Retirees and their advisers may need to plan alternative cash flow streams in the post-pandemic era as banks hit the pause button on dividends and traditional income planning strategies go awry.
Last week NAB cut its dividend by 64 per cent, while ANZ and Westpac deferred theirs after mortgage pullbacks, record low rates and huge remediation bills contributed to 51 per cent and 64 per cent (respective) profit slumps.
For retirees used to chasing dividends it’s a painful reminder that these are ultimately discretionary. Lingering uncertainty around the viability of franking credits only serves to reinforce sentiment that when it comes to retirement income, there are no sacred cows any more.
According to BMIS founder Brad Matthews, stopping clients from “fixating” on income-producing shares over those that focus on capital growth is the first step in reshaping the investor mindset.
“There’s certainly a need to re-educate clients who view income over capital growth as having more value,” Matthews says. “Rationally, you should be ambivalent as to whether you get income or growth in a tax-free retirement environment; from a wealth creation perspective it doesn’t make a difference,” he says.
Australian investors have historically shared a somewhat myopic love for blue-chip companies that pay generous dividends gilded by imputation credits. Advisers have done their best to spread the diversification message, but many still put income on a pedestal.
“I’ve had a number of prospective new clients in the last three weeks contact me because their strategy has been to hold term deposits and the banks,’ says adviser Richard Jackson. “That strategy is still pretty common.”
Getting clients to shake their income bias, Jackson believes, should go hand in hand with getting them to embrace a “total return” focus that embraces both sides of the income/growth coin.
“CSL is the classic example in Australia,” he explains, referring to the Australian biotech known for funnelling returns back into the company instead of paying large dividends. “It’s a low-dividend share that’s delivered great capital growth over the years.”
As Jackson explains, however, the tough part is selling people on the idea that divesting assets for cashflow is just as valid as chasing dividends.
“Harvesting growth is a legitimate way to generate income, and it doesn’t mean your sacrificing the sacred cow,” he says.
The annuity aversion
While annuities provide the most obvious alternative to dividend-based income streams they have always faced an uphill battle in Australia, which is probably due to cultural and market factors in equal measure.
Retirees haven’t embraced annuities here like they have in the US and the UK, so the market is thin. APRA reported the proportion of total pension member benefits paid out as annuities in Australia was 3 per cent in 2019, while account based and allocated pensions combined for around 83 per cent of benefits paid.
That may change, however, as the products improve.
“A deferred lifetime annuity can help with income,” says Centrepoint investment chief, Miriam Herold. “Previously they were quite inflexible with penalties for exiting earlier but there have been some improvements in exiting and around estate planning in an effort to modernise them.”
Allianz Retire+ CEO Matthew Rady is aware of the concerns, especially around annuity exits. As a provider of “annuity-type” products, he acknowledges they “aren’t for everyone”. He does note, however, that the provider doesn’t make a margin on exits and penalties only cover the cost of breaking the contract.
On the improvements to product, Rady gives the example of variable index annuities, which give capped exposure to the upside of equities markets without the downside. “We’re positioning that type of exposure as an alternative to a term deposit,” he says, noting that the newer, more innovative retirement income products are now “getting attention”.
Getting more of that attention may depend on overcoming an aversion to being ‘locked in’. However, in times of fierce uncertainty the prospect of securing an income could become increasingly attractive.
According to recent research from Melbourne Business School, people are just as interested in annuities as they are in traditional drawdown options. Senior Research Fellow Teagan Altschwager says account-based pensions lead the market “simply by default or out of ignorance, rather than actual preference”.
It’s not that Australian’s dislike annuities, she says.
“It may be better to describe attitudes as ‘Australians don’t hate annuities, they just hate making complicated choices’,” Altschwager adds, indicating that the key might lie in simpler products and better marketing.
Susan Bryant, an adviser and Founder of Seeds of Advice in Queensland, says annuities could be particularly attractive for retirees who can afford to set money aside. “You still need access to other capital because, y’know… life,” she says.
Bryant also notes the benefits of annuities for people with dementia so funds are “ringfenced” from those with nefarious intent. “That’s a growing scourge,” she adds.
Annuities do have one other critical mountain to climb, however; many are pegged to historically low interest rates that are forecast to remain for some time.
“I don’t know that annuities are better able to generate acceptable levels of income because they have the same challenges – fundamentally low interest rates and returns,” says Matthews. “It’s no silver bullet.
Outside the box
Of course, there are alternatives to dividend-based shares that don’t involve annuities.
Centrepoint’s Herold suggests blending traditional income focused strategies with managed funds that generate income in other ways, such as strategies that use derivatives.
“These generate income by writing options, with the option premia being a strong and predictable source of income,” Herold explains.
Providers will be quick to add alternative income producing products to the market. The challenge for advisers will be balancing these with the viability of the existing strategies, while the danger will be overcommitting.
“It’s important not to overact to what might be a temporary change in dividend levels,” Mathews warns. “What happens over the next 12 months might not be representative of the future and doesn’t necessarily predicate wholesale change.”