The sustainability of retirement incomes policies

Carol Ey, Social Policy

Key issue
Retirement incomes policy has been a major focus of governments over the last 30 years. There have been significant changes to the system, but it is unclear whether these have reduced the long-term costs of an ageing population.

Concern about the ageing of the Australian population and the potential impact this may have on federal budgets was first raised in the late 1970s. This concern in part led to the introduction of compulsory superannuation contributions for employees.

The first Intergenerational Report (IGR) in 2002 attempted to quantify the likely impact of demographic change and estimated that expenditure on age and service pensions would increase from 2.9% of GDP in 2001–02 to 4.6% in 2041-42 (for further information see Intergenerational reports – key influences on policy? elsewhere in this publication).

In response, governments have introduced a range of measures to encourage personal investment in superannuation and increased the ages at which superannuation and the Age Pension can be accessed.

Age Pension

In 1909 Australia was one of the first countries to introduce an age pension. The Pension was designed as a ‘safety net’, which entailed means testing to ensure it was targeted at those most in need. It has remained largely a payment targeted at those with few other resources. Today, a full Age Pension is available to a couple with an annual income of less than about $7,000 and assets outside the family home of less than $279,000.

However, because the means test is tapered – that is, income or assets above these limits reduce the amount of pension payable, rather than excluding payment entirely – those on relatively high incomes and with considerable assets may still receive a part Pension. For example, the cut-off rate beyond which a couple would receive no Pension is an income over $70,500 and assets of over $1 million in addition to the family home.

Around 50% of Australians over Age Pension age receive a full Age Pension, and a further 30% receive a part Pension, at a total cost to the budget of over $39 billion in 2013-14.

Indexation

Prior to 1997, the Age Pension rate (and rates for other income support payments) was indexed by the Consumer Price Index (CPI) to ensure Pensioners were protected against the impact of rising costs. Since 1997 the Pension has also been benchmarked against Male Total Average Weekly Earnings (MTAWE). This means that where wages rise more quickly than prices, the Pension is increased in line with wage increases, rather than at the CPI rate. Figure 1 shows the difference in these rates over the period since 1997.

Figure 1: MTAWE and CPI, June 1997 to June 2013

Source: Australian Bureau of Statistics

As can be seen from Figure 1, over the period since 2000, wages have risen much faster than prices. This has meant that pensions have increased almost 30% more than they would have otherwise. This increase not only affects the amount of income pensioners receive, through the operation of the taper, it also increases the cut-off levels for receipt of a part Pension.

Superannuation

Government policies encouraging private investment in superannuation appear to have been successful, with around $1 trillion having been invested in superannuation in the last decade. However, these policies have not been cheap. Tax expenditures associated with the concessional taxation of superannuation cost an estimated $30 billion in 2011-12, and are projected to rise to $45 billion in 2015-16 (for further information see Tax expenditures: costs to government that are not in the Budget elsewhere in this publication). The policies have also been criticised for providing significantly greater benefits to high income earners.

This investment does not appear to be achieving the aim of providing sufficient retirement savings to reduce the load on the Age Pension. Superannuation is generally able to be accessed from age 55, and about half of the withdrawals from superannuation are lump sum payments. Some reports, such as a recent study commissioned by CPA Australia, suggest people are accumulating higher amounts of debt in the lead up to retirement in the knowledge that they can use their superannuation savings to repay it.

The result is that some retirees will have used all their superannuation savings by the time they reach Age Pension age. While Treasury modelling suggests the proportion of people receiving the full Pension will decline slightly over future years, this is expected to be almost matched by an increase in part Pension receipt.

Attempts to control costs

There have been some attempts to contain the costs associated with superannuation concessions, such as limiting the annual amount of concessional contributions and moving to increase the taxation of fund earnings for those in pension mode.

In addition, the eligibility age for access to superannuation is being progressively increased from 55 to 60 years. Similarly, eligibility for the Age Pension is being increased from 65 to 67 years. However, these changes will still leave a period of seven years between the age at which superannuation savings can be accessed and Age Pension eligibility.

On the other hand, proposed changes to indexation arrangements for a range of Defence service pensions from their current CPI indexation to the same basis as the Age Pension is indexed, will increase outlays in the future, as indicated in Figure 1.

Options for change

The Henry tax review recommended a number of changes to retirement incomes policy. This included raising the Age Pension eligibility age, which has since been legislated, and aligning the Age Pension and superannuation preservation ages.

As part of addressing current superannuation tax concession inequity, the Henry review recommended changing the tax arrangements for employer contributions so they are taxed at the employee’s marginal tax rate, with a flat-rate refundable tax offset. Specifically excluded from the review’s terms of reference was the tax exemption of superannuation pension payments for those over 60 years. This had also been criticised on equity grounds.

Others have suggested limiting the withdrawal of lump sums from superannuation accounts to prevent superannuation savings being used to offset high pre-retirement debt levels.

Conclusion

Retirement incomes represent a major expense to government through the payment of pensions and the subsidisation of superannuation, which will increase as the population ages. The current system is not tightly targeted and includes inequities, with the major benefits flowing to high income earners. Changes in retirement income policies typically have long lead times, but potentially large impacts on Australia’s long-term fiscal position.