Listen as they discuss:

• The drivers of growing demand for retirement income products.
• Key concerns of future retirees.
• Balancing income generation and capital preservation requirements.
• Misconceptions about retirement income.
• The future of retirement income and the latest innovations.

Transcript

Welcome to Relative Return, get closer to the people, products and strategies shaping Australia's financial services industry.

Hi everyone, how you going? I'm Phil Tarrant, so I'm the host of Relative Return. Welcome. Hope you're well.

Getting sucked into what has been a very good period over the break for a lot of Australians thinking about the future and what it holds, and I know for a lot of people, irrespective of the change in years, but retirement is always a key objective, planning for retirement is a key objective for most Australians. And I don't know any Australian that doesn't want an uncomfortable retirement. Fortunately in Australia we've got a pretty good superannuation scheme which always supports most Australians, but for a lot of people seeking a positive and a productive and a fulfilling retirement, they look to take control of their own financial future and there's a lot of products out there to help them and support them to retire comfortably.

Something I think about, I'm still probably a good couple of decades away from retirement. Some people have asked me why I don't retire today, well I've probably still got a fair bit of time left in it, but us journalists here at Money Management and IFA and Investor Daily, myself, managing editor of financial services and real estate here, obviously cross a lot of ground and most people I know when they talk about creating wealth, it's to do with retirement, what they're going to do with it, and that means choice and all that other stuff.

So something which I know a lot of people think about, something we think about a lot here at Money Management and Momentum Media, we know that a lot of financial advisors, this is a core proposition for them, helping people plan for a comfortable retirement. There's a lot of opportunities, a lot of products and a lot of strategies available to people seeking retirement to do what they want to do. Something that I've been looking at for quite some time around annuities, lifetime annuities, there's a number of different operators in this space and for our portfolio construction guide, and particularly balancing income and capital goals in retirement.

One of the organizations I really wanted to chat to was Challenger Limited, I've been able to get a hold of Amanda Gardner, she's a national strategy manager, we're going to chat through all things lifetime annuities, their place in the portfolios, how it works in portfolio construction in consideration for clients, but importantly, and for financial advisors and planners, often they try and sub this stuff in later on in their planning rather than building it in at the front end. So we can cover all of this sort of stuff, but all around retirement income today.

Amanda, how are you going? You well?

I'm still very well. Thanks for having me.

It's great to see you, and apologies for the long-winded introduction, but I just want to give some color to this because I know a lot of planners and advisors, when they think about maybe lifetime annuities, they go, okay, all right, well, I'll worry about that later when people get a bit older and do this sort of stuff, but I know Challenger in the back end have been doing quite a lot of stuff. Australia has a large superannuation industry, as we all know, sort of three and a half trillion dollars under management, which is a huge amount of dough. We've been doing a lot of work here at money management around this recently, and giving some sense for the market, how it's growing. But up until recently, not much attention has been placed on post-retirement, securing people's income once they've finished their employment. So everyone's chasing these big goals to work out what retirement is, and some people maybe don't like retirement. You see them come back to the workforce, but Amanda, can we ever talk about this recent shift in demand for retirement income products? I know you've been working on Challenger, you've been seeing a big spike in lifetime annuity sales recently, so I guess this is underpinned by the increased demand of late from your observations. What's going on? Why is this picking up?

Yeah, it's a good question, Phil. There's actually a lot of factors that are driving this, and a lot of it's to do with the wave of people that are in or near retirement, as you were just speaking about. And they're really seeking out these types of solutions. But along with the client demand, lifetime income streams themselves, and the features and benefits that they deliver, have really evolved, and because of this, have an important place to play in modern retirement portfolios. I say this because traditionally advisors may have only thought about lifetime annuities as a selling strategy, which limited their use and popularity. So let's cast our minds back, Phil, if you can remember prior to 2004, there were certain lifetime annuities that were 100% asset test exempt, and very popular for that reason. And then they became 50% asset test exempt, and even still today, we have favourable means test treatment. So it's understandable that advisors have had a tendency to focus on that selling component, and potentially overlook the other benefits that lifetime income streams can deliver. But now generally speaking, advisors are using more of a portfolio construction lens, and lifetime annuities form a foundational piece for many clients, including self-funded retirees that don't look at those center link benefits. And because of this, not only do they deliver sustainable income, but they also help preserve more assets over retirement when being used as part of that overall retirement portfolio. And of course, I guess the final thing to say is that the current economic environment is also highlighting that need for certainty in retirement portfolios, and this is definitely helping to create that shorter term demand. Yeah. And I think you see more of it moving forward, and I was chatting with someone the other day talking about, I've got young kids and the expectation that they will live to a hundred years old generation, which is absolutely crazy. So we're going to have an aging population, it's going to be growing, good or bad, it's I guess you're in the business of annuity products, not a bad thing, but aging population and how the structural change is driving new ways to help support retirees over their lifetime. This must be a big sort of focus for you and your team when you're looking at how you structure these products. A hundred percent, because that's really fundamentally what's underpinning all of the innovation and growth in this space, Phil. We know we have an aging population, and interestingly, Australians tend to underestimate how long they're going to live. But over the next five years, approximately 670,000 Australians are intending to retire. You and I aren't one of those, unfortunately, but that takes the retiree pool to just shy of 5 million people. And Australia also has the third largest life expectancy of the OECD countries. So what we have is more retirees than ever before, living longer than ever before. And if we take a couple in their mid-sixties retiring today, this realistically means that they need their income to last well into their nineties, as you said. And in fact, 12% of these couples need the income to at least age 100. So it is a good news story that we're living longer, but it definitely puts pressure on retirees' finite pool of financial assets. And that's known as longevity risk, the risk about living your savings. And it's a key concern for retirees at the moment when deciding how to both invest and spend their superannuation. It's a challenge for the government of today and tomorrow to see how they're going to shape that moving forward. It's good to see that Australia has such a good health system to keep people alive longer. Pretty cool. But you touched on it earlier. There's a lot of volatility in the markets right now and over the last past year, what the future looks like. Who knows? We've got persistent inflationary pressures, aggressive interest rate hikes, there's perceptions of a moving, potentially of a recession, whether it's a stock lending or not, who knows? So I guess these factors are brought together from your end, I'm sure, as contributing to a big uptick in demand in the products that you have. Can you give me some sense of what you're observing from clients? So what's top of mind for them? Their priorities must be changing when they're looking for different income, retirement income solutions? Yeah, absolutely. Well, Challenger actually partner with National Seniors Australia and have been doing so for many years. And that's to help us better understand what retirees' main priorities and concerns are. So National Seniors put out a survey annually and they consistently find that the biggest priority for retirees, not only now in this environment, but across the last decade, is that regular income for essentials. So not surprisingly, pay your bills around your groceries, your electricity and healthcare. And also that they need that money to last for a lifetime. In the latest survey in September, they also saw that the recent cost of living impacts have increased the focus on income, adjusting for inflation. Given the environment we're in, I don't think that's a surprise. But in addition to the income, what's also remaining a priority is access to savings and having that flexibility to draw down on them when required. But interestingly, leaving money to the next generation was the lowest priority. I think that's a bit of a generational shift that we've seen, which is less of a need to leave that lump sum to your family and more of a focus on how do I actually maximise my own retirement goals first. So for those with higher balances, definitely they do have a slightly higher tendency to look at preserving at least some of their capital, even though that still wasn't their main priority. So in a lot of cases for the financial planners, they definitely have to help balance out both that income and capital goals. And that is often competing and complex, as we know. Well, I'm happy you said that and I'm sure my wife will be happy because she reckons just spend it, don't leave it to the kids, but pay the bills over waiting for a handout. Interesting that those attitudes are changing. And I guess with people living longer, they've got to spend their day rather than this idea of people picking up a big inheritance. There is ways that parents can help their kids out, by the way, to get into the property markets, but that's not for the purpose of this chapter. What we have seen with volatile markets, and you've sort of touched on it very quickly there, Amanda, clients have probably experienced a drop in their capital, but they still need the income for retirement, as you'd mentioned. How are the advisors you're working with sort of managing or balancing this requirement of both capital and income for their clients? Because I know most people want to just hold on to their capital as much as possible, the wealth effect of that, and how you feel at any point in time is directly connected with the performance of your product. So how are planners and advisors working with their clients on this? I think it's particularly difficult in the current environment that we find ourselves in. We're also finding those key risks in retirement, like longevity risks that we discussed briefly just then, as well as inflation risk and sequencing risk, and unfortunately what we're seeing at the moment is that they're all playing out at the same time. So what advisors are telling us is that with the changing interest rates, high persistent inflation and continued market volatility, it's making it harder to sustain income for their clients. If we look at sequencing risk, for example, that's the risk that you'll receive a negative return early on in your retirement, about plus or five years around that retirement date, and that's probably occurred for clients in recent years. And if that happens and you're drawing down income from the portfolio at the same time, this limits your ability to recover that loss over retirement. So the impact of sequencing risk means that two clients can experience the same average share market returns over a 20 year period, and yet one person can run out of money sooner than the other. These factors are commonly referred to as the unique risks in retirement, and they present a conundrum for retirees, particularly at the moment, who are wanting to maximize their income and enjoy their retirement, but do actually have a real fear of running out of money. And so advisors that we speak to are often faced with two blunt tools during these difficult times. One is, do they maintain that capital for future years of retirement and therefore reduce the spending today? Or do you maintain their income needs, knowing that that's going to put pressure on that capital and draw it down more quickly, which may impact the ability for that to last over retirement? And when faced with these questions, research actually shows that clients opt to reduce spending and therefore they might not be living the lifestyle they desire, which is why it's really important to have financial advisors in this conversation. But right now in a high inflation environment as well, reducing spending is also quite difficult to do. Yeah, it's tough. And I know a lot of people are struggling with it at all sort of spectrums, people who are new to the career of a retiree. And you make a very good point, Amanda, and this is really the catalyst. And the reason why Australians need good advisors is to balance this dichotomy of like spend now and essentially roll the dice on how you're going to live or preserve your capital and change the way in which you live your life. So there must be some good solutions for advisors out there who are trying to overcome this challenge or help their clients navigate it. You're right. There's probably no single solution or silver bullet that's going to help with all of the demands that retirees are asking. But what advisors have found is that a combination approach can help to achieve all of those things. So financial planners can combine something like a lifetime annuity with their other client's assets like the account-based pension. And this blend can help to improve total portfolio outcomes. It aligns with the idea of the retirement income covenant, which is the government framework that's been provided to super funds to ensure that they're giving consideration to longevity and sustainable income for their members. There's actually a lot of larger national licensee groups that have adopted this concept and brought it to life with their own framework, which is unique to retail advice clients. These frameworks discuss the benefits and considerations needed to include lifetime income when building retirement portfolios and how the combination of solutions can be a great way to help achieve a balance between that sustainable income and access to capital. This is often called a comprehensive or a modern retirement portfolio, and it's designed to meet all of those competing needs. So for example, what it might look like is in simple terms, instead of having your traditional account-based pension, which might be in a balanced portfolio, you might be rolling over, say up to 20% of that into the lifetime income stream and still have that remaining 80% in the account-based pension, which then can be actually balanced up to balanced growth. So then they still have that remaining 80% in their account-based pension, which can be increased to a balanced growth profile. And when you have that combination approach, you have the same overall risk profile, but you often find that the income goals are met more sustainably and you still have that flexibility to access funds. But importantly, what you're also doing with the portfolio is allowing it to participate in market growth for longer. And so the strategy in many cases delivers outperformance as a portfolio than if you had either the account-based pension or the lifetime annuity in isolation. That sounds like a pretty decent safety net for a lot of retirees, and I read a lot of advice I think about this, and I know a lot of people I know who have retired have thought about this as well. This is preconception that opting into a retirement income would, I guess, take away this nest egg, this interracial wealth that you can pass down on the generation. You've said it's not a priority anymore, I reckon for some people it may be. So I don't know how you balance this, and maybe it's a myth that you can bust for us around this. I'd like to get some insights on it. This particular solution to this product offering that you have in deteriorating international wealth. Is there anything to that? Is it a fair call or is it something we can bust? I think it's something we can bust, but it's definitely a pretty common misconception, Phil. And look, in isolation, it's true that a lifetime income stream is going to draw down on your capital. People love the idea of that lifetime income stream being there for as long as they live and having that regular paycheck. But what happens if I do need that capital later in life to pay for HCA Collisal to pass down to my family? So there's the apprehension to take out a lifetime annuity. But generally speaking, you need to think about it as a portfolio lens. And when looking at it more broadly, the use of a lifetime income stream in conjunction with other financial assets tends to improve portfolio and estate outcomes for clients. So it's a matter of not looking at it in isolation. So Amanda, this idea of sort of busting these myths around retention of interracial generational wealth and leveraging the benefits of annuity-based incomes. Can you give me a sense or can you sort of speak more to how it actually improves wealth incomes or retirees? Absolutely, Phil. I think there's probably two parts to this question that we need to unpack. So first, let's understand how the one lifetime annuity works and what the features and benefits are. And then by understanding that, you'll be able to see how it interacts with the broader portfolio and where those asset preservation benefits occur. So looking at the lifetime annuity itself, in isolation, as I said, it's true, you do have that reducing access to capital typically. However, these days, there's also a built-in flexibility in case your circumstances change. So it includes features like a death benefit that's payable right up to life expectancy. And yes, this reduces over time as the policyholder is paid more and more income. But there's also increased protection early on in retirement. So in the first half of life expectancy, if you were to unfortunately pass away early, 100% of your investment is passed back on to your estate. And there's also the flexibility to actually voluntarily withdraw at any point up into life expectancy as well. And so as you can see, that idea that you're giving your capital up straight away in return for a lifetime income stream isn't necessarily the case anymore. And throughout many years of holding the lifetime annuity, it is actually contributing in some way to the asset value of the portfolio. And then to circle back to the selling benefits we spoke about, there is still those additional benefits for some clients where relevant. And that's the means test treatment that we have from 1 July 2019. So under the new rules, you have an income test where only 60% of the income derived from the annuity counts, and only 60% of the purchase price of the lifetime income stream counts from an asset perspective. And this lasts all the way through to age 84. And from that point onwards, only 30% is assessed for the asset test. This is quite unique and different to many other types of investments where 100% is assessable. So that's how the product works. And now how does that help us grow wealth overall? And this actually arises where the lifetime annuity helps other assets to be preserved better through retirement. And this happens for a number of reasons, but commonly includes things like the payment rate on the lifetime annuity over a lifetime relative to the alternative defensive assets that it may have replaced. And this compounds over the 30 odd years that someone spends in retirement. Then there's the built-in death benefit profile we spoke about and the Centrelink benefits that we spoke about. So basically the way that the annuity works and interacts with all of these different components allows the portfolio as a whole to outperform because if you've got lifetime annuity rates higher than the alternative defensive assets, coupled with more income earlier from any age pension, there's less need to draw down on your remaining assets to fund your income. So these funds are allowed more time to grow in market. Hence the portfolio tends to end up with more assets over time. So let the annuity focus on the income, let the remaining assets be in market the longer and have the potential to grow over time. And that's why these two structures complement each other well, which is why we're seeing it become a core part of retirement portfolios across a broad range of clients, not just Centrelink clients. The only thing I would preface that by saying is that some of the best outcomes occur when the strategy is employed earlier in retirement. So in your sixties and seventies, as this really allows that strategy sufficient time to work in market. Yeah. I mean, I reckon the financial advisors plan is they need to know the products there, they're integral around sort of portfolio destruction. That's what we're talking about. A big thrust of the white paper on money management, but the best advisors I know are also sometimes family counselors, right? When you've got kids wanting to make sure that the parents don't spend all their money when they think of these different type of products. So I mentioned at the top end of the podcast is where it's critical, and I think this is where advisors really need to be operating, you know, and you give them a good sense for how annuity works and how it can sort of contribute to the growth of the portfolio. But it's about building this in at the front end of portfolio production rather than, you know, trying to sub it in later on. I think a lot of advisors now are getting this and they're a lot more focused on it and being more conscious of it. Obviously markets change and it helps sort of accelerate opinions or attitudes towards things. So this is a really good moment in time to have a discussion around this. But for you and for Challenger, how do you see this sort of contributing to the growth of the portfolio? Well, I think there's probably a couple of parts to that question, Phil, that we need to unpack. So we did just briefly touch on maybe how a lifetime annuity works. So let's have a look at that in a bit more detail, because once you understand the features and benefits of the lifetime annuity, you'll be able to understand how it interacts with the broader portfolio. And that's how the asset preservation really occurs. So lifetime annuities today, like I said, in isolation, it's true. They have a reducing access to capital typically. However, the modern lifetime annuities have built-in flexibilities in case your circumstances change. So now there's a death benefit always up until life expectancy. In particular, there's a 100% death benefit guarantee for anyone in their first half of life expectancy. And that's really important because, again, there's a fear that if you take out a lifetime annuity and unfortunately you do pass away early, that you've forgone all that capital and you haven't had any benefit out of it. So that 100% death benefit is really important for clients to understand. And also you can actually voluntarily withdraw that lifetime annuity at any point up until life expectancy as well. So all of those modern features mean that there is some capital at play with your lifetime annuity that's going to help towards that asset preservation piece. We also touched about on Centrelink earlier, and we do continue to have federal means test treatment today. So for lifetime annuities, you now have 60% of the income that's assessed for the income test and only 60% of the asset value that's assessed for the asset test. And that goes all the way until age 84, when then it drops down to 30% asset test exempt. So lots of numbers there, but basically what it means is that you're reducing your asset value on day one and potentially picking up more Centrelink along the way as well, which helps to contribute to that income pool and have less pressure on the remaining assets to provide that for you. So Amanda, I get a lot of that, but it seems to make a lot of sense. And as I mentioned, market dynamics will shift and change people's attitudes towards annuity-based products. But how do you think advisors can demonstrate the benefits of the strategy you've just outlined to your clients? As modeling out for 20 to 30 years is sometimes challenging to present to clients when everyone's always looking for the immediacy of like, what am I getting today and I need to replace the income I used to be on. So what works well? Yeah, I think this is a tough one for advisors. And this combination approach that we've been talking about, the idea of having a lifetime income stream and an account-based pension, it's modeled particularly well when you're using stochastic modeling. So that's when you stress test the portfolio in different market scenarios. And that's important when you're looking at a 20 or 30 year time horizon, because who knows what those market conditions are going to be over that time. But one of the challenges that financial planners face when using some of the current modeling out there is that it's based on deterministic outcomes. And what that means is that it's static returns year on year. And so you might have, say, a 4% defensive assumption and an 8% growth assumption. And whilst we know that might be true from an average's perspective, it's certainly not what happens in reality for these clients. And so it probably therefore doesn't adequately demonstrate the risks that we've discussed today. Challenger, as an example, have a stochastic modeling tool that advisors like to use to stress test their portfolios. And that uses 2,000 different market scenarios. And this helps to provide a confidence level for those advisors to use with clients to really demonstrate how robust their retirement strategy is in meeting their goals and how likely it is that that income is really going to last, no matter what type of environment you find yourself in. There's also a number of newer tools available in the market now that also includes stochastic modeling. And I think we're going to see more of this in the future as the industry continues to evolve our approach to retirement. One thing you can guarantee is how the industry will evolve its approach to retirement. We're in a sort of moment in time right now. There's been, as we sort of discussed, an increase in demand specifically for these type of renewing products with this volatility. You're going to get a period of stabilization on markets going to become more normal moving forward. So do you think this demand for these type of products will persist over time? And what do you think is going to be that, what does the future retirement income look like for financial advisors recommending and providing services to clients? I think it's pretty exciting and the retirement income space is only just getting started really. There's so many drivers that will continue to support the need for these types of solutions. Some of which we've discussed today, the structural changes like the aging population and client demand for these types of products, the retirement income covenant. And I think you touched on it actually in the introduction, Phil, Australia has a highly regarded and maturing superannuation system. We're really just turning our heads to building equally compelling retirement systems. So, you know, there's a long way to go still. Challenger itself as Australia's leading retirement income brand, we believe strongly in sustainable income that lasts a lifetime and can help put clients in a better position both emotionally and financially. And so we're continually building out our solutions to ensure they remain current and best of breed. And we know there's not a one size fits all solution either. So our lifetime annuities are already really customizable. Many advisors might not know that you can link your income payments to inflation. You can link them to market returns or you can have them fixed. So there's lots of different ways that you can utilize these products already in the environment that we're in, but they will continue to evolve and keep pace with all the differing things that are coming up into the future. I think we'll also see more education or information around retirement more broadly, along with the bigger market that includes probably new players, new and evolved solutions and better access to lifetime income streams so that all types of clients can have them as part of their portfolios. Yeah, you need a lot more government oversight in this as well. And that's completely connected with the long-term integrity and health of the Australian population seeing that we are ageing. So I know challenges being this market for many, many years, and it's good to see you still have that layer level of innovation taking place. I think you're probably on the radar of more advisors today than what you would have been maybe five, six years ago. A lot of that is market-led, but I think the structural shifts in the way superannuation operates and how long Australians are going to be living, smart advisors are really being clever around portfolio construction and very much around the thrust of today's conversation and our special reports on portfolio construction. I imagine you probably know every advisor in Australia, but for those advisors out there, want more info from you guys and to get some greater clarity on where you're heading, what's the best way or what's the best way to connect them and challenge it? Well, we have a team of around 30 distribution members nationally, Phil, so there's always someone to talk to if you haven't already. But I would say also have a look at our website. It's got a lot of great content on there if you're just learning. We also have regular webinars and workshops in each state, which are always very popular and sold out quickly. So please just reach out to your local BDM. I am sure there are ways that which we can help have some more detail around these strategies and help your retiree clients in the future. The best advisors I know are always educating themselves and making sure they're right across all the new ways of delivering value and their service proposition to their clients. So it's a great offer there from Amanda, again, to go out there and learn more about what Challenger is doing around a lifetime annuities. So Amanda, I've enjoyed the chat. Thanks for spending time. I know a lot of people are still on holiday, so that's cool. We can sort of catch up and have a yarn and I feel a lot more informed. I had preconceptions around Challenger and I'm sort of pretty much on the mark, but I've learned a lot more about it. It sounds like you and the team there and the wider Challenger business are doing some smart stuff around this. So thanks for your time today. Thanks very much, Phil. Happy New Year. Happy New Year. This is Amanda Gardner. She's National Strategy Manager at Challenger Limited. Lots of conversation around portfolio construction on relative return. Go and tune into it on this podcast channel review. Tuning into your podcast, remember to check out daily breaking news, market intelligence, moneymanagement.com.au, and all of our other wealth management products, IFA, and also Investor Daily. Go and check it out. Thanks for your time today. We'll see you next time. Until then, bye-bye. The information featured in this podcast is general in nature and does not take into consideration your financial situation or individual needs and should not be relied upon. Before making any investment, insurance, tax, property, or financial planning decision, you should consult a licensed professional who can advise whether your decision is appropriate for you. Guests appearing on this podcast may have a commercial relationship with the companies mentioned. Relationship with the companies mentioned.