THE NUB:

• We're living longer, so our retirement savings have to last longer - 20 years on average ... but for many people, even longer.
• Yet we started taking risks with our retirement savings, lured by juicy sharemarket returns that have since evaporated.
• Now the Henry tax review is considering whether we should be encouraged -- even compelled -- to put, say, 25-30 per cent of our super into some sort of 'lifetime' annuity product or longevity insurance.
• If we're happy to take the tax benefits of the superannuation system, surely we have a responsibility to husband that money?

By Lesley Parker
Sydney Morning Herald, August 5, 2009

Australians may finally have to come to grips with longevity risk - the danger they'll last longer than their retirement money - as superannuants count the cost of the financial crisis and the Henry tax review considers whether people should be forced to buy long-lasting retirement income streams.

It's been obvious for some time that the fact we're living longer means our retirement dollars will have to stretch further.

On top of that, recent investment losses in super funds have left some retirees in a financial position from which they may never fully recover. Retirees who were previously self-funded have had to go back work, while others have started drawing a part or even full government age pension, or will do so earlier than they might have done otherwise.

Meanwhile, the Henry tax review's interim report into the retirement income system has flagged that its final recommendations, due in December, will address the ability of people to use their super to manage longevity risk - so they don't just use the age pension as a 'put' option - once the money runs out.

''While super generates assets for retirement, current arrangements do little to ensure that those assets can be used for income purposes throughout the years of retirement,'' the review panel says in the interim report. ''As people live longer, there is a growing risk that individuals will exhaust their assets before they die.''

The chief executive of Challenger Financial Services Group, Dominic Stevens, says that, technically, after 40 years of compulsory contributions to super, a retiree could withdraw the lot and put it on red at the casino.

''A lot of that money will be the benefits of the tax breaks,'' Stevens says. ''But if you put it on red and lose, the taxpayer will end up supporting you.''

The Henry review's interim report describes a lack of products to insure against longevity risk as a structural weakness in the retirement income system, which was set up to relieve the fiscal burden of the Government pension as the population ages.

It says it will look at whether people should be forced, or merely encouraged, to use some of their retirement savings to buy an income stream and mentions the 'interactions' with the Centrelink means tests and the tax system in this regard.

Superannuation industry body ASFA the 'Voice of Super' suggested in its submission to the Henry review that one option would be to compel people to put, say, 25 per cent of their retirement savings towards buying some form of ''longevity insurance''.

ASFA chief executive Pauline Vamos says that could be an actual insurance policy, a product such as a lifetime annuity or some new combination of the two. Challenger, which has a foot in each camp with insurance and funds management arms, has proposed a mandatory 30 per cent be quarantined for an income stream.

Currently, longevity insurance isn't widely available in Australia and lifetime annuities have plunged in popularity since the Howard Government removed the means test exemption for complying income streams in 2007. They were a 'hard sell' anyway, at a time when prevailing interest rates, to which they're linked, were low but returns from investment markets were tantalisingly high, says Ipac Securities' head of technical services, Colin Lewis - who nevertheless believes that after pocketing super's tax benefits people have a moral obligation to make that money last.

Annuities provide guaranteed income streams and ''lifetime'' annuities or pensions provide payments for the rest of your life. The income isn't linked to market movements but contracted at the outset and the money can't be withdrawn as a lump sum. If you die earlier rather than later, the provider keeps the balance of a lifetime annuity, unless you've paid extra for the option of the payments reverting to your spouse.

The Australian chief executive of Lazard Asset Management, Rob Prugue, notes that when the US introduced its social security system in the late 1930s, life expectancy was 62 years but the age pension didn't kick in until 65.

Today, he says, even hard-living souls, like Keith Richards from the Rolling Stones, make it to 65 and the healthiest specimens can make a century.

But the trouble is that in recent years the super system has been more about 'wealth creation' and not so much about funding the liability of a potentially long retirement.

''Many of us have been lured by robust returns rather than trying to properly build a portfolio that could actually meet our financial obligations ... portfolios with true long-term objectives,'' he says.

Vamos says ASFA's research shows that people do like the idea of a long-term income stream - that Australians aren't just going out and blowing their lump sums on an Audi instead of an annuity. ''But somewhere along the line, perhaps, people aren't going to have enough money,'' Vamos says. ''They need to think about part of their money being set aside to manage longevity risk.''

Modelling by researcher Towers Perrin for the Challenger Financial Services Group found, for instance, that someone who retires at age 60 and uses $500,000 in retirement savings to buy a market-linked allocated pension could quite possibly deplete those funds by age 84 - just short of the life expectancy for an Australian man. This is based on the person withdrawing a 'comfortable' income of $37,452 a year.

ASFA feels there may need to be a new type of product that combines insurance and funds management, rather than forcing people to choose between the certainty of a low-return lifetime annuity and the potential for capital growth in a market-linked product that could help their money go further. Other options it has suggested include applying mandatory minimum and maximum withdrawals to a broader range of pension products.

Stevens says Challenger's view is that between the ages of 20 and 65, retirement savings are all about return but from 65 it's all about risk and you don't earn a big enough premium over the safety of government bonds to take on the risk of equities at this later stage in life.

The trouble with an allocated pension - and the relatively high exposure in Australia to equities - is that, in essence, people are acting as ''their own little life insurance company'', self-insuring against the risk they'll live longer than the average, he says.

''Do you have the skills, the understanding, the administrative ability to do all that?" Stevens asks. "If you get it wrong, can you go to the equity market and recapitalise.''

The recent sharemarket crash showed how devastating a negative year can be for someone just entering retirement, he says (see tables for growth and equity options).

''If you have a 13 per cent fall in the first year of your retirement, the statistic is that you have north of an 80 per cent chance of not meeting your [retirement] goals," he says. "If you have a bad year in the first two or three years, it massively affects the way your retirement pans out. We're saying there should be some form of incentive, or requirement, to put some money towards a more riskless strategy, like an annuity, so they don't get into these problems.''

A recent OECD report into pensions says equities should remain part of people's retirement savings strategy but it promotes the concept of ''life-cycle investing'' - moving from riskier assets to less risky assets, such as deposits and government bonds, as people near retirement (see also page 15).

''Governments should at least encourage people to choose this strategy but it may be necessary to go further,'' the report says, suggesting they mandate that a 'life-cycle' investment option be the default option within super funds.

Most members never exercise investment choice and thus would be covered by this option.