Reducing any dependence on the Age Pension is welcome news to a government which now spends in excess of $41 billion a year on this cost. Should the Age Pension be a “safety net” for a minority or a means-tested right for the majority? Actuary Geoff Dunsford gives his view. In conjunction with Vanessa Ho, I wrote a paper in 2003 for the Biennial Convention The Future of Retirement Incomes. In the paper, we noted: The ageing of the population will contribute to increasing government budget deficits unless current welfare rules are changed. This includes Age Pensions where some 85% of new retirees each year claim a least a part Age Pension and the associated “fringe benefits”. (The expression “Age Pensions” in this paper and the current article includes Service Pensions). We suggested: “A possible scenario is for the Age Pension to become a “safety net” for a minority, instead of the current means-tested right for the majority”. I remain of the same view – perhaps even more strongly in light of the latest annual cost of Age Pensions – some$41 billion.  Figures in the latest Intergenerational Report (2015) project this, on a per capita of the population basis, to more than double (in 2015 dollars), due to the increasing proportion of the population living to advanced ages and the increasing average length of retirement.

There will be fewer people of traditional working age compared with the very young and the elderly. This trend is already visible, with the number of people aged between 15 and 64 for every person aged 65 and over having fallen from 7.3 people in 1974-75 to an estimated 4.5 people today. By 2054-55, this is projected to nearly halve again to 2.7 people”.

Safety Net Focus

There are (at least) two ways which the government could relatively easily (in the administrative sense, albeit not politically) impose a “safety net only” approach to the payment of Age Pensions.

1. As currently applies to unemployment benefits, retirees could be required to more or less exhaust their own resources before being granted an Age Pension.
1. The “50% deduction” of Age Pension benefit in respect of income from private sources, could be gradually increased to 100% over, say 25 years.

The first policy could encourage dissipation of assets. Not everyone would take this course, but continuing a pre-retirement lifestyle, without the discipline of a limiting regular income, would be almost inevitable for some. This would result in full Age Pensions payable from an earlier date than otherwise – perhaps costing the government more in the long run than the current policy!

The second approach does not heavily affect current retirees immediately, and those close to retirement should be able to plan appropriately. The impact on younger workers would be the greatest, but is deferred for many years. Being announced while they are focused on work and life experiences (and being told that retirement age will be receding into the future anyway!), they will have time to adjust any retirement expectations that they might have had.

In practice, both of these approaches could be considered rather heavy-handed.  Accordingly we continued our paper with an alternative:

“This could be achieved by requiring the benefits from accumulated compulsory super contributions to be used to purchase a pension up to the full Age Pension”.

Conference participants at the concurrent session to discuss the paper gave it a polite response, but there was little support for this theme.

Age Pension wrongly seen as Entitlement

The Financial System Inquiry (supported by the Institute) said that the objective of superannuation is “to provide income in retirement to substitute or supplement the Age Pension” (my emphasis).

As a payment made out of taxation rather than funded, the Age Pension should be seen as just another welfare payment, rather than the first pillar of a three pillar retirement income system.  By now, after 23 years of compulsory superannuation, this should be regarded as the prime method of providing retirement income. The principle contained in the widespread view that “I have paid my taxes, so I am entitled to the pension” is unsustainable.  Unfortunately, with “Age Pension Entitlement” remaining well entrenched in the community, selling the concept of a “Safety Net only” approach would be difficult.

State Pensions and Compulsory Contributions

In the UK and other European countries, compulsory contributions are the main eligibility requirements for the State pension which represents the safety net for retirees.

The compulsory system was introduced in Australia in order to alleviate the cost to government of Age Pensions. For various reasons this is not likely to happen to any significant extent; the National Commission of Audit projects 80% of retirees still receiving at least a part Age Pension in 2050 when the system should have well and truly matured.

Arguably, we need to develop our compulsory super contribution system to become part of our Age Pension safety net for retirees, rather than a supplement to it.  The 2003 paper continued:

Transitional Implementation

Introduction of the safety net concept along the above lines would clearly reduce government expenditure. At the same time the outcome in $terms would be significantly less than that currently expected by the working population. With such a negative impact on expectations, any move to the “safety net” concept would need to be phased in over a long period”. This article continues the theme During the transitional period and ultimately, a form of integration of state and private benefits would apply. Accordingly a prerequisite will be a sensible restructure of the means test. For the purposes of pursuing this article further, a single test will be assumed. Private assets (excluding the value of any defined benefit superannuation) will be aggregated. Then a “deemed income” will be determined with a “deemed interest rate” applied to this aggregate, and any defined benefit super income added, to arrive at the means tested Income. A further desirable prerequisite would be for the Age Pension to be increased to a level which includes the average value of the current “fringe benefits”, e.g. car registration, telephone bill. This would leave pensioners to determine which ones they wished to avail themselves of. Apart from simplifying the integration process this would also save the government(s) the not insignificant costs of administration. Build Compulsory Superannuation to offset Age Pension From an “Appointed Day”, establish a separate member superannuation account (or accounts) for future Superannuation Guarantee Contributions, referred to as say, their “Age Pension account(s)”. The balance in such “Age Pension” accounts would be used first to purchase a lifetime pension (which may be capital protected) at or after Age Pension age, up to an amount equal to the Age Pension, and indexed similarly. An option would be for the account balance to be used to purchase from the government the part or full Age Pension. (The Actuaries Institute recent “For Richer, For Poorer” White Paper estimates the value of the full Age Pension for a single male at age 65 is$412,000; for a single female is $482,000, and for a joint life last survivor male/female couple is$816,000).

Any excess “Age Pension” account balance would be available for investment in other post retirement products permitted at that time, as would the member’s other super account balances.

The Means Test would continue to apply to the remainder of a retiree’s assets in respect of the balance of any Age Pension required.

Examples

The following are some simplified examples comparing retirement incomes (in 2015$) under the current (assuming the proposed Income Test) and proposed “Safety Net” rules: For simplicity, the Age Pension is shown for a single person and is assumed to be$20,000 a year.

Also assumed is:   the “Income before means test reduction” would continue to be allowed, i.e. approximately \$4000 p.a.

Unpopular?

Politically, proposals of this nature are unpopular. However, the message should be that the current structure is unsustainable. This is readily demonstrated. Arguably, most people would not want the next generation to be saddled with repaying increasing budget deficits.

Under the proposals, it would only be the changes to the Means Test which will impact on existing pensioners. While the “losers” will be vocal (and the focus of the media), if the revised arrangements are clearly sensible, perhaps presented with highlighting current anomalies, they could be acceptable to the main seniors’ representative groups.

There will be little (further) impact on those close to retirement: it will only be the benefits arising from their last few years’ SG contributions which would become part of their Age Pension. Such people should be able to anticipate the impact and plan for it.

Many younger workers take little interest in retirement when it is many years away (particularly in the light of the planned extension of the Age Pension age). After all, the arrangements change almost every year, so there is little point in diverting their attention from their more important current focus on jobs, relationships, children and enjoying life. Those who do take an interest can see broadly what the outcome would be for them. Hopefully the reaction would be ‘I need to save more for retirement.’

Self-Employed/Non-Employed

It would seem unreasonable for the self-employed and non-employed taxpayers to be able to receive the Age Pension under the proposed measures paying no contributions, while the employed have done so. Equally it would be unfair if non SG contributions have been made by such people and the accumulated funds derived from all of these were not taken into account when determining their amount of Age Pension.

Consequently, it is proposed that self employed and non employed taxpayers be required to make “equivalent” SG contributions through the tax system. The relevant percentage of gross income would be included in their tax bill (which would be adjusted for tax relief on those contributions) and paid into the ATO’s super fund. Transfer to a fund of the member’s choice should be available.

Suitable arrangements would be needed for the non employed who are receiving little or no income – whether permanently or temporarily

The “Rich”

A complaint against the proposals could be that there would be no impact on “the rich” – i.e. those who do not currently have (or will not need) an Age Pension.

Arguably, the proposals are only targeting “middle class welfare” and so such a concern is irrelevant. If it is perceived that that “the rich” are not paying sufficient tax, that is another matter.

Start Date

These measures could be introduced more or less immediately as they only apply to future compulsory super contributions.

The start date would however, need to accommodate the necessary changes to administrative systems – government and private.

Sustainable?

The lesser cost to the government of Age Pensions under this structure seems likely to meet needs on a more sustainable basis. This should enable the country to grow economically, and ultimately, for both workers and retirees to benefit.

The proposed structure will only be fully effective when today’s youngest workers retire: probably in 50 years’ time. Sustainability would need to be tested over this period.

The future of retirement incomes?

Perhaps not immediately, but the need to rein in Age Pensions spending will be a trigger for action at some time in the future.

Where there are limited government funds available, the focus must be to look after the most disadvantaged. The current “middle class welfare” of most people receiving some Age Pension and the fringe benefits will need to be addressed.

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