In 1998, Michael Rice wrote a Paper for the Institute of Actuaries of Australia, The Age Pension, Our Unstable Pillar. At the time, the superannuation system was beginning to settle down after 15 dramatic years of frequent changes to the rules and taxation of occupational benefits.  However, the mandatory Superannuation Guarantee (SG) system was in its infancy and average balances at retirement were small.

Whilst Australia’s retirement income system has experienced many changes over the past 20 years, many issues with the system remain. To examine these issues, and how we could move forward with the Age Pension over the next 20 years, Michael recently published The Age Pension in the 21st Century for the Actuaries Institute’s 2018 Financial Services Forum.

The Age Pension is an important part of the superannuation system as the majority of Australians will receive it for some or all of their retirement.  It is impossible to plan for retirement without considering any entitlement to this generous benefit.

In the 1998 paper, Michael argued that several changes would be needed to Australia’s three pillar retirement income system to make it sustainable.  Many at the time held the view that SG contributions were additive to the Age Pension entitlement, yet it was already clear that the growing superannuation system would make people wealthier at retirement.

Little attention had been paid to additional costs associated with ageing, particularly the costs associated with Aged Care in the later stages of people’s lives. The settings for the Age Pension means test were (then and now) largely driven by annual fiscal considerations and short-term policy objectives.

Increasingly, superannuation benefits are supplementing or replacing the Age Pension rather than providing additional retirement income on top of Age Pension entitlements.  If a person has a full career at an SG rate of 12%, they are likely to start retirement with a part pension, or no pension at all.

Rice Warner’s modelling shows that, over time, many people will increasingly self-fund their retirement income and the proportion of the population receiving the pension will fall.  Graph 1 shows that, by 2038, only 56.6% of the eligible population will receive any Age Pension, with 29.10% on the full rate pension and 27.5% receiving a part rate pension.

Graph 1.             Projected proportion of the eligible population receiving the Age Pension, by rate of Age Pension

The cost of the Age Pension was around 2.9% of GDP 20 years ago (and the 2002 Inter-generational Report projected growth to 4.6% of GDP by 2042).

In fact, the costs have fallen on this measure.  Today, Age Pension is expenditure is around 2.7% of GDP and it will keep falling in future.  Graph 2  shows that projected expenditure on the Age Pension will fall to 2.5% of GDP by 2038.  The downward trend will continue well into the future.

Graph 2.            Projected Age Pension expenditure (% of GDP)

With falling expenditure on the Age Pension in future, it is worth considering legislating an objective of the Age Pension, in much the same way as the Government has worked to legislate for an objective of superannuation.  In legislating this objective, the Government could consider whether the Age Pension should provide a safety net in retirement or a supplementary level of income for a large proportion of retirees.  The Government could also consider areas for reforming the Age Pension to make the assistance more equitable.

The sacred family home

Given the amount of wealth held in the family home, it is a valid question to ask whether it is a distortion to remain as an exempt asset on the means test.  Until 30 years ago, the average value of a family home was about 2.5 times average annual earnings.  It is now nearer to between 8 and 12 times annual earnings, varying by State and region.  Clearly, there is a significant investment component in the family home.

The exemption from capital gains tax and death duties has distorted investment behaviour towards residential property.  It is also sobering to note that a married couple could receive welfare benefits from the Age Pension worth more than $800,000 none of which is clawed back on death.

We believe the Government should consider including part of the value of the family home into the assets test. This policy change would require a reasonably long lead time (of say 10 years) to give people coming up to retirement an opportunity to prepare.  No change would be made for existing pensioners as this would be political suicide!

Including the value of the family home at a value exceeding six times average earnings (say $500,000) would likely result in the pension becoming a safety net in retirement.  Including the value at a multiple of 10 times (about $800,000) would likely still provide the benefit to 40% or more of the population.

It is true that some of these pensioners will be asset-rich and income-poor.  They could downsize in retirement or make use of the governments Pension Loans Scheme to release equity in their home should they not want to move house.

With home ownership rates likely to decrease in the future, the Government should also consider increasing rates of rent assistance for retirees.  Currently, rent assistance is $3,505 for a single person. This is too low relative to the current rental market.

At the time of the last Intergenerational Report in 2015, government expenditure on Aged Care was projected to rise from 0.9% of GDP in 2014-15 to 1.7% of GDP in 2054-55. With the projected fall in Age Pension expenditure, the Government should consider setting a target level of assistance to the aged (combined Age Pension and Aged Care expenditure). This could be set at around 4% to 4.5% of GDP. Decisions around means testing arrangements and assistance provided would then be set in the context of this long-term, sustainable funding goal.

As was the case over the past 20 years, Australia’s Retirement Income system will no doubt undergo many changes over the next 20 years. Hopefully these changes will prioritise long-term sustainability and improve the equity of the current system. We also hope that The Age Pension in the 21^st Century provides good background material for designing a blueprint for the future of the Age Pension and the Retirement Income System in Australia.