Treasurer Josh Frydenberg addressed the National Press Club this week with his thoughts on the COVID-19 health and wealth crisis. A clear message in the speech, was the need for economic reform. During the speech, he tellingly said “we will look at old reforms with fresh eyes.”
He closed his speech by quoting one of his constituents, 102-year-old Enid Williamson, who wrote to him and said after this crisis we would be like "a phoenix rising from the ashes” and should be prepared to “chase” our dreams.
Given the crises, and the fact the review of the retirement system is still underway, National Seniors believes there is no better time to talk about reform of the retirement system.
In the lead up to the Budget in October, National Seniors will be discussing reform options with older Australians. In this first article, we ask what the role of the Age Pension is in Australia’s retirement system.
The following article has been written for National Seniors by David Knox as part of our ongoing series on reforming the retirement income system. David Knox is an Actuary and Senior Partner with consulting firm Mercer.
Let’s begin with those with little or no savings.
The initial purpose of the government pension (or first pillar) of any retirement system within a developed economy is to alleviate poverty.
Simply put, older people with limited financial resources should be able to live out their final years with dignity and some financial security.
The level of the Australian Age Pension, measured as a percentage of the average wage, is above the OECD average for basic pensions and significantly above the minimum pension paid in both the UK and the USA.
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 paid to those with reasonable financial resources. In turn, this reduces the cost to the government and hence to the 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?
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, including the following two:
Option one is to take a consistent (inflation-adjusted) benefit from my super every year. But, 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.
Option two 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.
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 aged 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 the 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.
Your can hear David Knox talk about the benefits of a universal pension here.
As economists, commentators and others begin to fill the airwaves with ideas about how to reform the economy, it's more important than ever that seniors mobilise to tell government what we want.
Let’s fight for fairness together.