What can we expect from the Retirement Income Review?
- On 24/07/2020
Today, the Treasurer will receive the 600+ page report of the Retirement Income Review (“Review”).
The brief for the Panel is “to establish a fact base of the current retirement income system that will improve understanding of its operation and the outcomes it is delivering for Australians”. The Panel has been asked to identify:
- how the retirement income system supports Australians in retirement;
- the role of each pillar in supporting Australians through retirement;
- distributional impacts across the population and over time; and
- the impact of current policy settings on public finances.
The Panel has been instructed not to make any recommendations but to set the fact base which can then be used for public policy initiatives.
Objectives of superannuation
Surprisingly, for a system as large and important as superannuation, there is no underlying objective. Back in 2014, the Financial System Inquiry (FSI) did recommend an objective for superannuation. It simply stated the primary objective is to provide income in retirement to substitute or supplement the Age Pension. This objective was subject to wide consultation debated and then went to Parliament but lapsed last year.
Not only did this objective lapse, but our system covers far more than this. For example, it provides life insurance for most members and it has been a lifesaver with the recent Early Release Scheme – though that would have been better targeted to meeting the living expenses of unemployed Australians rather than allowing many to become day-traders!
In a discussion at the Financial Services Council recently, Senator Andrew Bragg questioned whether saving for a family home was not a more important consideration for young Australians, and he thought superannuation could provide a bigger role to raise levels of home ownership. He noted that those who rent in retirement are more likely to live in poverty.
Additionally, the Senator wanted a better outcome for the main objective since the projected numbers of people receiving the Age Pension in future years is not reducing as much as it should.
We need clarity around the purpose of superannuation beyond the FSI suggestion if superannuation is to continue to provide these ancillary benefits.
How do we pay for super?
The Henry Tax Review a decade ago recommended the Superannuation Guarantee (SG) rate stay at 9% of wages. It is scheduled to rise to 12% but there is increasing opposition to future rises.
The rate cannot be reviewed in isolation as many other factors influence lifestyles in retirement, including:
- the Age Pension eligibility – both the age it is paid (moving to 67) and the impact of the means-tests
- improving longevity (which means superannation will be spent over a longer period)
- home ownership – which provides an asset for use later in life
- investment returns, including allocation to longevity products
- spending patterns.
Further, the government stated in its terms of reference that it is important that the system allows Australians to achieve adequate retirement incomes, is fiscally sustainable and provides appropriate incentives for self-provision in retirement.
So, we want more people to be self-sufficient in retirement (which usually means having more superannuation) whilst keeping the tax support at a sustainable level.
A few years ago, two of our actuaries looked at the optimum level of SG and they concluded the rate should lie in the range 10% to 15% of wages. This is a wide range due to uncertainty about earning rates, future longevity improvements and the additional uses of the system. In Rice Warner’s submission to the Review, we noted that the current SG rate of 9.5% reduces to less than 6.4% after deduction of taxes, fees, and life insurance premiums.
When we add in Early Release Schemes, it does suggest the current legislated rate of 12% will be needed.
Making Super more Efficient
There are two ways of getting adequate retirement. The first is to increase contributions; the second is to make the system more efficient.
The Productivity Commission (PC) highlighted that the system could be far more efficient. Its central argument was to reduce the number of funds eligible to receive default (SG) contributions, so they all had scale benefits. Most people in the industry recognise that scale is important – in fact, the number of funds has been falling for 30 years. However, there is disagreement on the future structure for allocating default members.
The PC’s proposed “best in show” was flawed and is unlikely to be introduced. Instead, market forces will reduce the number of funds and they will all be bigger and much stronger than the funds existing today.
Some have suggested using the Future Fund for investments to generate lower fees and stronger performance. However, we have shown previously that several large funds (with different asset allocations) have done as well as the Future Fund despite the advantages it holds in being a pure investment vehicle. Further, the funds of the future will be much larger than the Future Fund and have lower unit costs.
There is still debate on whether to separate superannuation from workplace agreements. While the current system has created some monopolistic cash flows which reduce competition, we need to be careful about replacing it radically. For example, we don’t want to move from an efficient wholesale system back into a retail structure with high distribution costs where the potential cost savings from competition are consumed by the increased costs of marketing. As an example, electricity distribution companies have brought competition, but not reduced prices.
Also, we do not want to destroy the security of cashflows which permit funds to invest long term and take advantage of the illiquidity premium to boost returns. There is an argument that the current structure is restrictive, but the growth of SMSFs provides a valid outlet for those who want to manage their own money more closely. We expect the Review will comment on this critical component of our system.
Will the Review bring change?
The Review should provide information that will help us think about optimising the future.
We expect it will highlight areas of strengths and weaknesses. There will be much to ponder and no doubt more legislation to follow. Let us hope that politicians and the industry focus on the critical matters that will make our world-leading system even stronger.