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Federal

Feb 24, 2014

We’re old enough (but wise enough?) to make tough decisions on pension

The aged pension is increasingly unsustainable. And raising the age is only one reform Joe Hockey should be looking at if he's serious about "intergenerational theft", says economist Leith van Onselen.

So, Treasurer Joe Hockey has finally put the aged pension on the block for reform, placing it alongside Newstart and the disability pension. Hockey’s comments late last week that the retirement age of 65 (scheduled to increase to 67 by 2023) is unsustainable in light of increasing life expectancy, and that failure to reform would be akin to intergenerational theft”, is appropriate on a number of levels.

Like many other advanced nations, Australia is facing a demographic tsunami that threatens to cripple government finances. The large-scale retirement of the baby boomer generation means that the ratio of working-age Australians supporting dependents (mostly the aged) will shrink over coming decades, slashing the tax base at the same time as age-related outlays expand …

According to the Grattan Institute, without corrective action, the federal budget deficit could hit $60 billion per year by 2023, or up to 4% of GDP, due mostly to rising health and welfare costs. Grattan also argues that the only part of the tax and welfare system that is not well targeted is that for old people — a view supported by researchers from Curtin University, who recently found that welfare policies across the period 1984 to 2010 overwhelmingly favoured the elderly at the expense of the young.

Judging by the Treasurer’s comments, the government will likely follow the Productivity Commission’s recommendation and seek to raise the eligibility age of the age pension to 70 — a move that is estimated to save around $150 billion over the period 2025-26 to 2059-60 and increase participation rates among older workers by around 3% to 10%.

While such a reform is welcome, on its own it is not enough, and deeper reforms of the retirement system are needed in order to improve intergenerational equity and the long-term sustainability of the budget.

Superannuation is a particularly large problem. While the system was originally designed so that a younger generation could pay for its own retirement, it has instead become a mechanism whereby older people pay less tax given their income than everybody else, with the lion’s share of benefits also overwhelmingly going to richer people.

Under the current system, all employees that contribute compulsorily into super pay a flat 15% contributions tax, which effectively means that the amount of concessions received increases as one moves up the income scale …

For example, someone who earns in excess of $180,000 per year receives a 30% tax concession for each dollar she contributes into super (i.e. 45% marginal tax rate less the 15% flat tax). At the other end of the scale, someone who earns less than $18,200 per year in effect gets penalised 15% for each dollar he contributes into super.

According to Treasury figures, concessions on superannuation contributions were estimated at $16.5 billion in 2012-13, with concessions on superannuation earnings valued at $15.5 billion. Moreover, Treasury estimates that the top 5% of contributors would receive 20.3% of contribution concessions, with higher income earners also receiving the lion’s share of the earnings tax concessions.

Given that the main rationale behind superannuation is to both adequately provide for retirement and take pressure off the aged pension, the 15% flat tax system is inherently flawed and designed to fail. By providing massive taxation concessions to those on the highest incomes, the budget loses billions of dollars of forgone revenue. At the same time, the super system is unlikely to relieve pressure on the aged pension, since those that are most likely to need it — lower- and middle-income earners — receive minimal (if any) concessions, which both hinders their ability to build up a retirement nest egg and discourages them from making additional contributions.

A simple reform that would greatly improve the equity and sustainability of the retirement system would be to abolish the flat 15% tax on superannuation contributions and replace it with a flat concession (e.g. 15%) that is the same for all income earners. A reform of this nature would not only improve equity, since all taxpayers would receive the same taxation concession, but also boost lower-income earners’ super savings, thereby reducing reliance on the aged pension and relieving pressures on the budget.

Other inherent flaws in Australia’s retirement system include the exclusion of the family home from the assets test for the aged pension, combined with the ability to withdraw one’s super as a lump sum (instead of an annuity). Both loopholes create an incentive for households to borrow to purchase an expensive home in the lead-up to retirement, retire at 60, withdraw their super tax-free as a lump sum, use the money to pay off their mortgage or to fund consumption, and then go on the aged pension from 65 years of age. In such instances, the taxpayer is left wearing the cost of superannuation concessions throughout the individual’s working life, and then again once that same individual goes on the aged pension.

In fact, the latest Retirement and Retirement Intentions survey by the Australian Bureau of Statistics found that “of those who had made contributions, 55% had received all or part of their superannuation funds as a lump sum payment”. It also found that “many of those who received a lump sum payment used it to pay off or improve their existing home or purchase a new home … or to buy or pay off a motor vehicle”.

Obvious reforms that would improve the integrity, fairness and sustainability of the retirement system, therefore, also include:

  • Increasing the access age to superannuation (from 60 years currently) so that it more closely matches the pension access age;
  • Reducing the ability to draw super as a lump sum; and
  • Including one’s owner-occupied home (or part thereof) in the assets test for the aged pension, so that taxpayer assistance flows more to those in genuine need.

Hockey’s acknowledgement that the aged pension system is both unsustainable and inequitable is a welcome start. However, if the government’s “ending the age of entitlement” is to be equitable and consistent, it will need to place the retirement system front and centre, incorporating the growing army of wealthier, older Australians drawing unreasonable tax concessions and benefits.

To not target this group would indeed be “intergenerational theft”, and would place the budget in an increasingly precarious position as Australia’s population ages. It would also mean that the working-age population is left wearing the brunt of budget expenditure cuts at the same time as it incurs the cost of supporting its relatively well-off parents.

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28 comments

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28 thoughts on “We’re old enough (but wise enough?) to make tough decisions on pension

  1. Roger Clifton

    If industry wanted wrinkly workers, it would persuade us not to retire.

    However rather than pay humans wages plus hefty income taxes, industry is replacing us with high-energy machinery whose carbon fuel pays absolutely no tax at all.

    The economy ain’t shrinking, it can still support its hosts. Then shift the tax base, dumbo.

  2. klewso

    That’s all well and good for Shockey – but what happens to us plebs between being made aged-redundant and when the pension kicks in?

  3. JMNO

    As a retiree on super, I would support any measures to ensure that we retirees pay our fair share of tax.

    A couple of comments/questions on other measures advocated:
    1. If the age at which a person can access super or a pension is raised, where are these older people going to find work? Most employers aren’t interested in having employees aged over 55 unless they are very senior members of the organisation. If you are over 55 and apply for work (the sort of work that will support you until you are 67 or 70), you will be pre-selected out as being too old.
    Unless employers start to value older employees, all you are doing is increasing the number of people on a disability pension.

    2. Lump sums: Of course people pay off their house or buy a car. It means that a very large expense is dealt with without eating into what is left to live on. Once you are on a fixed income meeting the cost of large capital items becomes much more difficult.

    3. Including the family home in the assets test. My parents didn’t have much money after raising 5 children on a moderate income. They were eligible for the aged pension. The family home which they had bought many years previously had appreciated in value but that didn’t mean anything whilst they had lived there – after all they had to have somewhere to live and they didn’t want to move. After my father’s death and when my mother moved into aged care, the house was sold and a reasonable proportion of sale price was used to pay a bond for her hostel accommodation.

    4. The attraction of living on the aged pension: Once again my parents owned their house and car. Yet to survive on the aged pension meant they had to live very frugally. And for a single person living on a single pension when the costs of upkeeping a house are the same as for two people, it is even more frugal. Why would anyone who had the money want to dispose of it into an asset (an expensive house) that doesn’t produce an income purely to live on an extremely low income?

    Perhaps I am missing something here and perhaps the author would like to explain.

  4. Paddy Forsayeth

    I hear a lot about ‘pay a fair share of tax’ but it seems that doesn’t apply to the very rich. That the super rice can stash $32 odd trillion in faraway banks is abhorrent. Hockey banging on about pensions and taxes shows that he and most world treasurers are spineless when it comes to demanding that ALL income earners pay the same rate of tax. The unrest in many parts of the world is due, in many cases, to the general population getting fed up with these greedy wealth thieves who severely distort the global finances. This is pie in the sky, but I would suggest to the IMF that all banks globally institute a deposit and withdrawal tax of say 0.1%. This would go a long way to retrieving our cash from the small number of stupendously rich in this world.

  5. Kevin Cox

    So in 1961 we had 1.1 workers per dependent and this may be 1.3 in 2050. Hardly a tsunami but a gentle wave upward depending on the reference point. As the value added is increasingly provided by invested capital rather than worker labour it would seem there is little to worry about – provided we share the value added by capital with all in our society.

  6. bushby jane

    Still going for the less well off, Hockey has already reversed Gillard’s wealthy superannuants paying more tax. My husband has been a carpenter for 50 years, he will soon be 65, his body is buggered and ready to retire. Alright if you are a politician, but guess what-they don’t have any designated age to retire.

  7. Shaniq'ua Shardonn'ay

    @JMNO
    1. Like many younger people, you will just have to take any job, regardless of the salary, work for the dole or pay to retrain yourself. You may not get on the disability pension unless you can really prove you are severly disabled.
    2.Lump Sums – I can see a good justification for paying off the house but buying a car? A big fat depreciating asset? Yep it is probably a good idea to limit that.
    3. Including the Family home in the assets test. Yes it is a probably a good idea. Partly for the reasons stated in 4) As hard as we may find it encouraging the elderly to downsize and to do it sooner rather than later is a good idea. The current system encourages pensioners and older centrelink recipients to sit in Million dollar homes that are crumbling around them because they are frightened of the government getting any of their money.

  8. Brian Williams

    Some good points in this article, about an issue that will become more problematic the longer it’s ignored. It’s just a pity that the new Government has neutered Labor’s first (albeit somewhat flawed) attempt to try and attack it. JMNO has already made most of the points that I would have made (points 1 and 4 in particular), so I’ll just add the following to his/her analysis.

    1) The authors suggestion of a switch to a 15% tax concession on pre-tax contributions merits further discussion. It would be more cumbersome to manage than the current 15% flat tax, because a persons final tax rate (and therefore their contribution tax rate) would not be known until the following financial year, and many people could find themselves hit with an unexpected tax bill, if the extra tax owed was not taken from their super account, but it does pass the fairness test.

    2) I really wish that shock-jocks, slack journos and politicians of all persuasions would stop referring to outcomes they dislike as being ‘loopholes’. A loophole is an unintended consequence of a particular policy – there is nothing unintended about the ability of people to take their super as a lump sum upon retirement. It has been a known and fully publicised possibility from day one.

    3) JMNO has already touched on this but it bears amplification. The authors suggestion that new retirees are somehow waiting with bated breath to spend all their super in a lump sum in the first few years of retirement, and then live as near-paupers in a big house on the old-age pension for the next 15-20 years is intellectually ludicrous.

    4) The big elephant in the room, and one not touched on by the author, is when/if a government will try and reinstate the taxation of super account earnings on those who have retired – this is the time bomb that Costello bequeathed to his successors.

  9. Roy Inglis

    Good article and maybe the Abbott – Hockey government will act on these inequities. Then again, maybe they will do what the Howard – Costello and before them the Frazer – Howard governments did. Huff and puff about economic management and how good they are and how bad Labor is while leave their herd of well fattened rapacious sacred cows, including the wealthy aged, all but untouched or even more fattened and multiplying (eg: baby bonus). The May budget will either be the making of the current government or hoist it on a hypocritical petard of it’s own making.

  10. Sean Doyle

    A massive problem is that these proposals are seemingly made on the premise that everyone’s a white collar office worker. Just extending the pension elegibility age isn’t some magical elixir of youth and given how things are for quite a number of 50+ unemployed Australians, any pension savings made are likely to be lost straight away though more dole/DSP payments.

    Not really sure about including the family home in the assets test. For one thing, retired people still need somewhere to live and given how the rental market “works” in Australia, there could be major problems down the track. Even if it did free up supply, I still think there are better ways of doing that (taking a meat axe to negative gearing, for instance). The use of lump sums to pay off major debts before a fall in income comes about smacks of common sense to me, although maybe a percentage limit on the lump sum (40%? 50%?) could be implemented so the super doesn’t get all blown at once.

    I do agree with the author on the contribution tax concessions though. At the moment they are just a flat out tax rort for people who already have plenty of money and need fixing up immediately. It would probably go a fair way to fixing the pension funding issue all by itself, actually, which might make the scaremongering in service of attacking social welfare a bit needless, really.