Just as the Abbott government sorely needs a coherent health policy, welfare policy and family assistance policy, it should also put time and effort in 2015 into investing in a coherent approach to retirement incomes instead of focusing narrowly on the age pension.

The budget measures are being stymied by the Senate, not because of poor communications, but because they simply do not stack up as fair and reasonable.

David Murrays FSI offers a more considered approach though it too only covers part of the retirement incomes system. Perhaps its most important contribution is Murrays simple admonition to articulate in legislation the objectives of the superannuation system, the primary one being, to provide income in retirement to substitute or supplement the age pension.

The wider retirement incomes system in fact has two objectives:

1. The alleviation of poverty amongst the aged (addressed mainly by the age pension); and
2. The maintenance of income and living standards at and through retirement (addressed mainly by superannuation).

Australias multi-pillared system (to use the language of the World Bank) has considerable strengths. Its foundation pillar, the age pension financed by general revenue, addresses poverty alleviation effectively and efficiently. Instead of a pillar one national superannuation scheme with unfunded promised benefits, we have pillar two mandated contributions and pillar three tax-encouraged voluntary savings which are mostly fully funded. In theory at least, our approach imposes less risk on governments and future taxpayers.

But there are significant weaknesses. The tax concessions for pillars 2 and 3 are very substantial and skewed to those on high incomes; the accumulated savings are not directed efficiently or effectively into retirement incomes; the transaction costs are high; and the system is very complex and places an undue burden on individuals, particularly on older people whose cognitive ability may be impaired (indeed, few financial advisers have an adequate understanding of superannuation products, tax arrangements and the means test). These weaknesses greatly overshadow those the Government has so far tried to address through its proposed age pension measures.

Murray suggests changes to tax arrangements that would address the scale and distribution of the concessions for consideration through the White Paper process. The scale of the tax expenditures may be of the order of $10 billion (using a comprehensive consumption tax benchmark) rather than the $30 billion (using the comprehensive income tax benchmark) more commonly and inappropriately used, but this is still large, and it is even more skewed to the rich.

Murrays suggestions follow the Henry Report approach: taxing contributions at individuals marginal tax rates less 20 per cent, and applying a standard (low) tax on fund earnings whether individuals are in the accumulation or de-accumulation phase.

As Murray highlights, our systems greatest weakness is in the de-accumulation phase. Too much of the accumulated savings are taken in the form of lump sums and allocated pensions, and too little in the form of annuities or other forms of longevity insurance, with the result that many retirement incomes are lower than they could be, too much is left in unplanned bequests and too many rely on the age pension for their longevity insurance.

Murray does not go as far as I would in regulating the de-accumulation phase, but he is certainly heading in the right direction. He recommends that funds be required to pre-select a comprehensive income product (which includes insurance against longevity risk) as a default option that individuals would not be required to accept. He believes that most people would accept such a product or buy some other form of insurance against longevity and not rely so much on the age pension, and that as a result they would in fact consume more in retirement knowing they are adequately insured. My own preference would be to mandate some form of deferred lifetime annuity, not only to reduce reliance on the age pension and enhance living standards in retirement, but also to limit opportunities for tax avoidance.

Murray complements these proposals by recommending the removal of regulatory obstacles to longevity insurance products and greater competition to reduce fees.

Two other aspects of the system were not within his terms of reference: pension indexation and the age pension age, the only aspects so far addressed by the Government.

The Government rightly wants to move away from indexation based on average earnings (AWOTE). This index will move faster than community incomes as the population ages. But while CPI would protect the real incomes of pensioners, it is not appropriate as the sole adjustment factor in the longer-term. This will be most obvious to all if the Government sticks to it in Februarys Inter-Generational Report: forty years of CPI-only indexation will reveal a dramatic reduction (up to a third) in the pension relative to community incomes.

There is a case for some reduction in the relative level of the pension. Rudds costly increase in 2009 following the Harmer Report (which was in response to Abbotts reckless promise of a $30 a week increase) contributed much of the sharp increase in social security outlays in recent years and crowded out much higher priority increases in assistance for the unemployed, sole parents and those in private rental accommodation.

Once appropriate relativities are in place, all social security payments need to be regularly adjusted by more than CPI to maintain them. Biennial independent reviews should be set in legislation so that appropriate adjustments are made beyond automatic CPI indexation.

The Governments proposal to increase the age pension age to 70 is over-the-top the currently legislated increase to 67 comes on top of the very cost effective measures since the 1990s to phase out wives pensions, widow class B pensions and pensions for women under 65. We do not need to press everyone to work until age 70.

As Murray demonstrates, there are much better ways to improve the retirement incomes system, and to make budgetary savings.

Andrew Podger is Professor of Public Policy at ANU. He was formerly Secretary of the Department of Health and Ageing.

This article was first published in the AFR on 6 January 2015.