Default Dividend: How a default retirement product can help Australians retire with confidence

Australia’s maturing superannuation system warrants a retirement phase solution that benefits its members

Over the last three decades, Australia has developed a world class retirement income system. This includes a superannuation system that has accumulated more than $3.5 trillion in savings since the early 1990s. This has been underpinned by the Superannuation Guarantee (SG), preservation of these savings until 55 to 60 years of age, and strong fund performance that has delivered 8 per cent returns over the past decade. These strong settings have placed Australia 6th on the Global Pension Index (GPI) as of 2022.

As Australia’s superannuation system matures, there are a growing number of Australians moving into retirement with large superannuation balances. The typical Australian retiring in the next three decades could have a balance of up to $500,000 (2023 dollars) by the time they can access their superannuation savings. With this structural change imminent, there is a need for Australia to evolve its current policy architecture to reflect the importance of the retirement phase of the superannuation system, and support those transitioning into retirement.

Without the right retirement product, Australians moving into retirement could be losing out on thousands of their savings. For example, Australians that continue to hold an accumulation phase account will be subjected to earnings tax – costing the typical Australian that is eligible to retire up to $1,900 in a year. Similarly, Australians that opt to withdraw their savings in a lump sum could be missing out on up to $3,800 of additional earnings in a year if they had a retirement product invested in a balanced asset allocation.

While advice can be an important part of the solution, policy settings could be improved by introducing a default retirement product. Given this, there is a need to identify how the Government and industry should design a default retirement product, and who is likely to use and benefit from it.

Default retirement products need to be flexible, have an appropriate asset allocation and minimum safeguards to protect the interests of Australians

To protect the interests of Australians transitioning into retirement, a default retirement product needs to be flexible, have an appropriate asset allocation and minimum safeguards.

Retirement products have an inherent trade-off between flexibility and longevity risk. Account-based pensions provide members with significant flexibility and choice, however this is at the cost of managing longevity risk. On the other hand, annuities provide protection against longevity risk, but provide very limited choice and flexibility to members. While a default retirement product follows a generalist approach, it may not address individualised needs for all retirees. Therefore, it is critical for a default product to be reversible, ensuring Australians maintain control over their savings and retirement.

High levels of flexibility come at the expense of traditional longevity protection offered by products such as annuities. Default retirement products should have appropriate asset allocation that helps to manage risks associated with longevity and inflation. This will require exposure to growth asset categories such as equities, property and infrastructure.

Default products need to also be complemented with minimum safeguards focused on protecting the interests of Australians in retirement. At a minimum, retirement products that are eligible for defaulting should be (i) performance tested and included in a comparison tool; (ii) have low fees; and (iii) be standardised to ensure easy comparability.

The introduction of a default retirement product can be government-led, industry-led, or collaboration between the two.

By 2040, there could be 3.3 million retired Australians using and benefiting from a default retirement income product

Just like the accumulation phase, a default product will not be appropriate for everyone. However, as of 2023 there are 1.4 million Australians that are likely to use and benefit from a default retirement product.

This could grow by 1.9 million to 3.3 million Australians by 2040. For these Australians, a default product will provide them with a safety net that improves financial outcomes in retirement.

Next steps in superannuation policy reform

Reforming the existing policy settings and enabling these Australians to benefit from a default retirement product requires a three-phased approach:

1) Update legislative and regulatory frameworks to define the core objective of superannuation.

2) Establish frameworks and regulatory requirements for the default retirement product.

3) Evolve industry standards to introduce default retirement products for all Australians.

Download the full report here.