Despite turning 25 this year, Australia's system of compulsory superannuation is relatively immature and untested.
Baby boomers retiring over the next 10 years have not been in the system for long enough to determine how well the system works.
While contribution rates have increased from 3% to 9.5%, arguably they are still too low. This is because the average balance for members in APRA regulated superannuation funds aged 60 and over is $150,0001. The ASFA estimates an individual would typically need $545,000 in savings to ensure a comfortable standard of living in retirement. Current retirees on average derive 70% of their income from the age pension, a pattern that unlikely to change quickly.
Principal Source of Income for Retirees aged 45+
Source: ASFA, ABS 6238.0 2013
The introduction of a maximum cap of $1.6 million on funds that can be transferred to the pension phase and remain tax free suggests that there is substantial dispersion around the average position. So while no one ever gets the average, it is safe to assume superannuation savings are insufficient to cut the reliance on Government pensions any time soon. Superannuation for most will simply be a supplement to the age pension, not the other way around.
Longevity compounds the problem?
We know the average member is underfunded. Demographic shifts also suggest that retirees will need to make their superannuation savings stretch even further. The system has been slow to adapt to changing longevity. While the industry is currently considering ways to tackle longevity risk, namely through comprehensive income product for retirement (CIPRs), there has been little discussion on how longevity is changing.
When the superannuation system was designed in 1992, the average life expectancy in Australia was 77.3 years. Assuming an individual retired at 65, they only needed to fund 12.3 years of retirement. As at 2015, the average life expectancy increased to 82.5, meaning retirees need to stretch their superannuation out another 5 years.
The book entitled ‘The 100 Year Life’ (Gratton and Scott), provides an interesting, if not terrifying, insight into increasing longevity. A child born today in the West has a 50% chance of living to 105 years, suggesting a 40 year retirement!
As shown below, life expectancy has increased at a steady state of between 2 to 3 years each decade. Using these projections, individuals who are 55 today and looking to retire at age 65 will need to fund approximately 20 years of retirement.
Best Practice Life Expectancy
Source: The 100 Year Life, Living and Working in a Age of Longevity. Lynda Gratton & Andrew Scott
When the compulsory system was conceived, funding 12.3 years of retirement sounded feasible. With shifting longevity rates, retirement can be a 20 to 30 year proposition.
If we think out 20 years, it is clear the retirement saving system will not be what we have today. Clearly the system needs to undergo a significant step change. To date, government has looked to the superannuation industry to solve the retirement income puzzle, however simply changing contribution rates and improving investment outcomes will not solve the problem. Current approaches to longevity risk management will also be unfeasible given projected longevity rates.
We are about to experience significant shift in members moving from the pre-retirement to the post-retirement phase. With this, we have the opportunity to reimagine our industry and find ways to help retirees live comfortable lives.
What should the Future Look like?
A combination of underfunded retires and increased longevity will place significant pressure on the national debt position. In addition, the government will be faced with increased funding requirements for Health and Aged Care.
To reimagine the system, we need to think about interconnections between the age pension, superannuation, the owner occupied dwelling, the health and age care systems.
At the moment, government and industry are seeking to develop retirement solutions. Treasury is undertaking a long consultation process with industry to develop a framework to address retirement income and longevity risk through CIPRs. CIPRs will not be a silver bullet for a number of reasons – however this is a discussion for another day.
The industry is failing to think through more holistic solutions that are customer lead, rather than industry lead. If you talk to real current retirees, their collective concerns are clear, How can I make sure I meet all of my spending needs in retirement? We are currently too focussed on what members have at retirement rather than what they need in retirement.
The challenge for anyone in retirement is how to use their sources of income to fund their consumptions needs.
The average person retiring today is likely to have three sources of potential income; superannuation, age pension and any value they can release from their home.
These are the funding sources for various expenditure including but not limited to:
- Consumption – food, clothing, utilities;
- Life style – holidays, consumption over and above basic needs;
- Health costs; and
- Age care costs.
In addition, whether realistic or not, most individuals also want to leave some form of a bequest.
When looking at the problem through the lens of the consumer, it becomes obvious the superannuation industry is focusing on only a subset of the retirement puzzle. While I’m not suggesting the superannuation industry can completely solve for all needs in retirement, a unique opportunity exists to extend the value proposition into a member’s requirements in retirement. How can we help retirees to use their sources of income to meet their needs over an extended period? Should retirement products focus not only on managing investment related risks but consumption related risk? Can we build solutions that incorporate some of the major expenditure items in retirement; namely health insurance, preventative health services, home care services and aged care cost?
It’s time we broaden the conversation.
1Source: APRA – Annual fund level statistics 2017 AFLSS – 201606 issued 1 Feb 2017