To fulfil the promise of superannuation, super funds must now shift their focus from the accumulation of super to the decumulation phase. To do this successfully, funds certainly need product, service and advice solutions, but they also need to shift the thinking of their members. We need to get people thinking in terms of retirement income.
Members need to stop seeing their super as a lump sum and start understanding their capital in terms of the income it can provide for their retirement.
This understanding will lead to better long-term outcomes and more informed purchase decisions.
A lump sum figure is difficult to translate into an ongoing income
Most people are used to budgeting over short time frames, with regular ongoing income. So the prospect of one final lump sum to last a lifetime is daunting, and leads to three common mistakes:
Overestimating the income the capital can produce
Research1 has shown that people often overestimate the income that can be generated by their lump sum. So while $100,000 will likely provide an income of $5,000 a year for around 30 years, it’s common for people to believe that the income possible from $100,000 would be closer to $10,000 over 30 years. This is particularly the case with moderate lump sum amounts up to $200,000.
Underestimating the impact their lump sum can have
On the other hand, some people believe that they don’t have enough super savings to make a difference to their retirement, so they’re better off just spending their lump sum on a new car or holiday and then relying on the Age Pension. In this case people are not seeing the impact that an ongoing income stream of $5,000 can have on their standard of living in retirement. An extra $100 a week represents a 20% increase on the Age Pension2.
The windfall effect
When people dream of winning the lottery, their spending plans typically include a new house, a flash car, a huge holiday. Most people don’t plan to invest the money to provide a moderate income for the rest of their lives. A similar circumstance can happen with super lump sums.
Often a retiree’s super lump sum of $50,000-$100,000 is more money than they’ve had in their lives. So when compared to an ongoing income of $5,000 – the lump sum can appear to be so much more.
The result
So in some cases, a lump sum can lead to a person having an inflated perception of their wealth – meaning they don’t appropriately prioritise their retirement planning.
Alternatively, some impulsively spend their lump sum – underestimating the income that it can provide as a regular top-up to the Age Pension.
One way to change this behaviour is through education. By providing a retirement income forecast to members, preferably included on their annual statement which shows not only the growth of their lump sum – but what this lump sum is likely to provide in terms of future retirement income.
The way people budget and spend
Even though salaries are quoted and reported on an annual basis, most people are used to receiving a regular, after-tax income. Running the household and budgeting on a fortnightly or monthly basis.
So super funds should also give consideration to the time frames of the retirement income forecasts they provide. Offering tools with variable income timeframes – allowing members to view their savings as likely annual, monthly and fortnightly income.
The Age Pension is part of the solution
While our focus groups indicate that there is a certain level uncertainty surrounding the Age Pension, the Age Pension remains a big part of the retirement income solution for Australians currently in their 50s.
In shifting the focus to retirement income, from a lump sum, it becomes easier for people to see how their super can work with the Age Pension to provide a higher retirement income for life.
When members have a better understanding of what income their lump sum is likely to provide, they’ll understand how this income can supplement the Government Age Pension for a better long-term outcome. This understanding will also lead to the purchase of retirement income products that focus on the expert long term management of their retirement income.
1 The illusion of wealth and its reversal, 2014, Daniel G. Goldstein, Hal E Hershfield, Shlomo Benartzi
2 Maximum basic rate for a single $776.70 September 2014. www.humanservices.gov.au