Variations in personal circumstances show that a uniform rate of SG cannot be effective in targeting adequacy for all. However, we must choose a suitable rate – one that provides adequacy for most while not being excessively generous to too many.
In addition to the rate of SG, there are other levers which can be used to keep the system fair. These include thresholds and tax rates.
Our modelling demonstrates that without the Age Pension, Australians would need an SG of between15 and 20 per cent to provide them with an adequate retirement income. We recognise that the Age Pension will continue to be an integral part of the retirement income system for many Australians, but it could be better targeted.
The availability of the Age Pension reduces the required level of SG for adequacy and protects against longevity risks. Current policy with an SG rising to 12 per cent as legislated would provide most Australians with an adequate retirement income and allow for some reforms to the Age Pension when the system matures.
An ideal setting for the SG should be in the range of 10 to15 per cent if we allow for the Age Pension. It can be shown that a higher level will provide a more comfortable retirement 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. An SG below 10 per cent 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 that is about to be legislated. 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. The high real rates of return earned by the industry over 30 years has led to higher than expected retirement benefits, which flows to improved retirement adequacy.
If these trends were to continue, a lower rate of SG might achieve the same target outcome. However, this cannot be guaranteed, and it is better to have caps and tax in retirement to moderate such windfalls, if they were to occur.
The SG has generated several positive outcomes, including:
- Growth of Australia’s pool of capital markets. Superannuation assets are already over 150 per cent of GDP and are expected to peak at about 190 per cent in the 2040s. This pool has been useful in providing capital for infrastructure and venture capital. As the system matures, super funds will invest greater amounts outside Australia, so we will export capital.
- In a world where those with capital earn strong real returns, we can experience growing inequality. The SG system together with a strong allocation to equity-style investments means that most Australians share in the economy’s growth and moderate this trend of inequality.
- Forced savings have led to higher living standards in retirement. Analysis of the earnings of the Australian superannuation system shows that these are much higher than those which would be achieved on voluntary savings. Individuals save less efficiently as they would typically not invest as aggressively as professional trustees who can leverage their scale and are better at balancing the risk of negative returns against the long-term nature of the investment.
Without the SG, most Australians would not save enough for retirement due to behavioural biases in economic decision making. Our modelling shows that the current policy of increasing superannuation to 12 per cent would lift total superannuation savings when the system reaches maturity in over 80 years’ time, by about 15 per cent relative to freezing the SG at 9.5 per cent.
The achievement of an adequate retirement income is driven by the SG but many other factors play an important if not greater role:
- High real rates of return mean that adequacy can be reached at lower contribution rates. In fact, the majority of a retiree’s income will be derived from earnings rather than contributions.
- The potential for future changes to the means test for the Age Pension.
- Fees and insurance premiums. These can erode balances, leading to lower retirement balances (a 1 per cent fee can reduce the balance by 20 per cent over 30 years).
- Tax settings. These change frequently and influence net contributions, so the effective rate of contribution can be varied (in aggregate or by income) without changing the level of the SG.
The system objective should be for simplicity and certainty in the levels of both SG and Age Pension. This would rebuild confidence in the community that their retirement system works and would help them plan to build an adequate retirement income.
The Government can use means testing and thresholds for tax concessions to achieve broader objectives of equity, to ensure the system remains fair, and to ensure the system manage its own costs.
We argue that the SG should be set at a level to provide for an adequate retirement income for most Australians (including recourse to the Age Pension, for up to 60 per cent of the population).
On this basis, the theoretical range of the SG would fall to 10 to 15 per cent. The actual level needed depends on the other factors discussed above. If the SG was left at the current 9.5 per cent the Age Pension, rather than the SG, would be the primary source of income for most Australians.
The current policy target level of 12 per cent is not only within this range but can be well targeted by adjusting concessions and thresholds to tax and the Age Pension.
At this level, the Age Pension cost as a percentage of GDP would fall and allow the Government to divert the savings to other needs such as aged care. The higher SG also grows capital markets which is highly beneficial to the broader economy. We would recommend that the legislated increase go ahead as planned.
This article is an extract from a presentation by Michael Rice and Nathan Bonarius of Rice Warner at the Actuaries Summit. The authors thanked Susie Lu and Aanand Patel for helping prepare the analysis. Peer review was done by Alun Stevens.