The priority for retirement incomes policy is to ensure that retirement savings are used efficiently to generate an adequate income. Until this occurs, there should be no change in the legislated increases in the compulsory superannuation guarantee contribution rate.
Why superannuation contributions are compulsory
The purpose of superannuation is to generate an adequate income for families in their retirement. Adequacy means the income should be sufficient to allow each family to enjoy the same standard of living as they experienced immediately prior to their retirement. Furthermore, because living costs are normally lower in retirement, the evidence suggests that for most people their retirement income stream should be about 65-75% of their pre-retirement income.
Where Australia differs from other countries is that since 1992, under the superannuation guarantee (SG), all employees have been required to help support their retirement incomes by making compulsory contributions into their own personal superannuation accounts.
The current SG contribution rate is 9.5%, but it is legislated to increase over the next five years to 12% by 2025, starting with a 0.5% increase in July. The target of 12% was chosen because this was believed at the time to represent the contribution rate consistent with ensuring an adequate retirement income.
SG contributions were made compulsory because, as the Government’s recent Review of Retirement Incomes makes clear, ‘many people would not save enough voluntarily for their retirement on their own’.
Opposition to a further increase in the compulsory SG rate
Another key finding of the Review of Retirement Incomes was that most retirees could have an adequate income with an SG contribution rate of only 9.5%, defined as 65-75% of their pre-retirement income. This finding is, however, subject to an important qualification – it depends upon retirees fully drawing down their retirement savings and using them efficiently (see more below).
Not surprisingly, perhaps, several members of the Government parties have ignored the critical qualification about the efficient use of savings and have used the Review’s finding about potential adequacy to argue against any further increase in the rate of compulsory SG contributions.
Originally these opponents of an increase in the SG contribution rate called for the legislation to be changed so as to abandon any further increase in the 9.5% contribution rate.
In addition, those opposing further increases in the contribution rate argued that the evidence suggests that as much as 80% of the superannuation contribution comes out of the employee’s wages. They argued that the economy could ill-afford a lower rate of wage increase.
But supporters of compulsory superannuation never accepted that superannuation comes at a cost to employees’ current earnings; notwithstanding that this was a requirement initially. Instead, supporters of an increase in the SG rate have argued that foregoing future increases would amount to an unwarranted saving to employers and would not come at a cost to the current income of employees.
Now most recently, in response to this assertion, the Government members opposing further superannuation contribution rate increases have amended their proposal. They think that a more viable way to achieve their objective would be to allow workers to voluntarily opt-out and instead receive an extra 0.5% as direct income.
That way there would be no possibility of a saving to employers. It also has the apparent attraction of allowing workers to decide what is the best way to use their own money, now or later, and not leave that decision to an outside regulator.
Ensuring an adequate retirement income
The decision of whether or not to increase the SG contribution rate should be based on an assessment of what is needed to ensure an adequate retirement income, which is, after all, the fundamental purpose of superannuation.
Understandably, the Government members opposing a further increase have interpreted the Review’s finding about the adequacy of retirement savings as justification for their proposal that any increases in superannuation contributions should only be voluntary. After all, there is no point in making people sacrifice their present living standard to finance a higher living standard in retirement.
As already noted, however, the Review’s finding that the present SG contribution rate is adequate depends critically upon the assumption that people will efficiently draw down all their savings in retirement. More specifically, the modelling by the Review assumes that “retirees will run down their superannuation assets by age 92”. “It is also assumed that they will not leave bequests and will purchase a longevity product at retirement that provides them with an income from age 92.”
One can debate whether this is an optimal way for retirees to use their savings, but in any event, these assumptions are not valid at present. Instead, as the Review found: “Most retirees die with the bulk of their wealth intact.”
Necessary reforms to ensure an adequate retirement income
Given that retirees’ savings are not fully drawn down and used efficiently, it equally follows that unless this situation changes, the present SG contribution rate of 9.5% will not be sufficient to guarantee an adequate retirement income for most retirees.
Accordingly, any move to freeze the compulsory rate at 9.5% should be dependent on first addressing the reasons retirees typically do not use their savings efficiently to support their income. These reasons include:
- The complexity of the system, which discourages running down capital in retirement and makes it difficult for retirees to plan ahead
- The risks of unforeseen health and aged care costs, and of possibly outliving savings
- The lack of suitable investments that would generate an assured income stream akin to a pension
In brief, the required reforms that would respond to these problems include:
- Requiring superannuation funds to provide regular estimates of an individual’s retirement savings expressed in terms of an income stream rather than a balance at retirement. This should help people make better decisions about the use of those retirement savings.
- Amending and possibly increasing minimum drawdown rates so that income is delivered earlier in retirement when people are more likely to consume it. Current drawdown rates are higher at ages 85-91.
- Ensuring the availability of products that deliver an adequate income stream and provide protection against market fluctuations and outliving savings. Following the 2014 Financial Systems Inquiry, the Government did support the recommendation that superannuation funds be required to offer ‘Comprehensive Income Products for Retirement (CIPRs), which would help meet this need. But little has happened since. The Government needs to clarify what CIPRs should look like and, if necessary, be prepared to make available indexed annuities itself.
- Given that half a typical retiree’s wealth is represented by their home, increasing the availability of reverse mortgages would allow retirees to tap that source of potential income and/or help meet their aged care needs.
Conclusion
The fundamental purpose of superannuation is to provide adequate retirement incomes, not to finance bequests.
The debate about superannuation policy has focused almost exclusively on the accumulation of retirement savings. This was understandable when those savings were very small. But now that they are much larger, the policy focus should switch to ways to ensure those retirement savings are used effectively.
Furthermore, the Retirement Incomes Review found that these reforms “Assisting retirees to use existing assets more efficiently, and draw down their assets in retirement, can have a bigger impact on improving retirement incomes than changes to the SG rate”.
Reforms to promote the efficient use of retirement savings should clearly be the priority and not fiddling with the SG rate. Indeed, these reforms are so important that no change should be made to the legislation governing the SG rate in advance of clear and substantial progress in improving the use of superannuation and other retirement savings.
Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations. He is presently a visiting fellow at the Australian National University.
Comments
6 responses to “Fundamental purpose of superannuation is to provide adequate retirement incomes, not finance bequests”
The 65-75% replacement is more rule of thumb than evidence based. If you tally up changed expenditure needs (no work expenses, extra health expenses) you can easily have a 100% replacement rate requirement. Nonetheless, people are generally happy with less, which is probably more about social norms for reduced consumption in old age (which might change).
I agree with your analysis, but I would add reform of aged care financing to the list of required reforms. Given that a large fraction of people don’t need aged care, but are nonetheless concerned about it, stronger social insurance in this area will make it easier for people to increase their consumption in retirement.
‘Superannuation isn’t a retirement income system – we should scrap it’. This excellent article, by DR Cameron Murray, was published last year in the Conversation, 5 Feb 2020. The many startling statistics shows what a lunatic system we have built and what potential benefits are foregone by the present cost! Worth a ‘google’ for sure.
February 5, 2020 5.59am AEDT
Thanks for that Colin. How is it that virtually everyone, even on the ‘progressive’ side, thinks that Australia’s Compulsory Super system is PJK’s greatest achievement, and virtually no-one calls it out for the massive disaster it really is?
I would suggest that by far the majority of people in a superannuation scheme have not the slightest idea, and often no particular interest, in how these schemes work. And as the Hayes Royal Commission has demonstrated, that as a result our financial institutions have rorted the system to their hearts content (and now seem to be re-encouraged to continue those practices by the LNP which is apparently refusing to implement most of the commission’s recommendations). As Michael Keating rightly points out the superannuation scheme is to fund one’s own retirement, not to provide a bequest to the children (just check this with the other Keating).
The matter of superannuation is by definition a very complex matter. I read up on what the CIPR is meant to be. From what I read on the internet I feel as confused and ignorant as I was before. As far as the stated premise that super is spent “wisely” is concerned, it seems a meaningless condition to me. People spend it the way they deem appropriate. Whether it is appropriate in other peoples eyes is immaterial.
Such matters were previously argued and developed by a competent public service, submitted with full reasoning to its political masters, who then (would) discuss this with the relevant parties “on the other side of the house” to come to a nationally accepted frame work. After all this should be a national consensus rather than a partisan project.
Unfortunately, now that much of the public service doesn’t provide much “frank and fearless” advice anymore because of its politicisation but often panders to ideological requirements, it is difficult to see how such a complex issue can be resolved to the benefit of ALL Australians.
Nevertheless, this issue is of vital importance to Australia’s future economic wellbeing, because of the increasing pool of retired people.
Michael, your suggestions are clearly based on deep knowledge, and would certainly improve the super system.
Yet I can’t help disagreeing with your fundamental premise: “Adequacy means the income should be sufficient to allow each family to enjoy the same standard of living as they experienced immediately prior to their retirement”.
That’s not the retirement income system I want for this country. I want a system which says to people who have spent little or no time as employees (because they were sick, disabled, unpaid carers or chronically unemployed), “You didn’t have much money so far during your life, but in this wealthy egalitarian country we are at least going to ensure you have a comfortable old age”. And I want a system which says to the wealthy, “Put away as much savings as you like, but you’re on a good wicket, so rather than give you ‘special’ tax treatment, we’re going to tax you hard”.
Like Evan, I simply can’t understand why we don’t just use adequate taxation to reduce inequality and provide adequately in old age (if not earlier) for everyone. The only possible answer can be that it doesn’t suit the rentiers – and boy has the super system generated plenty of them!
That adequacy in retirement seems to presume home ownership – increasingly not the case. And also accepts ongoing inequality because related to income.
I’m for changing capital gains concessions and funding an adequate pension.