Retirement in Australia is unrealisable for most workers

Australian Financial Review

12 October 2017

Satyajit Das

Australians make up barely 0.3 per cent of the globe’s population and yet hold $2.1 trillion in pension savings – the world’s fourth-largest such pool.

Those assets are viewed as a measure of the country’s wealth and economic resilience, and seem to guarantee a high standard of living for Australians well into the future. Other developed nations, aging even faster than Australia and subject to fraying safety nets, have held up the system as a world-class model to fund retirement. In fact, its future looks nowhere near so bright.

Australia’s so-called superannuation scheme is a defined contribution pension plan funded by mandatory employer contributions (currently 9.5 per cent, scheduled to rise gradually to 12 per cent by 2025)

Employees can supplement those savings and are encouraged to do so with tax breaks, pension fund earnings and generous benefits.

The gaudy size of the investment pool, however, masks serious vulnerabilities. First, the focus on assets ignores liabilities, especially Australia’s $1.8 trillion in household debt as well as total non-financial debt of around $3.5 trillion.

It also overlooks Australia’s foreign debt, which has reached over 50 per cent of GDP – the result of the substantial capital imports needed to finance current account deficits that have persisted despite the recent commodity boom, strong terms of trade and record exports.

Second, the savings must stretch further than ever before, covering not just the income needs of retirees but their rapidly increasing healthcare costs.

In the current low-income environment, investment earnings have shrunk to the point where they alone can’t cover expenses. That’s reducing the capital amount left to pass on as a legacy.

Third, the financial assets held in the system (equities, real estate, etc.) have to be converted into cash at current values when they’re redeemed, not at today’s inflated values.

Those values are quite likely to decline, especially as a large cohort of Australians retires around the same time, driving up supply.

Meanwhile, weak public finances mean that government funding for healthcare is likely to drop, forcing retirees to liquidate their investments faster and further suppressing values.

Fourth, the substantial size of these savings and the large annual inflow (more than $100 billion per year) into asset managers has artificially inflated values of domestic financial assets, given the modest size of the Australian capital markets.

As retirees increasingly draw down their savings, withdrawals may be greater than new inflows, reducing demand for these financial assets.

This will be exacerbated by labour market changes, including lower job security and slower wage growth, which will reduce employee contributions into the scheme. Values, which depend on a growing pool of pension savings, will inevitably suffer.

Fifth, the system has accelerated the financialisation of the Australian economy. The large inflows and around 600,000 self-managed superannuation funds feed an industry of financial planners, asset managers, asset consultants, accountants, lawyers and custodians, as well as banks and stockbrokers. The more than $20 billion annually paid in fees and costs is of questionable economic value.

Finally, the system may well fail in its primary objective – that is, to minimise the need for the government to finance retirement. The typical accumulated balance at retirement age is around $200,000 for men and around $110,000 for women.

The averages are artificially increased by a small pool of people with large balances, yet they’re still well below the $600,000 to $700,000 estimated to be necessary for homeowning and debt-free couples to finance their retirements, which may last 20 or more years.

The Australian government will need to cover the shortfall for a large proportion of the population. In fact, it will lose doubly, having already suffered a loss of revenue from the generous tax breaks provided for the schemes (estimated at $30 billion annually and increasing), which have been used, especially by wealthy individuals, as a way to reduce their tax burden.

Future generations will also be affected adversely, having to finance payments to older generations through higher taxes or additional government debt, reduced wealth transfers from parents, and lower benefits than those awarded to their predecessors.

The Australian system illustrates the fallacy of all retirement schemes, whether underwritten by governments, employers or by individuals themselves.

Such arrangements can only work in an environment of high incomes, strong investment returns and limited post-retirement life expectancy.

Alternatively, they are sustainable where a rapidly rising population and workforce finance payments to a smaller group of post-retirement workers.

The real lesson of Australia’s experience may be that the idea of retirement is unrealisable for most workers, who will almost certainly have to work

Governments have implicitly recognised this fact by abandoning mandatory retirement requirements, increasing the minimum retirement age, tightening eligibility criteria for benefits and reducing tax concessions for this form of saving.

If the world’s best pension system can’t succeed, we’re going to have to rethink retirement itself.

Satyajit Das is a former banker turned consultant and author.