Bei Cui:
Hello, everyone. Welcome to Retirement Puzzle, brought to you by the Monash Centre for Financial Studies.
In this podcast we look at the current, critical trends in the pension sector and how they impact us all.
My name is Bei Cui, a researcher with the Centre. I am one of the three hosts of Retirement Puzzle, along with Dr. Nga Pham, and Dr Ummul Ruthbah.
In this episode I discuss with Nga and Ummul an important opportunity they were given in 2019 by Australian Treasury.
They presented their research on the impact of the Superannuation Guarantee on household savings, which was part of the review into Australia’s retirement income system.
Nga has a PhD and is a Charterholder with the CFA Institute. Her research interests include ESG, which stands for Environmental, Social and Governance.
She also researches shareholder activism, pensions and superannuation. She has worked for the International Finance Corporation, which is part of the World Bank Group.
My other colleague, Ummul has a PhD from MIT and has worked for the World Bank. She researches sustainable finance and retirement planning.
Today, we discuss their findings in more depth.
Hi Nga, could you please tell us why you think that retirement income review considered the effect of superannuation guarantee on household savings a very important issue?
Nga Pham:
Thanks for the question. Yeah, I think the superannuation guarantee and household savings and the interaction between them quite important. SG or superannuation guarantee plays an important role in national savings and in the retirement income system of Australia as well. Our superannuation guarantee is mandatory super savings. Currently it is 9.5 of wages, which is relatively high compared to the world.
While somebody might argue that it should even be higher, but if we look around – for the UK, it is 8 per cent, for Canada, it is 7.9 per cent. And for the U.S is only 2.5 per cent.
Thanks to the accumulation of compulsory, super contributions over time, the value of Australia’s super assets has grown from just over $73 billion to over $3 trillion last year, after about 30 years, so there was an increase of 40 times during the last 30 years, and that means it has a compound annual growth rate of 13 per cent per year, making Australia the fourth largest private pension system in the world, even when we have such a modest population.
Bei Cui:
Okay. Now, what can we see at a household level? Does super guarantee promote household savings in superannuation?
Nga Pham:
Yes, at the households level, we also see a very good picture. We have seen that over time, the average value of super asset tripled from about $80,000 to more than $240,000 during the last 20 years. And that represents more than a quarter of the household net worth. Super assets have become the second largest asset on the household’s balance sheet just after property. So after about 30 years, since the introduction of a superannuation guarantee, superannuation has become a major savings vehicle for Australian households.
Bei Cui:
That is super savings. What about household private savings outside of the super system?
Nga Pham:
That is something that we are not sure, and thus that motivated us to do this research because a main observation is that together with the accumulation of super asset over time, we also have seen a decline in the net household saving rates. Now, the net house host saving rate has reduced to just around 3% of disposable income in, 2020, and it used to be about 8%, just a decade ago, so, while this is similar to the UK and our saving rate is still higher than the U.S, our rate indeed is quite low compared to other developed countries. For example, France or Singapore, both say for more than 10% and Japan or Korea or Germany safe from about five to 8%.
Bei Cui:
Sure, now, So… It means that the mixed international evidence leads you to the question, whether, savings and a mandatory superannuation guarantee has reduced private savings as Australians. I think that is maybe one of the reasons that their retirement income review wanted to investigate as well. From what you said, just now the primary purpose of increasing superannuation guarantee is to grow [inaudible 00:05:42] retirement savings. But as far as I know, there are still some different views on whether it should be increased gradually. The current rate for the superannuation guarantee is 9.5% and the governmental legislator to grow the rate to 12% by 2025. And so almost from your research, what do you find about the impact of the increasing superannuation guarantee on household savings does having compulsory savings make people save more?
Ummul Ruthbah:
No Bei, it doesn’t. In fact, we found that it makes people save less. For example, when the superannuation guarantee went up from 9% to 9.25% in 2013, savings rate declined by 6.3%. And when it went up further to 9.5%, the following year, private household savings declined by 6.1%. However, from this finding, it is not possible to answer your question, whether the superannuation guarantee rate should be increased from 9.5% to 12%.
Bei Cui:
So you mean that when the superannuation guarantee rate increases, people actually have licensed and take the savings themselves?
Ummul Ruthbah:
Yes. You got it correct.
Bei Cui:
Okay. It means that a super energetic guarantee crowds out private savings. Do you know how big the substitution is? Does it add to all the savings generated by superannuation guarantee or just a part of it? Would like to address it?
Nga Pham:
Yes. Thanks. We found a significant substitution between compulsory employer, super contributions in household savings, but this substitution is not one-to-one. So basically what we mean is, when employers are contribution increases by $1 people reduce the private household saving, but by less than a dollar and have to be exact, each dollar of employer contribution reduces private households saving by 43 cents. Now this basically means that compulsory super crowns out some private household saving, so the net effect on S G O on superannuation guarantee on saving is positive.
Nga Pham:
I would like to add here that about 24 cent out of this 43 cents, so, more than half of this decline in net household saving came from increased mortgage repayments to buy property. This means employer contribution to super increases, more people borrow to buy property, and that leads to higher mortgage repayments, and therefore they have lower household saving, but also it means that households are not consuming all of this 43 cents. They are investing part of that in property and that in the long run increases their assets and add to the national wealth.
Bei Cui:
Oh, thanks. Now, you know, households are different in their level of wealth. Does your research have any evidence of the substitution in facts across all different types of households?
Nga Pham:
Yes, we do, but we look at the circumstances of the households. So in our sample, approximately 64% of households owned their home, including those with mortgages and 48% of households were classified as financially constrained.
Nga Pham:
So what we found, we found evidence that the substitution effect is bigger for homeowners than renters. What meaning that home owners actually reduce private savings more perhaps due to the impact of them taking on home mortgages. However, in terms of financially constraint households, there was no significant difference between the substitution effect for financially constrained households, and those that are not, that means that financially constrained households do not reduce their savings more than non-financially constraint households, and this is consistent with prior behavioral literature, because financially constraints households will find it difficult to borrow at any time. And therefore they are less inclined to substitute the extra savings with higher consumptions.
Bei Cui:
Thanks. So far, the household you’re talking about are those who are eligible to superannuation guarantee, however, please bear in mind that not all Australians eligible to a superannuation guarantee, and this I’m very curious to know whether superannuation guarantee has effect on savings for those households who cannot get access to superannuation guarantee.
Ummul Ruthbah:
Yes, it does. And this is another piece of interesting finding from our research. Generally one would not expect the superannuation guarantee to affect the behavior of households who do not receive it, right? But in our research, we find that the superannuation guarantee affects the saving behavior of board groups, those who have access to it. And those who don’t, both groups reduce their savings when the superannuation guarantee rate went up. However, there are some differences. We find that the reduction in savings is bigger for those not eligible for super guarantee.
Bei Cui:
Does it make sense?
Ummul Ruthbah:
I Think it does. First of all, households who do not have access to superannuation guarantee are usually the low income owners, right? And the savings should be less than the high income households. Second, the link between superannuation guarantee and savings of these households, it lies in how it, affects their wages as increasing superannuation guarantee slows wage growth, which other studies have found, the savings rate of low income households, even if they are not affected by employer contribution can go down as well.
Bei Cui:
Thanks, from your findings, we have shown that the superannuation guarantee indeed play a very important role in the household savings, no matter, no matter whether they have access to superannuation guarantee. But you also mentioned that in your research household’s balance sheet has shifted over the 15 years. And he also showed that this was due to the accumulation of the compulsory super savings, so, could you like explain to us what this shifts and now, and how big they are?
Ummul Ruthbah:
Yes, sure. As has already mentioned that even though there was some substitution between savings in super and savings outside super households asset as a whole more than doubled in the last two decades. When we looked into the different components of their assets, we actually found that they showed a clear preference for some forms of assets over others, on average, in a four year period for each dollar, their employer put in their super, the net wealth increased by $2 and 21 cents. And the share of superannuation wealth in this was a dollar and 51 cents. And there was no increase in other forms of financial assets.
Bei Cui:
Well, so over the years, household have built up good wealth in superannuation, but now in other assets, is that right?
Ummul Ruthbah:
Not exactly way. They did not build up other forms of financial assets, such as bank savings or stock investment. But we observed a big increase in property in the portfolio, which was mainly the residential home. We find that $1 increase in employer contribution was associated with $1 21 cents increase in property assets. One little secret I can share with you bay is that we found these pattern first while we’re looking into the different components of household wealth in the Hilda data. And that led us to investigate the different components of their expenditure. Only then we found out that they were making larger mortgage payments as well. And at the end, it all added up.
Bei Cui:
Oh, and will you just mentioned that the superannuation guarantee increases households debt and at the same time, the investment in property, why do households particular favor property over other form of assets?
Ummul Ruthbah:
We think there are two forces are at play here. One is how one can use the savings in superannuation upon retirement, and the second is how primary residence is treated in the whole retirement system. Under the current system, our retiree can withdraw all their superannuation savings as a lump sum when they retire and they can then, use it to pay off their leftover mortgages. I guess the knowledge that I have this pot of savings growing in my super, which I can take out in 10 or 20 years to pay off my current debt will certainly give me some confidence or incentive to borrow more in this specific case to take bigger mortgages. And that is the case for a large number of Australians.
Bei Cui:
So this explained the larger debt, but it doesn’t answer the other part of the question. Why do they borrow money to invest in property?
Nga Pham:
Well, I think the, the answer to this part of your question lies in the other feature of our retirement income system, which is how the age pension system treats the primary residence, in the eyes of our age pension system, the different kinds of assets someone owns and not the same, so some assets are excluded when the central link calculates the amount of age pension, a retiree receives and residential home is one of those assets. It is excluded in estimating the amount of age pension once gets, whereas the other financial and non-financial assets such as superannuation, bank savings and other investments are part of that calculation. If you, if people think about where to park their money without affecting their eligibility for age pension in retirement, the best assets is the home.
Bei Cui:
So the residential home is not counted in asset test. So what about investment properties Nga?
Nga Pham:
Yeah, that’s a very good question. Other investment property will be counted in the asset test. It is just the residential home that is not counted, this makes the residential home a very attractive form of assets compared to others. It does not matter how big and valuable your residential home is. It does not affect your eligibility for the age pension or the amount that you can get. There’s two features of the system together provide very strong incentive to invest in residential property, and, this is what we found in the data households pay higher mortgages and have more assets in property when they have accumulated a bigger, super balance.
Bei Cui:
Ok, so we have learned that the Superannuation Guarantee generates new savings and a partial relocation of household wealth into property.
What we now know is that for every dollar increase in compulsory superannuation, the associated decrease in private savings is less than $1. This suggests that the compulsory superannuation system in Australia generates a net overall savings increase.
Thank you again, Nga and Ummul for sharing with us insights from your research.
You have been listening to Retirement Puzzle from the Monash Centre for Financial Studies.
If you have enjoyed it, please tell your colleagues and friends about us. You can subscribe to our show, and don’t forget to leave us a review.
If you want to collaborate with us on retirement-related issues, please get in touch with us at mcfsinfo@ monash.edu.
