Getting the super debate back on track

Pillar chief executive, Peter Brook, explains why he thinks the current superannuation debate is headed in the wrong direction and why some refocusing is necessary.

The topic of superannuation has become charged with emotion, envy and politics. This makes it difficult to make the changes necessary for  lasting, positive impact. The debate tends to concentrate too heavily on current income and earning capacity rather than on what superannuation accumulation should deliver. I believe there is almost universal understanding of the tidal wave demand on the welfare and pension system building on the near horizon. This includes acceptance of the Financial System Inquiry recommendations on the need for a primary purpose for superannuation being “to provide income in retirement to substitute or supplement the Age Pension”. 

We must build a retirement system that is sustainable and alleviates the demand on the public purse. Yet we seem no closer to achieving this. Even the very recent musings on super have been about tax in various dimensions and the Budget. Our leaders are continuing to consider a 40 to 50 year investment dilemma within a three year lens of budgets and re-election.  

But let’s assume that a single purpose for superannuation is agreed. I want to suggest some thoughts on how we could deal with some of the problems. 

Enticement 

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I use that word deliberately, rather than encouragement. I don’t think a pep talk will do it. There needs to be a clear, pecuniary, “what’s in it for me”, benefit to contributing to superannuation. When we start our working lives, most of us have very little idea about what our retirement sufficiency will look like, unless you belong to some of our wealthier clans. There are some things we do know – the benefit of long-term savings and compound returns. From the time they enter the workforce, young employees need to be enticed to think and act positively about contributing to superannuation. To voluntarily sequester “spend now” money for a period of 40 or more years has at least two requirements.  

Firstly, the benefit needs to be appreciably better than the utility of the alternative. Suggestions that 70 per cent of current average earnings, equivalent to $40,000 just don’t cut it.

Simplistically, $40,000 would require an investment of $800,000, assuming that your fund earns five per cent – keeping in mind that in some years negative returns occur and that the distribution of the earnings doesn’t maintain the value of the capital. Even at a superannuation guarantee (SG) contribution of 12 per cent, a typical super payout will only be at $500,000. The likelihood is that we’ll see many more people living beyond 100 years of age and so requiring 35 to 40 years of retirement income. 

The Association of Superannuation Funds of Australia (ASFA) retirement standard recommendation of a $2.5 million super balance offers useful guidance about a “comfortable lifestyle” for retirement in Australia. When abolished in 2007, the Reasonable Benefit Limit was $1.35 million. Indexed to today, at say seven percent, this comes close to the ASFA recommendation. While this would return approximately $165,000, it could also accommodate capital maintenance and a cushion for negative returns. Importantly it does provide the enticement to squirrel away funds for one’s retirement. 

I know that many will not be able to get to these levels but that is exactly what the safety net of the Age Pension should be for. It will still be an extremely worthwhile exercise to do as much as possible to encourage self-sufficiency in retirement, to minimise claims on the public purse.  

The second requirement is the rock solid certainty that it will be there under the same terms and conditions when retirement arrives. 

The changing face of work and retirement 

We know that mandatory employer contributions of 9.5 per cent – or even 12 per cent should they grow as planned – will not be enough, on their own, to provide a comfortable retirement for most Australians. And the problem will only be exacerbated as longevity rates climb for both men and women. Life expectancy for Australian women today is around 84 years and for men it is around 80 years. The government itself is now acknowledging openly that the Age Pension is “adequate” – not comfortable. And certainly it will not cater for life’s little luxuries or emergencies. 

It makes huge sense to allow people to top up their contributions in good years, in fact in any year, without any cap. The goal should be for everyone to be enticed to build their balance. 

The current contribution limits don’t recognise that many of us are experiencing the modern equivalent of an industrial revolution – linear career paths are no longer in operation and instead our lives are made up of a series of jobs, which leads to  broken periods of employment. I suspect this will be the future working paradigm.  

Additionally, there is a changing phenomenon for some retirees – the decline in home ownership rates. Now only 75 per cent of us will retire without a mortgage. It’s almost inconceivable to think that many of us will have to factor in how to keep paying a mortgage in retirement. Anyone transitioning to retirement with $300,000 left on a mortgage has to find around $20,000 in today’s money before they can start to live their new life. For a couple this is the entire pension. And slowing wages growth plus rising interest rates and property prices will only aggravate the situation. Suddenly, the ASFA recommendations are not looking unreasonable. 

Limits on contributions mean that when you’re out of work or have other priorities – such as child rearing – you can’t afford to make contributions. Yet, once working again, the contribution caps restrict the opportunity to make up the shortfall.  

We need to shift from stipulating how quickly you accumulate super to focusing on the size of benefits and how they are delivered. Any suggestion to increase the tax rate at the contribution stage, based on current income, creates a disincentive. Rather, it makes huge sense to allow people to top up their contributions in good years, in fact in any year, without any cap. The goal should be for everyone to be enticed to build their balance. 

A flexible system to fit the future

We’d be better served by a system with greater flexibility. We need to accept that some of us are more or less fortunate than others. And that our personal liquidity and capacity to contribute will vary widely over our lives and between cohorts. 

In Australia’s current superannuation environment, industry commentators tell us we have the extremes of impoverished workers that the system will never support and billionaires stashing away wealth in a tax privileged environment. Of course, there is also every financial circumstance in between. 

Tax haven 

Let’s also ensure that superannuation is a tax effective environment only for its purpose and to reasonable limits. While I support the ASFA retirement standard recommendations, the principle remains relevant at other levels. Prior to retirement, I’d like to see all earnings over this sum returned to the member and taxed at marginal rates on a regular, say, half yearly basis.  

The only sums that should have any shelter, at 15 percent, are those necessary to generate the appropriate retirement benefit. The remainder needs to be taxed in the hands of the member. For those who may already have a higher balance, there could be a grace period to return those sums to the member – let’s say the distribution of surplus benefits within one year of implementation, and for this transition there would be a concessional tax of 15 percent. 

Thereafter, it would be returned at the marginal rate of the taxpayer. This should apply to all member balances, whether in managed super funds or self-managed super funds (SMSFs). These returned funds will then be invested in other areas, not sheltered by the superannuation tax environment. 

For those in retirement, the existing tax free character of retirement benefits should continue, but all additional income should be taxed at the relevant marginal rates taking account of the totality of the income. So if a retiree receives $80,000 retirement benefit from super and receives another $20,000 outside of super then there would be no tax on the first sum but the additional income would be taxed at 37 cents in the dollar under current tax rates. 

Wealth transfer 

The purpose of the tax favoured accumulation of super is to obviate the need for pension or welfare support. Benefits should only be paid as an income stream in retirement, with no commutation of super to lump sums. 

Additionally, super should not be a wealth or estate planning device. The tax shelter no longer serves a purpose on death. All death benefits paid to beneficiaries need to be taxed, at say a concessional rate of 30 per cent. Perhaps too, its introduction could be phased in from 15 percent to 30 percent over a number of years. I know many will cry that this is the introduction of estate taxes, but in reality this is the transfer of funds from a tax favoured environment.  

To motivate people to co-contribute for their retirement, another option is total tax relief for those who roll over into their own superannuation account any death benefit they receive as a beneficiary, up to the Reasonable Benefit Limit. 

Reasonable limits could be set at the ASFA recommendation or other levels. Perhaps a one-time lump sum of say $50,000 at retirement or some later date might be a middle ground. 

Instilling confidence in the system 

Successive governments have and will have to face structural budgetary problems. But it’s counter productive, in both the short and long-term, to dip into or tinker with superannuation to balance the national books. We need to be able to etch in stone a single purpose for superannuation – to provide a safe and known outcome for self-sufficiency. Further, if we deflect any superannuation to other uses, it will simply reduce the adequacy of retirement funds. 

Encouraging retirement self-sufficiency and instilling confidence in the system should be the primary aim of a superannuation regime. It’s a long game that requires the establishment of certainty, now, so it can be played very carefully for Australia’s economy and its people.  

Peter Brook is chief executive of Pillar.