In our article, ‘Australia’s three-pillar retirement income system’, we discussed in detail Australia’s retirement income system—a three-pillar approach, which has been pursued by the Government for the last few decades.
Despite changes over the years to each of these pillars (some more than others), their core aims remain intact.
Essentially, the three-pillar approach consists of the following:
1. Pillar 1: Means-tested Age Pension (publicly funded). This pillar aims to ensure Australians can meet a minimum standard of living in retirement. It’s a safety net for those who don’t have enough super or other financial resources behind them to generate a reasonable minimum retirement income.
2. Pillar 2: Compulsory superannuation. This pillar aims to improve the adequacy of retirement income to allow Australians to achieve a standard of living in retirement above that afforded by sole reliance on the Age Pension.
3. Pillar 3: Voluntary savings, including home ownership. This pillar provides flexibility to save more for retirement than what is required under compulsory super. Tax concessions applying to voluntary savings provide opportunities for individuals to set aside additional savings. This is important especially for those not covered by Super Guarantee such as the self-employed and those on a career break to catch up on saving for retirement. Voluntary savings may allow individuals to achieve a higher standard of living in retirement than those solely reliant on the Age Pension and compulsory super.
Please note: The third pillar also encompasses individuals and their voluntary private savings outside of the super environment, as well as homeownership.
Retirement Income Review final report
The Government recently released the Retirement Income Review final report—an independent review of the performance of Australia’s retirement income system. It provides a fact base of the current system in the context of an ageing society. Its purpose is to improve understanding of the operation of the system and the outcomes it delivers to Australians. The Review identifies:
- how the retirement income system supports Australians in retirement
- the role of each pillar in supporting Australians through retirement
- distributional impacts across the population and over time
- the impact of current policy settings on public finances.
Below, is a summary of several excerpts* from the report’s key observations section:
“The Australian retirement income system is effective, sound and its costs are broadly sustainable. However, it can be improved.
The system is complex. Adding to this complexity is the interaction with other systems, such as the aged care and the tax systems. There is a need to improve understanding of the system.
Complexity, misconceptions and low financial literacy have resulted in people not adequately planning for their retirement or making the most of their assets when in retirement.
- A clear objective for the system is needed to guide policy.
It is suggested that the objective for the system be developed with the goal ‘to deliver adequate standards of living in retirement in an equitable, sustainable and cohesive way.’
- As at June 2019, around 71% of people aged 65+ received Age Pension or other pension payments. Over 60% of these were on the maximum rate.
For most households aged 65+, the family home is their main asset. Super makes up a small share of their net wealth. This will change as the super system matures.
The Age Pension, combined with other support provided to retirees, is effective in ensuring most people achieve a minimum standard of living in retirement in line with community standards. Retirees receive health, aged care and other Government services worth more than the maximum rate of the single Age Pension.
The Age Pension plays an important role as a safety net in supplementing the super savings of retirees and allowing them to maintain their living standards. It also provides a buffer for retirees whose retirement income and savings fall due to market volatility, and for those who outlive their savings.
- Compulsory super allows people to achieve a retirement income that better reflects their pre-retirement income. As the super system matures, people will increasingly fund more of their own retirement.
Voluntary super provides the flexibility for people to save more than is mandated by the Super Guarantee (SG). It also provides an opportunity for those not covered by SG to make super savings.
Super savings are supported by tax concessions for the purpose of retirement income and not purely for wealth accumulation. Yet most retirees leave the bulk of the wealth they had at retirement as a bequest.
The home is the most important component of voluntary savings and is an important factor influencing retirement outcomes and how people feel about retirement.
- Homeowners have lower housing costs and an asset that can be drawn on in retirement. Also, the system favours homeowners (e.g. the principal residence exemption in the Age Pension assets test).
Saving for retirement involves forgoing consumption in working years. With voluntary saving, people decide on this trade-off. When there is compulsory super, the SG rate should be set at a level that balances pre-and post-retirement living standards.
- The weight of evidence suggests that increases in the SG rate result in lower wages growth and would affect living standards in working life.
More efficient use of savings in retirement can have a bigger impact on improving retirement income than increasing the SG rate.
- Using super assets more efficiently and accessing equity in the home can significantly boost retirement incomes without the need for additional contributions.
The Pension Loans Scheme is an effective option for accessing equity in the home for both age pensioners and self-funded retirees. The current exemption of the principal residence from the Age Pension assets test is a disincentive to using the equity in the home to support retirement incomes.
- An individual’s super balance, and retirement income, largely reflects the extent of their engagement in the workforce, both income and years worked.
Some groups are disadvantaged by the design of the system.
Changes raised by stakeholders that could improve the fairness of the system include, for example:
- ensuring people receive the SG they are entitled to;
- extending the SG earnings base to include overtime;
- removing the $450-a-month threshold when the SG is paid;
giving greater visibility of super balances in divorce settlements; and
paying the SG on employer-paid parental leave and the Government’s Parental Leave Pay.
The Government’s expenditure on the Age Pension as a proportion of GDP is projected to fall slightly over the next 40 years to around 2.3%. Higher super balances reduce Age Pension costs.
The cost of super tax concessions is projected to grow as a proportion of GDP and exceed that of Age Pension expenditure by around 2050. This is due to earnings tax concessions“.
(Retirement Income Review final report, 2020, pp.17-20)
Australia’s retirement income system is ‘effective, sound and its costs are broadly sustainable. However, it can be improved’—Australia ranks seventh in the Global Retirement Index^ for retirement wellbeing and security.
It’s important to recognise that everyone has their own financial situation, goals and objectives, which also means our ideas and expectations about retirement can differ.
Therefore, in terms of securing your own retirement wellbeing and security, consider taking a proactive retirement planning approach as there are things within your control, which if acted upon can affect the final outcome.
Importantly, we can help point you in the right direction with an appropriately designed roadmap aligned with your personal circumstances and provide you with a helping hand along the way.
If you have any questions regarding this article, please contact us.
*Australian Government, Treasury. (2020). Retirement Income Review: Final report, July 2020.
^Natixis Investment Managers. (2020). 2020 Global Retirement Index: An in-depth assessment of welfare in retirement around the world.