Can you afford to retire?
A submission to the Senate Select Committee on
Superannuation
Inquiry into the adequacy of tax arrangements for superannuation and
retirement incomes
June 2002
Table of Contents
EXECUTIVE SUMMARY ..................................................................................................................... 3
INTRODUCTION ................................................................................................................................................................... 3
CONCLUSION........................................................................................................................................................................ 6
1. INTRODUCTION ............................................................................................................................ 7
2. TAXING SUPER ............................................................................................................................... 9
2.1
2.2
2.3
2.4
INTRODUCTION ............................................................................................................................................................ 9
TAX REFORM PROPOSAL : TAXING THE BENEFITS AT PERSONAL TAX RATES ................................................... 9
ADDRESSING THE REVENUE SHORTFALL ..............................................................................................................11
SIMPLIFICATION .........................................................................................................................................................11
3. ADEQUACY AND ADDITIONAL SUPER SAVINGS ................................................................... 13
3.1 INTRODUCTION ..........................................................................................................................................................13
3.2 THE REPLACEMENT RATE.........................................................................................................................................13
3.3 WHAT THE STUDIES SHOW: ADEQUACY AND RETIREMENT BENEFITS ...........................................................14
3.4 ADEQUACY FOR SELF EMPLOYED ...........................................................................................................................15
3.5 ADEQUACY FOR WOMEN AND THOSE NOT IN THE WORK FORCE ....................................................................15
3.6 INCENTIVES TO CONTRIBUTE MORE TO SUPER ....................................................................................................16
3.6.1 Extending the co contribution .................................................................................................................................16
3.6.2 Making it easier for anyone to make a voluntary contribution .................................................................................17
4. MAKING INCOME STREAMS MORE ATTRACTIVE TO RETIREES ..................................... 19
4.1 INTRODUCTION ..........................................................................................................................................................19
4.2 BREATHING LIFE INTO COMPLYING ANNUITIES ..................................................................................................20
5. REFERENCES .................................................................................................................................22
Appendices
A: BACKGROUND ON AUSTRALIA’S RETIREMENT SAVING ARRANGEMENTS: ................24
A.1 INTRODUCTION .........................................................................................................................................................24
A.2 WHY THE INTEREST IN RETIREMENT INCOMES?.................................................................................................25
B: INTERNATIONAL PENSION TAXES ........................................................................................29
C: HISTORY OF AUSTRALIAN TAX ARRANGEMENTS .............................................................. 31
D: ECONOMIC IMPACTS OF PENSION TAXATION ...................................................................33
D.1 INTRODUCTION ........................................................................................................................................................33
D.2 AGGREGATE SAVING AND INVESTMENT .............................................................................................................33
D.2.1 The significance of inter-asset distortions ............................................................................................34
D.2.2 The retirement decision ..............................................................................................................................34
D.2.3 Implications for Superannuation Tax Design .....................................................................................35
E: TAX REFORM OPTIONS — A BENEFIT TAX WITH A WITHHOLDING TAX ....................37
E.1 FORMAL PROPOSAL FOR A WITHHOLDING TAX ...................................................................................................37
F: THE AUSTRALIAN INCOME STREAM MARKET.....................................................................40
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Executive Summary
This submission by AMP offers input to the Senate Select Committee on Superannuation’s
Inquiry into “the adequacy of the tax arrangements for superannuation and related policy to
address the retirement income and aged and health care needs of Australians”.
Introduction
The Intergenerational Report released as part of the 2002-03 Budget highlights the cost of an
ageing population, particularly in the areas of health, aged care and aged pension. The report
warns that, without substantial reform, the fiscal position of the Commonwealth will be negative
by 2016 and deficits will increase to about 5% of GDP by 2041-42. The challenge for
Governments is to find solutions and implement them early enough to make a difference.
Superannuation will go a long way to controlling future aged pension costs.
Superannuation can also form part of the overall solution to the looming aged care and
health care funding crisis, by enabling more people to save for this type of expenditure.
The AMP-NATSEM Income and Wealth Report estimates the average superannuation savings
for those about to retire (the 50-64 year old group) is only $56,000 per person. With this level of
saving, funding 15 years of basic consumption will be difficult enough, let alone additional health
and aged care costs. Obviously if superannuation is to be used to provide for aged care and
health expenses, more needs to be saved, and quickly.
Extra contributions to super would help build up superannuation accounts quickly. However,
reforming super taxes and providing better incentives for income streams would also provide
retirees with better outcomes. These areas are the focus of AMP’s submission to the Senate
Select Committee on Superannuation.
As the baby boomers are going to be the primary drain on future public finances, having them
save more while they are working is an equitable solution to the future funding crisis.
Taxation reform
When superannuation was first introduced in Australian, taxes were levied on benefits at personal
income tax rates. However, the many changes since 1983 now see tax levied on contributions,
earnings and benefits. These changes have reduced the tax effectiveness of retirement saving.
Grandfathering past arrangements has added to complexity. On the upside, the relative tax
effectiveness of income streams compared with lump sums has improved. However, the tax
incentive for income streams can be markedly improved on.
AMP considers that the only effective tax regime is one which taxes benefits at personal
income rates, and does not tax earnings or contributions. Relative to current
arrangements this regime would:
 increase the final retirement benefit for each dollar contributed;
 encourage voluntary savings;
 reduce the distortion between housing and super;
 encourage the take up of income streams; and
 improve the overall equity and efficiency of Australia’s retirement income policy.
3
Moving to a “benefit tax only” tax regime would create a substantial revenue shortfall in
the short term. To address this, the Government could adopt a withholding tax (say at
10%) on contributions in combination with a benefit tax such that the net impact of the
two taxes is equal to a benefit tax levied at the retiree’s personal income tax rate.
AMP estimates that by implementing a benefit tax, someone on average earnings could add an
extra 9% to their superannuation over 10 years, or12% over 20 years.
A benefit tax would also make income streams more attractive to retirees as an entire lump sum
payout would be treated as income in the year taken and subject to the personal income tax
schedule. Placing the capital into an annuity/pension would defer income tax until it is drawn
out of the saving environment to fund consumption.
The Government should also consider consolidating and simplifying past grandfathered
taxes. These currently create substantial complexity for customers and administrators
and are the basis of the need for advice for almost all superannuation members from
financial planners. The value of past taxes could be estimated on transition into the new
arrangements and preserved as an indexed amount until retirement. If successfully
implemented, this together with the other reforms, could dramatically simplify and
streamline the retirement savings system and establish Australia as a world leading
benchmark.
Incentives to save more
The aged pension funds minimum level of retirement income. While it is only a very basic level
of income, it might be considered as ‘adequate’. Individuals, on the other hand, often consider
an adequate retirement income to be one that allows them to maintain a reasonable standard of
living compared with the one they enjoyed in their working life.
Government studies have suggested that a replacement rate of at least 60% of pre retirement
income would enable individuals to maintain their standards of living1. The studies suggest this is
the de facto benchmark of an adequate retirement income. Saving 9% of wages over 40 years in
superannuation plus age pension entitlements can achieve this replacement rate.
If
superannuation alone was to fund 60% replacement rate, a higher level of saving would be
required.
The aged pension is an important component of retirement income. If aged pension
entitlements were tightened at some point in the future, a great deal more saving would be
required by all generations to make up for the loss of aged pension income.
For a male on average earnings, a 60% replacement rate means a before tax retirement income of
about $25,000. Superannuation saving of roughly $250,000 would buy a complying life annuity
income of around $15,000 a year. The aged pension would provide the other $10,000 a year.
See FitzGerald 1993, Dawkins, (1992) and Willis (1995). Once taxes are accounted for, this would be
equivalent to a replacement rate of disposable income of about 80%.
1
4
The latest AMP-NATSEM Income and Wealth Report indicates the average superannuation
balance for the 50-64 group is only $56,000 per person. This is a long way off what is needed to
purchase an adequate retirement income. It is clear that there is a very large gap between
expectations of the baby boomers, their retirement plans and reality.
With this in mind, retirement saving for baby boomers in particular must be addressed as
a priority. As part of the solution the Government should:
 Offer an incentive that encourages employees to make a contribution to
superannuation. Extending the co-contribution from the maximum threshold of $32,500 to
annual incomes of $60,000 would provide such a measure. AMP’s preliminary estimates
show that over 10 years, the co-contribution could add 28% to super for someone on average
wages.

Encourage voluntary retirement savings. AMP recommends that anyone between the age
of 18 and 75 be able to make personal undeducted superannuation contributions, regardless
of their employment status. This will enable those outside the workforce (especially women)
to voluntarily save through super while reducing the administrative complexity of checking
eligibility.

Index the tax deductible threshold for self employed persons to wages.
These measures would cost the Government revenue to implement (some less than others).
However, the short term costs would be offset by future reductions in spending on aged
programs.
Ensuring super is used to provide an income in retirement
There have been major improvements in the tax and social security rules for income streams,
which has improved their position relative to lump sums. However, only around 28% of
superannuation benefits end up in income streams. This is because of low saving levels and a
generous tax free threshold2. It is also due to the restrictions governing current product
offerings.
Under the current rules, complying annuities (term life expectancy and lifetime annuities) must
offer guaranteed returns. Capital is therefore generally invested in conservative assets. This
effectively prevents retirees taking advantage of capital growth and potentially higher incomes.
In a low inflation environment, it locks retirees into very low paying products which in turn
entitles them to more Aged pension.
Interestingly, the income streams receiving the most preferable tax and social security treatment
are not popular with the retiring public. For example, complying annuities are asset test exempt
but attracted only 4% of income stream sales in 2001.
Life annuities have an inherent disincentive in that the payments cease on death, with no return
of capital to the estate unless it occurs within the 10 year guarantee period. By comparison,
complying term annuities return capital to the estate on death.
2
The tax free threshold is $105,000, which is indexed to CPI.
5
About 90% of income stream sales in 2001 went into allocated pensions/annuities. These
products give the retiree investment choice and allow them to choose the amount of income they
can draw out (within limits). On death, the remaining balance of the fund is returned to the
family. However, the allocated annuity can also leave the retiree with no income if they live past
their life expectancy. They also allow leakage of funds into a lump sum, as the pension/annuity
can be cashed in at any time.
AMP strongly recommends that the legislation be changed to allow complying annuities
to offer non guaranteed rates of return, thereby passing on the benefits of an investment
in diversified growth assets to retirees. This will attract more retirees into long term annuities
that also provide the opportunity for long term capital growth and potentially higher incomes.
Aged pension entitlement and therefore Government outlays would fall as a direct result of these
potentially higher retirement incomes.
For life annuities, the guarantee period should be extended to at least life expectancy or 15 years.
Conclusion
Many Australians retiring in the next 15 years expect that they will have enough savings to keep
them in the lifestyle to which they are accustomed. However, analysis shows that they will have
little more than the aged pension to live on. Expecting this group to finance more of their future
aged care and health expenditures without an accompanying savings policy is futile.
The combination of tax reform and voluntary saving incentives are effective measures to
build up substantial balances in superannuation for baby boomers. Better income stream
design will then help retirees manage and draw down the savings over a long term retirement. All
three measures should further assist retirees and Governments face the challenges of an ageing
population.
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1. Introduction
The intergenerational report released as part of this year’s Budget highlights the
significant cost of an ageing population, particularly in the areas of health and aged
care. If future Governments are going to avoid deficit, they will have to constrain
expenditure in these areas. If this is the case, then retirees will have to fund more of
these services. Superannuation will go some way to helping retirees, however,
estimates show that many baby boomers are unlikely to retire with much more than
$56,000 in super. This is not enough to fund a 15-20 year retirement let alone
increased health and aged care expenditures.
The bottom line is that all generations (in particular the baby boomers) will have to
save more for their retirement. Measures can be taken now to improve the long term
financial position of retirees, including tax reform, voluntary saving incentives and
better designed income stream products.
The adequacy of Australia’s retirement savings arrangements is determined by a combination
of factors, not just tax. Equally important factors include: the level of contributions and the
investment earnings on these; the length of time over which the savings are made; whether the
savings are made in a defined benefit or defined contribution arrangement; and most
importantly, how the benefit is taken at the point of retirement — a lump sum or a pension.
AMP considers tax design, contributions and income streams as the key areas for the
Government to focus on.
The biggest criticism of Australian superannuation tax arrangements is that taxes are levied at
three points. At each point these taxes are levied at relatively high rates. This undermines the
tax incentive for making contributions and increases the level of complexity for the
administrators.
Most other developed economies with similar occupational saving
arrangements only tax savings once, usually at the benefit stage.
International best practice suggests taxing benefits at marginal tax rates. This would improve
the efficiency and equity of Australia’s superannuation system and increase the incentive to
make contributions. Importantly, a benefits tax would dramatically increase the incentive to
take an income stream at retirement.
If Australia replaced the current superannuation tax arrangements with a benefit tax it would
create a substantial short term reduction in the Government’s revenue. AMP proposes a
withholding tax on contributions as a way to meet part of this shortfall in revenue. The
withholding tax (of say 10%) would be deducted at the benefit stage, leaving the member in
the same net position as under a benefit tax only arrangement.
At the same time, complexity could be addressed by estimating the present value of
grandfathered tax arrangements and preserving these for future payment.
Adequacy cannot be fully addressed by taxation alone. While defining what an adequate
retirement income might be is difficult, past Government research has estimated that
contributing 9% to superannuation over a full working life can achieve a 60% before tax
replacement rate income. However, this outcome requires just over 5 times average earning
being accumulated in super and a substantial contribution of aged pension. The most recent
7
AMP-NATSEM Income and Wealth Report estimates that just over 1 times average wages or
$56,000, is the average superannuation balance. If a 60% before tax replacement rate is taken
to be adequate, then there is a huge gap between expectations and reality for upcoming
generations.
The forecast intergenerational inequity consequences of an ageing population as highlighted in
this year’s Budget (2002-03), and bridging the gap between expectations and reality could be
partly offset if people were able to save more now while they are in the workforce. Making it
easier for people to make contributions, and incentives for additional voluntary saving is a
start.
Integration between income streams and the aged pension is also required. In particular,
complying annuities, which qualify for asset test exemption under social security rules, require
legislative changes to enable them to offer non guaranteed rates of return. This will enable
retirees to benefit from an investment in growth assets and therefore potential capital growth
and higher incomes. In turn, this reduces eligibility for aged pension payments, saving the
Government money in the long run.
This submission works through the three key themes of tax reform, voluntary savings and
more effective income stream design which AMP considers necessary to deliver retirement
incomes that are capable of funding a good standard of living in retirement.
By way of background, the key economic drivers behind Australia’s retirement saving
arrangements are outlined in Appendix A.
8
2. Taxing super3
2.1 Introduction
Taxation of retirement savings is important from two aspects. First, the tax arrangement
create a monetary incentive to encourage people to save and second, it determines how much
the individual receives as a final benefit.
The pension tax system often found in developed countries is based on an expenditure tax.
While this is possibly the best design, it is not commonly associated with mandatory defined
contribution (DC) retirement policies. Perhaps this is because the political temptation to tax
the large capital accumulation is considerable. It may also be because some policy makers
believe that if a contribution is mandatory, the incentive issues central to the economic
analysis for tax design are no longer relevant.
For a mandatory superannuation system to be successful, international best practice should be
adopted. While compulsion does indeed blunt the behavioral response to taxation, mandatory
retirement saving is usually integrated with a voluntary component, making it possible to save
more that the minimum employer contribution. Any voluntary saving will take place at the
margin, where the incentives impact. In addition, taxing the accumulation at high rates along
the way seriously erodes the amount available for retirement purposes. It also reduces
people’s acceptance of the policy.
Australian super tax arrangements have been criticised for their complexity, however, they
have proved difficult to simplify. There are several reasons for this. First, even though
retirement saving is by its very nature a long term phenomenon, current tax revenue neutrality
has been accepted as a requirement of reform. Second, many are concerned with the equity
implications of superannuation tax change, and the very complexities of present arrangements
render equitable simplification problematic. Third, and perhaps most important, the debate
has been conducted without any clear economic framework for tax analysis being adopted. As
a result, there has been no serious consideration of the interplay between superannuation
taxation and taxation policy more generally, and the impact of superannuation taxation on
overall economic efficiency has been obscured.
The two most important questions facing policy makers in designing and reforming
superannuation taxation are; how preferential should the taxation of retirement saving be and;
at what point (contribution, earnings or benefits) should retirement saving be taxed; and how
to use taxation to effectively integrate the first, second and third tiers of the retirement policy.
It is argued that levying marginal tax rates on benefits is the best pension tax design. It
provides a strong incentive to save and is the most effective way of encouraging an income
stream purchase at retirement over taking a lump sum.
2.2 Tax reform proposal : taxing the benefits at personal tax rates
This submission starts with the proposition that the ‘best’ pension tax design is an expenditure
tax, levied on benefits at personal income rates.
An expenditure tax could be achieved by removing the taxes on contributions and earnings,
and to tax benefits at the retiree’s personal tax rate. This is how retirement saving is taxed in
3
This section draws heavily on Doyle, Kingston and Piggott (1999).
9
the US and many other OECD countries (see Appendix B for international pension tax
arrangements). Not only would equity and resource allocation be improved, but also adequacy
of the retirement saving would greatly increase. The simplicity and therefore administration of
tax arrangements could also be improved at the same time by rolling up past grandfathering
(for a history of superannuation tax arrangements, see Appendix C). The economic
arguments for a benefit tax are outlined in Appendix D.
Removing the earnings tax would be necessary, otherwise income would effectively be taxed
twice. In addition, removing the earnings tax might dampen the incentive to retire early. It is
when retirement is a viable option that the earnings tax bites most severely, reducing the
lifetime reward for working another year (Kingston 1997).
Given the recent changes under business tax reform, allowing shareholders with no net taxable
income to receive refundable imputation credits, it seems appropriate that pensions funds
should be able to retain the refundable imputation credits4.
Removing the earnings tax from voluntary contributions would also be required. This would
put deducted and undeducted contributions on a level playing field with regard to the
incidence of tax paid. In essence, it would allow both types of contribution to be taxed on a
consumption tax basis5. Deducted contributions would be tax exempt on contributions, tax
exempt on earnings and taxed on the benefit (EET). Undeducted would be the reverse, taxed
on contributions, tax exempt on earnings and tax exempt on benefits (TEE).
A benefit tax reduces the distortion that exist between the two largest investments that
Australians are likely to make in their lifetime — housing and superannuation. Owner
occupied housing is currently taxed in a manner resembling a consumption tax at marginal tax
rates — a house is purchased with net income and no tax is payable on imputed rental income
or capital gains. Efficiency would therefore be greatly improved by taxing housing and
superannuation in a similar manner. Such a policy would potentially reduce over investment in
housing.
Taxing retirement benefits is preferred to taxing contributions for two reasons. Firstly, taxing
benefits gives rise to a perceived incentive to the individual, thereby encouraging them to save.
Secondly, taxing benefits at the personal tax rate encourages individuals to take income
streams over a lump sum. Taking a lump sum at retirement would subject the entire amount
to personal income tax rates. Taking an income stream would defer tax until the money is
withdrawn to fund consumption.
Taxing super at personal income tax rates would also reduce the exposure of superannuation
to political risk. Using income tax rates makes it much more difficult for any Government to
change taxes on retirement saving unless income tax rates are also changed.
Pension funds should retain refundable imputation credits for three reasons: i) annuity/pension business has
it at the moment ii) refundable credits are really a way of correcting taxation already incurred and avoiding
double taxation, and iii) to treat fairly super funds that invest via companies. If a super fund owned a property
directly, it would pay no tax on rental income. If it owned a company which owned the property, the company
pays tax on the rental, and the super fund loses out unless it has refundable imputation credits.
5 When earnings are not taxed, there is an equivalence between a benefit tax and a contribution tax when levied
at the same rate. This equivalence is exploited under an expenditure tax.
4
10
Adopting a benefit tax allows the removal of RBLs and the tax free threshold on lump sums
(alternatively indexing of the threshold could be removed). The Maximum Deductible
Contributions (MDC) limits might be required to prevent excessive money going into super.
2.3 Addressing the revenue shortfall
Replacing the contribution and earnings taxes on superannuation would substantially reduce
Government revenue. Adopting a withholding tax on contributions harnessed with a tax on
withdrawals (a benefit tax) could partly address this shortfall. The combined impact of the two
taxes leaves the retiree in the same net position as if they were only taxed on benefits at
marginal rates.
Taxing the contributions or the benefits is equivalent if the tax on investment earnings is
removed (the principles of this are outlined in Appendix E). This equivalence is exploited by
the withholdings tax, because some of the revenue can be brought forward and leave the
retiree with the same outcome as if they had been taxed on benefits only.
In its pure form, the equivalence can be achieved by applying the benefits tax at a progressive
rate, less the withholding tax rate, say set at 10%, on a “grossed up” base. The gross up is
required to neutralise the impact on tax revenue of the reduction in payout caused by the
withholding tax.
Some simple estimates reported in Table 1 compare the current tax arrangement with a
benefits tax over 10, 15 and 20 years. The timeframe chosen is relevant for the baby boomer
generation, for which the oldest cohort is currently 56 and the youngest 36 years of age.
Focusing on SG contributions made over the next 10 years by a man on average earnings,
these should reach $42,361 (in addition to what is already in their account) with no change to
tax policy. If a benefit tax (with a withholding tax rate of 10%) is adopted, the super balance
would grow to $45,976 in today’s dollars, an improvement of 9%. The advantage of tax free
compound interest can be seen for someone with an additional 20 years of saving. The
superannuation benefit increases by 12%.
Table 1: Estimates of the additional saving that can be achieved under a benefit
tax: real dollars
9% SG
% change
Current tax
Benefits tax
10 years
$42,361
$45,976
9%
15 years
$70,865
$78,038
10%
20 years
$105,495
$117,938
12%
Assumptions: Current tax arrangements assume an effective fund earnings tax of 8% and contributions taxes
of 15%; the benefits tax arrangement assumes a 10% withholding tax on contributions. The discount rate is
inflation, assumed to be 3%; wages growth 4% and a nominal earnings rate of 7% nominal. The calculations
assume a male on AWOTE. The estimates are not net of final tax. No fees and charges are assumed.
2.4 Simplification
Simplification of superannuation tax arrangement is also desirable. One of the biggest causes
of the complexity is use of ‘grandfathering’. In almost each case where tax rules for super have
changed, selected amounts have continued to be treated under the old rules. This results in
11
very complex administration because the selected amounts treated under the old rules have to
be tracked over time. It also creates complex financial planning strategies to take advantage of
the old rules.
The transition to a benefit tax could be combined with a simple procedure to eliminate the
need for further “grandfathering”. This avoid the need for new grandfathering.
A simplification method outlined in Doyle et al (1999) looked at crystalising the value of past
tax arrangements. The Institute of Actuaries (1998) has proposed a similar approach6.
It involves a calculation of the value of past tax arrangements on each member’s account
balance at a certain date. At this point,
 The tax liability would be preserved in the member’s account and carried forward (at an
indexed rate) to the point of retirement; or
 The tax liability could be paid to the Government, which would go some way to addressing
the revenue shortfall expected with a benefit tax.
Estimating the value of past tax benefits would have to either assume a lump sum benefit, or an income
stream payout, or a combination of both.
6
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3. Adequacy and additional super savings
3.1 Introduction
Most developed economies subscribe to social values that imply income support for the poor,
especially the old poor. As such they might define a minimum retirement income benefit
which is provided through the first pillar, or safety net. This benefit is usually some prescribed
relationship with a poverty measure. Australia is no exception, and the aged pension acts as a
social welfare safety net that is quite generous by international standards.
However, the question of what is adequate for an average individual retiree or couple is not
addressed by most retirement saving systems around the world. However, one would expect
that the objectives of a retirement incomes policy, which mandates workers to make
contributions, should address the question of what is an adequate retirement income. Because
this has not been clearly defined here in Australia, the concept of adequacy and the overall
policy objectives are somewhat imprecise.
With a change towards greater personal responsibility for retirement saving, Australians are
becoming increasingly aware that they will have to fund more of their retirement. What is not
clear is if people are aware of how much they will need to save for their retirement. What is an
adequate retirement income for people to be aiming for, and how much do they need to save
to achieve this?
There are significant differences between what an individual and a community might think is a
“sufficient” replacement rate. The community might view a sufficient retirement income as
private saving which provides an income stream equivalent to the aged pension. On the other
hand, an individual may view a sufficient retirement income as an amount that will allow them
to consume a similar pattern of goods and services in retirement to that which they consumed
while working.
3.2 The replacement rate
The adequacy of a retirement income reflects a standard of living, which can viewed in terms
of replacement rates — the relationship between post retirement and pre retirement incomes
or expenditures. A basic principle of a retirement savings program should allow retirees to
maintain a reasonable proportion of their standard of living experienced during working life.
A replacement rate can be expressed in two ways. First is the ratio of retirement income,
expressed as an income stream, to income earned in the final year of employment. This
replacement rate is a measure of the extent to which retirement income replaces working life
income before tax is taken out. Alternatively, it can be expressed as a ratio of pre retirement
expenditure to post retirement expenditure. That is, how much of your pre retirement
consumption bundle of goods and services can you afford in retirement?
Research by the Government shows that the combination of Aged pension and a contribution
to super at 9% over a full working life should replace roughly 60% of a working income on a
before tax basis (Willis 1995). Alternatively this could be shown to replace about 80% of preretirement disposable income. It is generally accepted that a 100% replacement rate is not
required as retirees no longer incur work related expenses.
13
The bottom line, however, is that the required replacement rate depends on individual’s
circumstances, such as family size, home ownership and life-style aspirations in retirement.
For example, if the individual does not expect to own their home at retirement, then a higher
replacement rate will be necessary.
3.3 What the studies show: Adequacy and retirement benefits
Estimates by the Government and academics show that a combination of superannuation and
Aged pension can deliver adequate levels of retirement income to low and middle income
earners7. However, this result depends heavily on the availability if the age pension. About
two thirds of the retirement income comes from superannuation and the remainder from the
aged pension. This translates to just over 5 time average earnings being saved in super, which
is over $250,0008.
If superannuation alone was to fund a 60% replacement rate, around $410,000 (about 9 x
average earnings) would be needed which requires more than a 9% contribution over a long
term.
Yet looking at how much is being saved in superannuation, the results point to a major
shortfall between the expectations of retirees and the reality. Many baby boomers in particular
are likely to retire with much lower standards of living relative to their working life.
The latest AMP-NATSEM Income and Wealth Report (May 2002) analyses the income and
wealth of people aged between 50 and 64. This is a significant group of people, both in size
(2.7 million people) and accumulated wealth (an average of $240,000 per person). While the
average accumulated wealth of this group is almost double the national average, most of that
wealth is tied up in their family home.
The average superannuation balance for 50-64 year olds is just $56,000 (just over 1 x average
earnings). Relatively low average balances are understandable in this context because
widespread superannuation coverage did not become a reality until the mid 1990s, when the
oldest of this group were in their mid-50s.
While $56,000 sounds like a good amount of money, it needs to be seen in perspective. A
$56,000 lump sum paid by a 65 year old male into an allocated annuity will provide an income
of only $100 a week up to age 80, which is just short of an average 65 year old male’s life
expectancy9. If paid into a life annuity the income is much less, at $66 a week.
Over time the superannuation balances and therefore payouts for the baby boomer generation
should increase. However, looking at Government estimates on average superannuation
payouts at retirement, baby boomers are a long way off retiring with substantial amounts of
superannuation. They show that real average age payouts will rise from $62,000 per person in
See Dawkins 1992 and Willis 1995; and Bateman et al. 1996
Average weekly ordinary time earnings (AWOTE) for a male is just over $47,000 p.a.
9 Quotes prepared by AMP’s Allocated Annuity calculator, based on an annual payment of $5,200 paid yearly
from a $56,000 lump sum with no undeducted contributions, no invalidity component and no capital gains tax
exempt component. There is no lump sum withdrawal from the allocated annuity. Assumes a 7% per annum
gross of tax investment return (prescribed by ASIC).
7
8
14
2001 to $77,000 in June 2005, $97,000 in June 2010 and $135,000 in June 2020 (Kemp 2000).
These are a long way off 5 time average earnings.
The evidence suggests that the baby boomers need to do a lot more saving for their
retirement, and quickly. Relying on the 9% SG contribution and aged pension is not enough
for this group.
3.4 Adequacy for self employed
The self employed represent around 10 % of the Australian workforce, or approximately
857,200 people (ABS 1997b). Superannuation coverage at any level remains voluntary for this
group. Retirement saving is encouraged through tax incentives which include a 100% tax
deduction for the first $3,000 contributed to super, with additional contributions only
receiving a 75% tax deduction (up to age based limits). The threshold is expected to be
increased to $5,000 as of 1 July 2002. This will be the first increase since 1988.
It is difficult to estimate how well the tax incentives have worked in encouraging the self
employed to voluntarily save for retirement. Financial planners suggest that most self
employed people only make contributions up to the $3,000 threshold.

To encourage greater savings by the self employed, the tax free threshold on
superannuation contributions (set to rise to from $3,000 to $5,000) should be indexed to
average earnings. This allows the threshold to move automatically year to year, rather
than on an ad hoc basis.
Encouraging this group to save more is important. Relying on the sale of a business for
retirement income has a high level of risk associated with it, as it relies on the business being
successful, and the expected value of the business being realised on sale10. As a result, self
employed people are more exposed than employees to the risk of retiring with less funds than
anticipated.
3.5 Adequacy for women and those not in the work force
An important issue concerns the treatment of women within the superannuation structure.
Lack of compulsion and preservation rules meant that many women did not have super before
1992.
Women are seen as relatively disadvantaged by the Superannuation Guarantee because it is an
earnings related accumulation scheme, and women on average earn less than men throughout
their working lives. They tend to be concentrated in relatively low paid occupations, more
likely to work part time and have broken work histories. This is partly why it is women who
will be adversely effected by changing the minimum income threshold for super contributions
from $450 per month to $1,350 per quarter.
Many self employed persons rely on their business to provide for their retirement rather than contributing to
a superannuation fund, and usually reject the notion of compulsory superannuation on this basis. This position
has been entrenched with the policy changes allowing the use of a business as the source of retirement income,
with the capital gains on the sale of a business being tax free (up to certain limits) if the funds are used for
retirement purposes
10
15
Further, women often retire earlier than men and have a greater life expectancy, so that the
(generally smaller) superannuation accumulation has to last longer. Finally, there is no
requirement that, in the case of a couple, pensions with reversion be purchased with
superannuation retirement benefits.
3.6 Incentives to contribute more to super
As part of addressing the adequacy of retirement incomes, particularly for baby boomers
approaching retirement within the next 20 years, additional contributions are needed.
Salary sacrificing is a very effective way of increasing superannuation11. This is a voluntary
measure, where employees can ask their employers to make higher contributions in lieu of part
of their salary. This allows the money to go into a super fund on a pre-tax basis 12. However,
there are Maximum Deductible Contribution (MDC) limits on the amount that the employer
can make on behalf of their employees (these are also known as age based limits). For this
financial year, the MDC for someone under 35 is $11, 912; for those aged between 35-49,
$33,087; and for those over 50, $80, 054.
The MDC for those under 50 should be set at a much higher rate. This would enable younger
people to make a significant contribution to their super and take advantage of long term
compound interest. It also enables women who expect to take leave from the workforce to
make a significant contribution to their super while working.
Outside employer arrangements, voluntary saving is an important avenue to increase
retirement funding. Those who are likely to benefit most are those nearing retirement, those
without access to salary sacrificing opportunities, and people with broken work patterns.
Voluntary contributions are made from after tax income and are not eligible for a tax
deduction (except under certain circumstances for self employed people). However, in order
to make these contributions, the member has to satisfy the fund trustee that they are in the
workforce, or have been within the last 2 years. A person can make voluntary contributions of
behalf of their spouse as long as the spouse is under 6513.
The Government could increase the take up of voluntary saving by adopting two measures.
First, is an incentive program along the lines of the co contribution, and second, making it
easier for anyone, whether working or not, to make a voluntary contribution.
3.6.1 Extending the co contribution
The Government has already outlined in the 2002-03 Budget an incentive for employees to
save more in super. They offers to match up to $1,000 of voluntary contributions for those
on annual incomes of less than $20,000. The matching contribution phases out as incomes
increase, cutting out all together for those on more than $32,500 per annum. Only those with
an employment link will be eligible for the co-contribution.
See AMP SuperTrends 1997, which shows that salary sacrificing is the most tax effective means of saving
and can significantly increase account balances.
12 These are treated as deducted employer contributions.
13 The spouse must be non –working and legally married to the contributor.
11
16
Extending the co-contribution to those with an assessable annual income of $60,000 (the
highest income tax threshold), would provide an incentive for employees to make additional
superannuation contributions.
 The co-contribution could remain capped at $1,000 for those on less than $20,000,
reducing by $0.025 per extra dollar of income, up to the $60,000 threshold.
For example, a male earning an assessable annual income of $47,000 who made $1,000 of
voluntary contributions would be eligible for a co contribution of $325.
The Association of Superannuation Funds (ASFA) have proposed a similar measure in their
2002-03 pre-Budget submission. Their proposal is estimated to cost less than $50 Million p.a14.
The proposal outlined here would be similar in cost.
Table 2 shows by how much a co-contribution would add to a final superannuation benefit
under the current and proposed withholding tax arrangements.
Assuming that over the next 10 years, SG contributions alone would add $42,361 to a final
retirement benefit for a male on average weekly earnings, a $1,000 contribution matched by a
co-contribution of $325 would add $13,267 to the benefit. In other words, in the next 10
years, they could add another 31% to their retirement saving on top of their SG contributions
over the same period.
Table 2: Estimates of the co-contribution on the final superannuation benefit: real
dollars
Current tax arrangement
9% SG
Co cont
% change
Benefit tax arrangement
9% SG
Co cont
% change
10 years
$42,361
$13,267
31%
$45,976
$13,622
30%
15 years
$70,865
$20,472
29%
$78,038
$21,371
27%
20 years
$105,495
$28,299
27%
$117,938
$30,075
26%
Assumptions: The calculations for current tax arrangements assume an effective fund earnings tax of 8% and
contributions taxes of 15%; for a benefits tax a 10% withholding tax on contributions is assumed. The
inflation rate used to discount the flows is assumed to be 3% and wages growth 4% and an annual interest of
7% nominal. The calculations assume a male on AWOTE. The co-contribution is not indexed.
Over a longer period, the value of the co-contribution and therefore the percentage change
reduces because it is not indexed. The proportions under the benefit tax follow that of the
current tax arrangements, although their absolute value is higher15.
3.6.2 Making it easier for anyone to make a voluntary contribution
Taking in to account the Government’s recent election commitments relating to voluntary
superannuation (first child tax rebate, super for children, increasing the age for voluntary
contributions from 70 to 75), access to superannuation will be much improved. Although
access will still be restricted to certain groups.
Because the co-contribution is not indexed, the value of the incentive declines in real terms over time, which
also reduces the cost to Government over time.
15 Because the contributions are made out of after tax income they are treated as ‘undeducted contributions’.
Hence, the earnings tax is the only difference between the current tax and benefits tax result.
14
17
The Government should widen access to super even further, allowing anyone between the
ages of 18 and 75 to make undeducted voluntary contributions, regardless of their employment
or spouse status.
 This would avoid complex rules being designed to classify who can and cannot make
contributions.
 It would also simplify the fund trustees’ role in determining who could and could not make
voluntary contributions, particularly in relation to satisfying work test criteria.
This will be beneficial for older workers who might wish to move in and out of the workforce
once they have retired from full time work, but wish to save more for their retirement.
Recent figures indicate that Australians are voluntarily contributing to their retirement savings.
It is estimated that in 2000-01, 44% of total contributions to superannuation were voluntary
employee contributions, up from 23% in 1995-96 (APRA 2002). Data also suggests that the
proportion of employees making voluntary superannuation contributions rises with income (see
Table 3).
Table 3: Voluntary contributions to super by income— 2000
Annual income
% making contributions
Of this group, the level of weekly
contribution
Under $20
$20 - $39
$40 to $59
+ $60
$1 - $19,999
$20,000 $39,999
$40,000 $59,999
$60,000 $79,000
$80,000 $99,999
$100,000 +
8.6%
23.7%
43.9%
48.5%
44.0%
39.5%
35.7%
21.7%
10.0%
11.5%
28.3%
35.1%
12.7%
8.4%
13.2%
25.9%
26.8%
21.3%
7.6%
12.4%
23.6%
43.4%
8.4%
10.1%
16.8%
51.3%
6.5%
10.0%
9.6%
61.1%
Source: ABS 6360.0
By encouraging those who can, to make additional contribution, should go some way to
addressing the expected pressures on future Government Budgets in relation to aged pensions,
aged care and health expenditures. If the future expenditure issues are not addressed, then it
will be the younger generations who will be under pressure to fund retirees needs. Introducing
measures that encourage baby boomers (as well as younger generations) to fund their own
retirements today should be supported, as it also allows the cost of these incentives to be
spread across today’s tax payers.
18
4. Making income streams more attractive to retirees
4.1 Introduction
Complying annuities (term life expectancy and lifetime annuities) must offer guaranteed
returns to retirees. As a result, the underlying capital is generally invested in conservative
assets, which in turn reduces the retirement income payable to the retiree. AMP strongly
recommends that the legislation be changed to allow these products to offer non guaranteed
rates of return, thus allowing retirees to benefit from an investment in diversified growth
assets. This will give retirees the opportunity for capital growth and potentially higher
incomes, which in turn reduces eligibility to the Aged pension and saves the Government
money.
The manner in which retirees take their super will effect the overall adequacy of their
retirement income. Occupational retirement schemes in many OECD countries require the
payout to be taken as a pension, with limited access to lump sums. This is not the case in
Australia, where it is and always has been the norm to take a lump sum. This is possibly the
biggest single downfall of Australia’s retirement system.
APRA statistics show that only 20% of superannuation payouts in 2001 were taken directly as
a pension as seen in Table 4. The remaining 80% were taken as a lump sum payment.
However, a lump sum payout can be rolled over into an annuity at a later stage. Therefore,
looking at total income stream sales of $8.4bn in 2001, the proportion of superannuation being
used to purchase income streams increases to 27% (Plan for Life 2002) .
Table 4: Pension and lump sum payments from superannuation funds for
2001
Type of Scheme
Lump Sum Payments
Pension Payments
Proportion of lump
Aust$ million
Aust$ million
sum payments
Public Sector
7,170
3,628
%
66%
Industry
1,570
70
96%
Corporate
2,887
463
86%
Retail
10,958
2,084
84%
Small Funds
2,008
63
97%
Total
24,593
6,308
80%
Source: APRA statistics, March. 2002
The tendency to take a lump sum might be partly fueled by relatively low superannuation
balances (as reported on in section 3). Therefore, retirees consider taking the lump sum and
paying off debt or purchasing a new car or household goods as being wise use of the money.
Nevertheless, benefits are expected to grow and the Government should aim to ensure that
retirement savings are used for the purpose of providing an income.
Making an income stream purchase compulsory at retirement would ensure that super is used
to provide a retirement income. This is unlikely to happen as the baby boomers and therefore
the Government would not support such a policy. Therefore, the package of incentives (tax
19
and social security) used to encourage an income stream purchase needs to be strong and well
targeted.
There is a range of tax and social security incentives for income streams. Income streams
purchased with superannuation money (within the RBLs) are eligible for the annuity tax offset
of 15%. In terms of social security treatment, both lifetime and life expectancy annuities
(when these meet certain conditions they are called complying annuities) are exempt from the
assets means test. Income derived from all three product types is tested under approximately
the same concessional treatment. Complying annuities also provide access to the Pension RBL
which has enhanced tax concessions on benefits.
4.2 Breathing life into complying annuities
Australians have shown little preference for complying annuities, despite their favourable RBL
and social security rules Only 4% of income stream sales in 2001 went into complying
annuities (more detail on the Australian income stream market is outlined in Appendix F).
There are several factors which give rise to their unpopularity. Complying annuities must
provide a guaranteed rate of return to investors. The capital backing the annuities are
therefore generally invested long term in conservative assets (bonds and cash). The result is a
very low income for the retiree. Times of low interest rates make it unattractive to “lock into”
a guaranteed long term investment.
A further disadvantage of lifetime complying annuities is the loss of capital to the estate on
death. The longest that the capital can be guaranteed for is 10 years, which is less than most
retirees life expectancy. On the other hand, a complying life expectancy annuity allows the
capital to be returned to the estate on death.
Regardless, complying annuities have some attractive features: - they are not commutable, they
last for at least life expectancy, and they are designed to drawdown capital.
Allocated annuities and pensions are the most popular type of income stream with retirees,
accounting for 90% of sales in 2001. These products give the retiree investment choice and allow
them to choose the amount of income they can draw out (within limits). On death, the
remaining balance of the fund is returned to the family. However, the allocated annuity can also
leave the retiree with no income if they live past their life expectancy. They also allow leakage of
funds into a lump sum, as the pension/annuity can be cashed in at any time.
AMP proposes that complying annuities (being life expectancy and the lifetime annuities)
would be much more attractive products to retirees if they were able to invest in a range of
assets as chosen by the retiree.
 First, this would allow the providers to remove the rate of return guarantee from the
product and pass the investment risk and rewards through to the retiree, making the
annuity cheaper as a result.
 Second, retirees would have investment choice, allowing them to select assets according to
their risk preference.
 Third, this would allow retirees to benefit from a long term investment in growth assets,
with the potential for capital growth and therefore improved retirement income. It also
avoids retirees having to lock in at low rates of return.
20
Enabling retirees to take advantage of growth assets and potentially receive higher incomes
would reduce eligibility to Aged pension payments, in turn saving the Government money.
Allowing complying annuities to invest in growth assets would also be beneficial to the wider
economy, given a large pool of funds would remain in diversified assets rather than flowing
towards fixed interest at the point of retirement16.
IFSA and ARISA have proposed similar variants to AMP. However, the IFSA model only
applies to an income stream that last for average life expectancy. With the trend to living
longer, anyone living past their average life expectancy would run out of money under the
IFSA proposal, falling onto the aged pension. For this reason, products that cater for
longevity should be also be given preferential treatment.
The complying status of an annuity requires that the income from year to year cannot be less than the
previous year and any increase cannot be more than the rate of inflation (+1%) or a fixed rate of escalation.
An annuity which experiences volatility associated with the underlying asset returns can result in income which
can change from year to year by more than is allowed under the regulations.
16
21
5. References
APRA (2002), Superannuation Trends - December Quarter 2002, Sydney
ASFA (2002), 2002-03 Pre – Budget Submission, March 2002.
Bateman, H. (1998), Economic Aspects of Mandated national Retirement Income Schemes, PhD
Thesis, University of New South Wales.
Bernheim, D. (1994), “Do Households Appreciate their Financial Vulnerabilities?”,
Mimeograph, Princeton University.
Commonwealth (2002), 2002-03 Budget, AGPS, Canberra
Dawkins, J. (1992), Security in Retirement: Planning for Tomorrow Today, June 1992, AGPS,
Canberra.
Dixon, J. (1982), “Provident Funds in the Third World: A Cross-National Review”, Public
Administration and Development, Vol.2, 325-344.
Doyle, S., Kingston, G. and Piggott, J. (1999), “Taxing Super”, Australian Economic Review,
Vol. 32, No. 3 (September).
Hamilton, Bob and Whalley, John (1985), “Tax Treatment of Housing in a Dynamic
Sequenced General Equilibrium Model”, Journal of Public Economics, 27 (2), July, 15775.
Hamilton, J.H. (1987), “Taxation, Saving and Portfolio Choice in a Continuous Time
Model”, Public Finance, XXXXII, 2, 264-284.
Harding, A. and Kelly, S. (2002), “Live Long & Prosper?: the income and wealth of those
about to retire” , The AMP - NATSEM Income & Wealth Report, Issue 2, May 2002,
Sydney.
Institute of Actuaries of Australia – Simple Superannuation (tax reform) Taskforce (1998),
“Discussion Paper on Superannuation Tax Reform and Simplification”, Mimeo.
Kemp, R. (2000) “Speech by Senator the Hon. Rod Kemp, Assistant Treasurer” at the
Conference of Major Superannuation Funds, Ashmore, Queensland, 29 March, 2000
Kingston, G.H. (1996), “Efficient Timing of Retirement”, Mimeograph, University of New
South Wales.
Kingston, G.H. and Piggott, J. (1993), “A Ricardian Equivalence Theorem for the Taxation
of Pension Funds”, Economics Letters, 42, 399-403.
22
Johnson, P. (1992), “The Taxation of Occupational and Private Pensions in Western
Europe: in Mortensen, J. (ed), The Future of Pensions in the European Community,
Brasseys, UK, 133-150.
Merton, R.C. (1969), “Lifetime Portfolio Selection Under Uncertainty: The Continuous
Time Case”, Review of Economics and Statistics, 51, 247-257.
Mitchell, O.S. and Fields, G. (1984), “The Economics of Retirement Behaviour”, Journal of
Labor Economics, 2, 84-105.
Plan for Life Research (2002), The Allocated Pension Report, issue 38, March 2002.
Willis, R. (1995), Saving for our Future, May 1995, AGPS, Canberra.
23
Appendix A
A: Background on Australia’s retirement saving arrangements:
A.1 Introduction
The nature of retirement saving in Australia has undergone tremendous change over the past
15 years, most notably due to the introduction of compulsory superannuation. Prior to this
time, policies for retirement income had mainly focused on the provision of a means tested
public Aged pension and tax concessions for voluntary superannuation saving. Putting this in
the World Bank three pillars context, Australia essentially relied on the first and third pillars of
retirement saving. This put it at odds with most other OECD countries where there were
long standing compulsory occupational linked retirement saving scheme. That was, until the
mid 80s when productivity award superannuation was introduced, leading to the
Superannuation Guarantee in 1992.
If traditional retirement funding arrangements were to continue, that is, to rely primarily on
the Aged pension, the increasing proportion of retirees would place significant pressure on
public funding requirements. This pressure would be even greater if the rate of pension was
increased due to lobbying from retirees. Combined with this, retirees are also living longer
and therefore require pension payments over longer periods. Increased aged care and health
care costs further increase the pressure on Government finances.
Compulsory superannuation combined with tighter preservation rules has significantly
increased coverage of the workforce. Prior to the introduction of the SG, less than a third of
the private sector workforce received superannuation contributions. On the other hand,
public sector participation was much higher due to it being a condition of employment. It is
estimated that 86.7 % of all employees (over 8.8 million full time and part time workers) have
superannuation (see Table 5). Coverage of the nation’s workforce is even higher when the self
employed are considered.
Table 5: Superannuation coverage of labour force — 2000
.
Male
Female
Persons
Full time
91%
93%
92%
Part time
62%
76%
72%
Total
88%
85%
87%
Source: ABS 6360.0
Coverage of full time workers has not changed significantly in the last few years, hovering at
about 92 %. Coverage of part time workers, however, has improved markedly from 54 % in
1992 to 72 percent in 2000.
24
Over the last 10 years, the funds under management in superannuation have increased
markedly as shown in Figure 1. Over a ten year period, funds under management have grown
by $363 billion, or 220 % between June 1992 and December 2001.
Figure 1: Assets and funds under management in superannuation: 1992-2001
$b
600
500
400
300
200
100
0
Jun-92 Jun-93 Jun-94 Jun-95 Jun-96 Jun-97 Jun-98 Jun-99 Jun-00 Jun-01
Source: APRA
The structure of the industry has changed over this time too as seen in Table 6. In the mid
1990s, the public sector, corporate and retail sectors of the superannuation industry were
equally responsible for three quarters of the assets in super. As of last year, the retail sector by
itself held one third of all super assets. Growth has also been high in superannuation funds
with less than 5 members.
Table 6: Superannuation assets by fund type
June 1995
market share
$ billion
%
Corporate
47
21%
Industry
12
5%
Public sector
59
26%
Retail
53
24%
SMSFs & other
19
8%
Other*
35
16%
Balance
225
*Other includes the annuities and life office reserves
Source: APRA March 2002
December 2001
$ billion
73
47
110
174
94
34
528
market share
%
14%
9%
21%
33%
18%
6%
A.2 Why the interest in retirement incomes?
Key social developments have combined to inject urgency into developing a sustainable
retirement incomes policy not only in Australia, but worldwide.
One of these is demographic transition. The Australian Bureau of Statistics (2000) predicts
that the Australian population is projected to grow from 19 million in 1999 to between 24.1
and 28.2 million in 2051, and to between 22.6 and 31.9 million in 2101.
25
While the population is growing over this time, so is the composition of the population
changing. As can be seen from Figure 2, the ratio of those aged between 15 and 65 (the
major source of income tax revenue) to the entire population will fall slightly, from 67% to
60%, while the proportion of the population aged over 65 will increase significantly, from
12% to 24 %. This results in an increased aged dependency ratio, defined here as the ratio of
those above 65 to the working population between 15 and 64. This ratio is expected to more
than double, from 18% in 1999 to 41 % in 2051.
Figure 2: Estimate of the Australian population, 1999-2051*
$ million
80%
30.0
70%
25.0
60%
20.0
50%
40%
15.0
30%
10.0
20%
5.0
10%
0%
0.0
1999
2001
2006
2010
population
2021
% over 65
2031
2041
2051
% 15-64
Based on series 1 assumptions.
Source: ABS (2000) 3222.0
Compulsory private superannuation saving will go some way to restraining public expenditure
on the Aged pension in the long term. This is because over time, more retirees will move
from being eligible for a full rate pension to a part rate pension, thereby reducing pension
outlays. Estimates by Rothman (1998) indicate these savings to be in the order of 0.6% of
GDP over the next 20 years and 1.5% over the next 50 years (see Table 7). Estimates by the
Department of Family and Community Services indicate that in 2000, around 83% of people
of aged pension age are receiving the Aged pension of which 53% are receiving full
entitlements, and a further 20% are on Veterans Affairs entitlements. Only 17% of retirees of
aged pension age are self funded retirees.
From a political view, the ‘baby boom’ generation is considered to be a powerful lobby group.
Once in their retirement phase, there is a risk that they could lobby for higher benefits to raise
their living standards, particularly if they are heavily reliant on Aged pension for their income.
Estimates by the Retirement Income Modeling Unit show that an Aged pension at 30% of
AWOTE would be costly to the Government (compared to the current level of Aged pension
at 25% of AWOTE), increasing costs by 2.3% of GDP over the long term (Rothman 1998).
26
Table 7: Projected costs of Aged pension under various scenarios — % GDP*
Base (25%)
2.99
1998-99
2.94
1999-2000
2.94
2000-01
3.06
2010-11
3.55
2020-21
4.07
2030-31
4.49
2040-41
4.48
2049-50
* Source: Rothman 1998, table 4 page 9
30 %
2.99
3.45
3.45
3.61
4.22
4.86
5.33
5.32
Universal pension
3.68
3.61
3.62
3.81
4.72
5.79
6.38
6.44
No SG
2.99
2.94
2.94
3.08
3.67
4.33
4.76
4.76
Australians are also living longer and retiring earlier. People reaching 65 today can expect to
live a lot longer than those who were 65 in the 1970s and it is likely this trend will continue for
the baby boomers. While average life expectancies for older men remained fairly stable
throughout the first three-quarters of the 20th Century, they had improved significantly over
the last 25 to 30 years as seen in Figure 3. Analysis shows that between 1901 and 1972, the
average life expectancy of a 65 year old male increased by almost one year, from 11.3 years to
12.2 years. However, average life expectancies for older men had increased since then by four
years, to 16.2 years.
The life expectancies for 65 year old women has increased steadily throughout the 20th
Century, from 12.8 years in 1900 to 19.8 years at the end of the Century, including an increase
also of four years since 1972.
Figure 3: Life expectancy of a male and female aged 65: 1881 - 1997
Life Expectancy
years
25.00
Female age 65
Male age 65
20.00
15.00
10.00
5.00
1881-1890 1901-1910 1932-1934 1953-1955 1965-1967 1975-1977 1985-1987 1995-1997
Source: Australian Life Tables 1995-97
27
The most likely factors for the significant improvement in mortality rates are major
developments in medical diagnosis and treatment, and the improved lifestyle that the postDepression generation has enjoyed.
In addition there is also a trend towards earlier retirement (now 60 for men and lower for
women). Other OECD countries are experiencing similar trends. The average retirement age
might stay around 60, based on changing attitudes to older workers and Government
initiatives to keep older people at work. However, factors such as the spread of occupational
superannuation will tend to make early retirement more attractive for some.
Early retirement means that people will have to support themselves for longer in retirement
and there is less time over which to accumulate savings. This is really important given the
effect of compounding in later years. The longer the compounding process runs the more
powerful the accumulation of saving. This is an important issue when considering adequacy.
The combined effect of retiring earlier and living longer means that baby boomer generation
may find they are in retirement for almost as long as they were at work. Therefore, what
saving they have will need to last a long time.
28
B: International pension taxes
Appendix B
The taxation arrangements for retirement savings in most OECD countries are based on
consumption tax principles. That is, retirement savings are only taxed when taken out of the
retirement saving scheme to be used for consumption purposes. Essentially, the contributions
and earnings are not taxed, while the benefits are taxed at the individual’s personal income tax
rate.
Returns on the retirement saving investment (usually referred to as fund earnings) are untaxed
under such arrangements because otherwise, income would effectively be taxed twice, and the
costs of future consumption increased.
However, it is possible to tax pensions at three points: on contributions, on fund earnings, and
on benefits. Some countries tax contributions, but only a few tax earnings. Table 8 reports
current practice for a number of countries.
Australia taxes retirement saving at all three points. All are taxed concessionally, so it is less
the burden of tax than its complexity that is the difficulty here17. However, the flat rate
structure does introduce inequities. Taxing at three points does not necessarily make the
system complex. Rather, complexity arises from the many changes that have occurred over
the last 15 years, and the associated grandfathering provisions. These are discussed below.
Although there are circumstances where effective tax rates can be higher than 48.5% as acknowledged by the
Government in the 2002 Federal Budget.
17
29
Table 8: Taxation of Private Pensions in Selected Countries
Country
Income tax
treatment of
contributions
Fund Income
Contribution
Earnings
Pensions
Lump sums
Australia
Employer conts tax
deductible
taxed at 15%
to 30%
taxed at 15%;
tax
credits
available
on
Australian
equities
Taxed,
with
15% rebate
Taxed at 15%
above
threshold
Belgium
Tax deductible
Taxed
Taxed
(with
tax credit)
Taxed
16.5%
Canada
Tax deductible
Exempt
Taxed
Taxed
Chile
Tax deductible
Exempt
Taxed
Lump sum tax
Denmark
Tax deductible
Taxed
Taxed
Taxed t 40%
France
Tax deductible
Exempt
Taxed (some
deductions).
No lump sums
Germany
Employer conts tax
deductible
Exempt
Taxed
Taxed
Ireland
Tax deductible
Exempt
Taxed
Taxed
with
some
exemptions
Italy
Tax deductible
Taxed
Taxed
Taxed
12.5%
Japan
Employer conts tax
deductible
Taxed
Taxed
Taxed
Luxembourg
Employer conts tax
deductible
Exempt
Taxed
Netherlands
Tax deductible
Exempt
Taxed
Taxed
New Zealand
No tax deduction
Taxed
Exempt
Exempt
Portugal
Employer conts tax
deductible
Exempt
Taxed (subject
to
specific
rules)
Taxed
at
income
tax
rates on 20%
of benefit
Spain
Tax deductible
Exempt
Taxed
Taxed
Sweden
Tax deductible
Taxed
Taxed
Taxed
Switzerland
Tax deductible
Exempt
Taxed
Taxed
UK
Tax deductible
Exempt
Taxed
Taxed
with
some
exceptions
USA
Tax deductible
Exempt
Taxed
Taxed
but
eligible
for
concessions
Exempt
Exempt
Taxed
Taxed
Singapore
Sources:
Benefits
at
at
Dixon (1982), Johnson (1992), Bateman et al (2001).
30
Appendix C
C: History of Australian tax arrangements
Superannuation taxation arrangements have continued to evolve since the introduction of
mandatory superannuation. Mostly, they are not retrospective but, rather, preserved.
Combined with this, the design of superannuation taxation arrangements have been rather ad
hoc in nature. The result is that the Australian superannuation taxation system is complex to
administer and difficult to understand.
Prior to 1983, earnings on superannuation saving were untaxed, and when taken as a lump
sum, only 5 % of the total benefit was added to assessable income and taxed at the applicable
marginal income tax rate. However, from July 1983, marginal tax rates were no longer used
for retirement saving.
The new tax arrangement introduced in 1983 was to levy a 30% flat tax on the post 1983
retirement benefit when withdrawn. This form of taxation was based on consumption tax
principles, and equivalent to the taxation of retirement saving in most OECD countries. Then,
in 1988, tax was levied on both contributions and benefits, bringing forward tax revenue.
Known at the time as the then Prime Minister Keating’s “Magic Pudding”, the 30% benefit tax
was replaced with a contribution tax of 15% and a benefit tax of 15%.
This policy was sold as being nothing more than a rearrangement of the tax structure, not an
increase in the overall tax take (see Piggott and Kingston 1997 for the formal proof of this
equivalence). This would hold true if the earnings on retirement saving is untaxed, as the net
present value of a benefit tax is equivalent to a tax on contributions at the same tax rate.
Because of this equivalence, the new arrangements were estimated to raise an equivalent
amount of tax in net present value terms, leaving retirees no worse off. However, a 15 %
earnings tax was also introduced at this time, preventing the equivalence from holding.
A tax rebate on the income derived from a retirement income stream was also introduced in
1988. It was introduced as a means of compensating retirees for the new contribution tax,
while providing a tax incentive for income streams relative to lump sum benefits. The rebate
rate is set at 15% of the assessable income and is only available for income streams purchased
with an Eligible Termination Payout (ETP)18.
The concessionality of the super tax rates has been further eroded due to the lowering of
personal income taxes in 2000. For low income earners, the concession for making super
contributions is marginal.
Tax is now levied at three levels: — on contributions, earnings and benefits, effectively
increasing the level of taxation on retirement savings. The introduction of the surcharge tax in
1997-98 has increased the effective tax rate for higher income earners.
18
To be eligible for the rebate, the retiree must be at or over the preservation age.
31
As a result of the many tax changes, the total tax payable on super has increased in real terms
as seen in Figure 5. Taxes on contributions and earnings are now the fastest growing source
of revenue for the Government. Over the 12 year period 1990-91 to 2002-03, superannuation
taxes will have grown from just over $1 billion to over a (forecast) $4.8 billion
(Commonwealth Budget Papers 2002).
Figure 5: Tax revenue from superannuation funds: 1985-86 to 2002-03*
$m
6000
5000
4000
3000
2000
1000
19
85
/8
6
19
86
/8
19 7
87
/8
8
19
88
/8
19 9
89
/9
0
19
90
/9
19 1
91
/9
2
19
92
/9
19 3
93
/9
4
19
94
/9
19 5
95
/9
6
19
96
/9
19 7
97
/9
8
19
98
/9
19 9
99
/0
0
20
00
/0
20 1
01
/0
2
20
02
/0
3
0
* 2000-01 and 2001-02 figures are forecasts.
Source: Commonwealth budget papers
32
D: Economic impacts of pension taxation
D.1 Introduction
The unifying thrust of the economic theory of tax design lies in the question it poses: how to
minimise, or reduce, the economic cost of resource misallocations through the whole
economy which will occur as taxes distort prices and the choices of agents are adversely
affected. At an abstract level, it is possible to envisage a set of taxes levied at rates which
minimise these costs for a given revenue target, and where appropriate, for given equity
criteria. The luxury of de novo tax design, however, is not available to policy practitioners, who
must wrestle with options, which modify existing structures. Improvements (that is, changes
which reduce distortionary cost), taking into account constraints imposed by unchangeable
features of the tax system and equity concerns, are all that can be hoped for.
Take this latter position as a starting point. Also assume that the income tax base is here to
stay, and that equally, major institutional features of the income tax, particularly the tax
preference to owner-occupier housing, are permanent as well.
This allows us to consider what major resource allocation effects might result from alternative
superannuation tax reforms, given the existing tax structure, and what might be the best of
these alternatives. Perhaps the clearest resource allocation effect is the impact on aggregate
saving, and the implied flow of domestic funds available for investment. Two further
important effects relate to the choice of assets in the economy generally, and the retirement
decision. All three are likely to be directly affected by superannuation taxation. Here we
briefly review the literature on each.
D.2 Aggregate saving and investment
The impact of taxation on saving and coincident economic growth has a long history in public
finance. It is particularly important in the present context because there are other grounds to
suppose that the level of saving is sub-optimal, and the compounding effects of capital income
taxation are therefore likely to be especially costly.19
A number of important papers through the 1980s have produced the result that the taxation
of capital income is inimical to growth, and that the substitution of yield preserving taxation of
consumption or labour leads to welfare improvement. Important references include Fullerton
et al (1983), Judd (1987) and Lucas (1990).20
It is sometimes argued that many developed economies with income taxes at the center of
their fiscal systems are already part way to a consumption tax reform, and that the impact of
the income tax on aggregate saving and investment is overstated. Owner occupier housing,
These include the existence of a publicly funded aged pension, and undersaving by some groups in the
community. For analysis of this latter phenomenon, see Bernheim (1994) and Laibson (1996). A well known
principle in public finance is that efficiency cost increases with the square of the tax which induces the price
distortion. Compounding impacts can therefore be expected to impose disproportionately high efficiency costs.
20 Reducing capital taxes and increasing labour taxation would not necessarily make wage earners worse off, at
least in absolute and long run terms. In the long run, the enlarged capital stock induced by low capital income
taxation would actually drive wages up to the extent that wage earners would be better off with low capital
income taxes and high wage taxes than with an equal revenue combination of high capital income taxes and
low wage taxes.
19
33
which constitutes a major component of privately held wealth, is typically taxed under what is
effectively an expenditure tax regime. This is because the return on capital invested in owner
occupied housing (the imputed rent and the real capital gain) is not taxed. Pension
accumulations are often given similar tax preference: the proposal put forward here is an
example. While capital income taxation applies elsewhere, these two channels of tax preferred
saving are seen as a partial move toward expenditure taxation, albeit through specific saving
deductions from an income tax base, and therefore constitute a welfare improvement relative
to comprehensive income taxation.
D.2.1 The significance of inter-asset distortions
If, however, pension saving is not given expenditure tax treatment, price distortions are
introduced which adversely affect asset choice. This question has been relatively neglected in
the literature. An important paper by Bob Hamilton and John Whalley (1985) suggests that a
hybrid system, offering expenditure tax treatment to housing (but to no other form of saving),
is dominated from an efficiency standpoint by both a pure expenditure tax regime and a
comprehensive income tax regime. Using a dynamic general equilibrium model of the
Canadian economy, fully taxing imputed housing income at the marginal rate applying to other
capital income increases aggregate economic welfare by 0.3%. For a switch to pure
consumption taxation, the estimated gain is 0.8%. That is to say, the efficiency costs of the
inter-asset distortion introduced by a hybrid system can dominate the efficiency gains from the
reduced price distortion on intertemporal choice.
A second contribution, by Jonathon Hamilton (1987) uses Merton’s (1969) continuous time
model of the life time portfolio choice and consumption decision to analyse the taxation of
capital income. Two assets are modelled - one risky and one safe. Three types of capital taxes
are considered: a tax levied on wealth each period; a tax on interest income, that is the returns
to safe assets; and a tax on dividend income - the returns to risky assets. Hamilton then
calculates the efficiency costs for these different kinds of capital taxes, relative to a
consumption tax. He also models a general wealth tax.
While the compensating variation (a measure of efficiency cost) for a general wealth tax is
about 1 % of initial wealth, the compensating variation of an interest income tax is 3.2 %, and
is dramatically higher for a dividend tax. In the latter two cases, all revenue is raised from the
return to one type of asset. The static distortion from asset misallocation thus dominates the
dynamic distortion from the misallocation between current and future consumption.
Interestingly, although the two analyses use entirely different approaches, the Jonathon
Hamilton result is consistent with the Hamilton-Whalley finding that inter-asset distortion
resulting from a hybrid income expenditure tax system dominates the costs of the distortions
of a comprehensive income tax.
D.2.2 The retirement decision
Two possible extreme approaches to the analysis of retirement are the simple one period
model, where the timing of the retirement decision simply determines the amount of leisure
consumed, and the life-cycle optimisation model. The first approach is not illuminating
because it leaves out too much; the second tends to be intractable.
A compromise put forward by Mitchell and Fields (1984) essentially collapses the life cycle
model into a single period one by entering two arguments into the utility function: present
34
value of expected lifetime income and years of retirement. This allows them to take into
account that lifetime financial wealth, pension benefits, and earnings including earnings on
superannuation accumulations will all affect the retirement decision. Essentially, the MitchellFields retirement rule is as follows: “The optimal retirement date R* equates the marginal
utility from an additional year of work with the marginal utility of one more year of leisure.”
(p.87).21 In addition to considerations of financial wealth, therefore, you should, under the
Mitchell-Fields rule, retire early to the extent that your circumstances involve high disutility of
effort, low financial reward for work, and low life expectancy.
The Mitchell Fields rule, however, is time-local. In pension tax design, the more appropriate
framework is the life-cycle. This perspective is reinforced by demographic transition —
pension tax design should be focused on the retirement saving decisions of the relatively
young. For this group, a high net of tax return on saving (in other words, an absence of
earnings taxes) is the best incentive for adequate retirement provision: the power of
compound interest is crucial here.
D.2.3 Implications for Superannuation Tax Design
The studies cited here suggest that price distortions across assets can have much more
significant effects on economic welfare than has been generally recognised and that the timing
of retirement can be affected by pension taxes. What do they suggest about superannuation
tax policy design?
Perhaps the most important lesson to be drawn from this literature is that an expenditure tax
type design, where the only tax levied is on benefits at the applicable marginal income tax rate,
is likely to lead to the most efficient feasible allocation of resources in the economy. It
eliminates the price distortion between present and future consumption, and between owner
occupied housing and superannuation assets. Given the state of the debate in Australia,
however, it may be worth considering each of the three points of superannuation taxation in
turn, if only to make more concrete the economic implications of alternative tax design.
It is convenient to begin with the taxation of pension fund earnings. A number of
considerations suggest that the earnings from pension funds should not be taxed. First,
enforced preservation funnels the individual disincentive effects of such taxation into a
relatively narrow time frame late in the life cycle, where it is especially likely to induce socially
inefficient retirement and saving decisions. In particular, on a compensated basis it appears
likely that it will lead to earlier retirement, thus compounding the misallocation already
introduced by unfunded public transfers for the aged. Second, it is likely to adversely affect
asset allocation, penalising interest paying securities and tending to discourage international
diversification. Further, the taxation of pension fund earnings is likely to impact relatively
unfavourably on women, whose typical working lives involve early full time labour force
participation, followed by broken participation patterns later in life.
Kingston (1996) has re-examined the Mitchell-Fields rule in the context of a Merton based continuous time
model. His more formal analysis confirms the Mitchell-Fields findings, but extends them to incorporate capital
market considerations. For individuals with high risk aversion, early retirement will be preferred to the extent
that capital markets are characterised by: high expected returns to risky assets, high interest rates, and low
volatility of asset returns.
21
35
A concern relevant to Australia relates to the tax treatment of equities in the hands of pension
funds when earnings are taxed. Dividend imputation, which credits the individual shareholder
with the corporate tax paid on his behalf, effectively operates as withholding tax. This raises
the question of how pension fund access to dividend imputation credits might be effected by
removal of the earnings tax. Given the recent changes under business tax reform, allowing
shareholders with a taxable income less than the company rate to be refunded the difference,
it seems appropriate that pensions funds should be able to retain the refundable imputation
credits22.
The potential earnings tax base is set to increase in all developed countries, as the trend to
increased fundedness continues and as demographic transaction matures. In Australia, the
expanded coverage of funded occupational pension saving exacerbates this effect. The tax
change proposed here will therefore be much more expensive to implement 20 years from
now. If the arguments against earnings taxation are accepted, therefore, tax reform is not only
desirable, but also urgent.
Pension funds should retain refundable imputation credits for three reasons: i) annuity/pension business has
it at the moment ii) refundable credits are really a way of correcting taxation already incurred and avoiding
double taxation, and iii) it penalises super funds who invest via companies. If a super fund owned a property
directly, it would pay no tax on rental income. If it owned a company which owned the property, the company
pays tax on the rental, and the super fund looses out unless it has refundable imputation credits.
22
36
Appendix E
E: Tax reform options — A benefit tax with a withholding tax
E.1 Formal proposal for a withholding tax
As already sated, pension taxed can be levied at three points in the saving cycle. Kingston and
Piggott (1993) have derived conditions under which these three taxes are equivalent. They
abstract from behavioural response, and are able to show that equal tax rates on contributions
and benefits have equivalent impacts on tax revenues and benefits, while the tax rate required
for equivalent earnings taxation varies with the time span of contributions.
The equivalence of these two regimes may be formally demonstrated by considering the
following two methods of taxing members of superannuation funds:
1.
A benefit tax only: Tax at the payout stage only, with payouts P being treated as part of
each member’s assessable income Y during his or her payout year N.
2.
A withholding tax arrangement: Tax also during the accumulation phase, by means of a
flat-rate withholding tax W on contributions. Let Q stand for the accumulation net
of withholding taxes, and define the “grossed-up” payout Q   Q / 1  W  , which is
treated as part of each member’s assessable income during his or her payout year N.
The income tax rates applicable to payouts are defined net of the withholding tax rate.
For example, if the top marginal rate,  2 say, were equal to 0.47, and if  W  0.10 ,
then the top marginal rate on grossed-up payouts reduces to 0.47 - 0.10 = 0.37.
Then the first and second methods of taxation will yield the same tax revenue in
present-value terms.
Formal proof
Consider the following two-step progressive tax schedule, applying to total assessable income
Y during the member’s payout year:
Rate
Bracket
 0   0
0  D1 

D1  D2 
D2  Y 
1
2
where
 2  1  0
and
P, Y  D2  D1  0
(1)
37
If the first of the above two methods of taxing superannuation is adopted -- that is, if benefits
only are taxed -- then the value of tax revenues, B, at time N is given by

B   0 D1  1  D2  D1    2 P  D2

(2)
where
N
P
 ct 1  r  N  t
(3)
t 1
Here, ct is contributions at time t and r is the earnings rate of the fund.
If the withholding-tax method is adopted, then the time N value of tax revenues, W, is given
by the time N value of withholding tax revenues plus the time N value of adjusted income tax
revenues. The required tax rates are as follows:
 0   0  W 

1  1  W 

 2   2  W 
(4)
Now,
Q
N
 ct 1  W 1  r  N  t
(5)
t 1
and


Q   Q / 1  W   P
(6)
so that under the proposed withholding tax regime, the time-N value of tax revenues, W, is
given by
W
N
 W ct 1  r  N  t   0 D1  1  D2  D1    2 Q   D2 
(7)
t 1
 W P   0  W  D1  1  W  D2  D1    2  W  P  D2 
(8)
  0 D1  1  D2  D1    2  P  D2 
(9)
B
(10)
38
as required.
If the various pension tax paradigms – contributions, earnings, benefits, and the proposed
hybrid system – can be shown to be equivalent in the above sense, on what basis can one be
said to be superior to others? The answer lies in the relation of pension taxation to the overall
tax structure and in the implications of this interaction for economic and administrative
efficiency.
From an efficiency point of view, the best pension tax design is the benefit tax, levied at the
prevailing marginal rate of personal income tax at the time of withdrawal. Because the
progressive income tax rate is used, serious inequities are avoided.
The challenge in implementing this reform in Australia is that it would imply a shortfall in
current tax yield. The present proposal addresses this by exploiting the equivalence between
contributions and benefits taxation noted above. It replaces the current superannuation taxes
on contributions, earnings and benefits with a tax on contributions at a withholding tax rate
equal to or less than the present lowest marginal tax rate of 17%. When accumulations are
withdrawn, taxpayer liability is determined by applying the marginal personal income tax rate
to benefits, adjusted for the withholding tax. We have derived above a simple formula for
equivalent benefits taxation, which holds even when contributions vary over the accumulation
period. Any withholding tax rate can be chosen; once implemented, however, the benefits tax
equivalence will only hold if the withholding tax rate is not changed.
Under our proposals the annuities rebate is abolished, along with the superannuation
surcharge. Reasonable benefit limits (RBLs) are also removed.23 This further simplifies the
existing superannuation tax regime.
Rate scale progressivity implies that the impact will vary with income, and demographics
suggest that the impact on women will be different than that on men. The proposed reform
will tend to favour those with broken work histories, especially if they have worked full time
early in life, and then withdrawn from the labour force. This is because earnings are not taxed.
Income streams are favoured over lump sums. This follows from the application of the
marginal tax rate schedule on withdrawals. For example, an $80,000 lump sum withdrawal
faces the highest marginal tax rate on some of the payout, whereas using the $80,000 to buy an
income stream would generate an annual income which is taxed at a much lower rate.
In order to maintain the integrity of the retirement income policy, contribution limits could be introduced to
control its abuse for tax avoidance reasons.
23
39
Appendix F
F: The Australian income stream market
The Australian income stream market comprises of three major product groupings: – lifetime
annuities, term certain annuities, and allocated annuities and pensions (annuities are defined as
those offered by life insurance companies. Collectively, allocated annuities and pensions are
referred to as pensions).
In Australia, lifetime and term certain annuities are collectively referred to as either traditional
or immediate annuities. Term certain annuities are income streams that are payable for a fixed
term, regardless of whether the annuitant dies during the term of the contract. The duration of
term annuities varies from 1 year to 20 years, and they can be specified to return a proportion
of the purchase value at the end of the contract: a residual capital value. Those were the
payout term is equal to the life expectancy of the buyer are able to get favourable social
security treatment.
Lifetime annuity payouts may be fixed in nominal terms, indexed to the CPI, or escalated at a
fixed rate. A guarantee period can be nominated at the time of purchase, where payments
continue to be paid for a minimum period, even if the annuitant dies during this time.
At first sight, the allocated annuity appears to be more like a pure investment instrument than
a retirement income stream product. Its essence is that a sum of money is invested at
retirement, in a portfolio over whose composition the retiree has considerable control. Both
income and capital can be drawn down to meet the retiree’s needs. There are no guarantees
offered by the provider, all the risk rests with the buyer.
The drawdowns, however, are limited to a range, with both upper and lower bounds,
depending on the life expectancy of the retiree when the pension is purchased. The maximum
drawdown factor is calculated on the basis that the individual will live to their expected life
span at the time of the purchase. The minimum is calculated on the basis that they will survive
until the actuarial probability of survival from the date of purchase approximates zero. These
“drawdown factors” apply to the account accumulation each year.
Income streams can be purchased with money from superannuation money, or non super
money, for example, from the sale of a house. The sales for 2001 are outlined in Table 9.
Table 9: sales of Australian income streams for 2001
Super
Non super
Allocated
Term
Lifetime
Total
$ million
$ million
$ million
$ million
7,613
744
83
8,440
0
1,681
84
1,765
Source: Plan for life, 2002
Allocated pensions are by far the most popular form of income stream sold in Australia.
Funds under management in allocated pensions have grown from $81 million in 1991 to $32.7
40
billion by the end of 2001. In contrast, the fund under management in immediate annuities
has stalled at just over $10 billion for the last three years (Plan for Life Research 2002).
41