Retirement Income Review
- On 23/11/2020
The Retirement Income Review (RIR) took only ten months to provide the Treasurer with a comprehensive, lengthy, and informative Report. Four months later, it has been released without any recommendations (in the Report or from government). However, the Report makes many strong suggestions which are likely to influence government policy.
The Report is an excellent factual document which can assist to educate politicians and others, and allow us to set sound public policy, including objectives and rules for a strong retirement system. Fortunately, our superannuation system is already world-leading providing employees with strong average real returns over extended periods. The growth in superannuation balances also means our Age Pension costs are amongst the lowest in the world.
Nonetheless, our retirement system has grown in a haphazard way with Budget changes made every year since 1982. The frequent changes and lack of an overall objective hinder the making of sound long-term policy changes. In 2014, the Financial System Inquiry suggested a primary objective to provide income in retirement to substitute or supplement the Age Pension. The RIR Report expands on this and suggests the objective for the system be developed around the goal to deliver adequate standards of living in retirement in an equitable, sustainable and cohesive way.
Not surprisingly, the Report confirms that the Australian retirement income system is effective, sound and its costs are broadly sustainable. It does not need a “knockdown and rebuild”. However, major changes are needed to calibrate our retirement system to meet the proposed objective and the Report details many of these. While all the issues and concepts have been documented or debated before, it is valuable to have a compendium setting it all out for evaluation.
Broadly, the system can be improved through:
- Better tools to optimise use of retirement balances, including:
- stronger pension default structures.
- higher levels of pension drawdowns (at least in the first decade of retirement) to support higher living standards¹.
- Better use of equity in family homes to supplement retirement income, particularly at old ages.
- Better targeting of concessions with a significant reduction of tax concessions for the well-off and wealthy.
- Looking at the relevance of superannuation for low-income earners.
- Significantly improving the adequacy of living standards of single renters in retirement.
The Report argues that the current level of mandatory superannuation contributions (SG) at 9.5% should provide a reasonable income at retirement, replacing 65% to 75% of pre-retirement earnings for middle-income earners. This does require some changes to make better use of retirement assets – spending more on retirement incomes and leaving smaller bequests. It also means continuing government support for health and Aged Care benefits. Consequently, the Report suggests that the current level of SG is adequate – and this has dominated the media coverage of the Report.
The right level of SG
The initial response to the report has been to separate media, politicians and academics into polarised camps – those who support the SG rising to 12% and those who think it should be frozen at the current level of 9.5%. This debate has been a constant for the last decade and is split on ideological grounds.
In March 2012, Labor legislated for the SG to grow from its then level of 9% up to 12% gradually over the 6 years from July 2013. The first two quarter percent rises took place and the Coalition took office and has deferred future increases. The next increase of half-a-percent takes place in July next year, with 12% not being reached until 2025.
Rice Warner researched this subject 18 months ago² and concluded that a range of 10% to 15% of wages was needed. The value chosen impacts on other parts of the system. For example, the lower the level, the higher the dependency on the Age Pension in retirement.
The conclusion in the Report is based on retirement incomes growing by CPI (which maintains purchasing power) and not indexation to wages (which maintains relative economic value compared to the working population). We consider middle-income earners would want to maintain relative economic value – and this would need a higher SG rate.
Our view remains that a phased move to 12% will be beneficial for the following reasons:
- The shift from an unfunded government pension to higher levels of funded private sector superannuation is desirable.
- Capital markets will grow further, and this will support the Australian economy.
- Consumers do not often save for retirement themselves and many future retirees will want more than CPI increases in each year.
- Existing high levels of tax concessions can be cut by taxing pension earnings at 10-15% and/ or by curbing the values on large accounts. Bequests (including pension payments made in the last year of life above defined thresholds) could also be taxed at a higher rate.
- If strong earnings mean that retirees save higher replacement rates, the surplus can be used to pay for Aged Care (or taxed).
Some commentators have argued that the economic effects of the COVID pandemic preclude increasing the SG rate. We see the current economic situation as potentially changing the optimal timing and speed of an increase – for example it could move up in increments of 0.25% instead of 0.5% – but this should not be confused with changing the optimal long term level of SG.
What was not covered in the review
The Report is very comprehensive, but in the short time for delivery, it could not cover all relevant matters. Key gaps in coverage are:
- Nothing on insurance (deliberately out of scope, and possibly the subject of a separate review).
- Nothing on the impact of superannuation savings on capital markets including funding of infrastructure (strange to leave this out).
- Nothing on superannuation product design – for example, problems trying to change an Account Based Pension provider; need for advice but no cost-effective solution available.
- The modelling needs a caveat that people change status during a lifetime (marital, wealth, income, employment). Many low-income earners move up a few pegs later.
- Nothing on issues caused by policy outside the superannuation system:
- Poor investment in social housing has led to high numbers of single older (retired) women in poverty.
- Privatisation of the Aged Care system has been disastrous (see Royal Commission report on this).
- Poor tax system with no wealth taxes (all governments have ignored the Henry Tax Review) and inadequate tax on large superannuation benefits (which led the Treasurer to say he was shocked at the future growth of these).
- Sacred status of family home (no CGT; exempt from Age Pension means test) distorts our whole financial system.
We believe this is a valuable report which can assist government to focus on sound objectives, balancing the many complex factors involved. We would hope that the debate moves quickly to a proper analysis.
¹ The government recently reduced minimum withdrawal levels temporarily post-COVID, which simply holds large balances in the system for longer.