Exploding the five myths of our superannuation system

Far from being ‘the envy of the world’ – as the funds tell us – we were sold a pig in a poke.

The super nest egg won’t succeed in forcing most retired Aussies off the age pension, so in that sense, the system’s fiscal benefits are unclear.

It has been a big week for superannuation with Jim Chalmers announcing his intention to double the rate of taxation on earnings of accounts in excess of $3m, a figure that will not be indexed.

There is a massive amount of confusion about the proposal as well as the uncertain path to ensuring that high-income earning defined benefit beneficiaries suffer the equivalent detriment.

More generally, there is a lot of misinformation put out about our superannuation system – let’s call them myths.

These myths are mainly peddled by the lobbyists for the main beneficiaries, which are the funds, the fund managers and the investment houses. The actual superannuation members, both current and retired, are not central to how the system operates.

There are at least five important myths that are repeated in high rotation to convince wary members of the public of the benefits of our superannuation system.

The contributions and earnings stages of the saving process should be exempt from tax.

1Australia’s system of compulsory superannuation is the envy of the world

While you often hear this assertion and it is certainly great for those who work directly or indirectly for the superannuation funds, it has created a much larger (and high paying) industry than would otherwise exist.

The management fees charged by the funds to members are excessive; at least double the fees typically charged overseas for similar returns. It’s hardly surprising that the ticket-clicking collective are true believers.

But here’s the thing: if our system is really the envy of the world, why would other countries not copy the key features?

The answer is that there are many flaws to our system and other governments have been far too smart to follow our defective arrangements.

The degree of competition in the system is completely inadequate, which flows from the compulsory nature of the system. While members can switch funds, there is a high degree of sameness to the offerings, particularly of the industry super funds.

Over time, the extent of competition is becoming less as more super funds merge and many for-profit funds, including those run by the big banks, withdraw from the field.

We also have taxation arrangements that are the complete opposite of good policy. Both the contributions and earnings stages of the saving process should be exempt from tax to allow people to maximise their payouts, with withdrawals taxed at full tax rates. This is the most common arrangement overseas. By contrast, we tax contributions and earnings and partial exemptions from tax at the withdrawal stage.

It is complex and about to get more complex.

People adjust their behaviour and take out higher levels of debt.

2Superannuation is good for the economy because it encourages saving

The trouble with this argument is that the system may encourage savings within superannuation, it may also lead to dissavings in other forms, particularly higher household debt.

Australia has one of the highest levels of household indebtedness in the world. It is not uncommon for people to still have outstanding mortgages on their homes well into their 60s. The logic is that they can use all or some of their super lump sums to pay off their debts at that time.

In other words, against the backdrop of compulsory savings through superannuation, people adjust their behaviour to accommodate the forced reduction in their current consumption and take out higher levels of debt.

Additionally, we know the system will not succeed in forcing most retired Australians off the age pension, although there will be more on part-pensions. In that sense, the fiscal benefits of the system are unclear.

It beggars belief the super industry would oppose withdrawals for the purpose of buying a home, the most important asset older people can have for a dignified retirement.

3A dignified retirement is the only thing that counts

A dignified retirement has been in the news because that’s the adjective Chalmers prefers to include in the stated purpose of superannuation. It is also the preferred adjective of the industry funds. Down the track, it will be a convenient rationale to argue for an increase in the super contribution rate.

The superannuation industry, particularly the industry funds, strongly opposes any early withdrawals by members because they want the monies retained within the funds as long as possible. In this way, the amount of funds under management is maximised and the need for liquidity is reduced as members are essentially forbidden from withdrawing even a portion of their own savings before retiring. It’s a win-win for the superannuation industry.

The reaction by the funds to the decision by Josh Frydenberg to permit a two-staged limited withdrawal of funds during the Covid-19 pandemic was one of complete horror. At the end of the day, only about $30bn was withdrawn, which is relatively insignificant in a total savings pool of more than $3 trillion. But it was the precedent that worried the industry.

Similarly, the proposal for withdrawals for the purpose of buying a home, lobbed into the 2022 election campaign by the Liberal Party at the last minute, similarly drew deep disapproval.

But if the aim of superannuation is to provide a dignified retirement, the most important asset an older person or couple can have is their own home.

It beggars belief that the superannuation industry would oppose withdrawals for the purpose of buying a home if they are really concerned about people having a dignified retirement. Do they really want older people navigating the perils and incurring the expense of the private rental market as they grow older?

Assistant Treasurer Stephen Jones has also made some unwise remarks about people using early withdrawals to fund medical and dental procedures, focusing on what he regards as superficial plastic surgery. What he doesn’t realise is that these early withdrawals, which are strictly regulated, by and large fund important procedures such as breast reconstruction surgery for those with cancer; bariatric surgery for overweight people that can lead to longer and better quality lives; and IVF treatment for people unable to have children without assistance.

The point is that we want people to have dignified lives to the greatest extent possible. It makes no sense for people to live miserable lives and forgo interventions that could provide immediate assistance – all for the sake of a dignified retirement.

People are forced to forgo current spending, such as paying bills or putting food on the table.

4Low-income earners benefit from super because they wouldn’t save otherwise

One of the underlying precepts of compulsory superannuation is that people are too stupid to save for themselves so the government must compel them to set aside a portion of their wage. The flip side of this is that people are forced to forgo current spending, such as paying bills and putting food on the table.

This analysis however overlooks the central role that the pension plays in our retirement system, with those who qualify guaranteed a minimum income as well as a range of benefits. In other words, it is a safety net, with the amounts payable regularly indexed. What our system of compulsory superannuation does for low-income earners is to potentially knock off their full entitlement to the age pension.

In the meantime, they are forced to sacrifice current consumption and face tax arrangements within superannuation that are not particularly favourable to them, notwithstanding the special treatment for low-income earners. To be sure, they may end up with a small final payout that can be used for home improvements, a car or travel, but it’s not clear that the system does provide them with overall net benefits.

If the older years involve home-based care or a nursing home, hefty costs are often involved.

5People are too stupid to spend their retirement savings

Having assumed that people are too stupid to save for their retirement, the thinking flips on its head when people retire. Evidently, people are too stupid to spend all their retirement savings and end up leaving money for their children or other beneficiaries. The cheek of them!

The point is made that a relatively large number of superannuants die with substantial assets, rather than running them down.

What is generally not appreciated is that older people face considerable uncertainties when attempting to navigate their finances during retirement. In particular, should their older years involve the need for home-based care or entering a nursing home, there are often substantial costs involved. In any case, it’s not easy figuring out how long a lump sum, earning variable returns, will last given that we don’t know when we are going to die.

But the real point is this: it’s their money. If they want to leave it to their children, so be it. The bequest motive is surely as legitimate as using it all on wine, boyfriends and holidays. It’s not really for anyone else to judge. Leaving super to children can also incur a 15 per cent tax penalty.

So beware the myths surrounding our superannuation system, so beloved by the funds and the other hangers-on. If we had our time again, we would never design a scheme like this.