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

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Latest Updates

Investment strategies

Trump's US dollar assault is fuelling CBA's rise

Australian-based investors have been perplexed by the steep rise in CBA's share price But it's becoming clear that US funds are buying into our largest bank as a hedge against potential QE and further falls in the US dollar.

Investment strategies

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Property

Soaring house prices may be locking people into marriages

Soaring house prices are deepening Australia's cost of living crisis - and possibly distorting marriage decisions. New research links unexpected price changes to whether couples separate or silently struggle together.

Investment strategies

Google is facing 'the innovator's dilemma'

Artificial intelligence is forcing Google to rethink search - and its future. As usage shifts and rivals close in, will it adapt in time, or become a cautionary tale of disrupted disruptors?

Investment strategies

Study supports what many suspected about passive investing

The surge in passive investing doesn’t just mirror the market—it shapes it, often amplifying the rise of the largest firms and creating new risks and opportunities. For investors, understanding these effects is essential.

Property

Should we dump stamp duties for land taxes?

Economists have long flagged the idea of swapping property taxes for land taxes for fairness and equity reasons. This looks at why what seems fairer may not deliver the outcomes that we expect.

Investing

Being human means being a bad investor

Many of the behaviours that have made humans such a successful species also make it difficult for us to be good, long-term investors. The key to better decision making is to understand what makes us human and adapt.

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.