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 response to this intention, the former ALP government increased the Age Pension age to age 67 for those born on or after 1 January 1957, and the current Liberal government plans to increase further the Age Pension age to 70 years for those born on or after 1 January 1966, and raise it to at least 67.5 years for those born on or after 1 July 1958. The push beyond 67 years for the Age Pension age has received heavy opposition and it is not yet clear whether the Liberal government will succeed in extending Age Pension age beyond 67 years (for more information see SuperGuide article Age Pension age increasing to 67 years (not 70 years)).
Is the government too harsh trying to lift Age Pension age to 70?
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?
In my view, lifting the Age Pension age to 67 makes perfect sense with most of us enjoying long and reasonably healthy lives. Pushing the Age Pension beyond age 67 and out to age 70 is more problematic however since the capacity to work up to this age depends on the type of work that you do, and in many cases the genetic lottery of whether you will be prone to age-related conditions earlier than most. Although the Age Pension age of 70 will only be applicable to those currently under the age of 49 or so (born on or after 1 January 1966), the question of whether the average human body is up to full-time work, in particular, manual work, up to age 70 is debateable.
A further unknown is whether employers will employ older workers up to this age.
So, what is the federal government’s rationale for pushing for an Age Pension age of 70 years?
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 Treasury’s 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 Global Financial Crisis (GFC) 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. In 2007, Germany raised the pension age from 65 to 67 years. The GFC (or the Great Recession as it is known in Europe) has forced the hand of many European nations in tackling the funding dilemma caused by an ageing population. For example, France lifted the pension age from 60 to 62 (although political pressure meant they dropped it again to 60 years), while the United Kingdom has raised its pension age to 67 by 2026, and to 68 years several years after that date, there are discussions to raise it further to 70 years.
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 lifted 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, although pension age is moving to 66 years by 2018. 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 four 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 27.7 per cent of Male Total Average Weekly Earnings. The Age Pension age is currently age 65 for men and women, and is increasing in six-month increments to age 67 for those born after a certain date. For more information see the article Age Pension age increasing to 67 years (not 70 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 9.5 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, and then 9.25 per cent for the 2013/2014 year and 9.5 per cent from 1 July 2014. The SG rate that SG is set to increase to 12% by July 2025 (for more information about the SG increase see the article Employer super contributions: SG rate 9.5% for 2017/2018 year).
- 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.
- Tax-free co-contributions from the government. 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 (2017/2018 year).
Australia’s four-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 rather than by providing financial 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 25 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 unique 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: