The superannuation initiatives announced in the Federal Budget in May were the most significant changes to super in more than a decade and have caused angst amongst many Australians approaching retirement. However, the crux of the concerns appears to be more about whether the transition arrangements are fair, and therefore as the debate continues it is critical the baby is not thrown out with the bath water and we keep our eye on ensuring the changes are fit for purpose.
Constant political tinkering undermines the integrity of super and is detrimental to consumers’ confidence in the system. Mercer has consistently advocated for a superannuation system that provides certainty and a clear future. On the other hand, the world is changing with ageing populations, reduced inflation, negative interest rates, political uncertainty and volatile capital markets. This does not mean that the purpose of super needs to change though. The objectives of our system must remain focused on the provision of retirement income.
On the whole, the 2016 budget proposals will create a fairer, more flexible and more sustainable system. However, the government should reconsider the transition arrangements to help protect people’s trust in the system.
In terms of fairness, we saw the introduction of the $1.6 million pension transfer cap to limit the amount of tax exempt investment earnings for retirees with significant pension pots. The level of tax concessions was also reduced for those with incomes between $250,000 and $300,000. Finally, the low income superannuation contribution was extended and replaced with LISTO (Low Income Superannuation Tax Offset). These changes are to be applauded on the grounds of fairness.
In terms of revenue, there was a reduction in the concessional contributions cap to $25,000 and significant changes in respect of non-concessional contributions and transition to retirement pensions. These changes mean that certain behaviour by some individuals will be limited in the future and are therefore likely to generate additional revenue to the Government in coming years.
The most significant driver of these changes has been the government’s acceptance of the recommendation from the Financial System Inquiry that the primary objective of superannuation is “to provide income in retirement to substitute or supplement the age pension”. That is, the government’s goal for superannuation is to reduce future age pension costs. It is instructive there is no mention of adequate retirement incomes or maintaining previous living standards, even within certain limits.
This overall approach, with the age pension as a focus, is confirmed by the fact that the $1.6 million pension cap is about double the level of assets at which the age pension runs out for a single person. Furthermore, the indexation of this cap is to be CPI related, in line with the assets test thresholds, and not indexed to AWOTE (average weekly ordinary time earnings), as used for other superannuation thresholds.
Whilst it is true that most of the budget announcements will not affect the majority of Australians, superannuation will become less attractive for high income earners or those with significant wealth. However superannuation remains concessionally taxed, as it should be, for there are significant limitations on accessing one’s savings prior to retirement, and it is likely to reduce the capacity of many retirees to receive the full age pension during their retirement.
The budget also announced important initiatives to improve the flexibility of making superannuation contributions, including the expansion of the opportunity to make tax deductible contributions.
So with the taxation of superannuation now fairer and more flexible, albeit with an objective that is somewhat restrictive over the longer term, what remains to be done for Australia to rise above its current third placing in the Melbourne Mercer Global Pension Index?
I suggest the following four developments would further improve the adequacy and sustainability of our overall retirement income system.
- Extend the SG system to the self-employed. As our labour force becomes increasingly less formal, more Australians will not have superannuation coverage. Already, our super coverage is less than Denmark and the Netherlands and this difference is likely to increase in the future.
- Ensure that most retirees have some longevity protection beyond the age pension. Retirees who self-insure by living a frugal lifestyle limit the effectiveness of the system. For retirees with benefits between $250,000 and $1.6 million, default retirement products should include some longevity pooling or protection.
- The current level of the Superannuation Guarantee has stalled at 9.5 per cent. We need an ongoing commitment that it will rise to 12 per cent which, will reduce future age pension costs. This increase is even more important as investment earnings have fallen, insurance premiums have risen and our years in retirement increase.
- The current age pension entitlement age is gradually increasing from age 65 to 67. This age needs to be linked to life expectancy so there is an automatic future adjustment as we continue to live longer.
None of these changes will be without controversy. However, each will ensure that our system delivers improved retirement incomes in a sustainable manner.
Dr David Knox is a senior partner at Mercer
A version of this article was originally published in Investment Magazine on June 28, 2016 - Read Investment Magazine’s full Special report: Super purpose defined, but road map required.