Minimum drawdown requirement – a double-edged sword in a time of crisis

When markets and the value of investment portfolios fall, retirees can suffer the most. As they are no longer working, it’s hard for them to make up such losses to their capital. Depending on their age, they also may not have time to wait for markets and their investment portfolio to rebound.

On the other hand, because in the retirement phase they are required to draw down a minimum percentage as a pension each year, retirees not totally reliant on this for income can find themselves forced to sell assets into a falling market—thus making a loss on their superannuation investment—to generate income they may not even need.

Minimum drawdown rules exist to enforce the purpose of our super system – to provide income in retirement. They require retirees with super in account-based, allocated and market-linked pensions to withdraw a minimum amount of their super each year, based on their age. Without minimum drawdowns, the super system could be used by wealthier Australians who don’t really need a pension for a comfortable retirement to pass on tax-advantaged super savings to their heirs.

Why have minimum drawdown percentages been changed?

As a result of the COVID-19 pandemic, the Federal Government announced that the minimum pension drawdown rates would be temporarily halved for the 2019/20 and 2020/21 financial years. The Government did the same after the GFC, acknowledging how such crises hurt markets and therefore investment portfolios. If the drawdown rules force members to sell investment assets when prices are very low, a lot of these “paper” losses to super portfolios crystallise.

The Government’s temporary changes to the minimum drawdown percentages, therefore, mean that retirees with enough cash flow to ride out the pandemic will not be forced to sell assets, thereby preserving more of their capital, which means better returns when markets eventually rebound.

Those without sufficient non-super income to meet their living expenses (that is, without drawing down) can still withdraw on the pre-COVID-19 maximum drawdown amounts, despite the less than ideal consequences.

Normal and temporary percentage for minimum super drawdowns:

Age of beneficiary Temporary percentage Normal percentage
Under 65 2% 4%
65-74 2.5% 5%
75-79 3% 6%
80-84 3.5% 7%
85-89 4.5% 9%
90-94 5.5% 11%
95 or more 7% 14%

Early access to super offsetting lower minimum drawdowns

Halving drawdown minimums also helps preserve liquidity, the ability of funds to meet sudden redemptions or portfolio switches.

Human behaviour often puts pressure on liquidity in a crisis and so markets tend to overreact to the likes of COVID-19, pushing prices below their fundamental or intrinsic value. Ideally, investors will recognise that markets rebound eventually and staying invested is likely to deliver the best long-term outcome. History, however, tells us many investors panic, acting contrary to their own interest by selling out at potentially the worst possible time.

This is what investment managers usually see during a crisis, including those in superannuation who often see an increase in members switching from growth options that are high in equities to defensive options with lower returns such as cash and/or fixed interest. A flight from equities can hurt a fund’s liquidity.

In the current crisis, liquidity has also been tested by the Government’s initiative that allows early access to super for Australians financially hard hit by the pandemic. Fund members who are Australian citizens or permanent residents who meet certain criteria (Australian Taxation Office; Early Access to Super) can access up to $10,000 until 30 June 2020, and up to a further $10,000 from 1 July 2020 to 24 September 2020. Temporary residents can access up to $10,000 until 30 June 2020 only.

While the reduction in minimum drawdown percentages is keeping funds in super that would otherwise have been withdrawn, increased switching and/or redemptions from members combined with the COVID-19 early access scheme is a balancing act for superannuation fund investment managers.

The experience for super funds

The member profile of an individual fund is the biggest predictor of how it has been—and will continue to be—affected by these changes.

According to Allan Murphy, General Manager at BOC Super, which has a small number of allocated pensions, the Government measures have not significantly affected the fund’s cash flow. Initially there was a brief flurry of members moving from growth to defensive assets, but this stabilised quickly. However, whether the early access to super will be significant remains to be seen.

Murphy says that half of his 3,200 members are BOC employees, who haven’t lost their jobs during COVID-19. The other half are ex-employees who may be in a different financial position.

The question of liquidity, however, isn’t keeping Allan up at night – the potential amount of early access withdrawals as a percentage of BOC Super’s overall funds is very low. Even if every eligible member takes up early access, it will not hurt liquidity in the fund, said Allan.

What is concerning is the effect on our economy of economic disaster elsewhere in the world, such as where management of the virus and its economic consequences may not have been as well managed. If the fallout in the US, for example, is larger and more prolonged than expected, this will affect our economy for some years.

Christian Super CEO Ross Piper manages super for over 30,000 members from all sectors and geographies across Australia. With a less homogenous membership than BOC Super, it is harder to predict what individual members will do. Piper says that so far investor behaviour is being driven by a “flight to safety” mentality, and this has led to increased switching to defensive assets. He sees this crisis as different, being health-based, with a more intense and sudden fallout than during the GFC.

Nevertheless, Piper stresses fund liquidity is safe. Even in a worst-case scenario with maximum levels of switching, redemptions, and early access, Christian Super can comfortably meet redemption demand. The change to drawdown rules is very good news for those retirees able to stay invested, as this is the best way to ensure long-term performance outcomes.

plus ça change…

No crisis is the same, although funds can still learn from others when dealing with the COVID-19 challenges. The economic fallout will be substantial, even if the massive Government economic preservation packages have been significantly helpful. Ultimately, however, history tells us that there will be recovery. As the French saying goes, “the more things change, the more they stay the same.”

That’s good news for superannuation fund members who can stay invested during the immediate fallout. Super funds should emphasise the long-term nature of superannuation – and must engage thoughtfully, transparently, and honestly with members about decisions which affect their portfolios.