Introduction
It is a pleasure to be with you today and to talk about Australia's superannuation future.
Australia’s superannuation future is very bright indeed. This does not mean that it does not have critics or that it does not have challenges.
Today I want to focus on the following important propositions:
- Superannuation is a key component of our Retirement Income Framework which is very well regarded internationally.
- There is high growth in both contributions and fund earnings. This growth is higher than expected on the basis of long term trends. In part, this reflects a high level of member confidence in a strong system, which continues to provide good tax incentives for retirement saving.
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- This confidence in the system is well founded. Projections show the considerable improvement in the level of individual retirement benefits that will occur over time as the system matures.
- The Age Pension will continue to supplement the retirement savings of most Australians and provide for those unable to provide for themselves. By international standards, it is affordable.
- The Government has plans for further strengthening of the system, particularly through the further development of a savings culture and facilitating greater competition.
- As well as leading to better retirement incomes for individuals and to some long term savings in pension costs, our strong superannuation system benefits Australia’s financial markets and the economy as a whole.
Criticisms leveled at the Australian superannuation system are often not well founded. Australia’s retirement income system is well placed to meet the challenges of a new century.
These challenges include the further development of a savings culture.
Australia’s Retirement Income Framework
As we all know, the Australian retirement income system has developed gradually over the past century and comprises three elements:
- the public age pension and service pension;
- compulsory superannuation guarantee contributions; and
- voluntary savings, such as additional superannuation contributions, housing and investments in shares and financial securities.
The age and service pensions currently cost about $17 billion a year. This is equivalent to approximately 3 per cent of Australia’s Gross Domestic Product (GDP). By world standards this is modest, with the cost of public pension systems in some OECD countries being considerably higher. For example, pension outlays are currently around 10 per cent of GDP in the European Union.
Australia has been able to better control its pension costs than many other countries, mainly because the age pension is subject to a means test and is paid at a flat rate which is not tied to an individual’s earnings history.
The Age Pension is not projected to rise to the unsustainable levels of other countries in the long term.
The total cost of Age and Service Pensions is projected by the Retirement and Income Modelling Unit of Treasury (RIM) to only increase by 1 per cent of GDP over the next 40 years as Australia’s population ages significantly.
Australia’s age pension is an integral part of the Retirement Income system and must be accounted for in all analyses of retirement incomes.
The World Bank regards Australia’s system as a model for other countries without an established retirement income system, recognising its comprehensive coverage, long term sustainability and cost effectiveness.
For example, in his address at a Productivity Commission Conference last year, Qaiser Khan, a senior economist with the World Bank said:
"…the Australian Social Protection System (of which retirement incomes is the largest component) has been relatively more successful than other OECD systems in adapting to social and economic changes of the past few decades. It has provided full protection at the lowest cost (as a share of gross domestic product (GDP)) of any OECD country………… The system should do relatively well in the future in comparison to many other OECD systems from both the fiscal sustainability and social protection perspectives due to a variety of factors inherent in its design."
Many commentators take the view that as our population ages, future Health costs are likely to constitute a greater strain on Government resources than the social security framework.
Superannuation – A Good News Story
Superannuation is one of Australia’s great growth industries.
Asset growth continues to exceed informed expectations, and is faster than asset growth in most OECD countries.
- The system’s aggregate assets are now $415 billion, around double the level of 5 years ago, exceeding the levels and rate of growth projected by RIM.
- Both as a proportion of assets to GDP and in terms of growth, this places Australia up near the top of the OECD rankings.
- In 1990 superannuation assets represented 33 per cent of that year’s GDP; they now represent 65 per cent.
The recent investment returns of superannuation funds have been very strong, reflecting in part Australia’s sustained period of economic growth.
Over the last five years, returns for superannuation funds have averaged around 10 per cent real (above inflation), which is over double the long term earnings rates.
However, it is also important to recognise that much of recent growth also represents contributions. Member contributions are at much higher levels than indicated by trend projections and are continuing to grow strongly – in fact member contribution flows have doubled over the past three years.
Australian Prudential Regulation Authority analysis shows that most of this growth in member contributions represents genuine additions to system assets and is not churning or ‘recycling’.
This suggests that the strong growth of member contributions largely represents the voluntary injection of savings into a strong and secure superannuation system and reflects member confidence in the system.
Employer contributions are also growing. Over the year to September 1999, employer contributions grew by 17 per cent, and this is after removing $8 billion dollars in abnormal public sector contributions, mainly for the funding of previously unfunded schemes.
Contrary to some claims, employer contributions to superannuation are growing faster than wages. Over the three years ending June 1999, wages grew by 15 per cent and employer contributions grew by 21 per cent.
Sustained voluntary contributions to superannuation reflect confidence in the system and also an appreciation of the tax incentives involved. It is true that investment in superannuation is taxed at a number of points but it’s the bottom line that counts!
RIM analysis shows that compulsory employer contributions are concessional over a working life at all income levels. This will remain the case even after the major reductions in income and capital gains taxes being introduced under the Government’s major taxation reforms.
There will also remain strong incentives for higher income earners to save additional funds for their retirement inside superannuation rather than outside the system.
For example, take someone subject to the full surcharge. Assume that they invest a one off employer contribution of $10,000 of pretax earnings. This would result in $7000 being invested in the superannuation fund. After 10 years this would generate a benefit of $12,000. I stress that the surcharge, taxes on earnings and full ETP taxation have all been allowed for here.
The same salary, taxed on receipt and then used to purchase a portfolio of the same composition and gross return outside superannuation, would yield a net after all taxes benefit after 10 years some $3400 less.
That is despite the surcharge, the person’s voluntary investment in the super system after all taxes, is 40 per cent higher than the corresponding result outside super.
After 20 years the comparable advantage through super is 70 per cent.
The incentives to invest in superannuation provide a basis for growth. The other basis is the Government’s sound macroeconomic management.
Projections of Growth in Superannuation
As I have already noted, in September 1999, superannuation system assets totalled $415 billion. Looking ahead and bearing in mind the continuing relative benefit of investing in super, the Retirement and Income Modelling Unit (RIM) projects assets to reach around $700 billion by June 2005 and one trillion ( that is $1000 billion) by June 2010.
The ratio of assets to GDP is projected to move from its current level of 65 per cent to reach 90 per cent by 2010 and to exceed 100 per cent of GDP by 2017.
A high rate of continued growth is projected notwithstanding the increased payouts to baby boomers as they retire.
RIM uses long term fund earnings rates for its long term projections, that is, the historical rates are averages over a 25 to 30 year time frame. If the higher earnings rates from the past five years were used, the RIM projections would be higher.
Effects of the System on People
But the superannuation system is not just about big aggregates – it’s very much about improving retirement incomes for ordinary Australians.
The average superannuation balance per person now is about $54,000, with a wide variation about this average depending on years of membership and level of contribution. By June 2005 this average balance is projected to increase to $67,000, by June 2010 to $80,000 and $106,000 in June 2020, all in today’s dollar values. These estimates are probably conservative.
Average age retirement payouts are also estimated to increase. Average age retirement payouts are currently around $62,000 per person rising to $77,000 in June 2005, $97,000 in June 2010 and $135,000 in June 2020. Again all these are in today’s dollar values.
There will be wide variations around all these averages but the strong improvement in benefits as the system matures is clear.
Adequacy
Individuals will of course differ considerably on what would be regarded as an adequate income in retirement.
However, there is no doubt that our maturing system should bring about considerable improvement in the adequacy of retirement incomes for older Australians.
An important point is the dramatic improvement in superannuation coverage. Coverage of employees has grown significantly from 40 per cent in 1986 to 91 per cent in 1999.
Contrary to some claims being made, when the 9 per cent SG is fully implemented, the average person’s financial independence in retirement will be more secure than at any time in Australia’s history.
One measure of improvement in adequacy due to the SG is how much higher expenditure is expected to be in retirement, compared to that from a full rate age pension alone.
On the basis of an individual who earns Average Weekly Ordinary Time Earnings (AWOTE) throughout a 30 year period and receives the 9 per cent SG contributions only, such a person will have a standard of living in retirement 75 per cent higher than the aged pension alone.
Another measure of adequacy is the replacement rate of pre-retirement expenditure – with the target often quoted as 60 per cent. Such a person will have a replacement rate in retirement of about 64 per cent of pre retirement expenditure, slightly in excess of the normal target 60 per cent figure.
As a further comparison, according to ASFA, the average OECD country replacement rate is currently 53 per cent.
After forty years of SG accumulations on AWOTE earnings, a standard of living in retirement twice that from the age pension alone can be achieved. The replacement rate would be around 75 per cent.
Around seventy per cent of employees earn less than AWOTE. The potential replacement rates for such people are higher.
For a person on only half AWOTE through working life the replacement rate is higher at 86 per cent but the margin over a full age pension falls to 41 per cent, still a worthwhile improvement.
Voluntary saving
The SG and age pension provide a solid base for retirement income, but individuals can, and are encouraged to, increase their retirement income further on a voluntary basis.
Australians are taking increasing responsibility for their retirement needs.
People seeking greater benefits than available through the SG and the age pension should be encouraged to have higher voluntary superannuation contributions as well as non-superannuation savings.
The superannuation industry could itself increase voluntary superannuation saving by playing a more active role in promoting the benefits of such savings to individuals.
In fact, this is happening and some investment houses have taken on the challenge of consumer education.
Superannuation In Australia’s Financial Markets and in the Economy:
Superannuation plays a vital role in Australia’s Financial Markets. In December 1999 managed funds in Australia totalled $646 billion. Seventy per cent of funds come from superannuation sources.
Australian funds under management are far higher than for other countries in the region:
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- Total discretionary funds under management for Singapore were around $US83 billion ($A126b) as at 30 June 1999 – less than one quarter of the size of the Australian market.
- Funds under management for Hong Kong were at $US121 billion ($A183b) as at 30 April 1999 - less than one third of the size of the Australian market .
The comparison with Singapore may surprise some people – don’t they have superannuation contribution rates around 40 per cent? Yes – but the money is not privately managed and withdrawals can be made for housing and other purposes to the detriment of retirement savings.
Making sure that superannuation is used for retirement purposes has been a major theme of the Coalition Government.
On 1 July 1999 we introduced a preservation policy which prospectively preserves all contributions and earnings, except in limited circumstances. This policy is estimated to reduce non-preserved assets from around 60 per cent now to virtually zero per cent by 2020.
Over this period, preservation policy is also estimated to increase superannuation fund assets by about $140 billion.
The Government’s preservation policy has been estimated to have an effect on national saving of point nine of one per cent of GDP.
Preservation of superannuation is one example of Government measures to help promote the development of a savings culture in Australia.
Another is our introduction of a 40 per cent pension income test taper, enabling pensioners to keep 10 per cent more of their additional income.
Yet another is the Government’s promotion of a share-owning democracy. Ways for facilitating this include privatisations, such as that of Telstra, and promotion of share ownership, while simultaneously reducing public debt. The Ralph changes to capital gains taxation will give further incentive for households and individuals to invest and save.
Legislation has already passed Parliament which effectively halves the marginal tax rates for capital gains on assets held by individuals for a year or more. This change provides a greater incentive for individuals to invest in enterprises and to actively manage these investments. The taxation of capital gains made by superannuation funds has also been modified so that only two thirds of nominal capital gains are taxed.
Between June 1996 and June 1999, the financial assets of Australian households grew by $285 billion. Of this, $127 billion came from growth in superannuation and insurance assets and $85 billion came from growth in shares and equities held by households. The savings culture is developing.
By international standards, the Australian household balance sheet is in good shape. The ratio of household liabilities to assets is 17 per cent. This underlying strength is sometimes lost on those who concentrate on the narrowly defined household savings ratio.
Of course, the Government’s most important efforts in improving national saving have been through its strategies of returning the Commonwealth Budget to surplus and of reducing public debt.
It is exactly these fiscal strategies which make Australia among the best placed to deal with the costs arising from the ageing of the population. As I said earlier, in retirement incomes, our three pillar design and our cost-effective age pension give Australia one of the most sustainable systems in the world.
The Treasurer has nominated Australia's savings and retirement income system as one of the Federal Government's next areas of review but said that this would not occur until the New Tax System has been fully bedded down.
Meanwhile, the Government is strongly committed to building on the strengths of our superannuation system.
Strengthening the Structure
The Government is looking to further strengthen competition in superannuation through choice and consumer disclosure.
Choice
The Government is firmly committed to providing members with choice of superannuation funds.
Choice of fund will deliver substantial benefits to Australians, through increased competition and efficiency in the superannuation industry.
IFSA commissioned modelling that showed workers would benefit substantially from choice. In particular, the modelling showed that a 30 per cent consolidation of accounts could save $424 million per annum.
I have heard suggestions that people don’t take enough interest in their super and that the Government should do something about it.
My experience is that people often don’t take much interest in events over which they feel they have no control. The Government’s choice of fund policy will help Australians take more interest in their superannuation by giving them more control.
The Government’s choice policy will encourage Australians to take more interest in super, and will be another building block in the development of a savings culture.
Contrary to some suggestions, investment choice is not a substitute for choice of fund. A member should have the right to choose the fund that manages his or her superannuation, not just a choice of the products offered by one supplier.
It has been suggested that choice of funds will disadvantage certain funds such as industry and corporate funds. I do not see any reason why this should be the case.
Superannuation funds which are attractive to their members will be able to compete effectively.
Regrettably, the necessary legislation for choice of funds has been delayed in the Senate.
However, negotiations with the Democrats have been continuing for some time and they have been very constructive. I hope that we will soon reach a final agreement.
The introduction of choice of funds will be accompanied by enhanced disclosure requirements - the Government's Financial Services Reform Bill (CLERP 6) proposes a full commission disclosure regime for all financial service providers.
Financial services providers will be required to provide a retail client with a "Financial Services Guide" at first contact. This guide must include details of commissions, fees and charges applying to the provision of the service.
In addition, the key features statement of a superannuation fund must disclose details of commissions and similar payments to agents where they impact on the member’s superannuation fund benefits.
Where advice is then given, a financial service provider must to provide a retail client with a "Statement of Advice". This would include details of any fees or commissions or associations with superannuation funds that may influence the service provider in providing the advice.There will also be a strong education campaign to accompany the new choice regime.
These education and disclosure arrangements will improve the ability of individuals to choose funds that provide the services they want, such as insurance and investment choice and to compare costs between funds.
CONCLUSION
In speaking to you today I hope I have put to rest a number of myths about the Australian Retirement income system.
- Myth 1: That Australian Age pension expenditures will rise to the unsustainable levels of European countries. - In fact our pension expenditure is well targeted and is not projected to rise to even the current level of European pension outlays, let alone future European levels.
- Myth 2: That voluntary contributions to the superannuation system have dried up and it is only unusually good earnings that keep it going. This is not so. Employer and member contributions continue to increase.
- Myth 3: That investment in superannuation will no longer be concessionally taxed under the new tax arrangements. In fact, taxation remains concessional and investing via employer contributions to a superannuation fund remains as an excellent strategy for saving for retirement.
- Myth 4: That even a fully mature SG system will leave average Australians with inadequate income in retirement. Again, this is not true. The current system will bring about a significant improvement in retirement incomes for average Australians and produce replacement rates which exceed commonly used standards.
I have also spoken about some challenges for Australian Superannuation funds and the Government:
- To further promote confidence in the system, which clearly deserves it;
- To assist in encouraging the development of a savings culture in Australia, particularly one based on increased household voluntary saving; and,
- To further strengthen the structure by promoting greater competition within the superannuation industry.
I thank the organisers for the kind invitation to speak with you today. Superannuation is one of Australia's great growth industries. The Government's policies will further enhance the contribution this important sector can make to the lives of individual Australians and the overall strength of the economy.