The sweet spot and super failings

Two years ago, after a new taper rate for the age pension assets test took effect, economist Sean Corbett wrote about the retirement income sweet spot, which looked at issues around balancing private retirement savings and assets with the Age Pension to achieve an optimal annual income. He revisits that issue, but over the longer term of the average retirement, and explains why the superannuation system is not yet delivering a comfortable retirement to all baby boomers.

Super has been compulsory since 1992, but it has failed many baby boomers.

The compulsory super system was designed to force people to save throughout their working lives in order to “provide an income in retirement to replace or supplement the Age Pension”.

For baby boomers (those born between 1946 and 1964), the system has not covered their full working lives (40 to 45 years) and started at only three per cent of wages compared to the current rate of 9.5 per cent with legislation in place to increase that to 12 per cent by 2025. Australians retiring now and over the next 20 or so years have not had a chance to accumulate the amounts the system was designed to deliver.

This shortfall in accumulated savings, coupled with increased longevity and current low interest rates on safer investments such as cash and fixed interest deposits – which retirees tend to favour – means that many baby boomers are finding it very hard to enjoy a comfortable retirement.

Compounding this difficulty are tougher voluntary contribution limits that have been imposed in recent years, which make it much harder to contribute much more than the compulsory amount to super.

Even if people wanted to find a way around these restrictions, the new taper rate, which increased the rate at which Age Pension entitlements were reduced the more was saved in super, and increased taxation on retirement savings brought about by the introduction of the $1.6 million pension transfer balance limit, provided disincentives to save more super for retirement.

How should the Government adjust the Age Pension and the assets and income tests to permit a more comfortable retirement?

The changes to the taper rate made in 2017 increased the rate at which the Age Pension is reduced if more assets are held, including assets in super, and exacerbates the disincentive to save more super or invest super more wisely to grow your super.

Until 2017, fortnightly age pension entitlements were reduced by $1.50 for every $1000 of assets above the threshold. The rate of reduction since 2017 has been doubled to $3.00.

This has resulted in some very perverse outcomes across a wide range of super balances at retirement, stretching from around $400,000 to more than $1 million.

Before I look at the outcomes, I will put those retirement balances in perspective. Super savings of $400,000 can be expected to provide an income, which keeps up with inflation, of around $20,000 per annum, or about $400 a week, for around 26 years with the sort of conservative investment approach that most retirees favour.

Super savings of $800,000 can be expected to provide an income, which  keeps up with inflation, of around $40,000 per annum, or about $800 a week, for the same period of time.

To put that timeframe in perspective, a person who is 65 now is expected to live, on average, for around 20 years if they are male and for more than 22 years if they are female. And that is the average, which means that 50 per cent will live for longer. And if emergencies such as medical expenses or the need to go into aged care force people to dip into their super savings, then they will either be forced onto a lower income from their super or their income from super will run out sooner.

To add further perspective, if a person wanted to use his or her super savings to buy a retirement income for themselves and a partner – one that was guaranteed and equal to the couple’s Age Pension – it would cost them around $1.2 million.

So is there a sweet spot?

Going back to the outcomes of the 2017 changes, let us compare a person with $400,000 of super who initially withdraws $20,000 per annum and indexes it over time to keep up with inflation with someone who does the same thing but starts with $800,000 in super and initially withdraws $40,000 per annum and indexes it over time.

Both are aiming to make their super last for 26 years, which provides a small buffer above the average time that they are expected to live.

I should mention that the outcomes below are based on Age Pension rates and thresholds that applied at the time the rate changes were introduced in 2017. Using more recent rates and thresholds would marginally change the numbers, but would not change the overall results, so I have not updated the rates and thresholds.

The results are for a person who is part of a couple who own their home and have no other assets other than super. I have made a number of reasonable assumptions about such things as wage growth.

Weirdly, one of the outcomes is that the total income (Age Pension and income from super) will actually be higher for the person with $400,000 of super than for the person with $800,000 of super during the first six years of retirement. And it will be more than $10,000 higher in the first year ($52,625 versus $42,336).

In year seven, the person with $800,000 of super will enjoy around the same income as the person with $400,000 of super, after which the person with $800,000 of super will progressively enjoy a higher and higher amount of total income.

However, it will not be until the 20th year that the person who starts with $800,000 of super will reach a point where their income exceeds that of the person who started with $400,000 by $20,000 – the amount equal to the additional $20,000 they withdraw from their super every year. This only occurs once their super balance falls low enough so that they qualify for the full Age Pension.

If you look at the total income each person received during the first 25 years of retirement, the person who started with $800,000 of super will only receive an extra $242,000 of income compared with the person who started with $400,000 of super.

This means that only 60 per cent of the additional $400,000 of super they started with will be returned to them as additional income over the first 25 years of retirement.

I would suggest that the rate at which the Age Pension is reduced under the assets test be changed back to the rate that applied before 2017. If that were done, the person who started with $800,000 of super in the example above would not live on a lower income compared to the person who started with $400,000 of super in any year of retirement. In addition, they would receive back 84 per cent ($334,000) of their additional super savings as extra income during the first 25 years of retirement.

Sean Corbett has had more than 25 years’ experience in the Australian superannuation industry, principally in the areas of product management and product development with a focus on retirement income products.

Disclaimer: All content in the Retirement Affordability Index™ is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.

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