On Friday Treasurer Josh Frydenberg announced the terms of reference for a review of the retirement income system, which will look at the interaction of compulsory superannuation, the Age Pension and voluntary savings (including home ownership).
We got some valuable insight into what we might expect from such a review in a discussion paper released by the Actuaries Institute in August.
The Treasurer’s review will be conducted by an independent panel chaired by Michael Callaghan, a former executive director of the International Monetary Fund and a former senior Treasury official. The other panelists are Carolyn Kay, a finance sector professional, and Deborah Ralston, an academic and member of the Reserve Bank Payment System Board.
The panel has been asked to prepare a consultation paper by November and produce a report by June next year.
The Actuaries Institute paper, Options for an Improved and Integrated System of Retirement, says the issues that need to be explored include simplifying the Age Pension, addressing the treatment of the family home and embedding automatic adjustments to reflect changes in longevity in both the superannuation preservation age and Age Pension eligibility age.
The paper also proposes setting targets for government support in retirement in terms of expenditure, addressing taxation and funding anomalies benefiting unusually large superannuation balances, and better coordinating retirement, pension and age care policies.
“Australia’s retirement income system has obvious shortcomings. It is intrusive, complex, contains anomalies, produces perverse incentives and is sometimes unfair,” say the paper’s authors – Anthony Asher, David Knox and Michael Rice.
“The root cause of these problems is the lack of a national retirement strategy, with proper integration of the key elements of the system. Policies and settings have been treated disparately and have not been developed within an overall objective and framework of standards.”
The basis for the paper’s proposals is that the retirement system should provide an appropriate financial resource in retirement. “This would include an income adequate to provide not only for basic needs, but also for a standard of living comparable with what they enjoyed while working,” it says
Simplifying means tests
Underlying the current assets test is the principle that social security should not be paid to those with significant means. However, the authors say the approach that has been taken is complex and makes it difficult to plan for a stable income in retirement. Means testing is also intrusive.
They suggest that one way to simplify the means test is to reduce the frequency of applying the test. A retiree could be tested at the time they reach Age Pension eligibility age. Based on their assets at the time they could be given a full, part or no pension. This amount could be indexed through retirement. The situation could be reviewed every three to five years.
Another option is to get rid of the part pension. Retirees would spend most of their superannuation benefit and any other wealth first and then receive a full Age Pension.
Combine the assets and income tests into a single test
Australia is unusual in having both an assets and an income test for the Age Pension.
“The two means tests are confusing and complicated. They also make planning much more difficult for retirees. There is no need for a separate assets test. Deeming rules for all assets could allow for consistency between high and low yielding assets and prevent gaming the system, so contributing to fairness and efficiency,” the Actuaries report says.
Creating a single income-based means test, across both the Age Pension and aged care, would be a further benefit.
Provide some universal benefits
Providing benefits to all retirees above a certain age increases simplicity, provides greater confidence and reduces incentives to game the system, the authors say.
The current Age Pension could be divided into two parts: a universal pension equal to 10 per cent of the average wage: and an income-tested pension equal to the balance, namely 17.5 per cent of the average wage.
The family home
The current exemption of the principal residence from the Age Pension assets test works against fairness and efficiency principles, with these distortions have become increasingly pronounced in recent decades, the Actuaries paper says.
Up until about 30 years ago, the value of a principal residence in a capital city was about 2.5 times average annual earnings. It has grown to between eight and 12 times earnings, depending on the state or territory.
Consequently, the principal residence is a valuable investment, far beyond what was originally envisaged for social security purposes.
Non-homeowners are insufficiently compensated for the different income earning capacity of their assets relative to their expenses. Single retirees in private rental arrangements in capital cities are particularly affected because rents are high.
One option is to double the current difference of the assets test thresholds between non-homeowners and homeowners and allow for this increased difference to flow through to their income test threshold.
Another option is to include some or all of the home in the assets test. The exemption creates anomalies, such as discouraging homeowners from downsizing.
If there is a single income-based means test, a rent could be imputed for the value of the principal residence above a threshold.
Reduce the gap between super preservation age and Age Pension eligibility age to reflect changes to life expectancy
Preservation age is currently between 55 and 60, depending on when the person was born. By 2024 the preservation age will be 60 for everyone. At that point there will be a seven-year gap between the preservation age and the Age Pension eligibility age.
The current age at which people can apply for the Age Pension is between 65 and 67, depending on when they were born. By 2023, the eligibility age will be 67 for all people.
Their superannuation balance could be extinguished or significantly reduced during that seven-year period, the authors says, and this increases the likelihood of their calling on a full or part Age Pension from eligibility age.
“It is important to consider whether such a prospect fulfils the objective of the superannuation system,” the authors say.
They suggest an option worthy of consideration is maintaining a fixed gap, such as five years, between the Age Pension eligibility age and the superannuation preservation age. This balances the objective of superannuation substituting or supplementing the Age Pension with the fact that the superannuation benefit belongs to the individual.
Another option is to link changes in the Age Pension eligibility age with changes in life expectancy, which are published every five years by the Australian Government Actuary. The linkage need not be one-for-one. It could, for example, be that for every year life expectancy increases, there is a six-month increase in the Age Pension eligibility age.
Address tax and funding anomalies
Public support for the superannuation system is undermined by the existence of tax concessions for wealthy individuals with unusually large superannuation balances. Accounts worth tens of millions of dollars are being taxed at the concessional rates of 15 per cent on income and 10 per cent on capital gains.
One option would be to cap the amount that can be kept within the superannuation system, or by requiring those with unusually large balances to pay additional tax.
Consideration should also be given to limiting bequests and gifting out of super funds, to improve the fairness of the system.
The refundable accommodation deposits that can currently be used to fund aged care are undesirable. Their existence creates anxiety, as retirees become concerned that they might need to find significant lump sums at short notice. This also contributes to a reluctance to invest in lifetime annuities or pensions.