REVIEW OF RETIREMENT INCOME STREAM REGULATION

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1 10 September 2014 General Manager Personal and Retirement Income Division The Treasury Langton Crescent PARKES ACT Dear Mr Tilley, REVIEW OF RETIREMENT INCOME STREAM REGULATION The SMSF Professionals Association of Australia (SPAA) welcomes the opportunity to provide a submission regarding the Government s review of retirement income stream regulation. SPAA believes that any changes made to the current income stream regulations, especially those targeted at increasing the provision of deferred lifetime annuities must be made with a view to maintaining neutrality amongst income stream products. We support removing impediments to retirement income product development but any such changes must maintain neutrality across all retirement income products to promote competition and efficiency. This would extend to permitting deferred market linked income streams to allow retirees, especially SMSF trustees, an option to self-manage their retirement savings to meet longevity requirements. Further, SPAA believes that the retirement income regulations should encourage retirees to draw down on their retirement savings in a sensible manner while maintaining product neutrality. In order to achieve this result we suggest the need for maximum drawdown ceilings (in addition to the existing minimum drawdown requirements), where amounts withdrawn above the maximum are taxed to discourage excessive drawdowns. This would also apply to payments from DLAs Also, SPAA does not support the introduction of an automatic mechanism to adjust minimum drawdown rates when there is a downturn in investment markets. Instead, we prefer the existing method of adjustments being made as required to the drawdown rates.

2 Our detailed comments are provided in the attachment. If you have any questions about our submission please do not hesitate in contacting us. Yours sincerely Andrea Slattery Managing Director/CEO SMSF Professionals Association of Australia Limited Contact Numbers: Tel: (08) Mrs. Andrea Slattery Managing Director/CEO Mr. Graeme Colley Director, Technical and Professional Standards Cc: Page 2 of 10

3 ATTACHMENT Question 1: What types of income stream products would enable retirees to better manage risk in the retirement phase (in particular longevity risk and investment risk)? While SPAA believes that providing a great array of retirement income products for retirees to choose from can assist retirees in managing risks in retirement phase, the Government should be wary of focussing on the provision of retirement income products alone to enhance the retirement income phase of superannuation. Focusing on the need to further develop or mandate the use of retirement income products alone neglects to recognise the strengths of the current retirement income policy settings and the role that quality financial advice should play in best utilising the current system. Similarly, not looking at how current advice practices and consumer financial literacy and understanding of retirement risks affect the retirement phase of superannuation is misguided as it places an overemphasis on the mandating of products to fill this gap. Rather than focussing on products to manage retirement income we believe that retirement income policy should focus on providing a universal framework which encourages regular, consistent drawdown on retirement savings for meeting the needs of retirees. This type of system would have neutral treatment of retirement products, allowing retirees to choose what products best suit their circumstances. Also, such a system should not prevent retirees from adjusting their income drawdown arrangements to meet changing circumstances as required (i.e. does not lock retirees into, or out of, particular products). SPAA does not support policy incentives that encourage retirees to purchase a particular type of retirement income product which have the sole purpose to manage longevity and other risks. SPAA supports coherent retirement income, social security and tax policy settings which provide incentives to nudge retirees into drawing down on their retirement savings in a way that accords with the goals of the retirement income system. A coherent policy encourages the gradual drawdown of retirement savings from retirement onwards by making sure that the social security system and tax system do not allow retirees to benefit from social security and tax preferences where their actions do not align with the goals of the retirement income system. Policy options that could align with this type of coherent policy principle framework could take the form of: Page 3 of 10

4 Reintroduction of maximum annual drawdown levels in addition to minimum drawdown levels. A more comprehensive approach of introducing maximum drawdown ceilings beyond which there are tax or social security disincentives if withdrawals above those maximums are made. Large lump sums would be caught and discouraged by such a policy. Claw back of some tax-preferences on death of unused capital amounts which could be used to encourage drawdowns and discourage superannuation being used as part of estate planning strategies. Politically tolerable grandfathering introduced in stages. We believe that a product-neutral approach that encourages retirement income streams will result in the optimal outcomes for retirees. Products that meet set drawdown parameters with the aim of achieving the retirement income system s goals for managing longevity risk ensures retirees drawdown on their retirement savings appropriately. If necessary they may qualify for relevant social security and tax concessions. We note that the SMSF sector successfully provides retirement income streams to retirees under the current regulatory settings. The existing retirement income policy settings have allowed for a broad range of retirees with varying circumstances and lifestyles to effectively manage retirement incomes through account based pensions via an SMSF. Account based pensions have allowed SMSF trustees to drawdown on their retirement savings over time in a manner that suits them and allows flexibility to withdraw capital to meet lump sum costs as demands dictate, for example, unexpected medical and aged care expenditure. SPAA believes the existing account based pension system not only provides the flexibility for managing the drawdown of retirement savings to provide income streams but believes that it can be used to manage longevity risk. Question 2: Do the annuity and pension rules constitute an impediment to the development of new products and if so, what features of the rules are of most concern from a product innovation perspective? SPAA is aware that there are impediments in the existing SIS Regulations creating retirement income products. This applies especially to the requirement that an annuity must pay at least an annual payment to the beneficiary. We are also aware that tax treatment of earnings for DLAs is an issue for product providers. Page 4 of 10

5 SPAA supports the removal of regulatory impediments to the development of retirement income products. However, we strongly believes that any change to current legislation needs to ensure neutrality across retirement income products, for example, account based products and annuity style products. There have been certain impediments identified, particularly in the SIS regulations which should be removed. There should also be greater co-ordination between regulators in the product approval process. SPAA would be concerned if the outcome distorted the neutrality and equity between retirement income products. Decisions by consumers should be made on managing retirement income and longevity by choosing a product that best suits their needs rather than one which provides favourable tax or social security outcomes. Any changes to regulations to allow the development of annuity or deferred lifetime annuity (DLA) products should ensure that similar approaches to managing longevity risk can be maintained in the account based pension/smsf environment. For instance, if DLAs are to benefit from a tax exemption on investment earnings through the deferral period, then SMSF trustees should be able to setup deferred market linked income streams (MLIS) within the fund and receive equivalent tax treatment for their assets that are put aside in the fund during the deferral period. A deferred MLIS has the same purpose and intent as a DLA that is, to defer the consumption of capital to a later time and manage longevity risk. Therefore they should receive the same regulatory treatment as other products that receive the same retirement income outcome. Ensuring this type of neutrality occurs across different retirement income products is essential to promoting competition, innovation and reducing distortions in consumer decision making. Question 3: What changes could be made to the annuity and pension rules to accommodate a wider range of income stream products while having regard to the need to protect against abuse of the earnings tax exemption and to promote appropriate and prudent retirement income objectives? Removing the requirement that an annual payment be made from a pension and annuity products would remove a significant impediment to offer deferred income stream products. Equivalent changes should be made to both pension and annuity rules so that neutrality exists and allows development of deferred MLIS as well as DLAs. SPAA believes that having maximum drawdown ceilings, in addition to minimum drawdown requirements, will prevent abuse of DLAs and other deferred income stream products like deferred MLIS. Maximum drawdown ceilings should operate by ensuring that drawdowns above a given level will be taxed and effect. These ceilings would also apply to payments on Page 5 of 10

6 death from deferred income stream products, preventing abuse of using a tax exempt deferral period and not drawing an income stream from a product (i.e. using deferred products to gain a tax exemption until death for estate planning purposes). This type of policy would encourage retirees to drawdown on their retirement income savings in an income smoothing manner which should result in a reduction on the reliance of the age pension. Question 4: Would such changes lead to new products being brought onto the market? While SPAA is not in a position to make a comprehensive comment on how removing regulatory requirements would increase the supply of retirement income products, we do believe that removing existing regulatory impediments will increase supply of retirement income products. If the existing rules were amended as we suggest above in our answer to question three, we would expect that deferred MLIS would be offered, especially to the SMSF sector, to allow retirees to have greater self-management of retirement income, especially of assets underlying a deferred MLIS. Question 5: Should people only be able to purchase a DLA with superannuation money? Yes. In order to maintain neutrality between account based pension products and annuity type products, DLAs should be funded from superannuation money. This is especially important if income earned on the DLA s underlying investments is tax-exempt during the deferral period. Tax concessions on investment earnings and benefits paid from DLAs should be maintained in line with existing superannuation rules and accordingly restricted to being purchased with superannuation funds. Further, we believe that it would be appropriate policy that a DLA should only qualify for concessional treatment where it is parallel to an existing retirement income stream. Without such an arrangement, policy settings may encourage retirees to defer the use of capital to later in life and rely on government support earlier in their retirement. This would allow them to consume capital through lump sum withdrawals rather than as receipt of an income stream. The reliance of the retiree would merely shift to government support in relation to Page 6 of 10

7 managing longevity (i.e. from latter in life to earlier) rather than decreasing the overall reliance on government support. Question 6: Should people only be able to purchase a DLA for an up-front premium or should other purchase options also be allowed? If an annual premium approach is allowed, what should be the consequences if the premium payments cease? We believe that DLAs should only be able to be purchased upfront. Allowing DLAs to be purchased through an annual premium in essence amount to adding capital to an annuity product overtime, rather than purchasing a product or setting aside capital to manage longevity risk. Question 7: Should there be an upper limit on the amount that can be invested in a deferred lifetime annuity? No. SPAA does not support restrictions on amounts that can be invested in a DLA because we believe retirees should be allowed to choose how to best manage retirement income for their circumstances in a product neutral environment. However, as explained above we do believe that a DLA should only be allowed to be invested in alongside or in conjunction with an ABP to ensure that retirees are using their superannuation balances. Further, any use of DLAs to defer taxation on large superannuation balances should be clawed back through implementing a maximum ceiling on income stream drawdowns as described above. Such a maximum drawdown limit would see unused capital amount paid out of DLAs on death taxed, effectively clawing back tax exemptions granted during the deferral period. Question 8: Should there be a minimum deferral period for a DLA? If so, what would determine the period? Yes. SPAA believes that there should be a minimum deferral period for a DLA otherwise a short deferral period may amount to no more than a drawdown holiday which achieves a tax deferral for the retiree. Page 7 of 10

8 A sensible way to prevent the abuse of DLAs for short-term tax deferral is to link a minimum deferral period to age, with shorter deferral periods being required as age increases. For instance, at age 65 a DLA could require a minimum 15 year deferral period, at age 70 a minimum 10 year deferral and at age 75 a minimum 5 year deferral. This would ensure that DLAs and other deferred pension products are being used for their intended policy purposes of managing longevity risk and providing retirement incomes later in life. Question 9: Should there be a maximum deferral age or period? If so, what should it be? Yes. SPAA believes that there should be a maximum deferral age for DLAs. This is needed to ensure that DLAs are being used for their primary purpose of managing longevity risk in regards to retirement income. By not having a maximum deferral age or period, DLAs could be used to access a tax deferral rather than for retirement income purposes. Question 10: Do the payment features described in paragraphs 51 and 52 strike the right balance in allowing people to insure against longevity risk while avoiding unnecessary restrictions on product development? These restrictions are needed to ensure that DLAs are being used for their primary purpose of managing longevity risk. However, we believe that it may be prudent to allow for commutation of DLAs and other deferred products where there are circumstances that requires for a retiree to access capital to fund an unexpected expense such as a health issue or moving into aged care accommodation. This could function in a similar method to the existing in regards to the early access for superannuation on compassionate grounds (SIS Reg 6.19A). If DLAs are allowed to have commutations into capital sums before the death of the retiree, then we believe it is necessary to claw back tax exemptions and other concessions that are made available to the DLA during the deferral period where it is commuted before death. This could be achieved by introducing maximum drawdown ceilings as described above, which would capture payments upon commutation of DLAs above a certain threshold. Page 8 of 10

9 Question 11: Should providers of DLAs be able to offer a death benefit? If so, should there be restrictions on the size of the death benefit that could be offered? If so, what restrictions? We believe the providers of DLAs should only be allowed to provide death benefits where there is a tax treatment that provides a clawback of tax preferences (i.e. tax exempted during the deferral period). This would ensure that retirees are using DLAs only for retirement income purposes rather than estate planning purposes. Question 12: Are the current minimum payment amounts for account-based products appropriate to achieve the objectives outlined above, given financial conditions can change? SPAA believes that the current drawdown rules are effective in encouraging the drawdown of retirement incomes in a sensible manner for the current preservation age and pension entitlement settings. With an increase in the pension age, and possible future changes to the preservation age, we believe that the minimum drawdown factors should be altered to respond to these changes. Question 13: Should there be an automatic mechanism for adjusting the minimum drawdown amounts in response to significant adverse investment market performance? If so, what should that mechanism be? How would this also satisfy the rationale for setting minimum payment amounts? SPAA does not believe that there is a need for an automatic mechanisms for adjusting minimum drawdown amounts in times were investment returns diminish due to market conditions. We believe that the existing approach of the Government making regulations when required to reduce drawdown levels, as they did recently during and after the Global Financial Crisis, has worked well and is appropriate. Question 14: Should the minimum drawdown amounts also increase in response to very strong market performance? Would the mechanism be similar to that for decreases? Would this satisfy the rationale for setting minimum payment amounts? No. This would needlessly complicate the superannuation drawdown rules. Page 9 of 10

10 Further, applying increased drawdown minimums in times when investment markets are performing strongly may disadvantage superannuation fund members who have chosen a more conservative or defensive asset allocation. This is especially the case for superannuation fund members in pension phase who may have shifted to more conservative investment strategies in order to fund income stream payments. Question 15: For how long should the change remain in place? Should it be left in place only for the year in which the shock occurs, or until balances have recovered by a particular extent? There does need to be a set time for reductions in drawdown rates to be in place. We believe it is best to leave flexibility for policymakers to address changes and volatility in investment markets rates. However, setting a minimum period for the reduced drawdown rate to apply would give retirees some degree of certainty to be able to plan and manage their retirement savings drawdown in a sensible manner. For example, setting an adjustment for a minimum of two years would provide retirees with certainty for planning purposes. Any set minimum period should not preclude drawdown factors from being further lowered to address additional declines in investment markets. Question 16: What other issues need to be considered if the minimum drawdown amounts should fluctuate? N/A. Page 10 of 10

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