Fit for purpose? The super story so far…

We’ve come a long way since the mandatory superannuation guarantee was introduced in the early 1990s. 

Australia’s super system is now the world’s fourth largest private pension industry, with $2.1trn under management at June 2016.

But the super system is still immature. It took 20 years for SG to reach 9.5%, and will take until 2025 to get to 12%, assuming policy continuity. So it will be well into the 2030s before Australians have spent their full working lives with SG coverage of at least 9% of their salaries.

This means that for most of today’s retirees, the age pension continues to be the main source of retirement income, with approximately 80% coverage. But future retirees will be much more dependent on their own super savings, with social security falling back to more of a ‘safety net’ function over time. 

And this profound change in the dynamics of the super system is happening faster than many people expected.

From wealth accumulators to income generators

Until now, the primary focus for wealth providers has been maximising net investment returns through the accumulation phase. But things are changing, driven by the wave of baby boomers entering retirement.

Some stark numbers from the Government’s most recent Inter-Generational Report highlight the issues:

• Longevity continues to increase, with male life expectancy at birth now 91.5 and female 93.6, with this projected to rise to 95.1 and 96.6 by 2055.
• The ratio of workers to retirees continues to decrease, from 7.3 to 1 in 1975 to 4.5 to 1 in 2015 and a projected 2.7 to 1 in 2055.

These changes are leading to a greater focus on fiscal sustainability of the super system, exemplified by a number of recent policy changes.

• Increased preservation age (from 55 to 60) and age pension eligibility (from 65 to 67).
• Tightening of age pension means tests.
• Various measures to rein in super tax concessions in the 2016 Federal Budget.
• Promotion of longer workforce participation.

So as the super system matures and the population ages, the Government is looking to shift the industry’s focus from accumulating capital to generating income, from maximising returns to managing liabilities and from building wealth to drawing down.

Key changes emanating from the Financial System (Murray) Inquiry and other policy reviews are now poised to produce policy outcomes that will transform the retirement product landscape in Australia.

ABPs dominate the current scene

Currently, retirement product selection is almost entirely driven by the tax-free status of eligible retirement income streams from age 60.

However, there is only a very limited range of products that qualify, with the vast majority of these (around 95%) being account-based pensions (ABPs). While these offer great flexibility, investment choice, access to capital and bequest benefits, they expose investors to investment, longevity and sequencing risks. 

Some recent research also suggests that ABPs often lead to unnecessarily frugal drawdown behaviours, with retirees being anxious about the risk of outliving their savings. At an overall system level, the Government contends that super assets are not being efficiently converted into retirement incomes due to a lack of risk pooling and over-reliance on individual ABPs.

So the government has recently expanded the definition of products that can qualify for tax-concessions in the retirement drawdown phase, and is planning to introduce Comprehensive Income Products for Retirement (CIPRs), as laid out in the long-awaited discussion paper released at the end of last year.

Like to know more?

I often wonder how the experience of Australian retirees (and those about to retire) compares with their counterparts in similar countries. A recent Vanguard research paper examines this in detail—take a look here. It makes for interesting reading.

Paul Murphy
08 March 2017
www.vanguardinvestments.com.au