Are you planning to support yourself over a 30-year or even 40-year retirement or do you think Australia can afford to finance your retirement? The superannuation industry and the Federal Government continues to grapple with this issue, that is, whether Australia will continue to be in a position to look after its citizens or whether we will all need to modify our expectations.
Successive Federal Governments have made it clear that the Age Pension will always be available but an ageing and growing population means that Australia cannot continue supporting Australians at the same level without reviewing and altering the country’s revenue base, or reducing spending.
In the 1960s, the average period for receiving a government age pension was six years, among OECD (Organisation for Economic Co-operation and Development) countries, reflecting lower life expectancies. In the future, the average period for claiming a government age pension is expected to be between 30 and 40 years, which will place huge financial pressure on a country’s finances. OECD members are predominantly European nations, although Australia, Japan, Korea, Mexico and the United States of America are also members.
The average life expectancy for Australians at age 65 is nearly 22 years for a female, and 18.5 years for a male. The longer you live the better your average life expectancy becomes. For example, if you reach the average life expectancy that you had at 65, that is, you reach the age of 87 for a female, and 83.5 years for a male, then you can expect to live another 6 or so years. The average life expectancy for an Australian female aged 87 is 6.11 years (reaching the age of 93), and for a male aged 83.5 years, roughly 6.5 years (reaching the age of 90). If you retire before the age of 65, and many Australians do, then you can expect a potential retirement of more than 30 years. I provide the average life expectancy for all ages in the article Life expectancy: Will you outlive your retirement savings?
Will Australia run out of money?
Around one-third of all Federal Government spending is devoted to Centrelink payments such as unemployment benefits, parenting payments and the Age Pension. According to the Department of Treasury, the increased demand for health and aged care spending by an ageing population, and more specifically, the increasing demand for the latest medical technology and procedures, plus other public spending demands such as Centrelink payments, means that Australia could run out of financial steam within 40 years, if we continue on our merry way. According to the 2010 Intergenerational Report (IGR), unless action is taken, we can expect that by 2050 Australia will be spending more than it receives in revenue by 2.75% of gross domestic product (GDP). Removing the impact of the recent economic stimulus package, which was a temporary spending splurge, the Federal Government believes the factors set out below are the key to reversing this gap between Australia’s spending and earning:
- Enhancing productivity growth (producing more output with proportionately fewer workers, by improving skills, giving access to training and investing in infrastructure)
- Improving workforce participation (in particular increasing participation by older workers and women)
- Managing the costs of an ageing population, including health reform
- Tackling the costs of climate change
- Implementing pension reform (specifically Age Pension reform).
The hard fact that we all have to face is that the proportion of Australia’s population of traditional working age will nearly halve within 40 years which means there will be fewer workers financing the Age Pension and health costs of the retired and other non-working Australians. According to the IGR, the number of people of working age to support every person aged 65 years and over is projected to decline to 2.7 people by 2050 (compared with 5 people now). Around quarter of all Australians will be aged 65 or over by 2050.
Europe increases pension age
Funding an ageing population is clearly not only an Australian dilemma. The Global Financial Crisis (GFC) has forced the hand of many European nations in tackling the funding dilemma caused by an ageing population. Here’s a sample of how countries in Europe are dealing with long-life pensions:
- France: Raising the retirement age from 60 to 62 by 2018
- Greece: Considering boosting average retirement age from 60 to 63, and requiring 40 years of work (rather than 37) for full pension
- Russia: Considering lifting the retirement age by 5 years: from 55 to 60 for women, and from 60 to 65 for men. Apparently, the average life expectancy for men in Russia is only 59 years! In effect, eliminating the age pension for at least half of all Russian men.
- Germany: In 2007, raised the pension age from 65 to 67
- Ireland: Increased the public service pension age from 65 to 66
- United Kingdom: Increasing the state pension age from 65 to 66 by 2020, from 66 to 67 by 2036 (but considering bringing forward to 2026), and from 67 to 68 by 2046 (but considering bringing forward to 2036)
A case study: Italy
In October 2003, millions of Italians went on strike for half a day protesting the Italian government’s plans to increase the retirement age to ease the financial pressure on Italy’s pension system. At the time, an Italian worker must have paid into the country’s pension system for 35 years before retiring at a minimum age of 57. The strike was to no avail. The Italian government raised the age for entitlement to a full pension to 60 rather than 57 (effective since 2008), and increased the years of contributing to the system to 40 years, from 35. The age for entitlement under the contribution rules has since increased to 62, and from 2050 will rise to 65 years and 4 months. Entitlement to the Italian pension is also available to men aged 65 or over, and women aged 60 or over, provided they have contributed for at least 20 years. Anyone who has contributed for 40 years can retire at any age. The Italian pension system apparently costs the country about 15 per cent of gross domestic product, which is set to increase even more with an ageing population and longer life expectancies. By 2040, Italy will have 96 pensioners for every 100 workers!
How is Australia tackling the costs of living longer?
In many ways, Australia is fortunate that it has relatively developed retirement policies. Australia’s Retirement Income Policy has three limbs that the Federal Government hopes can raise everyone’s standard of living beyond relying solely on the Age Pension:
- Safety net. The Age Pension provides a taxpayer-funded basic retirement income for those people who can’t fully support themselves. The single rate Age Pension is set to at least 25 per cent of Male Total Average Weekly Earnings. The Age Pension age is currently age 65 (and 64 for women) and is increasing in six-month increments to age 67 for those born after a certain date. For more information see the article Take note: Age Pension increasing to 67 years.
- Super for everyone (SG). Superannuation Guarantee (SG) is the official term for compulsory super contributions made by employers on behalf of their employees. More than 90 per cent of employees receive SG, which is considered a minimum level of super and not necessarily enough to provide a comfortable retirement, especially if you enjoy the good life. Your employer must contribute the equivalent of 9 per cent of your salary, although SG started at 3 per cent of salary in 1992 and rose to 9 per cent from 1 July 2002. The Federal Government has announced that SG is set to increase to 12% by July 2019, although the successful implementation of this policy is uncertain with the ALP running a minority government. For more information about the proposed SG increase see the article Superannuation Guarantee set to jump 33%
- Top-up option with voluntary savings. You can make voluntary super contributions or have savings outside of super to boost your retirement kitty. Super is a tax-effective option for most Australians because the Government taxes super at a concessional rate and you pay a rate of tax that is less than what you would ordinarily pay on income you receive during the year. The Government gives self-employed people and others the opportunity to claim tax deductions when they make contributions.
The Federal Government is very keen for Aussies to boost their retirement savings by making their own super contributions. In 2003, the Government introduced one of its more innovative policies called the super co-contribution scheme. The Government puts extra money in your super account if you make voluntary super contributions. For more information about the co-contribution scheme see the article Cashing in on the co-contribution rules (2011/2012). Australia’s three-tiered retirement income system is often described as international best practice. Australia has a safety net for those unable to, or who have chosen not to, save for their retirement. We have a compulsory superannuation system that eventually will take some pressure off the taxpayer-funded Age Pension, and the message is slowly getting through that the easiest way to a financially stress-free retirement is saving more; either in your super or outside of your super.
Major policy gap in Australia’s super system
Australia is better placed than many other countries to support its citizens in retirement but a glaring omission from Australia’s retirement income policy is the complete lack of focus on outcomes – specifically, Australians need a tailored ‘target’ retirement income, and in turn a target lump sum to be saving towards, and a product or other type of mechanism that can deliver Australians a regular income in retirement. The only healthy private pension ‘market’ in Australia exists in the self-managed super fund (SMSF) world. The private sector (read all super funds and financial organisations) have dropped the ball in this area, and the Government and other policy makers don’t appear to have the knowledge, skills or experience to help Australians make the transition from working life to retired life in a financially fit state. The country is relying on financial advisers to deliver this outcome and 80% of these advisers are paid by selling products (via commissions) rather than by providing financial advice, although the world of commissions will change from July 2012 when a prospective ban on upfront and trailing commissions on all retail investment products takes effect. Apart from the ongoing issue of commission-based advice, I believe there are four main reasons for this glaring lack of strategic policy (and implementation) in such an important area:
- Nearly all senior public servants and parliamentarians are members of a defined benefit super scheme (guaranteed income stream for life) and they personally don’t have to worry about funding their own retirement via a pension product, a SMSF, or via non-super investments. In turn, the issue of running out of retirement savings only becomes an issue for politicians and policy-makers if it means more Australians end up claiming the Age Pension.
- For the past 20 years or so, Australian super funds have only been focused on securing market share (read attracting more members) and trumpeting investment returns and why they’re better than the other super funds. Until recently, virtually no super funds have seriously thought about how fund members will convert retirement savings into a primary or secondary source of income when they finish work. Pension products have been an afterthought, and continue to be an afterthought, although the recently introduced account-based pension (introduced in 2007) is a reasonably flexible product, which many super funds now offer to members, but few funds help members through the maze of combining super payments with Age Pension entitlements.
- The pathological hatred of SMSFs by some sectors of the superannuation industry has blinded those sectors as to what attracts individuals to SMSFs. The SMSF sector has the most sophisticated pension offering in the market because each SMSF pension is completely tailored to the uniqRetirement planning in six stepsue needs of the individual fund member.
- The super industry is full of very talented specialists but very few industry players have a grasp on the total general picture for super fund members – investment, tax, Age Pension, longevity, estate planning, risk management and income generation techniques. The most significant flaw in the composition of the superannuation industry is that very few individuals are investors (fund managers are traders not investors) and as a consequence, the super industry doesn’t appreciate the issues facing retirees when trying to manage investments and deliver an income when they stop working.
This skill-based and experiential flaw within the super industry has become more obvious in the aftermath of the GFC. Since the GFC, there has been a renewed interest in creating a retirement product that offers a guaranteed income for the life of the investor/retiree. Historically, this product is known as an annuity but due to the cost of such products they have experienced limited take-up. Financial organisations however are now developing more flexible annuity-style products. I explain annuities in the article Peace of mind, at a cost: 10 things to know about annuities. Annuities have a role but such products are not the solution because we need to tackle the problem from the start rather than from the end of the process. The biggest challenge for the government and for Australia’s future financial health is to encourage Aussies to bite the bullet and have a go at some retirement planning many years before they retire. For articles and tips on how you can create your retirement lifestyle, check out the ‘how much super is enough’ link on the right-hand side of this website, or click on the articles below:
- Retirement planning in six steps
- A comfortable retirement: How much super is enough?
- Setting a retirement target: Living on more than $55,000
- A case study: I’m 53. Is it too late to save for my retirement?