The shifting risk of superannuation

Since the 1980s, Australia has changed the way we prepare for our retirement. Rather than depending on an aged pension from the government and some personal savings, greater emphasis has been given to superannuation and building retirement incomes in that way. All three remain in play for retirement but for most employees superannuation has become the major component.

As part of the Prices and Incomes Accord, used throughout the Hawke-Keating years, compulsory award superannuation was introduced in 1986. At that time, it involved only a 3% contribution and was aimed more at helping control wages and inflation by having an effective wage rise paid into superannuation. It was legislated for all employees in 1992, as the Superannuation Guarantee, and the level of contribution has been progressively increased.

Treasury had already foreseen that the retirement of the ‘baby boomers’ generation would place a prohibitive cost on government if that generation was primarily reliant on the old age pension for its retirement income. In that regard, the mandatory superannuation contribution was a way of reducing government expenditure into the future: there was not enough time to make the baby boomers entirely independent of the government pension but it would at least reduce the amount of pension to which they were entitled.

Another issue for the Treasury, later addressed by Howard and Costello, was the superannuation liability the government was accruing for its own employees. At the time, the government made no forward commitment for that liability, anticipating that it would simply meet its superannuation liabilities from consolidated revenue in the year they fell due. Treasury, however, began pointing out that the amount was growing exponentially and could have serious budget implications in future years. Hence, the Future Fund was created to help meet those costs.

Superannuation for government employees, both state and federal, was traditionally a ‘defined benefits’ model, meaning the amount of superannuation to be received at retirement was predetermined by a formula. (Some large corporations, and other public bodies, both here and overseas, also used ‘defined benefits’ models.) In such schemes, it could be said that the employer bears the risk. Although the government did not put money away towards its future liability, if it had invested such funds there would have been years where its income from investments exceeded the accrued superannuation liability and years where it fell below: whether an employer ends up ahead or behind overall is entirely dependent on the success, or otherwise, of the investments.

Over the years there have been a number of significant changes: firstly, in the amount mandated to be paid into superannuation. Before his defeat in the 1996 election, Keating was discussing raising the contribution to 15% of a person’s income, through a combination of both employer and employee contributions. That never made it into law but during the first Rudd government it was decided that the amount should be increased to 12% by 2018 — that was considered the bare minimum to achieve a moderate level of retirement income over a person’s working life. It was legislated by the Gillard government to be achieved by July 2019. The Abbott government, however, when rescinding the Mining Tax in 2014 also extended the period over which the 12% would be achieved — instead of July 2019, it would now be 2025. The change was opposed by Labor and the unions, but also by the Financial Services Council and Industry Super Australia, but supported by business as it reduced its contribution for the immediate future, keeping it at 9.5% until 2021.

The Abbott government may have supported business with its decision but it did nothing to help the government’s long term budget problems. Delaying the increase only served to reduce the amount of superannuation workers would accrue, therefore leaving an entitlement to a larger part-pension from the government, whereas the real aim of the Superannuation Guarantee and the increased contributions was to reduce the government’s contribution to retirement income. Given the Abbott government at that time was carrying on about the ‘debt and deficit’ disaster, such a decision was contrary to the rhetoric and merely created additional budget expenditure in future years.

The taxation treatment of superannuation has also changed over the years. From 1 July 1988, the Hawke government introduced a tax on superannuation contributions but reduced the tax on superannuation benefits. Before that there was no tax on either contributions or fund earnings and people paid normal personal tax rates on their superannuation income stream.

The Howard government’s ‘simplification’ of superannuation included the abolition of tax on superannuation income for those aged over 60. Although some seem to believe that this applies to all superannuation, it applies only to benefits that have already been taxed at the contribution and earnings stage. A personal example involves my wife and I. We both paid additional income into our public service superannuation scheme but my wife did so via salary sacrifice and I simply paid into my superannuation from my after-tax income. Now my wife pays tax on that portion of her superannuation which comes from her additional contributions but I do not because my contributions were already fully taxed: without that concession I would effectively be paying something over 50 cents in the dollar, as the money would be taxed twice. It is the same principle that applies to ‘fully franked dividends’: if a company pays its dividends from its after-tax profit then those dividends are tax free for the shareholders.

The Superannuation Guarantee has been effective in drawing people into superannuation. In February 1974, only 29% of employed persons were covered by superannuation and the majority of those were in the government sector. That had reached 90% in November 1995 and 93% in August 2002. While the proportion has varied slightly in recent years, it has remained around 90% of all employed workers.

It has also given rise to a huge amount of ‘savings’ held in superannuation funds. It started slowly. At the end of 1991, before the Superannuation Guarantee was implemented, there was $146 billion in superannuation savings — equivalent to 38% of the nation’s then total GDP. That rose to $1.2 trillion by the end of 2007: equivalent to 110% of GDP. Again there have been fluctuations in recent years but superannuation savings have remained at a level of about 90‒100% of GDP.

As superannuation became more widespread, the cost to government revenue of superannuation tax concessions increased. The Hawke decision in 1988 to tax contributions was a way of bringing forward government revenue — previously government had to wait until a superannuation benefit was paid to gain any tax revenue. Despite that, Treasury figures for the 2014-15 Budget show that tax concessions on contributions cost the government $16.3 billion in foregone revenue, and a further $13.4 billion for concessions on superannuation funds’ earnings. The evidence is that these concessions benefit most those on higher incomes. The top income decile actually receive something like 37% of the benefits of superannuation tax concessions and the top 20% receive about 60% of the benefits. It was also found that there were 475 people with super balances in excess of $10 million who were earning tax-free income of about $1.5 million each year. Labor has proposed a policy that partly addresses this but the emphasis is on ‘partly’. It really captures only the top 2% and will raise revenue by only $1.4 billion a year (on average) which is only a fraction of the total value of revenue forgone but it is better than nothing — it is perhaps a ‘gentle’ approach in an election year.

In 2012, in a 20-year review, the CPA raised some other concerns about the impact of the Superannuation Guarantee:
The greater accumulated superannuation has allowed households to become more accepting of risk and debt in the knowledge that a payout is coming on retirement. The increased debt has allowed households to enjoy a higher standard of living during their working lives than their actual income could support. This higher standard of living has produced increased expectations for retirement. Against these expectations is the reality that they cannot pay for the higher expectations, as the superannuation is required to repay debt.

… It is now twenty years after the SG was introduced, and superannuation savings minus household debt effectively equals zero. [emphasis added]
The risk is magnified because nearly all new superannuation is an ‘accumulation’ model. Even new commonwealth public servants, since the Howard years, have been placed in accumulation funds (or can select the fund of their choice). That basically means that the amount of superannuation accrued over a person’s working life is entirely dependent on the investment choices made by both the individual and the superannuation fund.

As an example of how that may work, I will base the following on the premise that, on average, the superannuation grows at the rate of the stock exchange index for the All Ordinaries. If I had $100,000 in superannuation as at December 2004, when the index was 4053, it would have grown to $167,300 by October 2007 when the index reached 6779. However, the GFC then hit and by February 2009 the index was down to 3297 meaning my superannuation was then worth $81,350. The market index has still not reached the highs of 2007. At the end of January this year the index was 5059 (superannuation value of $124,800) and at the end of February 4948 (superannuation value of $122,000). So while my super may be above the original $100,000 in 2004 it is still $40,000 below the peak of growth in 2007 and has grown only slightly over $20,000 in 12 years, or on average about 2% per year (rounded). There are other factors that influence the growth of superannuation and it should be noted that total market capitalisation is now almost as high as it was in 2007 although the index is lower.

The point, however, is that in an accumulation fund all the risk is borne by the individual. The employer no longer has an interest in what happens to the money once it has been paid into an employee’s nominated fund, whereas in defined benefits schemes the employer bears the risk and therefore maintains a real interest in the growth of superannuation investments.

The volatility of the stock market is a double-edged sword. It may occasionally offer higher returns but it can also crash, wiping out millions in superannuation savings, and since the GFC the market recovery has been extremely slow — after over eight years the index is still 25% lower than its October 2007 peak. There is some evidence that since 2000, superannuation invested in fixed interest deposits (including government bonds) would have provided a slightly better return than investment on the stock market. But the default superannuation fund, which a majority of people do not bother to change, is what is called a ‘balanced fund’, which is meant to include elements of stock investments, fixed term deposits and sometimes commercial real estate. Many Australian superannuation funds have a higher proportion of stocks in their balanced funds than European superannuation/pension funds which have been reducing their exposure to stocks since the GFC.

So where does that leave the employee now largely reliant on his or her superannuation investment for retirement? — between a rock and hard place!

Some European countries had pension systems more akin to a defined benefits scheme where retirees were guaranteed a fixed proportion of their final working income — it was an expensive model which some countries are now trying to change and it was partly funded by a ‘pension’ or social security levy that all employees paid during their working lives but government picked up the balance.

Australia, however, began with a government guaranteed and funded pension, which is now guaranteed at 41.76% of Male Total Average Weekly Earnings (MTAWE) for a couple or about 27.7% for a single pensioner but that provides a modest standard of living, not much more than a safety net.

I don’t see why we can’t have a government defined benefits model for all workers, funded, as in the present superannuation model, by a combination of government, employee and employer contributions. Such a model would remove the risk from the individual and place it back with government and to a lesser extent employers. After all, the government, more than any other institution, is able to bear risk.

But no political party is going to change this. Markets now rule. Our retirement income is now determined by market manipulators who are seeking nothing more than making a profit from their share and bond trading. The effect that has on superannuation funds is not a consideration. Superannuation funds (and individuals) can change their investment choices but in most cases that tends to come after the event, so to speak, when losses have already been incurred. It is not a model that guarantees an adequate retirement income and, to that extent, will not reduce government outlays in providing pensions and part-pensions. If it is not achieving the aim of significantly reducing government outlays, why not use that funding to contribute to a genuinely adequate retirement income?

In my view, it is time to reconsider the model for our retirement incomes, not fiddle while the markets burn!

What do you think?
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