Fix the means test for a consumer-friendly retirement income system

Sep 9, 2021
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Australia’s retirement income system needs reform to make it more secure and user friendly.

While there is much to be said about the soundness of Australia’s emerging retirement income system, it is not at all user-friendly, failing to provide the guidance Australians need to ensure the adequate and secure retirement incomes the system is meant to provide.

Much of the recent public debate has been about the adequacy of the incomes the system will generate, particularly whether the superannuation guarantee (SG, now 10 per cent) is sufficient or needs to continue to increase. Too little attention has been given to the need for retirement incomes to be secure as well as adequate – helping people to manage risks including how long they will live, inflation, market fluctuations and changes in government policies; and too little also to reducing the system’s complexity so people can plan their retirement with confidence and obtain the income products most suited to their circumstances.

Critical to making the system more secure and user-friendly is to fix the age pension means test and the way it interacts with superannuation. When the system matures, around 60 per cent of Australians can still expect to be eligible for some age pension in addition to their superannuation. Other user-friendly measures needed include ensuring funds offer their members retirement income products the trustees consider to be in the members’ best interests, taking into account any likely age pension entitlement.

The Academy of the Social Sciences in Australia (ASSA) and the Tax and Transfers Policy Institute (TTPI) at ANU recently released a report by Robert Breunig and myself with our own conclusions and recommendations drawing from a roundtable of experts held in March to discuss last December’s Callaghan Retirement Income Review (RIR).

While the RIR rightly implied that the emphasis for future reform should be on the pensions phase, not the accumulation phase that has been the main focus for the last three decades, it understated the importance of security for retirees, presented an unrealistic ‘optimal’ drawdown of accumulated savings in retirement and offered insufficient guidance on how best to achieve coherence between superannuation and the age pension which is vital to help people plan their retirement with confidence.

The TTPI/ASSA report refers to the broad agreement amongst those at the roundtable on some of the directions for further reform:

  • the emphasis should now be on the pensions phase;
  • the system should be presented to people in terms of the incomes they can expect to receive in retirement rather than the amount of their accumulated savings;
  • addressing the serious problem of cohesion (particularly between superannuation and the age pension) so people can plan their retirement with confidence;
  • addressing the gaps that remain in the safety net provided by the age pension; and
  • more consistent treatment of savings and assets for tax and means test purposes.

Breunig and I identify five priorities that need to be addressed in the short term.

First, to legislate the objective of the retirement income system, building security into the formulation along with adequacy, equity, cohesion and sustainability as proposed by the RIR.

Second, to require funds to present members’ current and expected accumulated savings in the form of the retirement income they can be expected to fund, and to offer their members ASIC-approved ways to estimate any age pension they may be entitled to when they retire.

Third, to finalise the covenant proposed by the government two years ago that would require funds to offer default products the trustees consider to be in retired members’ best interests. The covenant will also need supporting APRA guidance.

Fourth, and particularly important as it has yet to attract serious attention by the government or the opposition, a merged means test which converts assets into equivalent retirement income streams and offers a more appropriate balancing of the costs from saving that people bear while working and the net benefits they receive from that saving when they retire. That is, still concentrating pension support on those most in need, but ensuring appropriate rewards for saving.

Finally, increasing rent assistance and Newstart, at least for older unemployed people.

These measures would address gaps in the system while also greatly helping people to understand how the system affects them so that they can plan their retirement with much more confidence.

People need to be confident about the age pension rules, now and into the future, so they can make sensible decisions about how much they save (the SG is designed to be sufficient only for those on median earnings or below and many people, particularly women, spend time not in paid employment so not accumulating SG savings) and about how best to use their savings when they retire. Few people have any idea whether their accumulated savings are really going to be enough or not, or how best to use them including to make sensible provision for uncertainties including about future government policies.

Replacing our unique, and uniquely complicated, income and assets tests with a simple merged means test would greatly assist, particularly if it had bipartisan support, with the parameters firmly locked in and not subject as now to continual policy changes. The key element would be the conversion factor. A fixed, standard factor based on lifetime annuity values would be consistent with the expectation that retirees fully draw down their superannuation savings; it would also avoid the current practice of constantly changing deeming rates. The income equivalent asset value would then be added to any other income and the existing tapered income test applied. The separate assets test would no longer be needed.

This suggestion is not new. We had a merged means test in the 1960s with a conversion factor of 10 per cent based on the then value of an indexed lifetime annuity. Given increased life expectancy, a slightly lower conversion rate would be appropriate today. A single income-based means test was also recommended in the 2010 Henry Tax Review.

As explained in the TTPI/ASSA report, such a test would effectively soften the current harsh assets test taper – which around 30 per cent of retirees are likely to face in the future – while still concentrating the pension on those in most need. The winners and losers, and the costs, from such a change would depend on the conversion rate chosen and the thresholds set, but these could be kept modest and, with phasing in, avoid immediate adverse impacts.

Additional measures to make the means test more certain, and hence to allow people to be more confident about their own retirement planning, include adjusting the assets and income thresholds under the test in the same way as the pension is indexed (i.e. to wage movements). For example, the income test free areas could be set at 25 per cent of the prevailing maximum rates of pension.

The above agenda would also allow reassessment of the most appropriate rate of the SG. It is not possible to determine the appropriate rate with confidence until several of these matters are settled, particularly the pension means test. Breunig and I suspect the appropriate rate will lie between 10 and 12 per cent. So there would be advantage if the government, and the opposition, considered the detailed suggestions in the TTPI/ASSA report to simplify the means test before the next scheduled increase in the SG.

While the above agenda warrants early attention to greatly improve our retirement income system, Breunig and I also identify some further reforms for serious consideration over the medium to longer term:

  • More consistent taxing of savings even if it is accepted (as we do) that superannuation warrants slightly different treatment (indeed, superannuation is not severely undertaxed at present despite what the RIR and some others suggest, nor are the concessions as skewed to those in higher incomes);
  • The inclusion, with appropriate thresholds, of owner-occupied housing in the pension means test (a start might be made by more explicit inclusion of the home in the aged care means test arrangements); and
  • A modest estate duty.

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