Retiring Well in Volatile Times

There seem to have been few Government initiatives to support retirees during this COVID-19 period. One concession put in place to support people drawing a pension from a superannuation pension fund is the halving of compulsory withdrawal rates from superannuation pension accounts.

While this provides welcome flexibility for people relying on superannuation pension income streams, there’s a strong argument to make this more than a temporary measure. Now is the time to provide this flexibility for lower withdrawals on an ongoing basis, not just in response to the market volatility that we saw last year, and when the flexibility was previously used during the Global Financial Crisis.

Compulsory Superannuation Withdrawal Rules

Let’s quickly review the rule that we are talking about. Each year people drawing a superannuation pension income stream are required to take a minimum annual pension. The minimum amount changes based on age, starting at 4 per cent per annum for those under the age of 65 and increasing to 14 per cent per year for people aged 95 and over.

The core justification for this that I have come across is that superannuation pension accounts have the benefit of a 0 per cent tax rate and if people are not required to take a minimum pension amount the superannuation fund becomes a highly tax effective vehicle for building wealth to pass onto other generations. This is not the central role of superannuation. Superannuation exists to fund retirement. 

The following table sets out the ‘normal’ minimum withdrawal rates and the rates as they are currently, halved.

Table 1: Minimum Superannuation Pension Withdrawal Rates

(Source: Minimum annual payments for super income streams | Australian Taxation Office (ato.gov.au))

Superannuation Contributions Limits

While the argument ‘superannuation is not for intergenerational wealth transfer’ may be reasonable, current superannuation contribution limits effectively place significant limits onto how much money can be contributed. These contribution rules work to limit the ability of people to exploit superannuation as a vehicle for long term wealth transfer.

In the current financial year the maximum value of superannuation contributions where a tax deduction is claimed (e.g. employer contributions, salary sacrifice contributions or personal contributions where a tax deduction is claimed) is $27,500. The maximum value of after-tax contributions is also limited and is $110,000 per year.

It is also worth remembering that the average person isn’t using superannuation as a vehicle to create long-term wealth — they are using it to fund their retirement. In the 2018 financial year, the ATO reported the average member balance in self-managed superannuation funds was just over $600,000. This is a level of assets that supports a person’s retirement, not has them thinking about how to make sure the great-great grandchildren will be able to live a life of perpetual luxury. 

The Government Benefit to Smaller Withdrawals

There is an argument that there is an alignment of interests between the Government and a retiree wanting to withdraw at a lower rate from their superannuation. 

In any year where a person chooses to withdraw less than they currently required to, it will lead to a higher future superannuation pension account balance and greater chance of that balance meeting the needs of future spending, in turn accessing less Government-funded Age Pension. 

It is reasonable to suggest that maintaining some level of required minimum withdrawal, in line with the halved 2021-22 financial year rates, does ensure that money is being spent, rather than hoarded.

The Current Investment Environment

The other element of the unique financial situation currently faced by investors involves the current rate of return on cash. With a struggle to even earn a 1 per cent rate of return on cash, the lowest ‘normal’ rate of compulsory withdrawal from superannuation of 4 per cent annually sees the purchasing power (real value) of the cash asset reduced significantly every year.

Consider $200,000 invested in cash earning 1 per cent interest, or $2000 per year. A person forced to withdraw at the rate of 4 per cent has to withdraw $8000 from these assets. The value of this part of their portfolio is eroded significantly even before they consider the impact of inflation which, at around 1.5 per cent a year, erodes the purchasing power of the $200,000 by another $3000.

This seems to be unnecessary pressure on someone managing their retirement with a superannuation pension account. Given that low cash rates have been a recent feature of the investment landscape and don’t seem likely to change quickly, they should be considered a factor in setting superannuation pension withdrawal rates.

Longevity Risk

One of the concerns of many retirees I have come across is whether their investments will last through their retirement. 

For a retiree who has accumulated assets through a working lifetime, this is a concern that is eased if the lower rate of minimum superannuation pension fund withdrawals were adopted permanently. In those years when a retiree did not feel they needed to withdraw as much from their superannuation pension fund, the funds can stay in the fund for later use, increasing the fund’s chance of meeting future retirement needs.

In this article, people being prepared to take lower portfolio withdrawals through periods of poor share market returns saw portfolios better able to recover after a downturn and provide adequate funds for the long-term. If a lower minimum pension withdrawal rate was permanent, people would have more flexibility to adopt this strategy when returns are poor and feel more comfortable about funding their retirement.

There is an argument that while people are forced to take a minimum annual withdrawal, they are not forced to spend it and can simply invest it outside of superannuation in their own name. While true, isn’t this just creating unnecessary work for the sake of compliance? Why shouldn’t they be allowed access to the simpler option of leaving those funds in their superannuation pension fund?

Conclusion

Making permanent the superannuation pension withdrawal rates offers retirees flexibility in a number of ways. It allows retirees to better cope with the current situation of unusually low interest rates. It allows retirees to be more flexible in considering longevity risk. It allows retirees to adjust their withdrawals to cope with market flexibility. It saves retirees the bother of building a second investment portfolio outside of superannuation from any excess withdrawals. It decreases the need to rely on the Age Pension. 

If, against this, concern remains about the use of superannuation pension funds as long-term wealth transfer vehicles, this can be addressed separately. Perhaps member balances greater than $2 million could be subject to the higher withdrawal rates? For everyone else, the greater flexibility of a lower minimum withdrawal seems to make sense.