Published by the Australian Financial Review, Tuesday 28 May
Treasurer Josh Frydenberg’s plan to review Australia’s retirement income system is welcome. Even though governments spend $50 billion each year on the age pension and another $30 billion on superannuation tax breaks, our retirement incomes system has never had a formal objective. To do better, we first need to set up the goalposts.
The review should start by setting the retirement living standard that the system should aim for. Retirement incomes can always be made higher – if people have lower living standards while working; or if taxpayers fund bigger super tax breaks or higher pensions. Without a clear standard, debate about the system has not balanced these alternatives.
Past governments have been reluctant to specify an adequacy target, and so the super industry has filled the void. But the one-size-fits all “comfortable”standard promoted by the Association of Superannuation Funds of Australia won’t do. A budget of $43,255 a year for homeowning singles, or $61,061 for couples might not seem generous to some, but it’s more than what most Australians have while working after covering the rent or mortgage.
We think that instead the review should define a new standard to help keep score. It would be sufficient to ensure older Australians don’t live in poverty. And it should also ensure most Australians have roughly the same living standard in retirement as they had while working. Because incomes vary, a one-size-fits-all approach cannot work.
The review should adopt the OECD’s approach, and aim for retirement incomes that are 70 per cent of pre-retirement (post-tax) incomes. This standard recognises that you can fund the same lifestyle in retirement with less than while working, because you have more time to do things for yourself and fewer expenses.
Once the goalposts are set, the review should consider whether super needs another free kick by increasing compulsory contributions from 9.5 per cent to 12 per cent of wages. Even without this wages penalty, most people across the income distribution are likely to have enough money to fund a lifestyle in retirement at least as good as they enjoyed while working. Worse, increased compulsory super contributions won’t do much to help the retirements of middle Australia – because the extra super in retirement would mostly be offset by lower pension payments.
Consequently, a retirement income review will also need to look at the age pension. It is usually enough to keep retirees out of poverty – provided they aren’t renting. But there are very real questions about the age pension means test, particularly how much pension you lose if you have more assets.
But the review will also need to think about what to do for the growing legion of Australian retirees who rent. Nearly half of retirees could be renting by 2056. And they will be much more likely to suffer poverty and financial stress than retirees who own their own homes. Increasing rent assistance is a live possibility.
And the review should think through how the retirement incomes system affects the Commonwealth’s budget. Many people believe that compulsory super will reduce the budgetary burden of an ageing population. But in fact compulsory super actually costs the budget money. Lifting compulsory super from 9.5 per cent to 12 per cent will cost taxpayers an extra $2 billion to $2.5 billion each year in super tax breaks. And these superannuation tax breaks will dwarf any budget savings on the age pension until around 2060, with the extra debt accumulated not paid back until 2100.
In thinking about retirement incomes and the budget, the review will need to consider whether the entire system is sustainable. The Parliamentary Budget Office says population ageing will add $16 billion a year to spending by 2028-29 – by then 0.3 per cent of GDP. At the same time, a shrinking proportion of retirees – now only one in six – pays any income tax. It’s not clear that the country can continue to afford to play the game this way.
The government may be tempted to ask the review to look at how the teams pick their players. Many have argued that industry funds need more independent directors, which in theory should lead to better outcomes. But experience on the field, as the Productivity Commission’s analysis showed, is that retail funds with independent directors have typically been thrashed by industry funds without them.
The review doesn’t need to rewrite the playbook on how default funds should be allocated. The Productivity Commission umpire has already taken 700 pages to blow the whistle on this question. An expert panel should select a “best in show” shortlist of default funds, using criteria including investment performance and fees. “Best in show” would improve returns as funds compete to make the shortlist and stay there. And poor-performing funds would be forced to merge or miss out on the default market entirely.
Signalling a review of the retirement incomes system is the easy part for Josh Frydenberg. Deciding what to do in response will be harder. After setting up the goalposts to keep score, and seeing which way the wind is blowing, he will have to kick a few goals of his own.