The benefits of a universal pension

Dr David Knox, Senior Partner at Mercer and Senior Actuary for Australia, outlines some of the problems with our pension system and benefits of adopting a universal approach. Hear Dr Knox discuss this and other pension issues at our free webinar on 8 December.

Key Points

  • The current pension system makes retirement planning complicated.
  • Many other countries (New Zealand, the Netherlands and Denmark) have simpler systems, with a universal pension at their core. 
  • Dr Knox will be a guest presenter at our upcoming free webinar discussing the pros and cons of the pension system.

Older people with limited financial resources should be able to live out their final years with dignity and some financial security. 

The initial purpose of the government pension (also known as first pillar) – or any retirement system within a developed economy – is to alleviate poverty. 

Measured as a percentage of the average wage, the level of the Australian Age Pension is above the OECD average for basic pensions and significantly above minimum pension payments in the UK and US.  

The Australian Age Pension is also means tested, with the tests based on both income and assets (excluding the family home). 

The objective of means testing is to ensure that the pension is paid to those who need it and not to those with reasonable financial resources. In turn, this reduces the cost to the government and taxpayer. 

However, this is where it gets complicated for many Australian households, both before and after retirement. 

For example, if I save more for my retirement (whether inside or outside super), then I may receive less Age Pension. 

So, the question becomes: is the extra saving worth it? 

This is where it gets tricky

Let’s assume I have a reasonable super benefit (say $500,000) and I want to receive a consistent income (in inflation-adjusted terms) for the rest of my life (say 25 years). However, as I drawdown my super, I will be entitled to receive more Age Pension. 

So that leaves me with a few options.  

Option one is to take a consistent (inflation-adjusted) benefit from my super every year. However, this means that my Age Pension will gradually increase such that my total income increases as I get older. This is what the Grattan Institute model assumes, so that a retiree’s income increases with age.  

In terms of an ideal retirement system, such an outcome does not make sense. 

The second option is to recognise that as my Age Pension will increase in future years, I can therefore afford to draw down my super at a faster rate in the early years (that is, above both the minimum drawdown rules and an annuity-style benefit). 

However, many retirees may be risk averse and don’t want to spend their super too quickly. Furthermore, the rate at which one should draw it down under this option is almost impossible to calculate, given future uncertainties. 

In brief, the means-tested Age Pension makes retirement planning for middle Australia, with their increasing super balances, extremely difficult. 

We need a better system where super and the Age Pension work together and are not two unrelated components within our system. 

Looking overseas for inspiration

One approach would be to provide the Age Pension to everyone as they do in the Netherlands and New Zealand. Under this approach, every dollar you save you keep, as there are no means tests. It would make retirement planning so much easier. 

Of course, such an approach would mean every older person would receive a pension, so the costs to government would increase significantly and would necessitate changes to the tax system to recover these costs. 

Perhaps there is a middle way, where half the pension is paid to everyone and the balance is income tested. Denmark has such a system. 

The advantage is the universal part-pension gives everybody a base to build on, while the means-tested pension ensures that no-one lives in poverty. 

Another advantage is that means testing will cease at a lower level of assets or income than currently, as it would only apply to half the pension. 

This means that many retired Australian households would not be subject to any means testing and there would be a much clearer incentive to make some extra savings for your retirement. 

As Australia is heading towards having the lowest pension cost of any OECD country, we need to be willing to be bold, think outside the square, and so improve our overall retirement income system. 

Listen to Dr David Knox talk about the benefits of a universal pension and join us for our free webinar on 8 December, where an expert panel – including Dr Knox, Noel Whittaker, and Dr Deborah Ralston – will delve into this topic and other pension issues.  

Register for webinar