Rafal Chomik and Hazel Bateman

A good proportion of the Financial System Inquiry’s 460-page interim report is dedicated to a discussion of superannuation and, in particular, to making the financial system better at facilitating the conversion of super into retirement income.

Currently, the system does poorly. It does not meet the risk management needs of retirees. They have few options if they want a stable income after retirement that is insured against longevity, investment and inflation risk.

Indeed, existing rules impede the development of such products. It may make sense in principle for a retiree to insure against outliving their savings by buying a “deferred annuity” consisting of an income stream that only starts paying out in 20 years’ time.

But this would not be a wise move if (as is presently the case) the Age Pension means test deems that they are receiving that income in the intervening 20 years, and lowers their interim pension as a result.

The inquiry correctly identifies these issues as part of a wider problem of policy inconsistency: on the one hand, tax-advantaged retirement savings and default fund and portfolio allocations are mandated because we recognise we are subject to under-saving and behavioural biases. The majority never have to interact actively with superannuation during their working lives.

On the other hand, retirement income decisions and risks are left entirely with individuals at the moment of retirement.

The report puts forward four options, some of which are expected to become solid recommendations when the inquiry submits its final report in November 2014.

These range from the full flexibility but limited risk management of the status quo (where individuals use super savings as they see fit, with some improvement in financial information, advice and education) to the limited flexibility but full risk management of compulsion (where some savings must be used to buy a longevity-protected product).

In between these extremes are two other options. The inquiry flags the possibility of incentivising longevity-protected products via tax or the Age Pension means test. But benefits from super are already tax-advantaged so incentivising longevity-protected products may require raising taxes on other income streams and lump sums.

This could tie in with addressing another concern noted by the inquiry: that the tax arrangements within the superannuation system are being used for estate planning rather than for providing retirement incomes. Super taxes may be an area that the government’s proposed tax review will also look at.

Finally, the inquiry opens the door to a full discussion of instituting a default for decumulation of super. A single default would not suit everyone and there are fiduciary concerns about automatically committing individuals to a given decumulation product, but an opt-out would be available and elements tailored to individual circumstances could be included.

Also, only a proportion of savings above a certain threshold may be subject to the longevity-protected product default. These can guide those who are less engaged and offer flexibility to those wanting to make their own decision.

We know from research that defaults have a strong behavioural effect – often more so than financial incentives. A recent online experiment, led by the Centre of Excellence in Population Ageing Research (CEPAR), showed that in a decision to allocate assets between an account-based pension and an immediate annuity, individuals were most likely to choose the default option.

Such products, perhaps combined with a tendering process (seen in countries such as Chile and Singapore) for the most competitively priced, may yet provide value for money with the right mix of flexibility and risk management, regardless of a person’s level of financial capacity, engagement or superannuation balance.

Rafal Chomik is a senior research fellow at CEPAR at the Australian School of Business (ASB). Hazel Batemen is an ASB professor of economics and head of the school of risk and actuarial studies. A version of this post appeared on The Conversation.

The two changes to superannuation announced in the Federal Budget, one of which is welcome news, were:

• the way excess non concessional contributions are dealt with, and
• the progressive increase of the Superannuation Guarantee will be delayed another year.

A third announcement, the 2% debt levy, is already encouraging the financial planning community to look at ways to avoid it (sigh).

In addition to these Budget changes, the Australian Taxation Office (ATO) recently put the market on notice that it will come down hard on taxpayers using leverage in a superannuation fund to circumvent the contribution limits.

Non-concessional contribution caps

The contributions caps in superannuation limit the amount of tax concessions anyone, no matter how wealthy, can receive from using a low-taxed superannuation fund. One of those limits applies to contributions which, in effect, have not been tax-deductible, and is considered a penalty. It has also been highly problematic for many.

When introduced in 2007, any contributions in excess of the limit were taxed to the member at 46.5%. While that extra tax on excess contributions was said to recapture any tax concessions that had been derived from having the excess in the fund, it was more in the nature of a penalty tax.

Indeed, through one of the other rules relating to this contributions limit, it was not unusual for people to make contributions, say, two years ago and without fully appreciating what they had done earlier, make a contribution now that resulted in an excess non-concessional contribution and a 46.5% tax bill on that excess. It is with some relief, and probably six years too late, that these rules are now changing for the better.

From 1 July 2014 it is proposed that a person who contributes non-concessional contributions in excess of the cap will be required to take it out of the fund. No more 46.5% taxes.

Super Guarantee increase delayed

The increase in the Super Guarantee payment from 9% to 12% will be delayed a year. The super guarantee will not reach 12% now until 2022. However, the increase from the current 9.25% to 9.5% in 2014/2015 will go ahead, and it will remain at this level for four years until the end of the 2017/2018 financial year.

Dealing with the 2% debt levy

I never cease to be amazed by the ingenuity of the financial planning profession (of which I am part, I feel obliged to add). Within a few days of the Government announcing taxpayers over $180,000 pa will be charged an additional 2% income tax as a levy to cover Australia’s debt position, plans surfaced on how to manage around it.

The 2% increase will mean that the highest marginal tax rate for those affected, excluding the Medicare levy, will now be 47%, rather than 45%. However, the FBT rate is staying at 45% until at least the 2014/2015 financial year. The proposed scheme to avoid the levy is to salary sacrifice into taxable fringe benefits, which will be taxed at 45% rather than 47% had it been paid in cash, until 31 March 2015 (the commencement of the new FBT year).

Leveraging around the contribution limits

There has been one other significant tax issue related to superannuation that does not come out of the budget. The ATO has put the market on notice that it is not happy with people using leverage in a superannuation fund to overcome the contribution limits.

In one extreme example, three wealthy brothers all over age 60 who each set up an SMSF then loaned $10 million to it interest-free. The three SMSFs would then co-invest in a $30 million commercial property.

There is no deeming of the interest free loan as being a contribution so there were no contribution limit problems and as each brother was over age 60, their SMSFs were in pension mode and no tax was being paid on any rent or gain on sale from the commercial property.

The only risk being run was if they died without a Death Benefit Dependent, when tax would be payable on any benefit payment.

In any case, the ATO is now signalling that this kind of structuring is problematic. Briefly, the ATO is suggesting that the rental income and indeed, any gain made by the SMSF on sale, will be taxed to the fund at 46.5%. Some tax professionals are not sure the ATOs technical analysis of these types of transactions is correct. However, they take the view that the more likely result would be the application of the general anti-avoidance rule, which would seem to directly catch this practice.

Importantly, the views expressed by the ATO are a message to the market that it does have serious concerns with using leverage to get around the contribution limits.

Gordon Mackenzie is a Senior Lecturer in taxation and business law at the Australian School of Business, UNSW. A version of this post originally appeared in Cuffelinks.com.au. This information is general in nature and readers should seek their own professional advice before making any financial decisions.

Professor John Piggott

With the election of the Coalition Government, incoming Treasurer Joe Hockey is being asked to firm up plans for his “Son of Wallis” root-and-branch review of the Australian financial system.

Certainly a big picture review of the financial system is a step worth considering. Such a review should look beyond banks to the broader interaction of the banking and other financial sectors, including especially superannuation.

As the first of Australia’s baby boomers turn 65 and start to retire, the challenges presented by population ageing will crystallise. There is still much to be done to address these challenges.

Australia is fortunate to have a very sound and sustainable superannuation system. Comprising three pillars – means-tested pension, compulsory savings and voluntary savings – it is, from a government expenditure perspective, one of the most sustainable retirement income systems in the world. Commonwealth expenditure on pensions is projected to increase from 2.7% of GDP in 2010 to 3.9% of GDP, compared with an OECD average of 8.4% in 2010 and 11.4% in 2050.

But the retirement income system in Australia is a bridge part built. Part of its sustainability is due to the system’s focus on protecting those on low incomes through the Age Pension. The role of superannuation should be to replace earnings for people across the income distribution.

But the remarkable success in accumulating super assets has not been matched by structures that will allow super to fund retirement effectively and allow for income streams that are to provide income beyond the basic pension.

Total estimated superannuation assets reached $1.62 trillion in the June 2013 quarter, an increase of 15.5% over the previous 12 months. Some of that increase has been due to solid returns, but much of it is related to contributions exceeding benefit payments. It indicates that the system is still maturing.

As more baby-boomers retire and the population ages during the next couple of decades, asset withdrawal will become a greater part of the picture. This is this part of the bridge that Australia still needs to build.

The financial products that will allow superannuation benefits to provide steady income streams, such as those featuring life-time or deferred longevity insurance, are lacking. For innovative longevity insurance products to flourish, governance and regulatory support for this market must be carefully developed to be in tune with products that will support consumer needs.

While the previous government’s Cooper Review made policy strides in making the accumulation phase more efficient and implementing an accumulation default, there has been little thinking about products and defaults for the stage when funds need to provide income.

As longevity in later life – that is, our life expectancy from 50 – continues to rise, the continued sustainability of our retirement income system depends on a closer examination of the draw-down phase.

Should Australia follow the example of Singapore, where mandated savings at a certain level translate to a certain level of mandated annuity? Or, perhaps we should look to Chile, where annuitisation is voluntary but well supported, and permits a combination of a deferred life annuity and programmed withdrawal.

This arrangement, suggested by a group of us in Australia more than 10 years ago, can help negotiate the balance between flexibility and security at the time of retirement.

Is the Age Pension sufficient in providing income insurance for all people all of the time? And if not, then what should be the product options? And how can policy help to bring them to market?

The next stage of Australia’s superannuation success story should be about how it provides actual retirement income though a thriving financial retirement products market. A financial sector review that answers questions and addresses concerns about the draw-down phase of super could be a significant part of that story.

John Piggott is a Scientia Professor at the Australian School of Business and  Director of  the ARC Centre of Excellence in Population Ageing Research. A version of this post appeared in The Australian Financial Review.

Rafal Chomik

Since its proposal at a 1910 conference, International Women’s Day, which we celebrated last week, has served as a reminder of the role of women in society and the struggle for equality.

The most commonly debated element of this struggle relates to balancing child care and work. Policy makers have responded with various measures.

In Australia and elsewhere even cuts to parental benefits are justified on the basis that they are aimed to help parents, particularly single mothers, into work. The recent introduction of paid parental leave for fathers and partners is intended to help parents become more equal in balancing work and family. And in courting women’s votes for the upcoming federal election the Coalition has pledged to take the issue further by proposing to extend paid maternity leave.

But another area of unpaid work in which women overwhelmingly participate involves care for people with disabilities and the elderly. Australian Bureau of Statistics data on unpaid care shows that women comprise 68 per cent of primary carers overall, 92 per cent of primary carers of children with a disability, 70 per cent of primary carers of parents, and 52 per cent of primary carers for partners. It translates to 1.5 million Australian women acting as either primary or secondary carers.

The benefit of this unpaid work is considerable. One set of recent estimates puts the value of unpaid care by both women and men at $650 billion – equivalent to 50.6 per cent of GDP.

But carers often bear the cost of their unpaid responsibilities. Informal care is associated with lower levels of formal employment, higher risks of poverty, and a higher probability of mental health problems.

Unpaid primary carers are half as likely to be participating in the labour force as non-primary carers. And when they are employed, they are twice as likely to be in part-time work and 30 per cent more likely to hold a temporary job. These impacts increase with hours of care provided.

Of course, the care involved may be incompatible with a full-time job or there may be a level of ‘self-selection’ into the role of unpaid care-giver by those who had lower market opportunities in the first place. But analysis shows that even controlling for such socio-demographic variation, informal carers are less likely to be in paid employment.

Lower employment rates, fewer formal working hours, and fewer household members with earnings can mean that unpaid carers have a higher probability of experiencing poverty. Women carers appear to be particularly vulnerable to such a risk. Moreover, less work and lower earnings during their working life translates to lower savings and incomes in retirement.

The psychological distress and isolation of caring and the lack of support are possible reasons why unpaid carers in Australia are shown to have a 40% higher rate of mental health problems than non-carers. Again, even controlling for socio-demographic characteristics shows that informal caring is associated with more mental health problems and that the impact is more detrimental for women. Being the recipient of a carers’ allowance does not seem to alter the negative impact on mental health in Australia.

With an ageing population the demand for informal care is only going to increase. Indeed, the Productivity Commission sees such care as an integral part of the Australian aged care system. At the same time, the Commission points to the likely reduction in availability of informal care due to demographic and motivational factors. Yet, most informal care is low intensity, with 55% of informal carers providing 0-9 hours of care. Such figures suggests that with the right level of support there is scope for some carers to increase their hours of care with limited impact on work and mental health outcomes. So how do we design support systems for informal carers that avoid the negative impacts?

The Australian government has started putting various measures in place. It developed a National Carer Strategy as a framework to address the economic, educational, and health needs of informal carers.

While flexible work for women with children has been on the agenda for a while, only recently has care responsibility across the life-course been recognised. Last month, the Prime Minister announced that the Fair Work Act will be amended to extend the right to request flexible working to carers – it was already available for those caring for children.

As ever, there is more that can be done. In January, the Sex Discrimination Commissioner, Elizabeth Broderick, released a report calling for a series of possible reforms to support unpaid carers including legislative mechanisms, flexible work arrangements, carer support payments, leave arrangements, services for carers, workplace initiatives and mechanisms within the retirement income and savings system.

Investing in unpaid carers would mean not only relieving pressure from the formal aged care system and improving the quality of care for recipients, it would also go some way to redress this particular area of gender inequality.

Rafal Chomik is a Senior Research Fellow at the Arc Centre of Excellence in Population Ageing Research at UNSW.

Professor John Piggott

Presenting a comparative analysis of Australia’s pension fund scheme in Frankfurt this week, Professor John Piggott demonstrated that Australia’s unique private pension system (superannuation) had the country well placed to meet the rising costs of the ageing population compared to other OECD countries. However, he says the Australian system is not without its issues.

Australia’s private pension assets total 95% of GDP placing us fourth among OECD countries – behind the Netherlands, Iceland and Switzerland and ahead of the United Kingdom, United States and Canada. This private investment, alongside a means tested Age Pension, reduces the burden on the public purse as the ‘dependency’ ratio of working to non-working Australians increases.

Countries like Greece, France, Italy and Spain have pension systems with little to no private assets, meaning that their retired and older populations are much more dependent on public funding.  This is a situation that, if unchecked, threatens the long term sustainability of pension systems in these currently fragile economies. Even Germany, regarded as the economic bedrock of Europe, has a system as reliant on publicly funded pensions as Italy and Spain. While Germany’s modelled net replacement rate is far more frugal and it has instituted a politically controversial sustainability adjustment to its pension benefits, the risk remains largely in the public sphere.

 While we are yet to see the results of the recent changes to the Australian system, it is expected that the decision to boost contributions from 9% to 12% and raise the retirement age by two years from 65 to 67 will continue to keep Australians in a well-balanced private/public funding position. Along with a stronger means test, it will offset the increase in public risk arising from the recent 11% real increase in the Age Pension.

The fiscal strength of the Australian system is also evidenced by its modest but adequate 59% net replacement rate for average earners and the fact that the strong private asset base provides a better risk balance between private and public provision. This stands in contrast to Greece’s current system which is set to provide 110% of pre-retirement income entirely through public funding.

That is not to say that the Australian system is home and hosed. Our heavy investment in private assets for retirement places increased pressure on individuals to be literate in investment strategies and jargon.

The ABS (2006) survey found that only 37 per cent of Australians have the minimum literacy and numeracy required “to meet the complex demands of everyday life and work in the emerging knowledge-based economy”. Despite the introduction of simpler default investment products through MySuper, there are many choices that remain with the individual. For example, the options for decumulation are still deficient and complex. In the absence of adequate private pension income, individuals might wish to access private housing wealth. But here too they find available products, such as reverse mortgages, daunting.

Our OECD counterparts will have difficulty navigating the treacherous waters of cultural expectations if they attempt to shift their much-loved publicly funded systems to ones encouraging private assets. But as our own private pension system demonstrates such structures have their own unique challenges.

In addition to the temptation for the Government  to continue to tinker with superannuation rules, the Australian system will need to grapple with new and emerging issues. The architecture of choice across the life-course, investment education, even the issue of cognitive impairment in older populations attempting to understand and undertake these complex financial decisions, will be our sticking points in the coming years.  Different issues but no less challenging.

John Piggott is Director of the ARC Centre of Excellence in Population Ageing Research (CEPAR), and Scientia Professor of Economics at the University of New South Wales. 

Rafal Chomik

The phenomenon of population ageing is often summarised in a simple ratio. Known as the dependency ratio, it measures the proportion of those of traditional working-age (15-64 years) to those above it (65 years and over). In Australia, as in most other countries, this dependency ratio is on the increase, having risen from 15% in 1980 to 20% in 2012. By 2050 it is expected to reach 36%.

Yet who we consider to be of traditional working-age can change over time. Arguably more important than the dependency ratio is the proportion of people actually in the labour force supporting those who aren’t.

For example, despite the rising proportion of older people, Australia’s total labour force participation rates have increased over the last few decades, from 61% in 1980 to 65% in 2012, driven by greater numbers of women working. Women still have some way to go to catch up with men. But even as that happens, if we wish to offset the declines in total participation that result from population ageing, we need some of the older people to remain in the labour force.

Many older people already want to work longer but encounter barriers to doing so. The barriers and incentives that lead to their inactivity come at a high cost of foregone potential. In a briefing paper on the trends and prospects for mature-age labour force participation, co-written with Professor John Piggott at theCentre of Excellence in Population Ageing Research, we estimate this cost to be around $30 billion, or 2.4% of GDP in 2012.

Besides dismantling mature-age employment barriers related to health, discrimination, and skills, there are some key institutional issues that government can tackle. These result from the carrots and sticks that make up the tax, benefit and retirement income system.

The most important of these are the three ages at which pension income can be accessed: 55 (increasing to 60) for superannuation access; 65 (increasing to 67) for age pension access; and 60 for tax-free superannuation benefits. These can be thought of as two sticks and a carrot.

Australia is increasing the access ages for the two sticks. But the access age for tax-free superannuation has been left untouched at 60. As Professor Piggott has noted before, “once the standard superannuation age reaches 60, in 2024, the carrot will have lost its crunch”.

These levers are not only more amenable to policy intervention, but also appear to have a greater impact. When New Zealand increased access to its pension from 60 to 65, mature-age participation rates shot up much faster than in Australia, and now stand considerably higher; 76% for those aged 55-64 compared to Australia’s 53%. A key explanation is that New Zealand doesn’t rely on a widespread superannuation scheme, which in Australia can be accessed much earlier.

But to what extent can we push for longer working lives? Some, such as my fellow contributor to The Conversation, raise concerns about leaving older people to the ravages of the labour market. There is indeed evidence that for mental health outcomes, a bad job can be as bad as or worse than inactivity.

Still, the quality of jobs in Australia is not necessarily worse than in other advanced economies. For example, the incidence of temporary contracts among 55-64 year olds, a key indicator of job insecurity, stands at 4.6% – about half the rate of the OECD average.

Indeed, there doesn’t seem to be a relationship between a country’s mature age participation rate and incidence of mature-age mental health issues. While Belgium has one of the lowestparticipation rates of 55-64 year olds in the OECD of 36%, Sweden has one of the highest, at 76%; yet both have the same incidence of mental health problems among 55-64 year olds.

It is important to remember that population ageing takes time. And society, as well as the labour market, can change and adapt over time. We know from health and education data that today’s older people are much better off than in the past. And looking at labour market data shows that while the proportion of unemployed 55-59 year olds who have been looking for a job for more than 12 months is at 34%, twice that for 25-34 year olds, this rate has declined more than for any other age group over the last decade.

Should labour markets become more turbulent and we find that older people increasingly struggle to engage with employment, then addressing labour supply and demand barriers seems more fitting than to simply retire them. The latter response is a mistake made in the past in the now familiar story across the OECD in the 1980s, of retrenchment and labour market exit of older workers to apparently make way for the young. This was in line with the debunked logic that there is only a certain number of jobs to go around.

Ever since the baby boomer generation, we have been redefining the timing of key life events. It is likely that later labour market entry, later marriage, child-bearing, and longer, healthier lives, will mean longer productive lives too. With the right mix of policy intervention, baby boomers who are now entering the age brackets of “traditional retirement age” may well redefine what that means too. And if they do work longer, then the “tsunami” of population ageing represented by an increasing dependency ratio will be no tsunami at all.

This opinion piece was previously published on The Conversation as part of their ‘Shades of Grey’ discussion portal  under: It’s time to redefine the traditional working age.

From the Knowledge@Wharton today blog.

It’s a conundrum that most men face at some point: thinning hair. And while it may not seem to be an especially grave problem, male-pattern baldness “has been linked with poor self-esteem and body image and with greater stress and depression,” according to Wharton operations and information management lecturer Albert Mannes.

But new research by Mannes points to a somewhat radical solution to the problem — one that directly contradicts a growing number of hair replacement services, growth serums and other products that promise to produce a robust mane. His suggestion? Just shave it off.

In his recent paper titled, “Shorn Scalps and Perceptions of Male Dominance,” published in the journal Social Psychological and Personality Science, Mannes describes three experiments he conducted that had some surprising results. Specifically, men with shaved heads were viewed as more masculine and dominant than other men. But it doesn’t end there: Two of the experiments showed that such men were perceived as taller (by an inch, on average) and stronger (that is, seen as being able to bench press 13% more) than those men who were well-coiffed. They were also viewed as having greater potential as leaders.

“The broad take-away is that perceptions about leadership and related traits like dominance can emerge from peculiar characteristics that aren’t really related to leadership at all,” says Mannes.

Mannes — who sports a shaved head — says the impetus for his research came from his own experience in his early thirties, when he began losing his hair. “After fighting it for a while, one day I just decided to shave it off.” Mannes liked the look and received some positive feedback, but his new appearance had one unexpected consequence: When he interacted with people who didn’t know him, they seemed “stand-offish and even deferential.” That led him to wonder if his experience was unique.

To test his notion, Mannes structured three experiments. In the first one, subjects were asked to look at a series of photographs of men of similar age and dress, including some with shaved heads. Then, they were asked to rate the men in terms of how powerful, influential and authoritative they looked. When the numbers were tallied, the shaved heads won.

In a second experiment, Mannes tried to control for other physical features that could convey dominance by showing his subjects the images of four men, but in two different versions: one with their hair, and one with their hair digitally removed. Again, the images of men without hair were perceived as more dominant — and, much to Mannes’ surprise, also taller and stronger.

For his third experiment, Mannes avoided all visual cues and offered subjects physical descriptions of men, including whether they had hair, thinning hair or a shaved head. Again, the shaved men came out on top.

Mannes says he does not advise that, in general, men looking for a boost in perceptions about their leadership capabilities should automatically shave off their hair. In fact, there is a cost to opting for a shiny pate. In his studies, those with shaved heads rated lower on scales of attractiveness and were also seen as older. However, his findings hold particular relevance for men with thinning hair, who may be tempted to invest money in hair replacement or other means of salvaging what’s left. By shaving their heads, not only will these men save money, they will receive a bump in terms of how dominant they are viewed by others.

Part of the effect may have to do with the bold nature of the move. Mannes notes that in his experiments, men with thinning hair were consistently rated lower in terms of dominance. Clearly, there is a difference between simply succumbing to male-pattern baldness and making the confident, but somewhat unconventional, choice to remove one’s hair altogether.

And according to Mannes, that’s where his study could have some relevance to women, who obviously have an equal investment in being perceived as leaders in a business environment. Just as head-shaving could be perceived by some as an unconventional move for men, women who show a similar disregard for convention may come across to others as self-confident, he notes. That doesn’t mean they should shave their heads, of course. “There is evidence, for instance, that unconventional dress in women is viewed as status-enhancing. So women may have more of an impact just by engaging in unconventional behavior.”

This post was previously posted in Knowledge@Wharton today blog: Hair Today, Gone Tomorrow: Why Shaved Heads Lead the Pack

Rafal Chomik | CEPAR Senior Research Fellow

Birthdays are a good time for self reflection. This month’s tenth birthday of the first Intergenerational Report (IGR) – an account of the long term fiscal sustainability of Commonwealth policies produced every 3-5 years – was no exception.

The occasion was marked with a conference in Canberra, bringing together leaders from the civil service, academia and industry to reflect on ten years of projections and policies coming out of the IGR, as well as some of the remaining problems. CEPAR Director, Professor John Piggott, spoke about pension policy and Deputy Director, Professor Peter McDonald, presented on population projections.

Of course, evaluating the past is easier than projecting the future, but instructive nonetheless [1]. The projections are for forty years and include the impact of population ageing on the retirement income regime.
The current picture looks positive. Australia’s retirement system compares well internationally. Spending on age-related pensions, the aged dependency ratio, and old-age poverty (measured after housing costs) are low by international standards. Super assets are approximately equal to GDP, one of the highest ratios in the world.

And the IGRs have shown successively less severe population ageing and less dramatic increases in related spending. The 2002 report projected that in 2041-42, the cost of pensions would be 4.6% of GDP. By the 2007 report, this was 0.3 percentage points lower. The 2010 projection was 0.6 percentage points lower still.

The first thing to note about these figures is that improvements in the projections within the three reports are not necessarily because of policy reforms, though there were many. Much of this is due to the underlying, long-term demographic and labour market assumptions. For example, the long-term fertility rate assumption increased from 1.6 to 1.7, and then to 1.9 births per woman; net migration from 90,000 to 110,000, and 180,000 people per year; and mature age participation saw dramatic upward revisions.

In most cases, Treasury was taking very recent experience and keeping it constant for 40 years. While IGR projection methodology is commendable on many counts, these examples suggest some assumption myopia. Increases to participation, for instance, have been variously predicted and documented [2]. Longevity assumptions also need careful analysis. Recent mid-life longevity increases took most people by surprise, particularly in Australia: between 1950 and 1980, life expectancy at birth and at 50 increased by 7% and 10%, respectively, but between 1980 and 2007 the increase was 12% and 26% [3]. CEPAR is looking at this by fitting a mortality model with data on reductions in smoking, a key explanation of the trends.

Other assumptions could be changing too (e.g. decumulation of Super) but the IGR does not make this clear. The reports already provide a lot of background information, but there is a case for still greater transparency, or even, as suggested by Adrian Pagan, that an independent body such as CEPAR be tasked to formally provide analysis for the IGR.

The second thing to note about the figures is that while they are less severe than in other countries and than was previously expected, they still show that demographic shift remains a challenge. IGR 2010 projects that, without policy change, ageing pressures will result in a fiscal gap of 2.75% of GDP by 2050. Policy measures implemented over the last decade addressed various objectives of a well-designed retirement income system to different degrees. But at times reforms were piecemeal and poorly balanced the competing objectives. The 2009 increases to Age Pension level (an adequacy measure) were balanced with a tighter means test and higher eligibility ages (to address sustainability), a sensible balance. By contrast, the 2012-13 budget savings sought from Super meant that the objectives of economic and administrative efficiency were undermined through greater complexity and uncertainty. As a consequence some issues remain unresolved, including those related to decumulation, taxation, early retirement, and choice.

A final point about the IGR process is that its methodology is seldom used to demonstrate specific policy impacts. This is a shame, because an important reason for predicting the future is in understanding how it can be shaped. It could answer questions about what changes will keep budgets balanced despite the demographic shift. One reading could be that if the IGR and the projected fiscal balances are tools to evaluate the fiscal sustainability of current policy then, by their own measure, successive Governments have failed to implement policies that will keep budgets sustainable.

The tenth birthday of the Intergenerational Report is also the twentieth birthday of the Superannuation Guarantee. These are a cause for celebration, but also a reminder that much remains to be done to shape policy structures for an older Australia.

[1] See the working paper initially prepared for the conference
[2] McDonald & Kippen, 1999; McDonald & Ultomo, 2011
[3] Author’s calculation based on www.morlity.org data

Rafal Chomik is a Senior Research Fellow at the Arc Centre of Excellence in Population Ageing Research at UNSW.

This post first appeared  on the CEPAR Blog, May 2012 under “Better policy needed for an older Australia”.

Professor John Piggott | CEPAR

Australia is lauded throughout the world for its retirement income structure. Although it is largely unappreciated at home, we are in an enviable position when compared to the implicit pension debt being racked up among our OECD counterparts. As a paradigm, it has everything going for it – income protection for the less well-off, cost containment, and mandatory minimal levels of mandatory self provision for those who can afford it.

But successive governments put the whole structure at risk by tinkering with super taxes.  No country has borne more capricious changes to the taxation of its private pensions than Australia.

It’s worth taking a step back from the current controversy to reflect on three questions. First, what should a pension tax system look like? Second, why should Australia’s pension tax system be subject to so many more changes than its counterparts elsewhere? And finally, why does it matter if Canberra fiddles?

Almost all countries offer tax concessions for pension saving. The implicit deal is, preserve your savings until you retire, and get a tax break.  The most common break is exempting the investment earnings of the pension fund. Then either contributions are deductible under the personal income tax, or benefits are tax-free.

On the whole, taxing benefits is the better way to go. This avoids complexities around employer deductions for pension contributions, and bad investment outcomes are cushioned through lower taxes, while investment outcomes above the norm pay some extra tax. The government shares the risk. The timing of tax collections is better too – tax revenues will increase when an expanding older population cohort is driving public expenditure up.

But whether contributions or benefits are taxed, as long as investment earnings are exempted, economic efficiency is well served. You have a system that closely aligns the tax treatment of super with the tax treatment meted out to the other major life-cycle asset – owner-occupied housing. This is a critically important aspect of the policy design.  In their roles as retirement saving vehicles, these two retirement assets should be treated similarly under the tax system. And by exempting earnings, the price distortion between consumption during working life and consumption during retirement is largely eliminated.

Australia’s super tax departs from both these standard paradigms. Instead, it separates superannuation taxes from personal income tax altogether. Contributions are income tax exempt, but taxable at a flat rate in the pension fund; earnings on those contributions are also taxed. And benefits used to be taxed as well, until the 2007 Better Super reforms exempted benefits paid to those over 60. The result is that there is no link with the progressivity inherent in the personal income tax.

Separating superannuation taxes from the personal income tax makes tinkering with pension taxes tempting for governments. Changes can be made without their showing up in a pay packet the next week.

This has happened several times since the Superannuation Guarantee was introduced, and it looks like it’s about to happen again. What is proposed may be a small step in the direction taken by the Henry Review on this issue, which accepted contributions taxes were here to stay, but recommended that the rebate be linked to the personal rate schedule. It also recommended a reduced earnings tax to help the power of compound interest generate more accumulations.

If that’s the direction of change, then it would be better to take the proposal in its entirety, rather than just apply it to the top 1%, as news reports suggest is likely. And this should be well thought out, converging to something stable, with discussion and consultation, not a last minute cash grab.

Not that the top 1% is taxed especially harshly in Australia. A somewhat higher marginal tax rate for the top 1%, say 49% above $250,000, maybe on a temporary basis, would be a better response.

So, why does the tinkering matter? Two important reasons. First, this is a whole-of-life issue, and long-term planning is part of it. Although some rules are bound to change with time, surprises are bad and should be avoided whenever possible. Once you get to a point where arbitrary policy surprises are expected, credibility in the system evaporates. The top 1% today, the top 5% tomorrow, who knows the day after?

People will likely reduce their non-mandatory contributions, saving will fall, eventual reliance on the age pension will be higher than it would otherwise have been, and most importantly, many people will have a less satisfying retirement.

Second, change increases administrative costs and charges. More records have to be kept, checked, and transferred when the worker changes funds. Australia’s pension costs are already on the high side. Through a full career, increasing charges by just a half percentage point can reduce the eventual accumulation by more than 10%. That impacts on everyone’s super outcomes, not just the top 1%.

Professor John Piggott is director of the ARC Centre of Excellence in Population Ageing Research at the University of NSW.

This article first appeared in the Australian Financial Review 30 April 2012.

Michael Sherris

Australia needs new infrastructure. We need to fund it. And there are substantial assets in superannuation funds. Why don’t we combine the two?

Former Treasury secretary Ken Henry says that Australia’s infrastructure projects should be reformed in a way that will make them more attractive to superannuation funds that fear taking on too much risk.

There are vast assets in superannuation funds that can do a lot of good for Australia. These are a potential source of funding to finance the infrastructure that Australia badly needs.

These superannuation funds will increasingly be seeking assets that will allow them to provide retirement income streams to their members either directly or through retail products such as indexed life annuities.

Among the potential reforms suggested by Ken Henry is one that would see the Federal Government assume greater risk, with less pressure on the private sector, to reassure funds and their investors that infrastructure projects are safe investments, such as the latest proposals for the fast rail network on the east coast of Australia.

Super funds could pay for these proposals now. If these funds are to finance major infrastructure assets they should be seeking long term inflation linked annuity bonds to fill the limited market in indexed linked and long term securities in Australia. This would provide opportunities for the funds to offer income streams to members and have matching long term assets.

I would like to see this taken further. Ken Henry’s Tax Review proposed that the government should issue more long-term inflation linked longevity bonds, to support the development of a longevity insurance market. Now, if we were to be really innovative we may even be able to develop a longevity bond with payments linked to population survival rates to allow the funds to manage mortality risk, which would naturally compensate for the population living longer. This mortality risk is driving the growth of longevity swaps for defined benefit pension funds in the UK and Europe as well as attracting interest in the US.

Australia is one of many countries that has a rapidly ageing population. However there are few products that provide longevity insurance, which is protection against the risk of individuals living too long, running out of cash and then relying on the state. Using these longevity bonds, we could also fund key infrastructure projects in Australia, which are currently suffering from a lack of cash from risk-wary superannuation funds which have seen large losses on projects such as the Clem Jones tunnel in Brisbane.

Michael Sherris is a Professor of Actuarial Studies at the Australian School of Business.