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Navigating the Retirement Income Covenant

On 27 September 2021, the Government released Exposure Draft legislation that will introduce a Retirement Income Covenant for Trustees of registrable superannuation entities (RSEs) as part of the Superannuation Industry (Supervision) Act 1993. This follows the release of the Retirement Income Covenant position paper by the Treasury on 19 July 2021.  The consultation period for the draft legislation closes on 15 October 2021. The Retirement Income Covenant is proposed to be legislated from 1 July 2022.

28th September 2021 / 7 mins read
Danielle Bose
Senior Consultant, Head of Retirement Strategies
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Executive Summary

  • The Government has released exposure draft legislation that will introduce a Retirement Income Covenant for Trustees of registrable superannuation entities (RSEs) as part of the Superannuation Industry (Supervision) Act 1993.
  • The draft legislation would “codify the obligation for superannuation trustees to have a retirement income strategy that outlines how they plan to assist their members in retirement. The strategy must consider how the trustee will assist their members to balance maximising their retirement income, managing risks, and have some flexible access to savings.”*
  • This follows the release of the Retirement Income Covenant position paper by Treasury on 19 July 2021.
  • The consultation period for the draft legislation closes on 15 October 2021.
  • The Retirement Income Covenant is proposed to be legislated from 1 July 2022. 
  • Subject to the passage of legislation, Trustees will be required to “formulate, review regularly, and give effect to a retirement income strategy.”* The strategy will be for the benefit of retired beneficiaries or those who are approaching retirement.
  • The strategy must address how the Trustee will assist those beneficiaries to achieve and balance the following objectives:
    • to maximise expected retirement income over the period of retirement;
    • to manage expected risks to the sustainability and stability of retirement income over the period of retirement (including longevity risks, investment risks, inflation risks and any other risks to the sustainability and stability of the retirement income); and
    • to have flexible access to expected funds over the period of retirement.
  • Trustees are “required to regularly review the appropriateness, effectiveness and adequacy of their retirement income strategy including the assumptions underpinning it. As part of reviewing their strategy, trustees are required to take reasonable steps to gather necessary information to inform this process.”* Treasury expects reviews would take place, similar to the investment covenant where reviews of the outcomes from the strategy are annual and reviews of the strategy itself occur every three years. 
  • In the latest Retirement Income Covenant position paper, the Government did not propose that trustees would need to offer members a Comprehensive Income Product for Retirement (CIPR).  There is no requirement for trustees to offer a particular retirement income product to members. The Government also flagged that future reforms will also encourage the development and offering of better retirement income products.
  • JANA is broadly supportive of the Treasury’s Retirement Income Covenant.  JANA notes there are some challenges which we have outlined in this article.
  • JANA’s recommendation for superannuation funds at this stage is:
  1. To become conversant with the proposed policy and draft legislation.  JANA is itself undertaking further work in this area with a specialised retirement strategies research team to fully understand the proposal and its implications; and
  2. Continue to expand on the Trustee’s understanding of its members so that it has a strong foundation on which to assess different retirement products. In the position paper, the Government outlined examples of data that it would be reasonable for the Trustee to collect from their members or make informed assumptions about their members’ circumstances to estimate their potential Age Pension entitlement, including age, assessable assets and income, home ownership status and coupled status.  The Exposure Draft includes the requirement for a Trustee “to take reasonable steps to gather the information necessary to inform the formulation and review of the strategy.”  The Exposure Draft Explanatory Materials note that information gathering may involve surveying beneficiaries or reviewing existing data. Trustees are permitted to use existing publicly available data where the trustee considers it appropriate and relevant in formulating a strategy.
  • JANA has been assisting trustees and internal super fund teams with our framework for assessing retirement adequacy as part of the SPS515 requirements, which involves working with funds to evaluate retirement income goals for members. Our modelling is cohort based and includes consideration of the age pension, which is aligned with the thinking that is set out in the proposed Retirement Income Covenant. We will continue to review the content of the Retirement Income Covenant and prepare to support Super fund trustees to meet the proposed requirements.

Introduction

  • In May 2018, the Government released the Retirement Income Covenant Position Paper which proposed that superannuation trustees should “assist members to meet their retirement income objectives throughout retirement by developing a retirement income strategy for members.”*
  • The Government released a follow up position paper on the Retirement Income Covenant on 19 July 2021.
  • The Retirement Income Covenant Position Paper outlined that the covenant will “codify the requirements and obligations for superannuation trustees to improve retirement outcomes for individuals, while enabling choice and competition in the retirement phase.”*
  • The aim of the Covenant is to “improve the retirement income outcomes of members by creating an obligation for trustees to assist its members in meeting their retirement income goals.”*
  • In the newly released position paper, the Government proposes that the Superannuation Industry (Supervision) Act 1993 will include a Retirement Income Covenant which will outline a “fundamental obligation of trustees to formulate, review regularly and give effect to a retirement income strategy.”*
  • The Government noted that “APRA, ASIC and the ATO will regulate trustees’ compliance and provide information on how trustees can comply with the new retirement income covenant.”*
  • The Retirement Income Covenant is proposed to be legislated from 1 July 2022. 
  • The Government’s Retirement Income Covenant position paper is available on the Treasury website.
  • Following the release of the Retirement Income Covenant position paper, the Government released Exposure Draft legislation on 27 September 2021 and Exposure Draft Explanatory Materials which provide further guidance for RSE Trustees.

Key Takeaways for Super Funds

JANA has summarised the key requirements of the September 2021 exposure draft legislation for registrable superannuation entities (RSEs) below. The covenant does not apply to trustees of self managed superannuation funds. The draft legislation is proposed to be added to the Superannuation Industry (Supervision) Act 1993.  This summary is based on JANA's interpretation of the September 2021 exposure draft legislation and is not a legal opinion.

Key Requirements of September 2021 Exposure Draft legislation

  • The Trustee will be required to “formulate, review regularly and give effect to a retirement income strategy”*;
  • The strategy will be for the benefit of retired beneficiaries or those who are approaching retirement;
  • The strategy must address how the Trustee will assist those beneficiaries to achieve and balance the following objectives:
    • to maximise expected retirement income over the period of retirement;
    • to manage expected risks to the sustainability and stability of retirement income over the period of retirement (including longevity risks, investment risks, inflation risks and any other risks to the sustainability and stability of the retirement income); and
    • to have flexible access to expected funds over the period of retirement.

The exposure draft legislation also includes the following requirements regarding beneficiaries who are retired or approaching retirement, as well as requirements for determining retirement income and the period of retirement.

Determining the class of beneficiaries who are retired or who are approaching retirement

  • The Trustee will be required to “determine the class of beneficiaries of the entity who are ‘retired or who are approaching retirement for the purposes of the strategy.”
  • The September 2021 Exposure Draft Explanatory Materials provides further guidance for Trustees with examples of factors that may assist a Trustee in making this determination, which include age, gender and employment status.
  • Trustees do not have to formulate a strategy for certain defined benefit members who are not eligible to commute that benefit (whether during the period of retirement or otherwise).
  • “The strategy may divide the class of beneficiaries into sub-classes and make different provision in respect of those sub-classes.”
  • The September 2021 Exposure Draft Explanatory Materials provide further guidance on identifying sub-classes of beneficiaries.
    • As part of meeting obligations relating to member outcomes assessments, trustees are required to conduct cohort analysis. Identifying sub-classes for the purposes of formulating a retirement income strategy is expected to involve similar analysis. Examples of factors that trustees can use to determine sub-classes include:
      • superannuation balance amount;
      • expected eligibility for the Age Pension at retirement;
      • whether a beneficiary is partnered or single;
      • home ownership status, whether the property is owned outright, with a mortgage, or the beneficiary is likely to be or is renting at retirement;
      • gender which may take into account differences in expected retirement ages, mortality and morbidity;
      • expected retirement age; and
      • age that drawdowns from superannuation are expected to begin."

Determining meaning of retirement income and period of retirement

  • The Trustee will be required to “determine the meaning of retirement income for the purposes of the strategy.”
  • This must include income, net of tax, received during the period of retirement, including:
    • income paid from, or supported by, a superannuation interest in the entity;
    • income from an age pension under the Social Security 36 Act 1991; and
    • income from any other source if the Trustee determines that it is appropriate to income from that source.
  • The Trustee must also determine the meaning of period of retirement for the purposes of the strategy.

The Trustee must also:

  • take reasonable steps to gather the information necessary to inform the formulation and review of the strategy;
  • record the strategy in writing;
  • record each determination made by the trustee for the purposes of the strategy, and the reasons for the determination;
  • record each other decision made by the trustee in formulating, reviewing or giving effect to the strategy that the trustee considers to be significant, and the reasons for the decision; 
  • record the steps taken to gather the information that informed the formulation of the strategy, and the reasons for taking those steps; and
  • make a summary of the strategy publicly available on the website of the entity.

The September 2021 Exposure Draft Explanatory Materials also provide further guidance for Trustees.  JANA has highlighted the below comments from the Exposure Draft Explanatory Materials which provide further detail relating to retirement offerings and retirement income:

  • In formulating the strategy trustees would be expected to identify the expected retirement income needs of beneficiaries and present a plan to build the fund’s capacity and capability to service those needs.
  • In formulating and giving effect to a strategy for beneficiaries approaching retirement, trustees may consider assistance that could be provided during the accumulation phase.
  • A trustee’s strategy could include providing a range of assistance, such as: 
    • developing and/or offering specific retirement income products;
    • developing specific drawdown patterns that provide higher incomes throughout retirement;
    • providing tools such as expenditure calculators to identify income and capital needs over time;
  • providing factual information about key retirement topics, such as eligibility for the Age Pension, the concept of drawing down capital as a form of income, or the different types of income streams available; and
  • providing guidance to beneficiaries early in accumulation about potential income in retirement through superannuation calculators or retirement estimates. 
  • The trustee has discretion to determine the type and scope of assistance provided, noting that the assistance must also meet the sole purpose test and be in beneficiaries’ best financial interests.
  • It is expected that determining what assistance is required to ‘maximize’ retirement income should involve considering:
    • current and expected member behaviour (for example, regular drawdown behaviour or the size and frequency of lump sum withdrawals); 
    • potential volatility (including situations of varying investment returns, inflation scenarios and mortality outcomes); and 
    • appropriate modelling and analysis, including modelling of expected Age Pension entitlement.
  • Due to the varying levels of exposure to risks for each member, trustees may develop different approaches to managing risks between funds or even between classes of beneficiaries. The Age Pension provides a minimum amount of investment, inflation and longevity risk management. Depending on the beneficiary’s circumstances the Age Pension may be sufficient without additional sources of investment, inflation and longevity risk protection.

JANA’s summary of the key takeaways from the 19 July 2021 Retirement Income Covenant Position Paper is contained below.

Navigating the retirement income covenant

 

JANA is broadly supportive of the Treasury’s Retirement Income Covenant

Proposed Retirement Income Strategy

JANA supports the Treasury’s position on Retirement which proposes that trustees of superannuation funds be required to develop a Retirement Income Strategy.

JANA believes the requirement for trustees to “formulate, review regularly and give effect to a retirement income strategy”* both for the benefit of retired beneficiaries or those who are approaching retirement is in the best interest of members.  In our role as investment adviser to our superannuation fund clients, we have been working with our clients on their investment strategy for many years, and JANA is accordingly supportive of this policy initiative.

Focus on Retirement Income

JANA supports the Treasury’s focus on income in retirement – we believe that income is of key importance for retirees.

JANA believes it is important to change the conversation with members from being focused on maximising superannuation account balances at retirement, to one of sufficiency of income streams in retirement.

Retirement Product Design

JANA believes that retirement product design should remain a priority for super funds.

JANA believes the Treasury’s objective of increasing the availability of better retirement income products is a positive move for members of superannuation funds, particularly in the context of Australia’s ageing population, which is driven in part by improvements in life expectancy.

JANA notes that the position paper and Exposure Draft legislation did not propose that Trustees would need to offer members a Comprehensive Income Product for Retirement (CIPR), and JANA is supportive of this.  We had previously expressed our areas of concerns regarding CIPR products to the Treasury in our 14 June 2018 Consultation submission paper.  We believe that flexibility of retirement product design remains vital.

Instead, the focus has shifted to Trustees evaluating the products they offer to their members and investigating whether their product offerings can be improved to better meet the retirement income needs of their beneficiaries.  JANA is supportive of this approach.

Advice and Member Communications

JANA is also supportive of the role for super funds to provide affordable advice or appropriate guidance to members. JANA supports measures to encourage superannuation funds to engage with their members about retirement from a young age (and on an ongoing basis).

Challenges of proposed Retirement Income Covenant

Whole of Life Strategy

JANA notes that the Your Future Your Super (YFYS) requirements do not apply to superannuation interests that are supporting a superannuation income stream in the retirement phase.  JANA believes that a Retirement Income Strategy should apply to both pre and post retirement products. JANA is supportive of the Exposure Draft Explanatory Materials highlighting that trustees may consider assistance that could be provided during the accumulation phase, for beneficiaries approaching retirement.

Interaction with existing Regulatory Guidance

JANA believes that consideration should be given to how the Retirement Income Covenant interacts with existing regulatory guidance e.g.  Superannuation Prudential Standard SPS515 – Strategic Planning and Member Outcomes (SPS515) which includes reference to retirement income objectives.

JANA is supportive of the recent further detail that has been provided by Treasury in the Exposure Draft Explanatory Materials which notes that as part of meeting obligations relating to member outcomes assessments, Trustees are required to conduct cohort analysis. Identifying sub-classes for the purposes of formulating a retirement income strategy is expected to involve similar analysis.
 
Behavioural Aspect of Retirement Income

JANA notes that the Treasury is supportive of retirees spending the bulk of their retirement balance in their lifetime, with a “maximising retirement income” objective. JANA is of the view that, in practice, members are naturally cautious in their spending patterns, largely due to the uncertainty of their income requirements and longevity.  In response, members tend to build up a ‘reserve’ to guard against future income requirements, for example, uncertainty around health costs and aged care requirements which might be large expenses that occur later in life.  This is arguably an entirely rational response by retirees given that retirees often do not have the benefit of future income derived from employment or capital contributions to “top up” their account balance.
 
JANA prefers a more flexible approach to accommodate members with differing risk tolerances and life expectation. JANA is supportive of the additional guidance provided by Treasury in the Exposure Draft Explanatory Materials that notes that maximising retirement income should involve considering current and expected member behaviour (e.g. regular drawdown behaviour or the size and frequency of lump sum withdrawals); potential volatility (including situations of varying investment returns, inflation scenarios and mortality outcomes); and appropriate modelling and analysis, including modelling of expected Age Pension entitlement.

Your Future Your Super (YFYS) and the Retirement Income Covenant

The implications of the YFYS reforms mean that the current benchmarks do not apply well to accumulation products that bridge accumulation to post retirement. Under a Whole of Life strategy, a fund may begin to de-risk their members approaching retirement (but still in the accumulation phase) to manage sequencing risk (typically in the last 5-7 years of accumulation phase).

This de-risking and use of investment strategies such as lower beta equities (to target “stability of returns”) do not lend themselves well to an assessment against listed market benchmarks or higher beta unlisted benchmarks. It is JANA’s understanding that the YFYS requirements do not apply to superannuation interests that are supporting a superannuation income stream in the retirement phase.

Granularity of Data
 
JANA notes that the proposed data in the Retirement Income Covenant and the Exposure Draft Explanatory Materials is, in some cases, of a granular nature (e.g. other income support payments to members such as the other non-superannuation assets, income from a partner, other income support payments under the Social Security Act 1991 or the Veterans’ Entitlements Act 1986 or superannuation interests held outside the fund if the Trustee considers it suitable.
 
JANA is very supportive of targeted retirement income (defined by salary replacement or other relevant measure), projected salary (and contribution rates), age, superannuation account balance(s), assumed retirement age, life expectancy, and Age Pension considerations (home ownership, etc) being incorporated into cohort analysis but notes that some of the other additional suggested data considerations would be difficult to obtain at this stage.
 
JANA believes that the value of the granularity of the data needs to be assessed for the value it adds to cohort analysis, improved member outcomes versus introducing additional complexity and cost.
 
Fund Mergers and Legacy Products
 
A further consideration as the market evolves is the issue of superannuation fund consolidation, and the potential legacy issues that having longevity solutions (such as pooled lifetime income products) could create for funds that have already offered these products to their members prior to merging with another fund.
 

What does this mean for a Super Fund Trustee?

  • Should the proposals become law, they will take effect from July 2022.
  • JANA’s recommendation for superannuation funds at this stage is:
  1. To become conversant with the proposed policy and legislation.  JANA is itself undertaking further work in this area with a specialised retirement strategies research team to fully understand the proposal and its implications; and
  2. Continue to expand on the Trustee’s understanding of its members so that it has a strong foundation on which to assess different retirement products. In the position paper, the Government outlined examples of data that it would be reasonable for the Trustee to collect from their members or make informed assumptions about their members’ circumstances to estimate their potential Age Pension entitlement, including age, assessable assets and income, home ownership status and coupled status.  The Exposure Draft includes the requirement for a Trustee “to take reasonable steps to gather the information necessary to inform the formulation and review of the strategy.”  The Exposure Draft Explanatory Materials note that information gathering may involve surveying beneficiaries or reviewing existing data. Trustees are permitted to use existing publicly available data where the trustee considers it appropriate and relevant in formulating a strategy. 
  • JANA has been assisting trustees and internal super fund teams with our framework for assessing retirement adequacy as part of the SPS515 requirements, which involves working with funds to evaluate retirement income goals for members. Our modelling is cohort based and includes consideration of the age pension, which is aligned with the thinking that is set out in the Retirement Income Covenant. We will continue to review the content of the Retirement Income Covenant and prepare to support Super fund trustees to meet the proposed requirements.

* All quotations and data marked with an asterisk are sourced from The Australian Government the Treasury.

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