Future Fund’s Peter Costello calls out flaws across super system

Drawdowns and deeming rates now need to be reviewed.

Chairman Peter Costello has warned the Future Fund’s targets are unrealistic. Picture: Luis Ascui

The worst thing about the super system today is the enforced risk older Australians are being required to carry in super — just now it’s bad, post-election it could get a lot worse.

Ex-treasurer Peter Costello’s pointed intervention into the heated issue this week captured the essential problem for everyone — for at least three years now investors are struggling to get anything like normal returns.

Costello, as chairman of the Future Fund, is warning the fund can’t be expected to meet its targets in this exceptional environment.

No wonder ... the bond rate is at its lowest for more than a century, cash rates are at their lowest in a generation, the ASX is lower than it was almost a decade ago — these are super-soft markets where deflation is a real and present danger.

How on earth then — you might reasonably ask — can mum and dad achieve their targets for super and savings?

As Costello explained, the government’s target for the Future Fund (which is 5 per cent above inflation) is not possible in these low-growth, low-inflation markets without taking on much more risk.

The same thing applies for all investors faced with the recent budget super proposals: in calculating its numbers — for cracking down on both how much you can save for retirement and how much you can have as a maximum tax-free pension — the ­government has assumed markets in the near future will return historical averages.

The government has claimed the proposed $1.6 million cap on funds to finance tax-free pensions could be expected to produce four times the old-age pension. This would mean the $1.6m earns 5.5 per cent to achieve $88,000, four times the current basic single government pension of $22,000 a year).

Costello certainly does not think this is realistic and indeed nobody can assume that level of return ... especially in 2016. This is the kernel of the current rage over super changes — in most cases it’s not greed, or arrogance, rather investors are flabbergasted the government can blithely assume such returns as a given.

In the real world investors cannot afford the bravado of electioneering politicians.

And for an increasingly elderly superannuation cohort — who will want to put the majority of their savings in conservative investment such as cash and bonds — the government’s assumed returns may be impossible to achieve for quite some time.

The issues in super are boiling over in relation to the mechanics of how it might work (see Glenda Korporaal today) but independent of those wrangles Scott Morrison must now concede that his new changes also mean two key elements of the retirement system must now be reviewed — drawdowns and deeming.

• If you are retired you must draw down — in other words take out — a certain percentage of your superannuation funds each year. This rationale behind this regulation was an early attempt at minimising super as a wealth creation vehicle. If you are over 65 it must be 5 per cent a year, as you get older it goes higher if you get to 90 it hits 11 per cent (see graphic).

We saw during the GFC how the system can fail when times are exceptional — in the GFC the regulation meant people were being told by law to sell assets — typically shares — that were hugely discounted. The law was insisting pensioners take losses. Fortunately, at the time the Labor treasurer Wayne Swan intervened and allowed a temporary reprieve on the drawdown rules.

Today a similar scenario is re-emerging — the drawdown rules are making people take money out often when it does not make sense to do so. The new $1.6m cap will inflame this situation — at worst it will make people instantly undercut the funds they have put into super to finance their tax-free pension.

• Separately, but on the same line of inquiry — eligibility for pensions or part pensions is based on what’s known as deeming. It all works on what the government calls the deeming rate — the amount you are deemed to have made on your investments — and of course with rock-­bottom returns once again a dimension of the system is revealed as out of touch.

The deeming rate is 3.25 per cent (on all investments above $48,000 for an individual), while cash rates are barely 2 per cent. — It’s unfair — and with the budget changes more unfair than ever. This has to be reconciled now with the new realities.

A few days ago Foreign Minister Julie Bishop suggested the budget changes may have unintended consequences ... we’re only just starting to understand them.