The Mercer Global Pension Index rates the Australian retirement income system as number three in the world. Nevertheless, the Government has commissioned an independent Review, and this article and another tomorrow discuss whether and how our retirement income system might be improved.
In Australia the retirement income system. is based on three so-called “pillars”:
· A means-tested age pension
· Compulsory superannuation, and
· Voluntary savings, including home ownership.
The assessment of retirement incomes systems normally has regard to how they satisfy the following four key principles (that the Review also proposes to use):
• Adequacy – whether the system allows for Australians to achieve an adequate standard of living in retirement.
• Equity – whether the system produces fair outcomes for different groups of Australians.
• Sustainability – whether the system is able to continue to meet its objectives into the future and maintain broad community support.
• Cohesion – whether the incentives across the system reinforce or conflict with the system’s objectives both before and during retirement.
There is of course some tension between these four principles – most obviously between adequacy and sustainability – and policy must therefore decide on what are the most desirable trade-offs.
In what follows I will discuss the most significant aspects of each of these principles, and where I think changes could be made. As I think “adequacy” is the most important principle that the retirement incomes system needs to satisfy, this will be discussed at somewhat greater length today, and I will discuss the other three principles in a further article tomorrow.
The purpose of a retirement incomes system is to provide an adequate income in retirement to support the continuation of the retiree’s lifestyle. Any government assistance should therefore not be used to provide an inheritance or for some other similar purpose.
The Review canvases a number of measures of the adequacy of retirement incomes, but the one that is normally used is to set a benchmark replacement rate that would allow a retiree to maintain a similar lifestyle in retirement to that enjoyed pre-retirement.
On this basis the OECD has recommended a replacement income benchmark of 70 per cent of pre-retirement income. The reason why this replacement benchmark is less than 100 per cent is because the costs of living are usually less in retirement, although it is debatable how much less.
For example, one problem with setting a uniform replacement rate benchmark is that the expenditure needs of people with different previous incomes tend to differ. Thus while, a 70 per cent benchmark may be reasonable for the majority of households, it appears to be more than is necessary for the top quintile of retirees, and less than is needed by retirees in the bottom third of the income distribution.
Most importantly, income needs in retirement will vary enormously according to whether or not the retiree owns their own home, and whether or not that home still has a mortgage when they retire. Furthermore, the proportion of retirees who do not fully own their home is expected to rise, as rates of home ownership are falling and the numbers of people retiring with a mortgage is also increasing.
The Grattan Institute has argued compellingly, however, that it would be more efficient and cost less to increase rental assistance to low-income retirees than to aim for a higher retirement income replacement rate benchmark for all retirees.
How adequate is Australia’s present retirement income system?
In Australia low income retirees are relatively well off compared to other countries, with Australia’s minimum age pension being the fourth highest in the OECD relative to average full-time adult gross earnings.
For those workers seeking more than a minimum income, modelling of future retirement incomes by the Grattan Institute finds that on present policies, “the average worker today can expect a retirement income of at least 89 per cent of their pre-retirement income – well above the 70 per cent benchmark”.
Obviously it is not desirable that compulsory superannuation forces workers to reduce their present living standards and save more than they will need in their retirement. Accordingly, the Grattan Institute and some politicians have opposed increasing the rate of workers’ superannuation contributions from the present 9.5 per cent of their earnings to 12 per cent by 1 July 2025, as presently legislated.
On the other hand, the Grattan Institute’s finding that Australian retirement income system is programmed to eventually exceed the 70 per cent replacement income benchmark is by no means agreed. For example, other modelling by Industry Super has found that the increase in the superannuation contribution rate to 12 per cent of earnings will be necessary to meet the 70 per cent benchmark.
The difficulty in choosing between these contending modelling results, on which significant policy decisions depend, is that any measure of the replacement rate benchmark of adequacy is significantly influenced by the model’s underlying assumptions. Some of the more important assumptions include issues such as career paths and associated earnings, the expected future yields on superannuation investments (which may well be lower than in the past), the appropriate time periods to be used, the expected rate of increase in national earnings and living standards, rates of spending in retirement, including most importantly on housing, the amount of non-superannuation savings, and retirement age and longevity.
Unfortunately, the Review’s Consultation paper provides no indication of what the Review thinks would be the best assumptions to use, and therefore the Review at this stage is totally silent on whether Australia’s retirement income system provides adequate incomes for retirees.
It seems to me that the Review would be well advised to provide a further discussion paper, or a Green Paper, setting out its position on what retirement incomes are likely to result from the present system. If the Review is to have any useful purpose then I think it should arbitrate this key question regarding what rate of superannuation contributions is necessary to generate adequate retirement incomes.
But until that information is produced by the Review, there is no good case for changing the existing policy to increase the rate of compulsory superannuation contributions from the present 9.5 per cent to 12 per cent over the next few years.
Women in retirement
Much of the discussion so far has focussed on the incomes which males can expect in retirement. That may not matter too much if retirees are married and share their incomes. However, the situation for single female retirees is different, and they are increasing proportion of the total.
The reality is that as recently as 2015-16, females’ superannuation balances at age 60-64 were not much more than half of males. There are several causes of this, but the biggest is that women have lower lifetime earnings.
Consequently the best solution would not necessarily involve changes to the retirement incomes system, but rather changes to pay and conditions during womens’ working lives. It is also important that the superannuation rights of women are fully protected in the event of marriage breakdown.
Drawing-down superannuation balances in retirement
A final big concern about the adequacy of Australia’s retirement income system is what Australians do and can do with their superannuation after they retire. As already stated if retirees are going to have an adequate income they need to draw down on their superannuation balances to provide a steady income stream over the remainder of their lives.
Thus, ideally at that time they retire and can access their superannuation, they would invest much or all the proceeds of their superannuation balance in an annuity which would guarantee them a regular weekly income for the rest of their life.
That would remove many of the risks that superannuants presently face regarding the adequacy of their future income. Furthermore, those risks may be why many superannuants do not take full advantage of their superannuation savings in their retirement, and actually die with quite large superannuation balances remaining.
However, the take-up of such annuities in Australia is very low with less than 5 per cent of retirees’ superannuation balances. Whether that is because of unwillingness by retirees to buy annuities, or because of the limited range and/or promotion of suitable annuity products, is also something that the Review should pursue.
Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.