In a recent Retirement Planner article, I considered sustainable withdrawal rates and the staggering lack of useful data on consumer behaviour following the introduction of the pension freedom in April 2015.
Some of those concerned think that pension freedom represents a slowly unravelling public policy disaster, and point to the experience of Australia.
Down Under, policymakers are actively trying to build up an annuity market two years after former Chancellor George Osborne sent the UK in precisely the opposite direction.
So why are the UK and Australia – countries with similar average life expectancies and facing the same demographic challenges – making such contrasting pension choices? And what does it mean for the future of UK retirement income policy?
Different starting points
While the UK and Australia as nations share many features, the respective retirement frameworks are vastly different.
First of all, the Australian system is underpinned by compulsory employer contributions – currently set at 9.5%, but set to hit 12% by 2019. There is no mandatory employee contribution.
The tax system is also different, with the Aussies favouring a taxed-exempt-exempt model over the exempt-exempt-taxed system prevalent in the UK. This is only really possible in Australia because the onus is on the employer to pay the contribution (effectively a pension tax on employees, who will often receive lower salaries to compensate).
After all, why would an employee voluntarily lock money away in a pension until age 55 or older without an upfront incentive to do so? The government could easily come along in the future and tax withdrawals.
Given that the UK and Australian pension systems start from very different places, it is no surprise that the retirement income phase is also different.
While in the UK there remains a choice between securing a guaranteed income (annuity) or keeping your money invested (drawdown), in Australia 94% of retirees end up in drawdown, known as “account-based pensions”. There is no annuity market to speak of.
When someone starts a superannuation account-based pension, they must withdraw a minimum amount each financial year to secure a tax exemption on their investments – another clear departure from the UK, where access is unfettered.
If they are aged 65 to 74, the minimum pension payment for an account-based pension is 5% of the account balance as at 1 July. This then steadily rises to:
• 6% (75 to 79)
• 7% (80 to 84)
• 9% (85 to 89)
• 11% (90 to 94)
• 14% (95 and older).
At first reading these rates may appear high, but remember that Bill Bengen’s “safemax” theory is based on 4% of the initial sum being taken each year from age 65. So while the percentage withdrawals trend upwards from 5% in Australia, investors will be drawing a larger proportion of a smaller pot (depending on the performance of their investments).
Behavioural bias
Intuitively, you might expect this spending nudge from the government would lead to people draining their pots too quickly. In fact, the opposite has occurred.
According to analysis by the Australian treasury, the majority of individuals draw down account-based pensions at or close to the minimum rates.
Rather than socialising the idea that spending your pension while you are alive is the right thing to do, people have become anchored to drawdown rates set by the government, fearful that exceeding these rates could leave them facing penury in later life.
As an Australian government report published in December 2016 notes: “Drawing down an account-based pension at minimum rates reduces the risk of outliving one’s superannuation wealth, but it also reduces the standard of living that individuals can enjoy in retirement.
“In addition, it implies that a substantial percentage of superannuation assets are expected to be bequeathed rather than used as income during retirement. By managing their superannuation assets in this way, individuals are self-insuring against longevity risk, which is an expensive way of managing this risk (measured in terms of foregone income).
“It means that individuals in retirement are drawing a lower rate of income so assets will last for the longest possible lifespan.”
The report concludes that pooled products (i.e. annuities) could potentially provide higher levels of income for the majority because they are priced over the life expectancy of the pool (typically closer to 20 years).
Lessons for the UK
Australian policymakers are therefore addressing the inverse problem to their UK counterparts. While over here concerns are being raised that people might be taking too much too quickly from their retirement pots, the Aussie conundrum centres on savers being too frugal in retirement.
But it is worth noting the Australian government explicitly states that in attempting to boost retirement income levels, it is not encouraging annuities over other products – it simply wants to improve choice in a market where drawdown is the only game in town.
So far from searching for lessons from the experience of our Australian cousins, they may in fact be looking enviously at the UK market, where investors can choose from annuities, drawdown or even hybrid packaged products combining features of the two.
That is not to say policymakers here can rest on their laurels. Indeed, I suspect at some point in the not-too-distant future, politicians will begin to assess the extent to which the pension freedom genie should be returned to the bottle from whence it came.
Already, the Centre for Policy Studies has suggested a default pathway featuring set drawdown rates and “auto-annuitisation” should be considered to prevent masses of people running out of money in retirement.
This may be one route forward, although instinctively I prefer to see more people encouraged to seek regulated advice so they can devise an investment and withdrawal strategy that fits their individual needs.
The UK also needs to be careful not to repeat the mistake of Australia, where the provision of government default withdrawal rates encouraged people to sleepwalk into a sub-optimal retirement outcome.
Tom Selby is senior analyst at AJ Bell
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