasons it’s not prescriptive. Well, one of the ad workings is to, to your point about generations. I mean, there’s nothing in this that outlaw that makes it illegal for a member to want to use their super to leave a bequest that that can still be accommodated. That’s one of the many needs or wants of the member population. But it’s having options that address other needs, like the longevity risk and like the peace of mind of you know, income that’s, you know, immune from inflation risk and all the different permutations of member wants and needs that

Vince Scully
that although interestingly, leaving a legacy is not one of the requirements

Ruth Stringer
not intended to be one of the ones that the trial trustee should prioritize. So the trustees doesn’t place a priority on the head part. But you know, if the members choose to have that as a, you know, a feature then if you don’t have it, they may go elsewhere.

Vince Scully
And of course, we have a system where the funds income or the trustees income is dependent on assets under management. And obviously, the more their retirees spin the money, the less Once they’re left with classic conflict of interest, you mentioned, they’re at the point of retirement, there is a need for education for knowledge for advice, for understanding the options. And might many of the strategies that were common strategies I saw did allude to the advice, pace. And that I guess goes to your point about the sole purpose test, that there are limits on fun, members resources, a whole being used to provide advice, and bring in what’s happening right now on the quality advice, review and the future of Superfund advice. If you’ve got a view on what you think, what might be happening, or

Ruth Stringer
what’s hard to know, I guess, politically, because obviously, the quality of advisory was commissioned by our former government and hasn’t released its final paper. But the interim paper was very, very interesting. And a key theme of that paper is an expectation that super funds have historically kind of, I guess, stood back and said, you know, we’ll manage the money, and we’ll, you know, after you and trust us, but they’ve not been typically not been coming forward in terms of wanting to get into the advice, field, certainly not personal advice, although many of them have a relationship with an advisor. But the thrust of the proposals to date are very much that the super funds are very well placed, to give advice, because they do hold a lot of data about the member. And that there’s there’s an expectation, in a sense that they will be more proactive in potentially approaching members and potentially offering guidance. I think it’s, I guess, the way I look at it is historically, you know, more or less super funds have offered one retirement income product. So, I mean, there hasn’t been an advisor advice required about which, which type of pension should I get? Because there’s kind of one, there’s only been one pension type. And typically, the investment options are the same as the ones on the way through so, you know, in a sense that you could say that, you know, the advice need hasn’t been forefront of the trustees minds, because I guess their interest is in the person simply saying, this is a continuation. It’s all the same as when I was in accumulation. Right now I’m in pension phase up, I get a tax exemption isn’t that great, and the government tells me how much to take, because the government that prescribes the minimum, but when you think about that, that’s quite an unsophisticated position to be in, because the members are left unless they do have an advisor, you know, potentially in a default, that may not be the best outcome for them or may require may result in them living very frugally because they’re taking a minimum income where they could actually well afford to take a bit more.

Vince Scully
I mean, those minimum drawdowns are obviously designed to get you to last long enough for it to disappear. Correct. But obviously, the number of people who get to the big drawdown levels is relatively small. We’re talking about life expectancy. Ada, I think you get into the 90s. Before you have to start drawing down. Yes, very substantial. That it does leave retirees generally with significant balances, yes, death and Superfund that has no incentive to encourage you to spend more, which I think is a big challenge that potentially, that’s an opportunity for advisors to help their retiree clients enjoy the fruits of their labor. Certainly, we see retirees dying with often as bigger balances, they started with sometimes more, and not having enjoyed it whilst it was there. And on the other extreme, we see late 50s People endangering their own retirement by buying homes for their kids or putting their kids through university. So I mean, that is a challenge that requires significant amounts of advice and genuine question whether the Superfund is the right place to to get there, including most of the audience, as well. I

Ruth Stringer
question whether the super funds will have the appetite for that, because when you think about it, they’re already quite a broad church in offering a range of investment options and potentially a range of products. You know, they’re there to suit the needs of a large cohort of members not to get into the tailoring side of things. So I you know, it’s a nice idea, perhaps that they will suddenly leap into giving advice but I’m not entirely sure that that will actually be how, how it plays out. But just something you said, made me think of a point we were discussing before, which is, when you think of just even the basic concept of income, you know, up until retirement, people will think of income being simply the investment earnings. And it’s a huge mind shift to think, well, now I’m in retirement. You know, I think a lot of people just think retirement income, well, that’s the income or my capital. So the reluctance to actually convert the capital into a cash flow. I mean, I sometimes wonder if we ever need a different, different terminology. Because income, Deus has this kind of very deeply held concept that it’s the fruit of the tree, and it’s not the tree itself. And so that’s a huge change in thought thought pattern and thought processes.

Vince Scully
I mean, it is a really difficult transition for the human brain to deal with that we go through 40 years of spending bad saving good. And now we have to say to consumers, actually, spending good just not too much, yes, saving, maybe it’s time you stopped thinking about it. But we still need to be able to give them comfort that they understand that you will actually be able to cash the Undertaker’s check when you actually get there. And what markets will do? What taxes will happen in the future? How long are you going to live? Is my spouse gonna live longer than I am? How do I deal with all these uncertainties, and spend with comfort? So the advisor sort of becomes as much a therapist and psychologist as they do a financial adviser? Absolutely. And it’s so important to treat the whole point you raised about the sole purpose test, and how that flows into who pays for this advice. Clearly, we know from practice that retirees are the people who are most willing to pay for advice that two thirds of all financial planning clients are over 55. And then shouldn’t be surprising, because hey, they got lots more money. And it’s becoming an immediate problem. They’ve got to deal with this right now. And super funds have been limited in their ability to use members money to subsidize or pay for services. But the same thing apply to the Superfund investing in digital tools to deliver that adverse effect we enhancing their website.

Ruth Stringer
It’s important to I mean, the the the overriding thing is the digital tools need to be focused on the Superfund. So the tools are around, you know, what will my balance be at this age and playing around with different returns? and the like? I think, you know, if you had a specific tool that said, you know, should I have a fixed or variable mortgage, then that probably is outside. So as long as it’s in the general territory of retirement savings under the Superfund, you know, where it fits into the retirement savings picture, that should be fine. I think that is the area that is more likely to, to interest, the super funds, that the idea of kind of guidance, or putting out cameos or watching what you might call sort of investing investor literate literacy in trying to improve standards of literacy and education. So I think superfans would be well placed to provide that kind of guidance. And, you know, I think that, you know, I suppose just on the quality of advice, review, if we can divert from that for a moment, I’ve, we’ve just made a submission on that. And one of the things we think is, to me, I’m not an advisor. So I don’t know how this works. But to me, it feels very artificial, for the advisor to go in and say, well, it costs x amount of money to advise, you know, on your super fund, and then we’ll we’ll charge this other little bit of about, you know, what’s going on outside super, but disappointingly, the review, I guess, propose that that distinction be maintained that it’s only the part that relates to the Superfund, that should be able to be paid for out of the account, we’ve put forward a different idea, which is that really, there should be some kind of modest release amount. That is, I’m not going to say what amount it is, someone can figure that out. But, but that should be just released for advice.

Vince Scully
A condition of release, as well as being for hardship could be to pay for

Ruth Stringer
financial advice, because that, you know, then the advice can be, you can look at the whole picture and go look at the spouse for example, rather than this sort of constraint that for it to come out of the fund, you know, it must be limited to that member because it’s coming out of that members account. And secondly, that it can only be limited to advice in relation to the super I just think that’s it’s creating a ridiculous cost for someone to have to define that boundary and then for the trustee to supervise it so yeah, yeah.

Vince Scully
is an interesting, interesting point, I’m much shorter given that two weeks thought, but certainly, you know, we do a lot of work around budgeting and debt elimination, all of which can’t be paid for from Super Yeah. And then the bits around retirement savings, and potentially stuff around using the first time Super Saver scheme. So you end up with this quite artificial split, which I guess we’ve just got so used to dealing with and haven’t actually given it, that level thought, but that is actually quite an interesting idea.

Ruth Stringer
Well, again, we’ll get into this question. Some people will say, Oh, but it’s eroding savings, etc. But I think if you kept the amount, and, you know, made it, you know, something that over time, you know, you could have certain opportunities to do that, it just seems I’m all for trying to make things simpler.

Vince Scully
And I guess the these issues all arise when, as a society, we mandate that the 20 year old, you’re not allowed to spend, you can only spend 91%, or 89% of your income. Now, you have to set aside 10 and a half for retirement, that every time we start interfering in people’s spending habits, we need to be very careful about the consequences, intended or otherwise that arise from there. Absolutely. And so

Ruth Stringer
that the COVID realizes, you know,

Vince Scully
that the first time Super Saver is a potentially overcomplicated way of addressing some of those issues for younger members and COVID releases were were helpful. And maybe we just need to think about it over the longer term. What if you’re forcing people to set aside a portion of their income? Yeah, we have a duty to make sure that they are actually better off both now. And in retirement?

Ruth Stringer
Well, I do think that that I mean, I probably, you know, I guess when you look at it internationally, we could have a system where we said well, instead of the tax concessions on server will increase the Social Security. But because we’re forcing people to save privately, not everyone’s going to have the skills and the tools to to be able to manage that. So I think it’s doesn’t seem to be a big leap in my mind to accept that people will need assistance to to navigate, you know, what is a system which has a lot of choice and gives the individual a lot of freedom. But but you know, that it helped to, to, to navigate it all.

Vince Scully
So is there anything else you’d like to add to the retirement income that we haven’t covered off?

Ruth Stringer
Well, I think, you know, I think personally, having been involved in you know, it’s been a bit of a very long project to really shine a light on retirement incomes, I feel very pleased that we do have the covenant. I think it’s a really great first start, and I think it will be very, very interesting to see the strategies, particularly I think the day one strategies are all kind of, you know, it’s like a race, they’ve all kind of got off the blocks. But as they mature, and as they gather their data and do make their inquiries, I do think they will mature and will be very interesting. So I do feel like it’s quite a tipping point. And I think I’m hopeful it will lead to new products that will really assist assist members to get the most out of retirement.

Vince Scully
I certainly the ones that I saw in my brief review before sitting out on this exercise, did seem to sort of really slavishly copy the words of the covenant and most looked like work in progress to me.

Ruth Stringer
Absolutely. And I think that’s why really, I had to start and be you know, I guess it’s probably reflection that the fact that a lot of them are quite basic, to my mind is actually proof of concept as why we need it. Because it shows in my mind again, that without the covenant, there probably is not the focus on this part of the part of the problem if you like that, there would have been

Vince Scully
excellent. Well, thank you for sharing your thoughts on it with us, Ruth. It’s been great having you.

Ruth Stringer
Thank you very much.

Vince Scully
That was Ruth Stringer superannuation partner at Minter Ellison. As she said the retirement income covenant on its own won’t necessarily lead to greater innovation in the Available retirement income products. But it will help focus the minds of the bigger super funds on the retirement income phase, and away from the accumulation phase as their membership ages, the account based pension will over time cease to be the dominant vehicle for spending superannuation savings, and will be supplemented by Innovative lifetime income streams. This will create a huge opportunity for advisors as a wave of Superfund members reach retirement over the next decade, with larger balances than previous generations. They also have higher expectations for what retirement means and of course will live longer than their older equivalents. All of this is great news for advisors. Over the next four episodes, we’ll delve into these opportunities and the related challenges for advisors will chapter authors who have written extensively on the new retirement paradigm. Spoiler alert. This is as much about psychology as it is about the technicalities of products, regulations, tax and Social Security. We’ll also talk to practicing advisors to learn what they’re doing. And of course, we’ll check to our sponsor Jin live about the innovative things they’re doing in the income space with investment bonds and market linked annuities. I’ve greatly enjoyed putting this series together and I hope you’ll enjoy listening just as much. So till next time, bye for now.