What are compulsory super contributions really for?

What are compulsory super contributions really for?

Superannuation is a unique Australian economic triumph, but if a system is going to compulsorily quarantine someone's wages, it has a moral imperative to provide a clear explanation as to why this intervention is necessary. The federal government's current efforts to define super's objective provides a valuable opportunity to look at the purpose of superannuation afresh.

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Partner, Head of Wealth Management Advisory

KPMG Australia

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What is super actually for?

Even the most ardent superannuation proponent should appreciate what a big deal it is to compulsorily quarantine someone's wages.

There is therefore a moral imperative for the system to provide a clear explanation for why this extraordinary intervention is necessary.

But super currently means many things to many people.

For many earning high incomes, super has been viewed as a tax-effective savings vehicle to build wealth that can be bequeathed.

For many in the union movement, superannuation represents a pool of "workers' capital" capable of reshaping the economy and society.

And recently we have even seen calls for superannuation to be used to help young people buy houses.

The question is, do any of these goals justify the statutory quarantining of earned wages? And if not, what does?

The government's superannuation objective bill

The government's Objective Bill is currently being considered by the Economics Legislative Committee, which is due to report soon.

The definition it's working with is: "To provide income in retirement to substitute or supplement the age pension."

This seems uncontroversial. But it should provoke a key question: what is the actual income target?

The Association of Superannuation Funds of Australia has defined a "comfortable" standard of retirement living at $43,372 a year for a single retiree. To achieve this income, a single retiree would need to retire with a lump sum of $545,000.

Whether you consider that too low or too high doesn't matter for now. The point is it gives us a benchmark for what our super system should do.

By defining a target we can start using the super guarantee as a means and not an end.

What super guarantee do we need to hit the target?

Let's consider someone with average earnings.

If they started in the workforce in 1992 then we can assume their contributions were four 4 percent at the time. By the time they reach 2025/26 we assume they will be contributing 12 percent. That's where their SG rate will remain until their assumed retirement, after 40 working years, in 2032.

Such a person would finish their career with just under $400,000 (in today's dollars – this calculation assumes inflation at two 2 percent.) That's considerably less than the $545,000 we're gunning for.

We can say then that the super guarantee is too low for the average person. It needs to be raised to hit the benchmark we've defined.

But what about those who started their working lives later who started with a higher Superannuation Guarantee? KPMG has crunched the numbers and the graph below makes it clear:

Anyone on average earnings who starts their career before 2006 will fail to hit our $545,000 mark. Everyone who starts after 2006 will exceed $545,000.

The point is that when we ask: how big should the Super Guarantee be? The answer is: depends on when you started work.

So it might make sense to ratchet the Super Guarantee up rapidly to 15 percent now, to help Gen X reach a comfortable level of retirement savings. But then be prepared to lower the Super Guarantee back down again when those who started work this century start making up the bulk of the workforce.

What about low income earners?

Defining a target of $545,000 also has massive ramifications for low-income earners. After all, can it be right to take money from people who could really use it today if it's not even going to help them enough tomorrow?

Take someone working full-time on the minimum wage. They are making $38,304 and the current 9.5 percent SG rate costs them $2449 in lost take-home pay – a life-changing amount of money for someone on such a wage.

As things stand, a full-time wage earner on $38,304 would retire with $375,000 – far less than the $545,000 to make them comfortable.

And the fact is most low-income earners are not working full-time. They are retiring with super in tens of thousands, instead of the hundreds.

So what do they do when it gets paid out on retirement?

Unsurprisingly, they often use the lump payment to retire debt, before going straight onto the aged pension.

That should give us pause.

Because assuming this debt has been attracting interest during a lifetime of work, it surely would have been in the low-income earner's interests to pay it off earlier (or not create it at all.)

Government should therefore consider raising the wage rate at which the Super Guarantee kicks in.

Rethinking retirement and boosting productivity

The objective should also provide impetus to harmonise the preservation age (the age at which you can withdraw your super, currently 56 years) and retirement age (which will be 67 for those born after 1959).

Because if "income in retirement" is the official point, it stands to reason that anyone accessing their savings should be retired. (For some industries requiring physical labour, exemptions could obviously be made.)

This move would likely enhance productivity by encouraging older people to stay engaged with the workforce and offer their knowledge and expertise.

 

Featured article originally published in The Australian Financial Review, 31/03/2017.

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