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A world-class retirement incomes policy?

Retirement usually means the loss of a regular income from working. As the need to spend does not stop, survival depends on either accumulating sufficient savings prior to retirement or relying on the social welfare system. Enter superannuation as one avenue for accumulating the required savings. The Australian government evidently did not believe that citizens were saving sufficiently for their retirement when it introduced compulsory superannuation in 1992. The government chose to provide tax subsidies which have become more generous through time. The rate of compulsory contributions has grown to 9.5% and the assets of funds now exceed $2 trillion.

Transfer of consumption from working life to retirement

Compulsory and voluntary superannuation contributions along with the age pension form the three pillars of the much-lauded Australian retirement income system. Indeed, the wisdom of our system is hardly ever questioned with any attempt to do so regarded as akin to questioning the virtues of motherhood. The view foisted on the community is that more is always better and it is essential that balances be left untouched until retirement. What is missing in this discussion is a realisation that people have to survive up to retirement as well as during retirement. Many argue superannuation is a magic pudding whereas all it is doing is substituting consumption during a household’s working life to consumption in retirement.

Is our compulsory superannuation system as good as we are led to believe?

The approach we take is to simulate the impact of the existing system for households with three disparate levels of income: Low income (20th percentile of earnings), medium income (50th percentile) and high income (80th percentile). The income is assumed to fund three different activities: consumption, taxation payments and superannuation contributions with any positive residual going into savings and any negative residual funded by a loan. The detailed information on the consumption of each of our three households comes from the HILDA Survey. The actual tax rates are applied to calculate the tax obligations and each group is assumed to allocate 10% of their earnings to superannuation. We assume households begin earning income at 25, work for 40 years (until the age of 65) and live for 20 years beyond retirement.

We run simulations to track each household’s consumption, savings and investments (including superannuation) over this 60-year period allowing for some volatility in household earnings and in investment returns. The two outcomes that we track are:

  • the present value of each household’s lifetime consumption (which we assume they would want to maximise) and
  • the probability of them running out of resources while they are still alive (which we assume they would want to avoid).

The findings show the merits of subsidised superannuation vary according to household income:

A. For low income households, compulsory super does nothing

We first run the model ignoring the age pension and also assuming that everyone rents. We find that compulsory superannuation does absolutely nothing for low income households – about 90% of them run out of funds with the average low income household being totally dependent on the social welfare system over their last 16 years.

Further, the tax subsidies are net negative for these households who would be better off investing any savings outside of superannuation. Compulsory superannuation is completely ineffectual for low income households (about a third of all households) being akin to moving deck chairs around on the Titanic making their life a bit more miserable in their early years and not even going close to funding their retirement. The age pension will always be the salvation for low income households irrespective of what is done with retirement income policy. Indeed, the age pension funds about 93% of their post-retirement consumption.

B. For high income households, tax subsidies are a gift

The findings for the high income household are the obverse. Members of this group have more than they require to meet their consumption needs during their working life and with or without compulsory contributions have a minimal probability of running out of funds. Less than 0.5% of these people will ever draw an age pension which makes minimal contribution to their post-retirement income. Compulsory contributions are again ineffectual for this group (about one-third of the population) with the exception that the tax subsidies provided represent a gift in excess of $1 million for most members of this group. Typically, this gift from the government just increases the size of their bequest and perpetuates the wide spread in the income distribution.

C. For medium income households, subsidised super makes sense

This leaves the remaining one-third of households (medium income group) whose consumption needs to leave some room for savings but not of the magnitude of high income households. Only 4% of these households totally run out of funds but 40% draw on at least a partial pension which funds approximately 20% of their post-retirement consumption. Further, the tax subsidies provided to medium income households are upwards of $200,000 which may be justified because the retirement balances of this group results in a reduced demand for the age pension. We now have a group for which subsidised compulsory superannuation may make some sense but it is questionable whether it justifies a retirement income strategy which is ineffectual for the majority of households and results in a sizable waste of taxpayers’ money.

Surviving and the impact on home ownership

There is a fourth pillar of retirement income that we have not considered – home ownership. A household that retires not owning a house cannot survive on the age pension. They will have insufficient funds to meet their consumption needs (defined as 75% of their pre-retirement consumption). Low- and medium-income households without a sizable inheritance have almost no chance of affording the deposit on a house in a major capital city. This is consistent with the rapidly falling levels of home ownership. One form of help that is spasmodically raised is to allow households to use their superannuation balances as a contribution towards the deposit required to acquire a first home. Such a proposition always results in an outcry from the industry typically based on the negative impact that this will have on their retirement savings. It is as though acquiring a house is like taking the money to the casino and gambling it away.

We find that allowing superannuation balances to be used in this way would be of little benefit to low-income households who in most cases still could not afford to enter the housing market. However, for medium-income households, it would increase the proportion who can afford to buy a house from almost zero to almost two-thirds. Further, having access to their superannuation balances is the difference in getting many high-income householders into the housing market. Assuming historical increases in housing prices persist, those who are able to acquire a house are able to increase their post-retirement consumption by a factor of two. The growth in housing prices would have to fall to 2.5% per annum before the advantages of owning a house are eroded. Other than self-interest, it is difficult to understand the industry’s resistance to allowing balances to be applied towards the deposit on a first home.

What are the policy implications of our findings?

The retirement income policy in Australia is nowhere near as good as the government and the industry would have us believe. This is largely a consequence of looking at retirement in isolation and paying no regard to the need for people to survive through their working life. Compulsory contributions are only of consequence for about one-third of households.

Low-income households should be given exemption at least during the period when they are establishing themselves and raising a family. With respect to the tax subsidies, they are pretty well a waste of taxpayers’ money. One option would be to reduce its magnitude and only make it available to those earning less than medium income on the proviso that at worse it is tax-neutral for low-income households.

Home ownership, along with the age pension, is probably the most important pillar of retirement income policy. The government should divert a significant proportion of the savings due to diminishing the existing tax subsidies to assisting low-income households to enter the housing market. Such a policy has the potential to increase the welfare of these households by around 30%.

Of course, no government would be willing to introduce such policy changes as they would be subjected to the wrath of the finance industry that would turn fund members against the government through a misinformation campaign. In the May 2016 Budget, the current government has shown its temerity to tackle such issues by only being willing to make changes to a flawed system which by their own admission will only affect the top few percent of income earners. As a consequence, the inequities remain in the system along with the huge wastage of taxpayers’ money.


Ron Bird is Emeritus Professor at the University of Technology Sydney. His long career in the private sector included head of global research for Towers Perrin and establishing the Sydney-based quantitative funds management business of GMO. The research is done with Joe Hu and Hardy Hulley of the UTS Business School.

May 14, 2016

Good point Ian, wish I was a high income earner, but then again, don't have to put up with being taxed at about %50

May 13, 2016

Always good to see another point of view - shame that this one hasn't been properly thought out. Perhaps a little more time out of the ivory tower?

The area most in need of the reform is the tax system - fix that and super would be much fairer. Lower income taxes, higher GST, eliminate payroll tax, introduce land tax and crack down on tax avoidance.

We need more savings, whether in super or otherwise as the government won't be able to afford anything like the age pension system we have now in the future. If you scrap super, individuals will waste the extra money rather than save it and governments will waste the extra taxes collected on submarines, and inefficient spending on schools, hospitals and other "feel good" schemes.

May 17, 2016

I am always surprised when people regard using one's income for consumption purposes as wasting it. I presume you are saying that funding a holiday on a cruise liner when one is working is wasting funds but funding the same cruise in retirement as being acceptable. Your response is off the main point.

May 13, 2016

High income earners effectively receive a tax "gift" of $1m? And what of the $1m tax gift an age pensioner couple receive (conservative estimate of present value of indexed age pension at age 65) funded by the taxes those same high income earners pay? High income earners have to fund two pensions: their own and someone else's!

J Barrett
May 13, 2016

Do people not save for retirement because they think either compulsory super or the pension will be there for them?

It would be interesting to compare Australian savings rates with similar countries that do not have either of the above schemes or less generous ones.

Garry Mackrell
May 13, 2016

Unless forced to,many people will not save for their retirement.Conversely,those who are prudent and save should not then be expected to be taxed later to compensate those who haven't saved.
Another aspect is that in the early years of employment when people are raising families and paying off mortgages,it seems sensible to make the burden of enforced saving lighter,but later in work life when at their earning capacity and they are empty nesters,people have much greater capacity to make lump sum contributions for utilisation when no longer working and/or health begins to deteriorate.
Final observation is that much of the current debate about "fairness", is entirely a construct of the current progressive rates of personal income tax in Australia.If we were in New Zealand ,with a much lower top rate of tax and higher rate of GST( and no capital gains tax),the debate would be much different.
The constant tinkering has now rendered the superannuation system in Australia impotent-nobody will have the confidence to put more into the system than is required by enforced contributions.This is now effectively an industrial/incomes/welfare policy ,not a national saving policy.

May 12, 2016

Not sure I like "Assuming historical increases in housing prices persist" as a basis for an analysis. If I had a clue what prices were likely to do long term I'd be much richer already, but if you base a policy on the last couple of decades high growth I fear you might be very wrong in a few year's time.

Although allowing super into the housing market might help keep the fire under prices...

Fergus Hardingham
May 12, 2016

Compulsory super or any savings program (in or outside of super) is a sound solution for many - as if not compulsory people won't do it - that without it will have nothing at retirement (including not owning a home). Housing affordability will only occur IF house (and apartment) prices fall dramatically...incomes will not catch up nor will savings.

May 17, 2016

Social welfare is about the rich helping out those more in need - taking from the rich and giving to the poor. Our retirement income policy is a Robin Hood in reverse - subsidising the wealthy to save for retirement when that is not necessary but forcing the relatively poor to save and penalising them for doing so.

May 12, 2016

The study does not combine the impacts of taxes with age pension payments. It considers the two in isolation.

May 14, 2016

The pension is considered in the context of the current tax system so I cannot understand when you say the two are considered in isolation


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