In this guide
Since 2022, all Australian Prudential Regulation Authority (APRA)-regulated super funds have been required to have a retirement income strategy in place for fund members who are approaching or already in the retirement phase of superannuation.
This requirement forms part of the Retirement Income Covenant (RIC), which was introduced under the Corporate Collective Investment Vehicle Framework and Other Measures Act 2021.
While the RIC puts a greater focus on how all super fund trustees satisfy the income requirements of members in retirement, self-managed super fund (SMSF) trustees will not be legally obliged to comply, as SMSFs are not regulated by APRA. They are instead regulated by the Australian Taxation Office (ATO).
However, when SMSF trustees develop their investment strategy, they are required to take into account the individual needs of all fund members. When a fund has members in both accumulation and retirement phase, its investment strategy must explain how it meets the needs of both groups. It should therefore address retirement income for members who are in, or approaching, retirement.
The Retirement Income Covenant
The federal government first announced its intention to introduce a retirement income covenant for all super fund trustees, including SMSFs, in the 2018–19 Budget. It wanted to strengthen existing covenants in the Superannuation Industry (Supervision) Act 1993 (SIS Act), which include obligations to formulate, regularly review and give effect to investment, risk management and insurance strategies. The proposed RIC was intended to ensure that trustees addressed members’ retirement needs.
“The draft legislation would codify the obligation for superannuation trustees to have a retirement income strategy that outlines how they plan to assist their members in retirement. The strategy must consider how the trustee will assist their members to balance maximising their retirement income, managing risks and having some flexible access to savings,” former Minister for Superannuation, Financial Services and the Digital Economy, Senator Jane Hume, said when releasing the draft legislation.
But after lobbying by sections of the SMSF industry, SMSF trustees were dropped from the draft legislation.
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Find out moreHow did the Retirement Income Covenant come about?
The covenant stems from concerns that retirees do not draw down on the capital of their super balance, and instead attempt to live on the income from that capital balance.
“The ‘nest egg’ framing of superannuation compounds the complexities around deciding how to manage their superannuation in retirement. Partly because they have only ever been primed to save as large a lump sum as possible, retirees struggle with the concept that superannuation is to be consumed to fund their retirement,” the initial discussion paper stated.
It goes on to say that “multiple studies have shown that retirees die with around 90% of the assets they had at retirement” and that without a change in behaviour it is projected that by 2060 one in every three dollars paid out of the superannuation system will be part of a bequest.
The paper drew on findings from the Retirement Income Review 2020. However, a separate study by the Association of Superannuation Funds of Australia (ASFA) – Superannuation balances of Australia just before death – found that most Australians actually exhaust their super before they die.
Using Household, Income and Labour Dynamics in Australia (HILDA) survey results, ASFA found more than 90% of people aged 80 or over who died in the period 2014 to 2018 had no super in the four-year period before their death, and only 5% of that group had more than $110,000 in super in the period of up to four years before their death.
What does it mean for SMSFs?
Although the covenant does not apply to trustees of SMSFs, SMSF trustees should still consider their members’ long-term retirement income requirements when developing and reviewing the fund’s investment strategy.
The SMSF Association, for example, has said that just because it is not a legal requirement for SMSFs, that doesn’t mean SMSFs shouldn’t consider having a retirement income strategy.
“It’s not a green light for SMSF trustees to ignore the spirit of a RIC, as we know from bitter experience that failure to properly address these issues can derail even the best-laid retirement income plans,” former SMSF Association chief executive officer John Maroney said following the decision to exclude SMSFs from the RIC.
Transcript
Yes, I do think there are areas where the Retirement Income Covenant principles and thinking could be relevant for self-managed super fund trustees. You’re right, they don’t need to actually do anything. But there could be benefits in looking at how to go about structuring in terms of what is an affordable level of drawdown of accumulated superannuation moneys in the retirement phase.
Because no one knows how long they’re going to live for. And so there is a tendency to potentially keep more in the fund in case you do live in your 80s and 90s. Whereas there is evidence that people could experience a better quality of life by making sure they don’t underspend in their 60s and 70s when they are more active. They do have a greater ability to travel more without worrying about health issues.
And that’s where getting advice in terms of what are the boundaries of ability to draw down that fit with your investment strategy, your own risk profiles. And that’s the sort of thing the APRA funds will be doing on a generic basis for their memberships.
And I think it is worthwhile for SMSF trustees to read some of those articles that will be describing what’s happening in the large fund world and say well, what does that mean for me on a comparative basis? And then asking questions of yourself or of your adviser, your accountant.
And just being comfortable that there are essentially additional support systems. That could be the Home Equity Access Scheme, is one of them for those homeowners. And there’s also the Age Pension, for most Australians will continue to draw a part or full pension for some or all of their retirement. And that is a real important safeguard so that even if you do draw down more than what you planned for the first 10 or 15 years, there are sort of backups. So it’s not as if you run out of money, people are going to be destitute.
But the last thing you want to do is go for a higher standard of living than what you really thought you’re going to have and then drop down too much. But that can be done with regular reviews, over time and again the covenant is all about setting up the plan, but also that regular monitoring.
What to do?
Even if it’s not a legal requirement, the RIC is a timely reminder to SMSF trustees to carefully consider how their funds are to be invested, managed and used in retirement.
Already, all SMSF trustees must complete an investment strategy, which needs to include the fund’s ability to pay benefits, along with the risks involved in making certain investments and the likely return from the fund’s investments regarding its objectives and cash flow requirements.
If all members are in the retirement phase, the investment strategy should include how the fund plans to meet the income demands of members, how current investments would satisfy those demands and if assets need to be sold or reallocated to meet that demand.
SMSF trustees should use this opportunity to update their investment strategies if required and could even use the legislation for APRA funds as a guide.
Another option would be consideration of a specific section in the investment strategy on the fund’s retirement income approach, which might include larger drawdown rates for allocated pensions and reallocation of investments to enable those larger drawdowns.
For instance, trustees may choose to hold enough lower-risk, liquid assets to meet expected pension payments and expenses. Depending on the fund’s objectives and members’ circumstances, this may require reallocating some higher-risk assets to investments such as cash and term deposits, reducing the likelihood that assets must be sold in a falling market to fund current living expenses.
The bottom line
SMSFs are not required to comply with the RIC, but trustees should still consider the retirement needs of every member. They should review this approach at least annually and document it in the fund’s investment strategy.
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