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It’s a common dilemma which most Australians confront towards the end of their working lives: when should I retire, when should I draw down on super and by how much?
Many other countries have a defined pension system but the Australian system with its super guarantee combined with the Age Pension means the retirement income puzzle requires, at the minimum, a basic level of financial literacy.
The Centre of Excellence in Population Ageing Research (CEPAR) published a research brief in November 2018 titled ‘Retirement Income in Australia’ as an in-depth study into trends in retirement income for Australians. It looks at the current state of, and projected future of, retirement income and the system that shapes it.
The CEPAR report also examined research which showed a person who is financially literate will plan more and save more, and questions whether there is a need for older Australians to take and follow financial advice.
Why financial literacy levels need to rise
The CEPAR report finds that not only do the financially literate plan more and save more, they also invest more in the stock market.
And it cites evidence that suggests causality flows from financial literacy through to behaviour with estimates that 30% to 40% of retirement wealth inequality is accounted for by financial knowledge.
One of the main impediments to improving financial literacy related to retirement is the fact that “horizons” seem a long way off for some people and decisions are often once-off.
But improving the financial knowledge of the least educated is shown to increase their wellbeing and reduce wealth inequality.
Measuring financial literacy
CEPAR’s partner investigator, Olivia Mitchell, developed a system, now accepted internationally, which provides a good measure of financial literacy. The three standardised questions test an understanding of interest rates, inflation, and diversification.
The tests, conducted in 2012, show that financial literacy is higher for men and the more educated, as in other countries, and that it increases with retirement and age.
Respondents answering all 3 questions correctly by characteristic, and by country
Overall, fewer than half of Australian respondents answered all three questions correctly, a level that is not much better than many countries. Most don’t realise their knowledge gap – only 14% of people considered themselves below average.
The findings in Australia were similar to other countries. As elsewhere, low financial literacy in Australia translates to less planning with only a third of non-retired respondents attempting to work out how much to save.
The importance of non-conflicted financial advice
Financial advisers play a major role in how the retirement income of Australians is formulated. Around 60% of Australian retirees access professional financial advice and for 14%, advisers are their sole source of financial information.
CEPAR points out that often the best advice is free of conflicted interests, trailing commissions, and hidden fees, but this isn’t always the case.
The financial advice system was recently overhauled with what were known as the Future of Financial Advice (FOFA) reforms, initiated in 2013. The aim was to move the industry away from a commissions-based system where advisers were remunerated on products sold to a professional service with a fiduciary onus on advisers to put the interests of clients ahead of their own.
The Australian Securities and Investments Commission (ASIC) in 2018 reported its fees-for-no-service repatriation efforts have returned over $250 million to consumers from financial advisers that charged fees for ongoing advice that was never received.
ASIC says improvements to the system still need to be made as there is evidence that vertically integrated institutions that provide financial advice and financial products have a disproportionately large number of consumers investing in in-house financial products.
Around three quarters of customer files reviewed by ASIC indicated that advisers had not demonstrated compliance with their best interests duty and related obligations.
Another 2018 report by ASIC found that over 90% of financial advice given on setting up a SMSF did not comply with relevant laws.
The fallout from the Hayne Royal Commission
These systemic issues in the industry were identified in the Hayne Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
In its final report handed down in February 2019, the commission recommended a ban on “grandfathered” commissions for financial advice along with tighter curbs on the fees charged by advisers. It also recommended a new disciplinary regime for the financial advice industry.
However it stopped short of recommending an end to the system where banks and wealth managers also own advice businesses, a model which is known as “vertical integration”. Commissioner Kenneth Hayne identified the vertical integration system as one that is open to conflicts of interest which do not benefit the consumer.
CEPAR also points out that a remaining concern is that the advice industry is not well prepared for the decumulation part of superannuation, both in terms of incentives structures and adequate knowledge.
For example, even for independent advisers, if fees are charged based on assets held, advisers may be less likely to suggest mortality insurance products, since these involve a once-off decision and need no further advice.
Such a fee structure may be incompatible with helping retirees run down assets.
How likely are we to follow bad financial advice?
In the recently published study by CEPAR, researchers found that more financial literacy and experience meant a lower likelihood of following bad advice.
But the differences were only slight, and the complexity of a topic increased the likelihood of even financially literate and experienced individuals making the wrong choice.
The researchers also concluded that adviser credentials increased the likelihood of advice being followed, but that some consumers had difficulty discerning real credentials from fake ones, as shown in the regular crackdowns on scam advisers in Australia.
Perhaps most worrying, and yet understandable, was the finding that clients were unlikely to recognise and ignore bad advice from someone who had gained their trust in a previous interaction.
CEPAR even goes so far as to question whether satisfactory financial advice is beneficial for seniors. They cite research from American economist Olivia Mitchell, of the Wharton School of the University of Pennsylvania, which found that the later the decision is made to delegate control of funds in a person’s lifetime the less beneficial this becomes, and by the 60s the benefits approach zero.
For many people, the capacity to make big financial decisions may be lacking or the information they are provided about products too complex. CEPAR concludes that financial literacy needs to go hand in hand with adequate information provision, including improvements in the presentation of product disclosure statements.
There is an ongoing process of adjusting product disclosure regulations to help make information more easily digestible and products more meaningfully comparable. However, CEPAR says the execution of this has been problematic.