Mandatory superannuation contributions have grown from the original 3% Award contributions of the 1980s to 9.5% and are legislated to get to 12% in 2025.  Yet, there has been little comprehensive analysis of the right level of Superannuation Guarantee (SG) contributions, nor any strategic work on the impact on the economy and member retirement outcomes.  As the level of SG has not been based on any target, there is no consensus on the right level of contribution rate.

The government has several levers available to support adequacy in retirement.  These include the level and availability of the Age Pension, the level of SG contributions, and tax concessions and other incentives for voluntary contributions.  Collectively, these provide a pathway, but the behaviour of people also contributes – adequacy improves for those who invest in growth assets over a full career, retire later and make regular extra contributions.  Those who plan properly will be able to withdraw more in the earlier active years of retirement without the fear of running out of money before they die.

The SG is closely linked to the value of the Age Pension.  Even though many of those retiring today have not had mandatory superannuation for their full careers, they have higher average benefits than any previous generation.  This has reduced pressure on Age Pension costs and our forecasts show that these will continue to fall in future years when expressed as a percentage of GDP.

Nonetheless, there are conflicting views on whether the SG has been set at the right level.  There are some who believe it should be frozen at 9.5%.  For example, the Grattan Institute has urged government to freeze the SG at its current level on the grounds that:

…the current plan to increase compulsory superannuation payments from 9.5 per cent to 12 per cent, would force workers to accept lower living standards today even though they are already likely to enjoy living standards in retirement comparable to living standards while working[1].

We disagree that increasing the SG will lead to lower living standards.  When previous increases were made, real wage rises still occurred.  While wage growth does not currently exceed inflation to the same extent as the last two decades, it is still higher, suggesting that small incremental increases to the SG can continue to be made.

Setting the right target

To have retirement adequacy without any Age Pension, the SG rate would need to be set at 15% to 20% of salary.  However, the government pension provides a significant part of the income for most retirees, so its value needs to be considered.  In fact, the primary objective of the superannuation system is to provide income in retirement to substitute or supplement the Age Pension.

This objective is broad, and it does not deal with adequacy.  Intuitively, the rate of SG should be set at a level where, over a full career, it provides enough superannuation which, together with the Age Pension, provides a comfortable (but not extravagant) retirement for most Australians.

Ideally, we should have a system where the disadvantaged (perhaps 15-20% of the retired population) should be supported by social security.  This includes the Age Pension, rental assistance, subsidised health care and access to dignified aged care late in life.

The next cohort (perhaps 35-40% of the population) should be partly self-sufficient through the SG and any private wealth they hold.  However, the Age Pension will supplement their retirement income, particularly late in life.

The wealthier retirees (perhaps 40-50% of the population) should be self-sufficient in retirement.  They will make use of voluntary contributions and other wealth to achieve this.

Setting the level of SG

We recognise that the Age Pension will continue to be an integral part of the retirement income system for many Australians.  Its availability reduces the required level of SG for adequacy and protects against longevity risks.

An SG below 10% would result in median income earners relying on the Age Pension for most of their retirement income.  While this would provide a comfortable living standard for middle-income Australians under many scenarios, it’s not a desirable result if we want people to be self-sufficient in retirement.  It does not meet the primary objective of the superannuation system.  Further, many people living on a full Age Pension (particularly renters) are living in poverty, indicating that the Age Pension by itself is not enough today and will not be in future.

An ideal setting for the SG should, in conjunction with the Age Pension, will provide broad adequacy across the population.  The rate is higher than 10% but less than the 15% needed in a system without an Age Pension.  A higher level will provide a more comfortable lifestyle for a greater number of retirees.  However, higher levels will also require adjustments to tax and contribution thresholds in order to moderate the benefit for those in the top income deciles.

Consequently, current policy (with the SG rising to 12% as legislated) would provide most Australians with an adequate retirement income and allow for some reforms to the Age Pension when the system matures.

Graph 1 summarises these results and demonstrates how the Age Pension on the current policy would still be the dominant source of retirement income for most Australians.  The Graph shows averages only and utilises ideal assumptions around the optimisation of drawdowns, savings patterns and retirement (for example, full career, retire at 67, use all assets by life expectancy).   While the improvement from a 10% SG to the current policy looks small in overall retirement incomes, this largely reflects the tapering of the means test which we consider to be too steep.

A Paper presented by two of our actuaries (Nathan Bonarius and Michael Rice) to the Actuaries Summit in Sydney on 3 June explores the sensitivities around these outcomes in depth.

Graph 1.            Adequacy attainment by level of SG – single person, 50^th income decile, with Age Pension

The high real rates of return earned by the industry over 30 years have led to higher than expected retirement benefits, which flows to improved retirement adequacy.  If these outcomes were to continue, a lower rate of SG might achieve the same target outcome.  However, this cannot be guaranteed, and it is better to pre-fund reasonable retirement benefits to avoid increasing taxes to pay the unfunded costs in future.

[1] Grattan’s Orange Book prepared for the 2019 Federal Election

A full copy of the paper presented to the Actuaries Institute can be found below: