The OECD has recently commented that due to several influences the community’s belief that pension systems will deliver on their promises has been eroding around the world. This has led to reducing long term confidence in many systems.
One of the major reasons for this reducing trust is that most systems are too complicated and therefore poorly understood by individuals, including those in the workforce and retirees. Australia is no exception. Our retirement income comprises the well-known three pillars, namely:
• The means-tested age pension, funded by taxation
• Compulsory superannuation, funded by an employer contribution of 9.5 per cent and taxation support
• Voluntary superannuation, funded by individuals as well as taxation support.
However, it’s not that simple. Over time, it has been recommended by politicians or commentators that the system should be improved, revised or revamped to achieve the following outcomes:
• Reduced poverty amongst older Australians
• The provision of a comfortable retirement for all
• A focus on retirement incomes and not just the accumulation of capital
• Reduced age pension expenditure in current and future Government budgets
• Increased progressivity in the overall taxation system
• Encouragement for older people to stay in the work force
• Improved benefits for women to remove the gender gap in benefits
• Increased super contributions to reduce pressure on wage growth (remember that!)
• A stronger focus on ESG-related investments and/or innovative start ups
• Increased investment in opportunities with a strong social impact
In short, we have been asking the age pension and superannuation system to achieve a lot, many of which are desirable outcomes. However, some may be considered second order issues when compared to the primary purpose of the system. That is, they get in the way of designing the best possible system.
There has also been constant tinkering with superannuation taxation and the age pension rules in virtually every budget over the last 20 years. With this constant change it is not surprising that many Australians do not have the long term confidence in the system that is desirable.
What’s the answer?
Here are two suggestions:
First, establish very clear objectives for the overall system. For example, the objective could be to enable retiring Australians to maintain the lifestyle they have enjoyed prior to retirement. This could be achieved through a combination of the age pension and income from super.
Second, changes to the system should be restricted to once every five years, following the publication of the Intergenerational Report. That is, any reform would be based on the findings in this report and not the political whims of the Government of the day.
We need to simplify the system and make it very clear what the system is there to achieve. Some of the above issues can then be considered within the context of clear and constant objectives.
Let’s also compare the provision of retirement income to other financial services that most Australians engage with on a regular basis; namely banking and insurance.
In each case, the consumer’s expectations are clear. In respect of banking, there is the opportunity to deposit or invest money with the bank and, where appropriate, borrow some funds. Sure, the interest rates will vary on both the deposits and loans but there is a known set of conditions. The overall framework is stable. Similarly, with insurance. Premiums are paid and if a particular event occurs, claims are paid. Naturally, there will be disputes from time to time but most claims are paid quickly and efficiently. Again, there is relatively consistent understanding within the community. Generally speaking, Australian consumers have a fairly high level of confidence in our banking and insurance industries, despite the issues highlighted by the Hayne royal commission.
Of course, retirement income is much more complicated than banking or insurance. It is over a much longer time period. It also has many more stakeholders including employers, trade unions and the Government through the age pension and super tax concessions, as well as individuals. There are also many more rules and they keep changing. In addition, there is the tension between individualism and the potential benefits of pooling certain risks such as investment returns and longevity.
It is little wonder that most Australians are confused or uncertain.
We must simplify the system so the objectives are clear and the expected outcomes are known. The current Retirement Income Review has the opportunity to make very clear observations about the current system and so encourage the Government to establish a clear long term direction that can be easily understood.
*David Knox, senior partner and actuary at Mercer, will be speaking at Investment Magazine’s Retirement Conference to be held on March 31, 2020 at The Fullerton Hotel, Sydney. Please register here.