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How a sidecar can keep super motoring along

The COVID-19 pandemic highlighted that we live in an uncertain world where our financial position and lifestyle can change quickly. Of course, these changes can be caused by many events including unemployment, sickness or an unexpected financial shock, such as a medical bill or home repairs.

Many Australian households live from one pay packet to the next, with no savings that are easily accessible for emergencies. In such circumstances, it is not surprising they need to borrow funds, often through their credit card, and so can begin a debt spiral with significant long-term consequences.

Is there a better way?

Trials in the UK and the US are developing an emergency savings account linked to the individual’s superannuation or pension account. The idea is simple.

Behavioural economists discuss the concept of mental accounting. That is, we have different buckets of money for different purposes. Unfortunately, many households have only two buckets – the immediate bucket for today’s needs and the longer-term bucket for their retirement through superannuation.

What’s missing is the emergency savings account representing a third bucket, which has funds available to respond to those unexpected costs.

An important feature of these 'rainy day' accounts is that they are not as easily available as cash in the bank. They are slightly different and so there needs to be another step in the process. For example, millions of Australians accessed some of their superannuation in 2020 by applying through the Tax Office. A similar process could work with these accounts.

This emergency financial buffer is likely to provide many households with improved wellbeing as they know that some funds are available, if and when the money is needed. Without access to such funds, these unexpected and costly events can lead to additional adverse outcomes such as mental stress, relationship issues or reduced productivity at work due to the individual’s financial concerns.

An important question related to savings, highlighted by the pandemic, is what is the best balance between short term and longer term savings? This is a current policy debate around the world and there is no 'correct' answer. However, a binary answer of either the 'now' or the “longer term” is not the best solution for many households. There is need for some middle ground.

Further, behavioural science has repeatedly demonstrated the power of defaults. That is, a good outcome happens without the need for a personal decision.

As noted above, these emergency saving accounts are now being developed overseas. So, how might Australia do it?

Another use of the SG increase

One approach would be to direct some of the increase in the Superannuation Guarantee (SG) planned for 2021-2025 into an individual’s emergency savings account. Call it a sidecar, if you like, operated by the individual’s super fund.

The emergency savings account would be invested for the shorter term, say in a typical conservative fund, whereas the existing retirement account would continue to be invested for the longer term, say in a balance fund. Individuals would be able to access their savings account at any time, subject to a minimum withdrawal of $1,000, and no questions would be asked about reasons for the withdrawal, which could also include housing costs.

For example, let’s assume an individual is earning $80,000 pa and the increase in the SG from 10% to 12% (i.e. 2% of their income) is saved through the sidecar account. At the end of the year, this would represent at least $1,600 ignoring earnings. Even allowing for a 15% tax on withdrawal, this would provide them with available funds of $1,360.

Individuals, who wish to save these additional contributions for the longer term could transfer funds from their savings account to their retirement account at any time. However it would then be subject to the standard rules and preservation that apply to superannuation. A cap could also be applied to the savings account to ensure that significant investment income was not lost.

Of course, the tax treatment of the withdrawals would need to be considered to make sure there is no tax avoidance. However an application through the ATO using existing technology would make this feasible with a tax rate on withdrawal linked to the individual’s marginal tax rate (which is known by the ATO) less the 15% tax already paid on concessional contributions.

The concept of a second account in the pension system is not new and would not be unique to Australia. Singapore's Central Provident Fund has three accounts (or buckets) for different purposes. Its experience is that the savings account is often left unused during the working years and is subsequently available to increase the retirement benefit. It's a win-win; some cash is available during the working years, but otherwise, the savings are invested for retirement.

The introduction of this 'superannuation sidecar account' will require imagination, political will, industry commitment and clear communication. But it’s worth it for the benefit of our community.

We'll achieve greater flexibility for individuals and households and ensure more Australians can save for their future.

 

Dr David Knox is a Senior Partner at Mercer. See www.mercer.com.au. This article is general information and not investment advice, and does not consider the circumstances of any person.

 

10 Comments
Kruno Majcen
April 14, 2021

This might actually work if people were sensible but people are not sensible, far from it. Lots of people are financially responsible and keep that sidecar buffer in their savings account themselves or many do in an offset account.

But then you have the other side of the story, the people that would withdraw funds at the first possible opportunity every single time and these are the people that this incentive is trying to protect. The people who are not financially responsible or just not able to save due to their circumstances.

Unfortunately, this will not work because it's forcing people to save and it would be handed out too easy.

What we need is financial literacy for everyone. If people understood the detrimental effects of bad debt, the power of compounding returns and the safety of homeownership, then these discussions would be held at barbecues and family dinners. Right now talking about finances is taboo for most families.

Ramani
April 03, 2021

David's idea taps into many fuzzy concepts our mechanical regime misses: the unpredictability of the average cascading into individual levels, changing health, relationship and left-field 'unknown unknowns'; the human frailty of taking credit for favourable developments due to one's brilliance while blaming adversities on others including governments.
A worthwhile tip, but it should be improved by also looking at the demand side. Excessive focus on materialistic possessions, keeping up with the Joneses regardless of needs and the necessary flexibility to cull wants unrelated to retirement well-being.
The retirement cart cannot only be pulled by the supply-side horse!

Kym Bailey
April 01, 2021

Given how difficult super is, this has no chance of floating. It would require yet another condition of release, for a start.
As to suggesting the returns would be better than out of super, really, what trustee would invest this pool in anything more than very short dated cash?
This is another reason the build out the purpose of super into something that is meaningful and able to be readily interpreted.
(Suggestions such as this are in the same category as the FHSSS - a feel good but impractical and just about useless.)
The reality is that the nirvana of "comfortable retirement" is not possible for everyone via super. It is after all a function of what goes in. Covid early super release showed us what people really think about saving for retirement.
In my view people should be incentivised to add extra - like the public servants! Sure that was around defined benefits augmentation but it certainly incentivised. Surely there could be some clever idea to encourage more folks to put savings into super. At the end of the day, those that can, will, those that don't want to won't.
Employers carry a share and fundamentally SGC is a great idea - terribly constructed and in dire need of a re-write of the legislation - but in principle, a wage trade-off. I think enough has been asked of employers, for now.

Peter K
April 04, 2021

"Covid early super release showed us what people really think about saving for retirement."
A very worthy statement that governments need to take notice of.

Before such releases are allowed, a persons whole financial situation needs to be assessed. Just because someone has lost their job should not automatically entitle them to access super. The 'cash at bank', partners income etc, needs to be taken into account in their capacity to survive (with some 'belt-tightening if possible).
If they claim a need to pay a mortgage, pay school fees or put food on the table etc, then money should be directly paid to the mortgage provider, to the school or for food and essentials to their bank account on a monthly basis and not as a lump sum.
It will cause extra administrative burden, but sometimes is necessary to protect people from their short sightedness.

Billy Bloggs
April 01, 2021

Personally I don't see why we can't have a "super offset account" like there is with mortgages. That way you can tap into it at will, but only on "post-tax" money so there won't be any tax benefit by doing so. The major advantage is you'll have greater leverage with your super gains without the downside of it being locked away. Perhaps there would need to be a relatively low cap, say $100,000-250,000, perhaps this could adjust with age. The major downside I see is that banks will struggle to have capital to lend. Crazy idea?

Dean
April 01, 2021

Novel idea David, but do we run the risk of our super funds becoming leaky buckets with sidecars for rainy days, a health one, maybe a tertiary education fee one, etc? Hasn’t this been one of the design faults of the US system where 401k plans have leaked in these ways, to the detriment of longer term retirement saving?

David Knox
April 01, 2021

Gary M, that would certainly be an option and your super fund would then put all your contributions into a preserved account = no sidecar for you.

Steve
April 01, 2021

Great idea. We have 3-4 months living expenses earning very little at bank for emergency buffer. Would be great to get Super level returns, and then to move into main super when it increased past a desired number of months.

SMSF Trustee
April 01, 2021

Steve, you're dreaming! Earning super returns on money that may need to be available at the drop of a hat without any risk that the amount has been reduced by a market downturn is NOT going to earn Super returns.

As David Knox says in the article, the sidecar would be invested conservatively.

Gary M
April 01, 2021

Neat idea for some but no more complications for me. Please give me a box to tick that leaves my super vehicle in one place without a sidecar. I won't need emergency money.

 

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