Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 54

Pension indexation is a $300 billion question

In the past week, some of the heaviest hitters in Australian economics have addressed the impact of various policy changes on the budget deficit. Professor Ross Garnaut, former Governor of the Reserve Bank, Bernie Fraser, and former Secretary of the Treasury, Dr Ken Henry, have all spoken publicly. Ken Henry said the entire welfare system needs to be fixed, and “There will be a day of reckoning”, specifically identifying the age pension as needing attention. And Treasurer Joe Hockey is currently worrying about where the money is coming from while he frames his first budget.

I have previously suggested that reform of the age pension is likely (Cuffelinks, 21 February 2014). Age pension reform is a complex, controversial and sensitive issue. What may seem at first glance an obvious (and perhaps an easier) reform opportunity proves difficult once all issues are considered. The indexation of age pension payments is a case in point.

Background on age pension payments

Currently the full age pension fortnightly base payment for a single is $751.70, which can increase to $827.10 once supplement payments are included. Combined couple base payments are $1,133.20 ($1,246.80 with supplements).

Base pensions are indexed twice a year. The pension is increased to reflect growth in the Consumer Price Index and the Pensioner and Beneficiary Living Cost Index, whichever is higher. When wages grow more quickly than prices, the pension is increased to the wages benchmark. The wages benchmark sets the single base pension rate at a minimum of 27.8% of Male Total Average Weekly Earnings (41.8% for the combined couple rate).

Wages have grown at a faster rate than inflation, by about 1.2% pa over the last 30 years. It is likely that real wage growth will be positive and thus it will be changes in wages which drives changes to base pension rates.

Wage indexation is generous, but is it sustainable?

The Department of Social Security website states that the “Age Pension is designed to provide income support to older Australians who need it, while encouraging pensioners to maximise their overall incomes.” If income support is interpreted to mean poverty alleviation then wage indexation may appear a generous provision by the government. An argument could be made that poverty alleviation refers to a cost of living and this makes inflation a more relevant indexation reference.

Given 40% of the population are predicted to receive the full age pension at some point in their lives and 80% of the population receive the part age pension, then wage indexation will have a significant impact on the retirement outcomes of the majority of Australians. Consider the chart below where we assume that real wage growth is 1.2% pa and inflation is 2.5% pa into the future.

Chart 1: LHS: Single age pension rate growth under two indexing approaches; RHS: Real single age pension rate under wage indexation.

While, as expected, age pension payments grow faster when indexed to wage growth rather than inflation, it has a remarkable impact over time. In today’s dollars, in 30 years’ time, age pension payments would be 43% higher ($1,075 per fortnight).

What does this mean for retirees? For those on the full aged pension, real aged pension payments will be significantly larger when they are indexed by wage growth. The story for those with higher super accumulation balances is less clear as the threshold income levels also rise with wages making the age pension harder to access.

If age pension recipients are far better off under a wage indexation process then this means the government is paying out more. If we take Treasury’s forecasts (from the Intergenerational Report), age pensions will cost 3.9% of GDP in 2050 or about $60 billion in today’s terms. If we just look at those on the full age pension (which I will guess makes up 75% of the budget expense) then an estimate of the difference in age pension expenditure in 2050 due to the choice of indexation is $18 billion ($60 billion x 75% x 40%). From now until 2050, an estimate of aggregate government expenditure due to the choice of indexation method is $270 billion. That’s a large number in anyone’s books!

This is not forecast to create a huge windfall benefit for retirees (as we saw in Cuffelinks on 7 February 2014, the benefits of higher wage growth are modest for low income earners). This is because the increased age pension payments may be offset by income tax due to bracket creep. Over time tax brackets have tended to be indexed by inflation rather than wage growth and this means more people, including future full age pension recipients may actually pay income tax (this in itself is an interesting policy issue). So what the government giveth with one hand, it may taketh with the other.

The social importance of wage indexation

The Harmer Review advocates wage indexation, or ‘benchmarking’, of the age pension rate. The finding of the Harmer Pension Review was:

“The Review finds that automatic indexation of pensions and a two-part approach of benchmarking and indexation should continue. Benchmarking pensions relative to community standards should be the primary indexation factor, with indexation for changes in prices acting as a safety net over periods where price change would otherwise reduce the real value of the pension.”

The primary argument is that benchmarking maintains the relativity of the age pension to community measures of living standards, and avoids dispersion of quality of life increases between those who are working and those who are retired. Changing living standards and changing social and technological structures in society are important issues for which income is a better proxy than inflation. The example provided in the Harmer Review was computing and the internet. Most would find that computer and internet access is a near essential part of life now.

The Harmer Review is well-balanced and raises additional concerns about wage indexation:

  • In an aging society where the ratio of pensioners to workers is increasing, an age pension rate indexed to wage growth will mean that workers, via tax, will forgo an increasing proportion of their income. This would create an inequity in the other direction – pensioners maintain living standards while workers experience declining living standards (due to higher income taxes). There are obvious social and equity issues that follow from this. Any sustainability-driven approach to link pension payments to tax receipts would likely find wage indexation unsustainable.
  • Wage indexation provides a mechanism to share the benefits of productivity gains across the community. There are other claims on productivity gains, notably those that come from the workers themselves (working harder and smarter), their employers, and ultimately their shareholders if the employer is a corporate. Governments may argue for their piece of any productivity improvements as well.

Some countries have moved away from earnings to price-based indexation, arguing that the purchasing power of pensions is preserved but that fiscal constraints restrict them from providing wage indexation. Of course they could in the future provide one-off adjustments to the pension rate to improve social balance if the fiscal position permits. One positive aspect of indexation is that it is automatic and removes uncertainty and politics from pension rate determination.

Indexation of the age pension rate is a complex, controversial and sensitive area. The debate needs to balance both economic and social issues. Ultimately, given the numbers are so large (circa $300 billion over the next 30 years), I’m sure the government at some point will review indexation practices as part of its desire to bring the burgeoning budget under control.


David Bell’s independent advisory business is St Davids Rd Advisory. In July 2014, David will cease consulting and become the Chief Investment Officer at AUSCOAL Super. He is also working towards a PhD at University of NSW.


Almost there
April 30, 2014

The problem of breaking the link with wage indexation is that the Age Pension will fall as a % of AWOTE. Over time it will fall to a derisory amount and retiring will be like falling off a financial cliff. Using the example here, a pension which rises by 43% less means that it would be close to impossible for the newly retired to survive on the Pension. It would make more sense to have a lower pension as people age, eg over 75, over 85, as an alternative to lowering it for everyone. Combined with Medical Card, this could be a sensible solution.

March 21, 2014

Can't the politicians just keep borrowing endlessly in order to "keep their promises"?

Surely Australia couldn't end up like Italy or Greece with politicians demanding drastic haircuts to pensions and services because we can't pay back our debts!

March 21, 2014

While i agree a multi-year pause is 'low hanging fruit' for a budget cutback this year, one should not underestimate the howl of pain from the older demographic which knows only too well what indexing to wages is worth to them. Remember, first they stole their kids' future, and now their grandkids' ...

John Hipwell
March 21, 2014

I am part of 'the older demographic,' now 75 and at the end of my savings and super,
I am going to apply for an aged pension to see myself and partner out.
I think we are ENTITLED to that support.

If the treasurer applies a cattle prod to the (mostly tolerant),
'older demographic,' as part of his 'end of the age of entitlement' he and his boss Tony will get such a kick up the blurter their noses will bleed!!!


Leave a Comment:



Two strong themes and companies that will benefit

Why don't higher prices translate into inflation? Blame hedonism

Six suspects in the murder of inflation


Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates


$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.


Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated' investors can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.



© 2021 Morningstar, Inc. All rights reserved.

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. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). 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.

Website Development by Master Publisher.