Retirement Income Review buys Treasurer time on Super

 

Last September when COVID wasn’t a thing, Treasurer, Josh Frydenberg, commissioned the Retirement Income Review. The government had been re-elected and the economy was chugging along, although with some hope of a pick-up. Reform ideas would be welcome for the three-year term and beyond.

Frydenberg had the good sense to ask the review panel, chaired by former Treasury official, Mike Callaghan, simply to report on the key features of the retirement income system rather than offer recommendations. Dealing with politically difficult recommendations is always a problem for a government at the best of times.

The review sagely notes that “there are competing interests in the [retirement income] system. In what is often a highly contested environment, it is important to gather the facts and establish the evidence.” You can say that again.

The terms of reference for the review were relatively straightforward. Following on from the Productivity Commission’s report on the efficiency and competitiveness of superannuation, the review panel was asked to consider the three pillars of Australia’s retirement income system, viz: the Age Pension, compulsory superannuation and voluntary savings (including home ownership). (There is really a fourth pillar, which is the range of in-kind benefits available, particularly to AP recipients – this is picked up in the review.)

The report released today is comprehensive, to say the least. It is 638 pages long and contains a mass of material. It outlines the results of a number of modelling exercises undertaken by Treasury to illustrate the empirical effects of different policy settings as well as to highlight the impact on different groups – men versus women, low-income retirees versus the better off, renters versus homeowners.

While the review contains no specific recommendations, it’s possible to read between the lines about the panel’s preferred courses of actions on key matters, including changes to the Superannuation Guarantee rate (it is currently 9.5 per cent), home equity release and the taper rate in the AP asset test, among others.

The broad theme of the report is that there is a lot to be gained if retirees were to use their accumulated wealth, including their principal residence, more efficiently over the course of their retirement. One of the important observations in the report is that a lot of retirees die with their savings intact, which of itself undermines the case for adding to these savings – via a higher SG rate, for instance.

A key finding of the report is that the AP, particularly in combination with the available in-kind benefits, is effective in ensuring that most Australians secure an adequate standard of living in retirement. The review also finds that the fiscal cost of the AP is sustainable.

The two principal groups that potentially fall through cracks are renters, particularly single ones; and those who have been forced to retire early, well before being eligible for the AP.

The proportion of the Australians aged 65 and over who receive the Age Pension is now around 71 per cent, with 60 per cent on the full pension. By 2060, this proportion is expected to fall to 62 per cent, with a lower proportion again on the full pension.

At the same time, the cost of the superannuation tax concessions rises over this period to the point that the combined cost of the pension and tax concessions reaches 5 per cent in 2060, relative to the current cost of 4.5 per cent, putting paid to the proposition that superannuation saves the taxpayer a whole lot of money.

One of the most contested political issues in this space relates to the (legislated) increase in the SG from 9.5 per cent to 12 per cent, a transition that is expected to commence from 1 July next year.

The review makes the point that “the appropriate adequacy objective for a system based on compulsory superannuation is to balance living standards across a person’s working life and retirement.” This is something that is generally ignored by the super funds who tend to view retirement incomes in isolation, forgetting that savings during a person’s working life is forgone consumption.

Using a replacement rate (the ratio of income in retirement to income before retirement) of between 65 and 75 per cent., the replacement rate is exceeded for most groups with a 12 per cent SG, according to modelling presented in the review. Indeed, “working life income for most Australians would be around 2 per cent higher in the long run if the super guarantee was kept at 9.5 per cent (rather rise to 12 per cent, as already legislated).”

The review concludes that the SG rate should be set at a level that balances pre- and post-retirement living standards for middle-income earners. “It is challenging to set a single SG rate that suits all Australians given the variety of people’s circumstances and experiences. A rate that would result in people having an increase in their living standards in retirement may involve an unacceptable reduction in living standards prior to retirement, particularly for lower-income earners.”

Another interesting, although not unexpected, result of the SG rising to 12 per cent would be a widening in the gap between male and female superannuation balances. The gap is currently around 22 per cent and would be higher again in the case of a SG of 12 per cent, simply because men earn more than women.

A number of changes to improve the workings of the system of compulsory superannuation are canvassed in the review. One is to eliminate the current exemption from superannuation for employees earning less than $450 per month, something that discriminates against women. The cost of removing this exemption would not be excessive and would add to the fairness of the system.

Paying superannuation on paid parental leave would have a small effect on the super gap between women and men, but could be considered. Synchronising the payment of superannuation with the payment of wages and salaries would add to the integrity of the system.

Disclosing superannuation balances as part of divorce property settlements looks sensible. But applying superannuation to overtime, bonuses and the like would add to employers’ costs and overwhelmingly favour men over women.

One of the current conundrums in the system relates to the taper rate in the AP asset test. Set at $3 for every $1000 of assets – it was previously $1.5 – above fixed thresholds, what it means that pensioners who hold assets above certain levels are effectively taxed at high rates for having more assets.

The review undertakes some modelling to determine the fiscal costs of moving the taper rate to a lower figure. It turns out that this would be very expensive. There is also the point that under the previous system, retiree couples with assets of close to $1.2 million and owning a home could still access a part AP. That was unsustainable.

The review emphasises the scope for retirees to access equity in the home as a means of boosting retirement incomes. It is certainly true that, in the past, many of the reverse mortgage products on the market were inferior.

And the government has also dragged its heels in finalising the details of Comprehensive Income Products for Retirement, something which the 2014 Murray review of the financial system recommended. CIPR annuity products potentially provide a part solution to AP recipients stuck in the taper asset zone.

From the government’s point of view, the Retirement Income Review is a very useful addition to its knowledge in what is complex field. While it is certainly the case that various improvements are possible, the system turns out generally to provide adequate incomes to retirees, is both equitable (AP) and inequitable (superannuation), is broadly sustainable fiscally speaking and cohesive in the sense of its interaction with other government policies.

There are no immediate actions that the government needs to take arising from the review apart from using the findings at budget time next year to decide on what should happen to the SG rate. The review will have served its purpose.