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SMSFundamentals: The Longevity Trap

SMSFundamentals | Sep 20 2012

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By Greg Peel

Here's an interesting statistic: Our prehistoric ancestor homo erectus first walked the earth some 100,000 years ago. If we take homo erectus as being the first “human”, then of all the humans who have lived on this planet in the past 100,000 years, half of them are still alive today.

I'll just let that one sink in for a bit.

In 1910, the average life expectancy for Australians was 56 for males and 59 for females. In 2010, those numbers had increased to 79 and 84 respectively. It is not hard to imagine why, with improvements in health being the obvious factor. Such improvements range from medical breakthroughs to greater health awareness (eg smoking bad, balanced diet and exercise good) and on to safer motor vehicles.

Now of course we all know of plenty of men and women in their nineties, and even some past the ton. Average life expectancy is simply that – an average – based on the usual distribution across the “normal” bell curve. These averages are nevertheless very important for the Australian government because it uses such figures, as provided by the Australian Bureau of Statistics, to project future fiscal obligations with regard to age pension and superannuation policies. We all know Australia now has an “ageing population”, and with the Boomers beginning to retire we are going to see a step-jump in the government's budget drain from here into the near future. Gens X and Y are the prodigy of less productive stock, and hence offer up a flattening out some time in the future, but that future is quite simply a great unknown.

Between now and then we might, on the one hand for example, find a cure for cancer. On the other, we might all be wiped out be a meteor. Who knows? It makes it rather difficult for a government to set policy, but at the very least a government needs to be cognisant of what policy requirements might transpire in what we might, in a reality-check fashion, call a “worst case scenario” of too many old people. At the individual citizen level, we equally have the difficult task of planning ahead for a lifestyle that will last until a completely unknown date – the day of one's ultimate termination.

Try this quick quiz: Who has the greater life expectancy, a man aged 30 today or a man aged 65 today? One is logically tempted to answer “the younger man” but in fact the opposite is true.

As noted above, as at 2010 the average life expectancy from birth of Australian males is 79. However the average life expectancy from age 65 is 86. The point is that if you have made it to 65, you clearly have avoided a fatal accident to that point (car accidents are weighted toward younger, less experienced drivers for example) and assuming you're healthy, you managed to avoid the various diseases that can take a life in the time leading up to age 65. If you have been and remain focused on a healthy lifestyle regimen, you are no doubt expecting to be hanging around for a while yet, thanks very much. Statistically, a 30-year old still has more chance of meeting an early demise, and hence has a younger average life expectancy.

If you began to think seriously about superannuation planning at 30 years old, you would presumably be working on the basic model of investment for growth up to retirement, and then drawing an income from your investments after retirement. For how long will you need an income? Well if you work off average (male) life expectancy, it would the 14 years from 65 to 79. However at 65 you are expected to live to 86, which is seven more years, or a 33% longer time frame than the ABS average life expectancy number suggests. Is your current growth-to-income superannuation plan prepared for 33% more income?

And these figures are snapshots for today. It is projected that by 2050, a man aged 65 can expect to live to 92, or nearly twice as much longer a retirement period (from 65) as today's ABS birth-time stats suggest. 

I'm not ignoring the ladies. Females who were 65 in 2010 can expect (on average) to live to 89, rather than the birth-time assumption of 84, and by 2050 a 65-year old could expect to live to 93.

There you were sufficiently worried about whether you will have enough retirement income from today's perspective, and now you have to further face the reality that you might linger on this Earth even longer than you had planned for. The government might call it overstating one's welcome. It's the stuff of mixed feelings.

Of course, we must consider that income requirements per year will diminish with advancing years, such that recent retirees will expect greater lifestyle choices from their super than those in their eighties or nineties, on average. Those approaching retirement might be dreaming of the day they will finally set off to cavort around the country in a campervan, cruise the Mediterranean, reduce their handicaps, take their first skydiving lesson, buy that vineyard, or all of the above. Those in their nineties may simply be happy to be able to walk unaided and not fall asleep during Midsummer Murders. If we are now concerned over greater longevity than we might have anticipated, at least we can work on the basis that our (real) income requirement per annum will tail off into time.

The Australian Actuaries Institute has contributed to the debate over what it calls the “Longevity Tsunami” by preparing a white paper which identifies the issues that should be on the table when the government is developing its retirement incomes policy. “The objective of this discussion,” notes the Institute, “is to highlight structural changes in the current retirement incomes rules that are needed to mitigate the financial risks of unpredictable increases in life expectancy”. In its white paper, the Institute is speaking to the government on national policy discussion basis, rather than speaking specifically to any individual superannuant. However individual superannuants (SMSF or otherwise) would be wise to absorb the underlying themes of the Institute's recommendations via-a-vis their own situation.

In its white paper, the Institute has recommended six policy changes. We must first note current policy parameters with regard to super, being that: (1) current access to superannuation assets begins at 55, moving to 60 (the “preservation age”); the disability support pension provides an early “age” pension from 55; one has unlimited access to super benefits tax-free from 60; and the current age pension threshold is 65 (moving to 67 from 2017) which does not necessarily suit everyone.

The first policy change recommended by the Institute is to provide greater incentives to individuals to take the majority of their retirement benefits as an income stream. Currently there is no tax payable on lump sum withdrawal from super for those 60 and over, although there are some tax incentives for assets to remain in the super system. While there is no actual evidence of such, it is possible for retirees to withdraw their assets in one big hit, live the life of Riley until such time as it all runs out, before falling back on the age pension. “In particular'” says the Institute, “those retirees that can afford to should be incentivised to protect themselves against their own longevity”.

The second is to increase the “preservation age” to 3-5 years less than the age pension age.

The third is to extend the MySuper regime to include post-retirement solutions with “intelligent defaults” that provide retirees with secure income streams. Specifically the Institute suggests that those who choose only the MySuper default option are then placed into an income stream product that allows flexibility and control of capital in the younger retirement years, and then potentially provides a guaranteed income stream in later years to supplement the age pension.

The fourth is to remove impediments that discourage older people who want to keep working. In particular the age limits on superannuation contributions can be removed, workforce participation can be encouraged by removing the Means Test, and a later increased age pension or lump sum payment could be offered to those choosing to work past the retirement age.

The fifth is to remove existing legislative barriers preventing innovation in developing post-retirement income stream products such as annuities.

The sixth is to link changes in age pension eligibility age to improvements in life expectancy. The Institute acknowledges that the government is already increasing the retirement age from 65 to 67 over the next six years, but over the longer term that eligibility age should rise along with increasing life expectancy.

The Actuaries Institute's white paper, Australia's Longevity Tsunami (What Should We Do?) can be read in full at this link.

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