Could we have a better system for self-funded retirees and is America the best inspiration?

The federal Opposition has mused about a US-style retirement plan for Australia but although self-managed super funds are far from perfect, do we really need America’s so-called 401(k)?

Federal Opposition treasury spokesman Angus Taylor. Picture: Martin Ollman

Opposition Treasury spokesman Angus Taylor floated the notion of 401(k)-style retirement accounts at an investment conference a few weeks ago in Sydney.

He said Australia would be better off being aligned with global retirement systems, of which the American 401(k) is one of the most famous.

The ACTU immediately knocked the idea, noting it would wreck the superannuation system if a US-style voluntary contributions retirement savings scheme was adopted.

Although subsequent clarification from Taylor’s office were that the comments made were “limited to the rule around using super for housing”, many now are wondering what 401(k) is and if it is better or worse than our own superannuation system.

American expats would be well aware of the differences between a 401(k), Roth 401(k), IRA and a SDIRA, but most Australians don’t because these all relate to accounts under the US retirement savings system.

The most popular 401(k) accounts are comparable to retail and industry super funds. They are employer sponsored and the usual mechanism for Americans to build retirement savings.

The comments were in the context of using super to buy a home.

For those who want greater investment flexibility, an individual retirement account is used; if direct property is to be acquired, a self-managed directed IRA is used. Both share similarities with self-managed super funds.

Although there are common features between the two retirement systems, a key difference raised by the ACTU in response to Taylor’s comments is in regard to the nature of contributions. There are no mandatory contributions in the US whereas in Australia we have compulsory super, currently at 11.5 per cent and increasing to 12 per cent from July 1 next year.

It is common for US employers to match 50 per cent of employee voluntary contributions up to 6 per cent of salary or 100 per cent up to 3 per cent of salary. To encourage employee retention, a vesting period commonly applies between three and five years before the employer contributions are available for the employee to access in their retirement account.

Another key difference is that 401(k) and IRA contributions are made pre-tax. A tax deduction is claimed by the employee in their personal tax return and the 401(k) or IRA balance is invested and earns income tax-free within the account. Tax is payable when the person retires after age 59½ and starts to draw from their 401(k) or IRA. The full withdrawal (including the initial contribution plus the earnings) is assessable in the hands of the individual.

In contrast, locally we can begin a tax-free super pension up to $1.9m.

The exception to the US system is the Roth IRA, which receives only post-tax contributions and is paid out tax-free. It is also possible for an American to access part of their 401(k) or IRA before the normal 59½ retirement age if they wish.

In Australia we have very limited circumstances where money in superannuation can be withdrawn before age 60, namely for compassionate grounds and financial hardship, whereas in the US it is fairly common for people to withdraw part of their 401(k) savings early.

Another way for Americans to access their retirement savings early is via a loan. You borrow money from your retirement fund and pay it back across a five-year period plus interest, which is currently about 10 per cent. The maximum loan is $US50,000 ($76,000) or up to 50 per cent of your account and the money can be used for any purpose including a home deposit.

With some similarities but also many key differences between the US and Australian retirement systems, whether we have it better or worse compared with our US counterparts comes down to whether you agree that the government should be paternalistic when it comes to our retirement saving strategy.

In the US, you are left to your own devices to make decisions about how much and when you put money into your retirement savings account. You also have the ability to drain your retirement savings account before retirement if you wish and are happy to wear the 10 per cent penalty fee. True American democracy at work.

Whereas we have mandatory super and the government takes the view that we need to be forced to do something for our own good. Just like the laws in place regarding mandatory seat belts in cars, there are mandatory laws in place regarding how much of our wages must be quarantined for retirement.

Regarding the effectiveness of compelling everyone to contribute to super, the system is not perfect when it comes to sole traders and other self-employed people who can manipulate their income and avoid super contributions. But, on the whole, the super system is in place to ensure the average worker has some level of savings at retirement, which can be supplemented with the government Age Pension if necessary.

James Gerrard is principal and director of Sydney planning firm www.financialadviser.com.au