Covenant is an antiquated term most commonly associated today with biblical stories, the slightly more modern Steven Spielberg ‘Raiders of the lost ark’ classic movie or property disputes.

The ancient word, however, is making a comeback that may see Australian financial advisers reaching for their dictionaries.

Generally, a covenant amounts to a promise to do, or not do, something via agreements that can create the legal grey areas beloved by lawyers.

But in the case of the Retirement Income Covenant (RIC), the Australian government intends to impose clear obligations on superannuation funds in a move also destined to spill over into financial advice.

Under the RIC legislation, currently awaiting final parliamentary approval, all super funds overseen by the Australian Prudential Regulatory Authority (APRA) will be required to develop and regularly review retirement income strategies for their members. (In a last-minute change, self-managed super funds were carved out of the proposed RIC regime.)

The draft law, expected to be in force by July 1, 2022, sets super funds the tricky task of considering and balancing the retirement income needs of members across three key objectives, namely:

  • maximising their expected retirement income;
  • managing risks to the sustainability and stability of their expected retirement income (i.e. ensuring members can receive income for life); and
  • having flexible access to funds during retirement.

In practice, all APRA-regulated super funds will likely build or outsource default retirement income strategies to reflect the average needs of their respective members (or membership cohorts) including factors such as social security and tax outcomes. The result being many new and varied retirement products on the market.

Based on membership data analyses, the default super fund retirement income strategies must find an appropriate line between providing sustainable lifetime income versus the need to access capital, as well as accounting for the usual investment and inflation risks.

While the mooted retirement income products – likely to fall between the current account-based pensions and full annuities, through to a new breed of innovative solutions– won’t be compulsory, super funds will face obligations to promote and explain the strategies to members.

And the expected information barrage will almost certainly see members turning to financial advisers to guide them through the new retirement income product choices.

In turn, financial advisers will have to quickly develop an understanding of the RIC products once they hit the super fund shelves.

Advice finds the line between off-the-rack and tailor-made

Despite the looming RIC product design requirements, super funds won’t be able to issue tailored retirement income recommendations to individual members without veering into personal advice territory.

Members seeking a greater degree of guidance on whether a suggested super fund retirement income strategy matches their specific circumstances will inevitably turn to professional financial advisers.

Of course, some super funds offer in-house financial advice services but independent advisers will also have to stay abreast of retirement income product suites.

Either way, the RIC regime will take retirement income planning in super well beyond the familiar account-based pension versus lump sum question.

Given the broad membership-based product design parameters set under the proposed legislation, many Australians will need to decipher whether and how best to match any super fund-built retirement income strategy to their individual needs.

As well as decoding any super fund-supplied retirement income product information, financial advisers will undoubtedly be called upon to walk clients through alternative solutions, if appropriate.

For example, a super fund might create a default longevity risk product assuming that most of its members will only access part of the Age Pension.

As members approach retirement age, the fund – as per RIC requirements – could promote its default option using retirement income projections based on the individual’s account balance and part Age Pension payments along with generalised assumptions of other assets and income.

Clearly, the model super fund product would not necessarily suit members relying on the full government pension or those who are self-funded retirees.

Advisers should have a much deeper understanding of their clients’ total financial position (as well as life goals) compared to a statistically generated ideal – and are better-placed to create personalised optimal retirement income strategies.

As the RIC encourages super funds to communicate more with members about retirement income solutions, advisers should also ensure they remain part of the conversation with clients, or risk losing influence.

For many super fund members, new RIC-inspired options could help them address well-known retirement issues such as longevity and sequencing risks.

However, the benefits may come with potential liquidity constraints, compared to the flexibility of account-based pensions: advisers have a role here in explaining that trade-off and how it could affect retirement lifestyle choices.

The exact amount of fenced-off capital per product will certainly vary across super funds as they build membership and cohort models (based, say, on age, risk profile or income and assets) but the draft RIC requirements provides a clue.

Early RIC projections estimated members would have to set aside a minimum 15 to 20 per cent of their super fund savings to a pooled longevity risk product to provide certainty of income for life.

Complex situations, promising solutions

Importantly, too, the looming influx of new retirement products comes after recent government policy changes with super, tax and social security laws to encourage income streams – mixing welcome incentives with some operational complications.

Unadvised members run the risk of only considering any super fund-produced retirement income strategy in isolation rather than against the complex web of social security and tax laws familiar to most advisers.

In July 2019, for instance, a new law altered the assessment of lifetime income streams for social security benefit purposes. Under the change, only 60 per cent of gross income (from lifetime income stream products) now counts against thresholds for government benefits like the Age Pension. Furthermore, only 60 per cent of the lifetime income stream product purchase price falls under social security asset-tests from commencement until a cut-off age (currently 84): post-84 just 30 per cent of the product price will be asset-tested provided the income stream meets capital access schedule limitations.

Potentially, not all of the default RIC products will fall under the recent retirement income stream rules: some strategies addressing longevity risk may be assessed without the asset-test concession, for example, or in the same way as account-based pensions.

Super reform remains an ongoing process, too, with government flagging imminent reviews of technical components such as the minimum pension drawdown rates.

In the meantime, advisers, like everyone else, will have to wait until the final RIC law passes and new super fund products arrive before delving into the detail but they should start familiarising themselves with the concepts now.

Now, more than ever, retirees will need trusted advice to turn in the right direction once the RIC world turns up: advisers will have plenty to do – and that’s a promise.