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Lump sum love affair
Australians have always had a fondness for a lump sum at retirement.

Super is really a series of life choices but the continuing appeal of the lump sum is perhaps puzzling given recent years of market volatility.

Stand back from your own super portfolio and consider the choice: would you rather a lump sum of money that then becomes your responsibility to invest to provide your income in retirement or would it perhaps make more sense to buy a guaranteed income stream with your super balance?

Professor Susan Thorp from the University of Technology in Sydney has been conducting a research project into the choices people nearing retirement have - and whether they choose to take a lump sum or buy an income product.

Speaking at the Association of Superannuation Funds of Australian annual conference in Brisbane this week she says that currently around 50 percent of people take a lump sum when they retire. But of the remaining 50 percent who opt for an income stream product 45 percent choose an allocated pension which is a market-linked portfolio with no guarantee of income. Only 5 percent take out annuity products where there is some level of certainty of income payments.

Given that the entire purpose of superannuation savings is to provide an income in retirement it seems out of kilter that so few people are prepared to exchange their pot of super money for a guaranteed income stream.
ASFA also released new survey data at the conference into community attitudes around superannuation. It also highlighted the mixed views about the desirability of annuity-type income streams in retirement.

Two out of five respondents were not interested in the concept of annuity that was tested. Only around a quarter found the concept attractive, with about 30 per cent not having a view.

Even more surprisingly with increasing age came a fall in preference for annuities.

Clearly a number of factors are at work here. First is that the notion of handing over your life savings to an institution to provide an income stream is not an appealing concept to many and - as the global financial crisis proved - even large financial institutions can collapse so in the absence of some form of government guarantee this is not a risk-free exercise.

But probably the main reason life-time annuities are not having broader appeal is that the return levels are relatively unattractive and when that is combined with the loss of control over capital it is not hard to see why annuities are not winning popularity contests.

For good reason much of the focus on superannuation for the past 20 years has been on getting contribution rates up and addressing the issue of savings adequacy at the time of retirement.

But the issue of income style products is rapidly becoming the next big challenge for the super system.

Market volatility has given investors a harsh lesson in terms of market returns - and in particular the absence of certainty about future income streams.

Life-time annuities may not be the answer because they are expensive products to offer given the long-term liabilities involved. Indeed no one product is likely to deliver a magic fix.

But some combination of term certain or variable annuities with more sophisticated fixed interest products like inflation-linked bonds combined with exposure to traditional growth assets may provide investors - and their advisers - with a greater range of options that deliver greater levels of certainty around income for people retiring in the future.

By Robin Bowerman
Smart Investing
Principal & Head of Retail, Vanguard Investments Australia

11th November 2011