Ummul Ruthbah:
Hello, everyone. Welcome to The Retirement Puzzle, brought to you by the Monash Centre for Financial Studies. I’m Ummul Ruthbah, a researcher at MCFS and one of the co-hosts of the podcast where we explore the current and critical trends in the pension sector and try to explain how they impact us all.
In this episode we are going to talk about equity of superannuation and age pension systems.
One of the desirable features of a good retirement system is equity. There are quite a few areas within our superannuation and age pension that raise questions on how these two pillars treat the retirees in different income groups. To talk about all these issues related to equity and how to address them, today we have with us, Dr. Stephen King.
Stephen is a commissioner at the Productivity Commission and has been deeply involved in regulatory issues throughout his career.
Stephen was also a member of the Australian Competition and Consumer Commission, where he chaired the Mergers Review Committee. He is a member of the Academy of Social Sciences in Australia, and a lay member of the High Court of New Zealand.
Stephen also has a very successful academic career. Before joining the Productivity Commission in 2016, he was a Professor of Economics at Monash University, as well as Dean of the Faculty of Business and Economics. He has a PhD in Economics from Harvard and is widely published in international academic journals.
Ummul Ruthbah:
Thanks for joining us today, Stephen. Let me start with the Retirement Income Review; it is an outcome of the recommendation made by the Productivity Commission. Do you find any part of the review surprising or somewhat unexpected?
Dr. Stephen King:
Okay, so let’s start off this by saying well, what was the point of a retirement income review? So really, the Productivity Commission recommended that review to fill an important information gap for policy. And if you think where we’re sitting with superannuation, we’ve had a lot of concentration on the savings side, if I can put it that way, over the last 20 or so years.
Dr. Stephen King:
But as more people are retiring and they’re accessing their superannuation savings … so these savings are becoming more important as part of people’s retirement … we really need to start asking questions about that post-retirement draw down phase of superannuation. So the Retirement Income Review is aimed to help fill in the details, for government, about that post-retirement period of superannuation.
Dr. Stephen King:
Second thing … before I say what they found, or look at what they found … is to remember the context here. And this is clear in the terms of reference of the Retirement Income Review, that there are three pillars of Australia’s retirement income system, and we can’t ignore any of those. So, in fact, they’re interlinked. So when we’re looking at the Retirement Income Review and their findings, we need to keep those three elements in mind.
Dr. Stephen King:
So, did I find anything particularly surprising? No. They suggest, for example, that there needs to be a clear objective for the superannuation system, but that’s completely in line with what the Productivity Commission found in our pre-retirement analysis. They note that the system is complex and individuals have trouble understanding the system. Again, that’s pretty clear. They note the interactions between the different parts of a retirement system, so the importance of the age pension and those three pillars that I’ve already mentioned. So I don’t think that there was surprising findings.
Dr. Stephen King:
Of course, there were some controversial findings, and some of the findings have been disputed. Perhaps the most obvious one, is the Retirement Income Review’s claim that most retirees leave the bulk of their wealth that they had at retirement as a bequest. So the superannuation industry very quickly responded, noting that when considering retirement income accounts held through superannuation, the Retirement Income Review’s claim may be true in nominal terms, but when you adjust for inflation of the superannuation industry claims that, in fact, people do draw down their superannuation accounts. And in fact, they point out that the minimum annual withdrawal limits, put in place by legislation, effectively mean they have to draw down those accounts in real terms.
Dr. Stephen King:
So the superannuation industry said, “Well, we don’t quite agree with the Retirement Income Review on this.” My take on that, by the way, is that they seem to be comparing a bit of apples and oranges. They can both be true. The Retirement Income Review looked at retirees’ wealth. The superannuation industry came back and said, “Well, we’re going to look at part of that wealth, which is your superannuation accounts.” And, of course, the big elephant in the room, when you just look at your retirement income account, is that you’re leaving out the wealth in the family home. And capital appreciation in family homes can offset any real reduction in superannuation balances. So, both can be true. But we’ve got to make sure that, in the debate, where we’re not comparing apples with oranges.
Dr. Stephen King:
Another slightly controversial finding they had was that we may be overshooting the trade-off between saving and consumption while working, versus in retirement. And the Retirement Income Review suggested that if people drew down their wealth in retirement at an appropriate rate, then, in fact, you could see the increases in compulsory superannuation pushing people to have too little consumption during their working life and, in a sense, too much in retirement. So some controversial stuff, but not surprising stuff.
Ummul Ruthbah:
Ah, yes, there were some very heated discussion on these issues after the review came out.
Ummul Ruthbah:
Now, let’s talk about our superannuation guarantee and how it may or may not generate inequality. So one set of opinions say that the superannuation guarantee should be increased to 12% because retirees don’t have enough savings. On the other hand, the Retirement Income Review finds that increasing it to 12% would hurt the low income earners as it would slow down the wage growth and lower their take-home income.
Ummul Ruthbah:
So one possible way to not worsen their standard of living, during the working age, is to keep the superannuation guarantee rate fixed at 9.5% for these low-income earners and increase it gradually to 12% for others.
Ummul Ruthbah:
So do you think it is feasible to have such a tiered system? And what would be the implications of such a system for the middle and high-income earners? Will it make them have a more comfortable retirement without hurting them during their working age?
Dr. Stephen King:
Yep. So let’s think about those middle-income earners and ask: what is happening there when the contribution rate goes up? There are some people who seem to view superannuation contributions as simply an employer impost. So the idea here is, is that if you put up the superannuation guarantee rate for middle-income earners, their wages will stay the same, the amount their employer is putting into superannuation will go up, and so they will be able to have a better retirement at no cost during their working life.
Dr. Stephen King:
Now, that’s a nice view. It would be great if it were true. Unfortunately, the evidence over the longer-term … and the evidence is referred to in the Retirement Income Review … shows that there is a trade-off. And in the absence of some sort of magic pudding economics, you would expect there to be a trade-off. So a higher superannuation guarantee rate for middle-income earners will feed through … not immediately, but will over time … feed through to their wages. It’s not a free trade-off. That if you have higher superannuation guarantee rates for middle-income earners during their working lives, that means, over time, they will have less money during their working lives. Albeit, some more in retirement. Albeit. But some of them will need to rely less on the age pension in retirement.
Dr. Stephen King:
Second thing, you focused on those people who can have a more comfortable retirement because they have a higher compulsory superannuation guarantee. So we’re sort of now talking at the upper end of the income spectrum. Why will they have a more comfortable retirement? I agree they will. But the reason is not that the guarantee rate goes up, per se, because these are individuals who often have substantial private savings. The reason why they will have more income in retirement, is that if the superannuation guarantee rate goes up, with the current tax concessions, then they’re simply able to pay less tax.
Dr. Stephen King:
So if our aim here is to say, “Well, we want to have a less equitable system so that we can have more tax concessions going to high-income earners,” then having that split of superannuation guarantee rates seems to be a good way to achieve that. But that’s a very inequitable outcome. So, in other words, if we’re thinking about, “Well, yes, we want some more people to have higher retirement incomes at that upper level, those who will be in the higher contribution rate level, then all we’re really saying is we want the government to give these people more tax concessions so they can have a better retirement.” And these are generally people who have a fair bit of income in retirement anyway. And if you got rid of the tax concessions, completely pull them, would still have a very good retirement, they’d just be doing it through private saving.
Dr. Stephen King:
So I can’t see any logic, in Australia, for having that sort of range of superannuation contributions.
Ummul Ruthbah:
You just gave me the perfect cue, Stephen, as my next question is on tax concession. We all know that tax policies usually have little or no effect on savings. And a recent study by MCFS finds that the various tax incentives provided under our super system have an insignificant impact on private savings. The review discussed it at length, and you also mentioned it earlier, that the largest amount of government support for the rich comes from these concessional superannuation taxes.
Ummul Ruthbah:
So my question to you, Stephen, is why do we still have such huge tax concessions for superannuation savings?
Dr. Stephen King:
Yeah. Okay. So let’s, again, just work through this in a number of stages. So your first point, was for Monash Center for Financial Studies work, and work by some others, asking, well, does superannuation actually increase total saving?
Dr. Stephen King:
And Retirement Income Review, as I’ve already mentioned, it notes that some people find it difficult to understand the benefits of saving versus immediate consumption. And some compulsion, with or without the tax concessions, could lead to increases in savings for these people. But overall, as the Monash Center for Financial Studies has found, the extent of that increase in savings is, at best, unclear, and probably fairly small over the system as a whole.
Dr. Stephen King:
In which case, why do we give them the tax concessions? Or why are the tax concessions as generous as they are? As you know, for tax concessions, earners enter a quid pro quo for: you’re locking up savings, often in your 20s and 30s, for your retirement, rather than using them for other things; such as to pay down the home mortgage. That may or may not be a good thing, by the way. As the Retirement Income Review notes, for many of those middle-income earners, we’re probably at a point where, in a sense, you’ve got too little consumption, they’re not paying enough down on their house, they’re not having enough consumption during their working life. So to have a tax incentive that pushes people towards having more retirement consumption and less consumption during their working life may not be a good thing for those individuals.
Dr. Stephen King:
But if we had the tax concessions in there, in the superannuation system, and they are generous, there’s been research done to show that it is the most tax effective way of saving, moreso than even the family home, is to put money into superannuation.
Dr. Stephen King:
We then have to ask, well, who are the big beneficiaries of these tax concessions? And the big beneficiaries, at the moment, of these tax concessions, are those individuals who have very high superannuation balances because the tax concessions largely don’t cut out. And that’s changed a bit that, there’s certainly been some changes to the amount of money that you can put in superannuation during your working life to try and limit those top-end tax concessions. There’s certainly been changes to the amount that you can put in an allocated pension post-retirement, to, again, try and limit the tax concessions that are being offered.
Dr. Stephen King:
But both those pre-retirement and those post-retirement tax concessions are huge benefits for people who actually don’t need them in retirement. And as I’ve already mentioned, and the Retirement Income Review mentions, they’re are a large cost. So really, what the debate about those texts concessions needs to be, is how do we reform them, so that if we feel there needs to be that compensation for low and middle-income earners, we’re forcing them to save more than they would otherwise do for their retirement, that they get the tax concessions. But the tax concessions aren’t being provided to people, for example, as referred to in the Retirement Income Review, who have $5 million or more in superannuation. How do we actually get that balance better? is really the question around tax concessions.
Ummul Ruthbah:
The last issue, our age pension. It’s tapering mechanism generates another source of inequality. Some experts have shown that a lower asset tapering threshold would reduce some of the disparity, but it would also raise the cost of age pension as it would make more people in the middle eligible for a higher age pension.
Ummul Ruthbah:
So, Stephen, what is your opinion on this? I mean, is there any other way to reduce this inequality?
Dr. Stephen King:
Okay. So one, already, that I’ve mentioned, is related to the superannuation tax concessions of the inequality. But if we’re thinking about the age pension and the tapering system there, any social welfare needs some form of tapering, it needs to be some way that you can say, “Well, you have more assets, you have more income, so you will receive less of the age pension.”
Dr. Stephen King:
And there’s always a trade-off in there. You could make the age pension universal. That would increase its cost, it would have been for very rich people get the age pension as well as people who are poor and don’t have enough retirement savings. I’m not sure that’s where we want to go, that sounds like a rather expensive policy; and certainly not more equitable. So some form of tapering is needed so that we best target the age pension to those who need it.
Dr. Stephen King:
The big issue, when we’re looking at the asset tests though, for the age pension, comes back to the family home. And as I mentioned earlier on, the most effective tax effective method of saving in Australia, as I understand it, is superannuation, the second most effective is through a family home. The family home is exempt from any asset tests. It’s exempt from any capital gains tax when it’s sold. And Australians have a long-term love affair with having rather large houses, rather large expensive houses. But again, that is a significant gain to those most wealthy Australians.
Dr. Stephen King:
So again, what we may need to think of … and governments are already thinking of this, they’re already moving down this track … is how to better deal with the family home when we’re looking at assets tests, for things like the age pension.
Ummul Ruthbah:
Yes, this is another source of inequality within our age pension system, how it treats the homeowners and the renters. Of course, the asset test threshold is higher for renters, but the income generated from those additional assets is not enough for paying the rent.
Ummul Ruthbah:
So let me ask you, Stephen, why the need to treat residential property differently? Why cannot we treat it as any other assets in determining the retirees age pension eligibility, or the amount he or she is entitled to?
Dr. Stephen King:
Okay. So, two points there. First off, yeah, you correctly point out the Retirement Income Review notes the big disparity between those who retire with their own home and those who are renting in retirement. And those who are renting in retirement are much more likely to be worse off than those who own their own home; so it’s a direct equity question.
Dr. Stephen King:
What’s the problem with just treating the family home like any other asset? Well, there’s two elements to that. One, as I’ve already noted, it’s a big lumpy illiquid asset. So the first problem with just simply adding the family home to the asset base, is to say: how do we deal with that liquidity problem? And that’s where products like reverse mortgages have been thought about. They haven’t been particularly popular. So we need to really understand and ask: why haven’t they been popular? Why have people, who have been in that situation, where they’ve had substantial wealth tied up in the family home, why have they been reluctant to access that as a form of liquidity, as a form of income? Even in situations where they rely almost entirely on the age pension and could have a much more comfortable retirement if they were able to access the family home?
Dr. Stephen King:
So that really brings me to the second problem of just adding it, the family home in Australia, over a long period of time it’s been viewed as sort of sacrosanct. Home ownership, being able to bring up your family in your family home, being able to welcome the grandkids and eventually peacefully dying in your family home, is a sort of myth around Australian life.
Dr. Stephen King:
Many Australians do not have that luxury, but it’s still a view of life that many Australians consider important. So, politically, there would be problems with just saying, “Right, we’re adding the family home to the wealth base for asset tests.”
Ummul Ruthbah:
Yes, Stephen, I agree with you. I think it’s not a problem specific to Australia, I think people all over the world, they view their family home, something that should not be touched.
Dr. Stephen King:
Yep. As someone who is still working, but at the older end of the spectrum, and has a ridiculously large family home, which he, his wife, and his cat live in, I can understand that.
Ummul Ruthbah:
Thank you so much, Stephen.
Ummul Ruthbah:
So what are some of the questions, in this space, that you’d like to have answers to?
Dr. Stephen King:
Ooh, that’s a large question in itself. I think we’ve really touched on the two main areas. So the answers that we need, and the areas of policy that we really need to understand more about and we need to think more about and experiment more about, are the tax concessions and the family home. So, in some ways, I’m not telling you anything new, most people understand that the tax concessions and the family home are the two weak points of our triple tiered system that we have.
Dr. Stephen King:
The sort of questions that I’d like, or the areas that I think the government should go … and I’ll look at the tax concessions, just to give an example. The government has slowly reduced some of those tax concessions for individuals with very high superannuation balances.
Dr. Stephen King:
But maybe we need to ask: why don’t we go further? Let’s suppose that, as a society, we consider: for a couple, with their own home, $1 million in superannuation savings, where they’ve received the tax concessions, that’s more than enough for the vast majority of people to have an appropriate retirement. If, as a society, we consider that reasonable, we then have to ask ourselves, well, once a couple with a family home reaches that $1 million, with the tax concessions and the benefits they’ve received, why should they receive any further tax concessions? Of course, then why should they be forced to have more superannuation savings as well?
Dr. Stephen King:
So is it the case that we should be thinking about: what are the appropriate levels of superannuation balance? There’s a whole range of questions in there, but I think they’re all important questions that we need to ask and answer.
Ummul Ruthbah:
Thanks a lot, Stephen, for being with us today. From today’s episode, we learned that there are many parts of our retirement system that generate inequality. Some of these policies that benefit the rich, for example, the tax concessions during the accumulation phase, are required to encourage us to save for retirement. And others, for example, the age pension, tries to undo some of that inequality. The system is complex, and attempts to make it more equitable might add to its complexity. So there are trade-offs that we need to consider. And we need more research, in this space, how those trade-offs work.
Ummul Ruthbah:
Thanks a lot for staying with us. Stay safe, until the next time.
Ummul Ruthbah:
Thank you for listening to The Retirement Puzzle Podcast from Monash Centre for Financial Studies. If you have enjoyed it, please tell your colleagues and friends about us. You can subscribe to our show anywhere you listen to podcasts, and don’t forget to leave us a review.
Ummul Ruthbah:
If you want to collaborate with us on retirement related issues, please get in touch with us at mcfsinfo@monash.edu.
