Australian Superannuation System - Essay Example

RUNNING HEAD: AUSTRALIAN SUPERANNUATION SYSTEM Australian Superannuation System [The Writer’s name] [The name of the Institution] Australian Superannuation System Introduction Up to 2005, most Australian public servants and the military received as a part of their remuneration a defined benefit superannuation payment in retirement. (Manning, p, 203, 2005) At the time of employment, no funds were set aside for these future outlays. Rather, the payments were to be met when required on a pay-as-you-go form from recurrent government expenditure. In effect, the government was building up unfunded liabilities, or borrowing from its current employees. At May 2007 these unfunded liabilities were estimated at around $103 billion, or 10 per cent of a year’s GDP, and the liability is expected to grow to around $148 billion by 2020 (Hughes, p. 232 2007). While some superannuation retirement benefits will be paid in the next few years, given the age distribution of expected retirements, a large proportion of these unfunded liabilities are not expected to mature until after 2020 (Hughes, p. 232 2007). Financing these superannuation liabilities from recurrent funds as and when they are claimed is referred to as the business as usual (BAU) strategy. The Australian Government has established a Future Fund (FF) to bring forward the time of collection of public sector funds to pay for the unfunded superannuation liabilities of public servants and the military. The FF strategy proposes to use government budgetary allocations over the next decade or so, revenue from the sale of the government’s Telstra shares, and the investment returns on these funds to meet the unfunded superannuation liabilities of public servants and the military. The FF scheme was announced in 2004 and it has been in operation since April 2006. (Hughes, p. 232 2007) From the perspective of fiscal policy, the FF idea means that over the next decade or two the budget surplus will be lower, or government expenditure will be lower, or tax rates will be higher, or a combination, and then the reverse will happen from about 2020 onwards, compared with the BAU policy strategy of funding the superannuation claims out of current revenue on a pay-as-you-go basis. The Market Pillar The role of the market pillar in providing retirement in comes prior to the 1980s was very limited, despite the fact that private pension plans generally known as occupational superannuation schemes have a long history in Australia. The limited role played by occupational superannuation in providing a retirement income was not only attributable to the narrow cover age of the workforce. There were two other factors at play. The first of these was that, because of the absence of preservation requirements, superannuation benefits were paid not only at retirement but also at any time a worker changed jobs. This often resulted in the dissipation of benefits during a working life time, leaving relatively little for retirement. (Bateman, 2003, p. 126) The objectives of Australia’s “new” retirement income system While the seeds of change as far as the Age Pension is concerned were sown with the 1978 change, the reshaping of Australia’s retirement income system began in ear nest with the election of a Labor government under Prime Minister Bob Hawke in 1983. The prime mover was the Treasurer, Paul Keating, who eventually re placed Hawke as Prime Minister in December 1991. (Bateman, 2003, p. 126) The following six objectives for Australia’s retirement income system emerged with the unfolding of the reform process: • To enhance the role played by the market pillar in providing income for retired workers through expanding occupational superannuation coverage; • to improve the coverage of the market pillar with a view to enhancing the adequacy of superannuation provided retirement in comes for future retirees whose retirement income expectations will be higher than those of past retirees; • To contain the public subvention of the market pillar through the tax concessions enjoyed by superannuation schemes; • To enhance the role played by the market pillar as an income stream throughout the retirement years; • To reduce reliance on the public pillar the Age Pension — as a source of retirement income through tightening eligibility; • To increase house hold and national savings and, in turn, investment. More recently, two further objectives have become evident, albeit not of the same revolutionary order as the first six: • To strengthen personal savings for all Australians, whether in the workforce or not; • To strengthen the incentives for delaying retirement. The first group of objectives, on the face of it at least, appears to be quite simple, straight forward and uncontroversial. However, within the Australian con text they mostly rep re sent a grand departure from the objectives to the ex tent that they were discernible of the retirement income system before the early 1980s. Indeed, they are so profoundly different that they and the changes they have shaped have been described as “revolutionary” in Thomas Kuhn’s (1970) sense of this term, involving a paradigmatic shift in which the roles of the pillars of Australia’s retirement income system have been turned on their heads (Borowski, 1987; Olsberg, 1994, 1995 and 1997). Regulation of Superannuation An important means for reducing the risk borne by covered workers is the regulation of superannuation funds. Australia’s superannuation Industry was substantially self-regulated before the mid-1980s. The public regulatory provisions largely related to the taxation of superannuation under the 1915 Income Tax Assessment Act. Fortunately, the expansion of superannuation coverage and the growth in defined contribution funds have been accompanied by major reforms in the regulatory frame work to protect workers’ superannuation savings. Thus, in 1987 the Insurance and Superannuation Commission was established as a specific industry regulator. Further regulatory legislation was passed in 1993 (the Superannuation Indus try (Supervision) Act). And in 1998 the Australian Prudential Regulation Authority was established as a single regulator for the finance industry. But options for still further reform continue to be canvassed. This is because “the ability of superannuation regulations to ensure the security and adequacy of retirement incomes is unclear” (Bateman, 2003, p. 126) despite the marked improvement in the regulatory regime. The improvement in coverage: Enhancing retirement income adequacy, another goal for Australia’s retirement income system that emerged with the unfolding of the reform process was to enhance the adequacy of superannuation provided incomes for future retirees, whose expectations will be higher than those of their predecessors. For most of the twentieth century, the major source of income in retirement for most Australians was the Age Pension. Consequently, what constitutes an adequate retirement income was an issue constructed solely in poverty alleviation terms. As recently as the 1980s, the notion that an adequate retirement income is one that al lows retirees to maintain accustomed preretirement living standards was an alien one in Australia (Borowski, 1984; Borowski, Schulz and Whiteford, 1987). However, by the early 1990s it was beginning to take hold.5 Today there is a broad consensus that an adequate retirement income is one that, for a per son on average earnings, replaces about 60-65 per cent of gross preretirement earnings (Commonwealth of Australia, 2002a). This adequacy standard was recently endorsed by the then Leader of the Labor op position, Mark Latham, who, during the campaign leading up to the 2004 federal election, advocated a retirement income goal of “65 [per cent] at [age] 65” for the non-poor. Al though the in adequacy of projected retirement in comes is due mainly to the low level of contributions; there are other factors at play here too. One of these is the tax treatment of superannuation. Superannuation in Australia is subject to a unique tax regime by international standards. (Common wealth of Australia, 2003). This regime has sought both to en courage saving for retirement in the form of superannuation and, at the same time, to contain the public subvention associated with superannuation tax incentives. A major effect of the tax regime has been to very seriously compromise one of the objectives of the reform process begun in the 1980s, namely to enhance the adequacy of the retirement incomes provided by means of superannuation. (Common wealth of Australia, 2003). In addition to encouraging retirement savings and seeking to recoup or re duce forgone revenue, the superannuation tax regime seeks, on equity grounds, to limit the amount that can be invested in superannuation and taxed at concessional rates. The government has capped the level of tax advantaged benefits it considers reason able for a retiree. On 1 July 1994 it introduced indexed flat-dollar Rea son able Benefit Lim its (RBL). (Tesfaghiorghis, 2002; Department of Family and Community Services, 2003). Any amount received above the RBL is taxed at the maximum personal marginal tax rate, which is currently 48.5 per cent. For the 2003/04 financial year the reason able benefit limit for a lump sum was $A 588,056. However, where at least 50 per cent of the total benefit was used to purchase an annuity (private pension), the RBL was twice this amount ($A 1,176,106). (Tesfaghiorghis, 2002; Department of Family and Community Services, 2003). From Lump Sum to Income Stream The changes in the tax treatment of superannuation were not only animated by the government’s de sire to re duce the public subvention of superannuation. They also sought to re dress the situation of the more generous tax treatment of lump sums relative to private pensions and thereby make the latter, which provide an income stream throughout retirement, more attractive. The change in the tax treatment of lump sums, the two-tiered RBL, a 15 per cent pension tax off set available to those aged 55 years and over who draw in come from a private pension, and the generous treatment of complying annuities under the Age Pension’s means test (the ex emption under the asset test of 100 per cent was only recently reduced to 50 per cent) all seek to provide an incentive for the purchase of an income stream. (Tesfaghiorghis, 2002; Department of Family and Community Services, 2003). And to the ex tent that superannuation is pre served until retirement and provides an income stream throughout the retirement years, it would also obviate the need for an Age Pension. Despite the tax and other incentives to take retirement income in pension or income stream form rather than as a lump sum, the government’s efforts to en courage retirees to purchase private pensions with their lump sums have met with little success. Today, two decades into the reform process, three-quarters of all retirees opt for lump sum payments (Common wealth of Australia, 2003). There are several reasons for this. One is that life time annuities in particular provide low re turns. They also en tail a loss of capital to the estate upon death. (Capital guarantees are usually less than life expectancy.) Further, the comparatively small sum of accumulated retirement benefits may be in sufficient to purchase a private pension that pro vides a reason able income stream. Thus, recent figures indicate that the average superannuation balance of 50-69-year-olds is just $A 83,000 while average house hold retirement savings where at least one 50-69-year-old is still working are just $A 170,000. Suggest (AMP Financial Services, 2004) Given that lump sums are often used, in part at least, to re tire debt upon retirement, the balances available to purchase a private pension may be still smaller than these figures suggest (AMP Financial Services, 2004). And because lump sum benefits of this order would at tract relatively little taxation, the tax disincentive to take a lump sum payment remains small. Never the less, policymakers continue to support the notion that superannuation lump sum payments should be used to provide a source of income throughout the retirement years. After two decades of reform, the Age Pension today remains the major source of retirement income for most Australians. About 80 per cent of the elderly population currently receives the Age Pension or the Service Pension (Tesfaghiorghis, 2002; Department of Family and Community Services, 2003). Of those, two-thirds receive a full pension and one-third receives a part pension. This level of take-up should not come as a great surprise given that the superannuation system still has a long way to go to reach mat u ration. But projections of the future pat tern of age pension entitlement indicate that the take-up rate will be substantially higher than was expected in the early years of the retirement income reform process. Thus, the Economic Planning Advisory Council (Tulpule, 1992) expected that perhaps only 20 per cent of the elderly population would be eligible for the Age Pension after 30 years, by which time the effects of the SG would have been felt. Yet it has been recently estimated that over an even longer projection period by 2050 — the pro portion of older people receiving the age pension will have fallen by only 5 per cent age points to 75 per cent. (Tesfaghiorghis, 2002; Department of Family and Community Services, 2003). However, the balance between full and part pension recipients will have re versed itself, with two-thirds receiving a part pension and one-third a full pension (Common wealth of Australia, 2002a). It should also be borne in mind that despite this expected future decline in the take-up rate and the shift in the mix between full and part pensions, there will still be a large increase in Age Pension expenditure because of population ageing. Clearly, Paul Keating’s objective of re placing the Age Pension as the standard form of retirement income for future retirees (Olsberg, 1994) will only have been partially realized, further underscoring the importance of substantially increased superannuation. Increased savings A final objective of the reform process was to increase house hold savings and, in turn, national investment. The introduction of mandatory superannuation contributions has meant that virtually all Australian workers now hold growing sums in one or more superannuation fund accounts. Interestingly, however, despite the introduction of the SG, the house hold savings rate in Australia has continued the down ward trend that began about 30 years ago. It is now less than zero. The reasons are complex. Suffice it to note that they do not lie in the SG scheme itself (Warren, 2004; Manning, 2005). Conclusion A recent study that sought to assess the “vulnerability” of 12 industrialized countries to rising old-age de pendency costs ranked Australia least vulnerable according to an ageing vulnerability index. This was because of, among other measures, its lower projected age dependency ratio, comparatively low-cost Age Pension and the fact that superannuation benefits will reach 11 per cent of gross domestic product by 2040, far exceeding the level of any of the other countries (Jack son and Howe, 2003). In light of findings such as these, prominent observers (e.g. Harris, 2004) have held up Australia’s retirement income strategy of mandating superannuation and rolling back public income support in the form of the Age Pension as worthy of emulation by others. But even assuming that the assumptions and analyses under pinning the development of such measures as the ageing vulnerability index are correct, this pa per has sought to show that, after two de cades of reform, the changes in Australia’s retirement income system either have not realized or cannot expect to realize some of the revolutionary objectives that were expected of them. To be sure, there form process is continuing. The most recent ex ample of this is the pas sage in June 2004 of “choice-of-fund” legislation that al lows, from mid-2005, employees to choose the fund into which their SG de fined contributions will be de posited. (Manning, 2005) This legislation also provides for improvements in disclosure regarding superannuation funds’ fee regimes. But major challenges remain to be tack led. These include, for ex ample, extending superannuation coverage to the small proportion of the workforce that remains un covered, raising the mandatory SG contribution to levels that will produce an adequate retirement income in the future, substantially reducing and simplifying the superannuation “tax bite” that so seriously compromises the realization of the adequacy objective, guaranteeing the safety of retirement savings held in the now pervasive accumulation-type superannuation funds, ensuring that superannuation is actually used as a means of funding an income stream throughout the retirement years and, as a result of all of these, reducing still further the future take-up rate of the Age Pension. (Manning, 2005) In sum, if Australia’s retirement income system is to be truly worthy of emulation, then more zealous fidelity to “revolutionary doctrine” the objectives of the reform process will be necessary. References AMP Financial Services. 2004. 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Manning, I. 2005. “Retirement incomes: National superannuation, social insurance or something else?”, in Transitions in Australian labour markets: Initial perspectives (CEDA Information Paper No. 82). Melbourne, Council for Economic Development of Australia. Olsberg, D. 1994. “Australia’s retirement income revolution: A new model for retirement savings and investment politics”, in Economic and Indus trial Democracy, Vol. 15, No. 2. Olsberg, D. 1995. “Australia’s retirement income revolution: A Finnish system ‘down-under’”, in Scandinavian Journal of Social Welfare, Vol. 4, No. 1. Olsberg, D. 1997. Ageing and money: Australia’s retirement revolution. St. Leo nards, NSW, Allen and Unwin. Tulpule, A. 1992. “Can social and policy developments cope with demo graphic change?” in Economic Planning Advisory Council, Economic and social consequences of Australia’s ageing population: Preparing for the 21st century (Back ground Paper No. 23). Canberra, Australian Government Publishing Service. Warren, N. 2004. Tax: Facts, fiction and reform (Research Study No. 41). Sydney, Australian Tax Research Foundation. Read More