Superannuation: how much do we need to save?

Aug 26, 2020

A hot political issue is whether to proceed with the legislated increase in superannuation contributions from 9.5 to 10 per cent next July. There are pros and cons but if the superannuation increase is further postponed, there should be an offsetting increase in the minimum wage.

Credit – Unsplash

Compulsory superannuation was introduced by the Keating Labor Government in 1992. Before that only senior executives and government employees had access to superannuation. Most of the workforce had to rely on the age pension to provide their retirement income, which typically resulted in a significant decline in their living standards.

The contribution rate for the new compulsory superannuation guarantee scheme was deliberately set at a low 3% of earnings. This low rate was adopted so as not to impose too big a burden on employers, thereby risking higher unemployment, and ensure employees didn’t absorb the cost of superannuation by getting much less pay.

Originally Labor wanted to reach a 12% contribution rate by 2020. But the Coalition has always been hostile to this initiative, and after it was elected the Abbott Government put this date back to 2025. Now, perhaps not surprisingly in the middle of a Covid-induced recession, the same issues are emerging again.

Numerous Coalition back-benchers are calling for the next increase in the contribution rate from the current 9.5% to 10% next July to be postponed. Some are also querying whether there is any need to ever increase superannuation contributions above the present 9.5%. The Government so far seems to be hedging its bets and not clearly stating a position one way or another.

To my mind there are two issues:

1. What level of contribution would be consistent with the objective of smoothing disposable income over a person’s life to maintain their living standards over that time?

2. How will an increase in superannuation contributions affect the economy?

What contribution rate is needed to maintain living standards

The reason a contribution rate of 12% was chosen in 1992 as the long-term goal was because that figure was believed to be consistent with enabling people to maintain their living standard in retirement. Recent modelling by the Grattan Institute has queried this assumption.

According to the Grattan Institute, a living standard in retirement consistent with a person’s pre-retirement level can be achieved with the present 9.5%rate. Indeed, it would be better not to depress current living standards if an increase allowed people to live better in retirement than when they were working.

But of course, everything depends upon the modelling, and the superannuation industry has disputed Grattan’s modelling. Two critical assumptions that are debateable are:

· The likely rate of return on superannuation savings in future

· What savings balance does a retiree need to maintain to protect against the risks of increased care costs if they become more frail and/or living longer than expected?

Grattan assumes a normal rate of return on the investment of super funds based upon past experience. However, interest rates are now very low, with the yield on invested savings also at record lows. How long this will last is uncertain, but it could well be longer than currently expected, in which case people may need to save more to achieve their retirement income goals.

Second, Grattan assumes that reserving 10% of a person’s superannuation savings would be adequate to guard against the possible increase in caring costs. However, the evidence strongly suggests that most retirees are much more risk averse than this. Consequently, they retain much bigger superannuation balances than Grattan has assumed to guard against these risks.

If the government were to make life-time annuities readily available, this would allow retirees to operate with smaller superannuation balances. If these were indexed, then many of the risks that retirees presently self-insure against would be taken over by the government. However, the cost of a life-time guarantee is not cheap, and so while the availability of such an investment vehicle would reduce the size of savings needed, more would still be required than Grattan has assumed.

Ideally the Treasury Retirement Income Review, which the Government is sitting on, will have examined these issues more authoritatively, and that could provide the basis for determining the end-goal for the contribution rate. However, for the time being, there is no good case for changing the goal from the legislated 12% contribution rate.

When should the superannuation contribution rate increase to 10 per cent

The opposition to proceeding with the July increase to 10% seems to be based on the argument that while it is in recession the economy cannot afford this increase.

While the superannuation contribution is initially paid by the employer, it depends upon the state of the economy and market forces as to whether the cost of any increase comes out of a person’s wages, from profits or is passed on to customers in higher prices.

The conservative forces opposing the increase argue that it will mostly come out of wages, which will damage already low demand.  On the other hand, as the unions and Paul Keating have pointed out, there is no guarantee that if workers postponed or even permanently lost the expected increase, that they would receive a wage increase now.

Indeed, in the six years since the Coalition first postponed the expected increase in the contribution rate, the real wage rate per hour has increased at an average annual rate of just 0.4%. In contrast, labour productivity has increased twice as much at an average annual rate of 0.9%. Thus, experience shows that pre-Covid, wage increases lagged productivity growth, profits benefited disproportionately, and that employers should be able to afford to pay the 2021 July increase in superannuation as promised.

Nevertheless, if the Government is again determined to postpone the promised increase, then in good faith it should take steps to ensure that wage increases make up the difference. Of course, that is easier said than done.

A good starting place would be for the Government to support an increase in the minimum wage equivalent to the cost of the foregone increase in superannuation. That extra increase would likely flow through to a lot of other wages, which given depressed household demand, would further help economic recovery.

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