Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 30

A fundamental flaw in the Australian retirement system?

Written by John Evans

Most Australians accept that during their working life, some earn more than others. But will they accept that the compulsory Superannuation Guarantee Levy system could deliver very different post retirement incomes to those who had similar pre-retirement incomes?

The Australian retirement system, consisting of the Age Pension, the SGL system and personal savings has one serious flaw that will only start to emerge once the system has matured in 2020.

Almost all analysis done on the retirement system uses ‘on average’ assumptions in relation to periods of contribution, investment returns, costs and period of retirement and usually concludes the system is ‘adequate’. But this analysis fails to consider that over a typical working life of 40 years, a lot can vary. In particular, all SGL contributions go into some type of investment vehicle where the member’s accumulated retirement benefit is a function of investment markets. Naturally, these include significant ‘shocks’ from time to time, such as the recent global financial crisis.

The consequence of investing SGL contributions in market-linked securities, regardless of the capabilities of the fund managers, is that workers are going to have very different retirement incomes depending on how ‘lucky’ they were in not being subjected to market shocks during their working life. My own research, conducted with colleagues, shows that even without any market shocks, the typical worker could end up with a replacement ratio (the ratio of post retirement income to pre-retirement net income) ranging from around 45% to almost 300%. With even a modest number of market shocks, this range could extend down to almost 35%, and that includes the Age Pension.

This range in post-retirement standards of living is highly likely to be viewed as unacceptable by retirees who have been forced to defer part of their income to retirement savings. This will not only create unanticipated demands for the Age Pension, but possibly social unrest.

The solution to this issue already exists and was a fundamental part of the industry fund philosophy when first established. The solution is to go back to the concept of the SGL contributions being invested in a common pool, but to credit the member account with an interest rate, much the same as occurs with bank deposits on a regular basis. The interest rates would reflect the underlying earnings of investments in the pool, but would be smoothed by creating reserves to balance the poor times with the good times.

This is not a new concept and has been practised in investment-related insurance contracts for many years. It is, of course, not perfect and if mismanaged can create problems and failures as it did with Equitable Life in the UK. But if properly managed, it can create much smoother returns to members of retirement funds and reduce the effect of market shocks and the impact of market volatility.

One of the reasons that industry funds abandoned this concept was that they were expanding very rapidly, and $100 worth of reserves at the beginning of a year had considerably less impact in smoothing returns during the year when assets doubled to $200. But industry funds are now much more mature and this issue can be managed.

The interest rate concept would create more significant financial risk for the Boards of superannuation funds, and greater financial skills would be required than are currently needed. But the result would be less volatile retirement benefits for members who are already pooling their contributions and are expecting some level of retirement income evaporation close to retirement. The regulation of superannuation funds would also need greater attention, but the regulator already has similar issues with the few remaining defined benefit funds.

A return to a more stable distribution of investment returns is socially desirable and will help to avoid the negative results of the current system. Without it, many people will find they reach retirement without much of the money that they thought they would have.

John Evans is an Associate Professor in the Australian School of Business at the University of New South Wales, and chairs several Risk & Compliance Committees for financial institutions. This article originally appeared in The Conversation.

 

RELATED ARTICLES

Getting the most from your age pension

Behavioural reasons why we ignore life annuities

Why we overlook lifetime annuities

banner

Most viewed in recent weeks

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Why we should follow Canada and cut migration

An explosion in low-skilled migration to Australia has depressed wages, killed productivity, and cut rental vacancy rates to near decades-lows. It’s time both sides of politics addressed the issue.

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Australian house price speculators: What were you thinking?

Australian housing’s 50-year boom was driven by falling rates and rising borrowing power — not rent or yield. With those drivers exhausted, future returns must reconcile with economic fundamentals. Are we ready?

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Welcome to Firstlinks Edition 627 with weekend update

This week, I got the news that my mother has dementia. It came shortly after my father received the same diagnosis. This is a meditation on getting old and my regrets in not getting my parents’ affairs in order sooner.

  • 4 September 2025

Latest Updates

Shares

Why the ASX may be more expensive than the US market

On every valuation metric, the US appears significantly more expensive than Australia. However, American companies are also much more profitable than ours, which means the ASX may be more overvalued than most think.

Economy

No one holds the government to account on spending

Government spending is out of control and there's little sign that Labor will curb it. We need enforceable rules on spending and an empowered budget office to ensure governments act responsibly with taxpayers money.

Retirement

Why a traditional retirement may be pushed back 25 years

The idea of stopping work during your sixties is a man-made concept from another age. In a world where many jobs are knowledge based and can be done from anywhere, it may no longer make much sense at all.

Shares

The quiet winners of AI competition

The tech giants are in a money-throwing contest to secure AI supremacy and may fall short of high investor expectations. The companies supplying this arms race could offer a more attractive way to play AI adoption.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Infrastructure

Renewable energy investment: gloom or boom?

ESG investing has fallen out of favour with many investors, and Trump's anti-green policies haven't helped. Yet, renewables investment is still surging, which could prove a boon for infrastructure companies.

Investing

The enduring wisdom of John Bogle in five quotes

From buying the whole market to controlling emotions, John Bogle’s legendary advice reminds investors that patience, discipline, and low costs are the keys to investment success in any market environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.