Australia’s retirement savings system has two great points of distinction: it is compulsory, and it is largely a defined contribution (DC) system. Employers are required by law to contribute on behalf of workers to what Australians call “superannuation” (a fancy word for pension).
The superannuation system is paternalistic. It assumes it is best that part of workers’ income (currently 9.5 percent) is deferred from current-day consumption and put away for retirement. It also assumes that if it weren’t compulsory, most people wouldn’t save enough or at all. As a result, one of the biggest problems that besets voluntary retirement savings systems—getting people to save—has been legislated away in Australia.
Australia also leads a global trend away from the defined benefit model, where the plan sponsor bears the responsibility (and associated risks) of paying each of its members a predetermined sum in retirement. In contrast to most private pension systems around the world, over 85 percent of Australian superannuation assets are in DC schemes.[i] Individual savers bear the investment risk in a DC plan, and their final retirement benefit is uncertain. Once retired, they are also exposed to inflation and the risk of outliving their savings.
A compulsory contribution system is where the paternalism stops in Australia. Once retired, people can do as they please with their retirement savings. It’s their money, after all, particularly in a DC system. Buying an annuity or income stream is not mandatory, and retirement is tax free—with no inheritance taxes, either. So, do Australians take the opportunity to spend big and then find themselves in trouble? The answer is no for two reasons. First, we have a safety net first pillar, which we call the “age pension.” Unlike in the United States, it is not a contributory scheme, but one funded by current-day taxpayers. Second, the average retiree is quite frugal and even becomes a net saver as they move into the so-called “passive” stage of retirement in their early 80s. That’s right: they underspend and hoard their savings because they fear running out of money. Why do they do this? It is partly because they are left to their own devices and such behavior is their homegrown solution to managing their own longevity risk. Retirees who do this are enjoying a lower standard of living than they would if they had a way of safely spending all of their money until the end of their lives.
That said, the majority of retiring Australians still take a lump sum rather than a product that is designed to provide retirement income.[ii] There is always the colloquial conversation that fuels the lump sum debate—stories about blowing money on grandkids or touring in a Winnebago. In reality, lump sums are used more conservatively—to pay off outstanding mortgage debts or to improve the home.[iii] These may not provide the best overall outcomes for members when it comes to funding retirement, but it might speak to broader retiree issues around housing tenure and perceived access to funds.
The other interesting thing is that most of the lump sums that are taken at retirement are relatively small—an average of around $27,000 US dollars.[iv]
Self-directed retirement might appear easy for members to deal with at the outset. And this is understandable, as retiring Australians emerge from a world of well-designed defaults whirring away in the background during their working years. But they move into a parallel universe in retirement. In that universe, retirees are expected to cope with the actuarial intricacies of managing spending and investing over an indeterminate period of retirement. To illustrate just one of those intricacies, let’s look at how difficult it is to understand averages. A 65-year-old Australian woman today has an average life expectancy of 90 years. We all think we understand averages. The average maximum temperature in Miami, Florida, in April is 83 degrees, so we won’t need a coat. But, the chance that an Australian 65-year-old woman dies at age 90 (i.e., at any time in her 91st year) is actually only 1 in 20, or a 5 percent chance. Two-thirds of such women will pass away over the period from age 82 to age 98—a very wide and relatively unpredictable range. No wonder the average senior finds this all too complicated.
So it follows that the next step for Australia is to help members manage the risks that they face in retirement. While investment risks are commonly understood by the wider community, the industry lacks a range and depth of products to help manage the risk of outliving your savings and having them eroded by inflation. Even in this low-inflation environment, an Australian retiring 10 years ago would have experienced total inflation to date of over 25 percent.
The Australian government is currently working on how to facilitate a wider range of products to help retirees provide themselves a lifetime income after they stop working. In 2015, it introduced the idea of a “comprehensive income product for retirement”, one that would provide flexibility as well as a regular income stream that lasts for life, thereby protecting against longevity risk.
We have not yet seen the detail of this proposal, but nonetheless, some superannuation funds have anticipated the outcome and are already designing products that better serve their members’ needs for stable lifetime income.
The Australian system was recently ranked third, with a B+, in a global pension survey. However, we must move quickly to create more ways for retirees to spend their retirement savings safely and sustainably if we are to stay world-class.
[i] Towers Watson, Global Pensions Assets Study, 2016. https://www.willistowerswatson.com/en/insights/2016/02/global-pensions-asset-study-2016
[ii] Fifty-one percent, in fact, according to the latest data from the Australian Prudential Regulatory Authority’s Annual Superannuation Bulletin for June 2015 (issued February 9, 2016).
[iii] Australian Bureau of Statistics Cat 6238.0 Retirement and Retirement Intentions, Australia, July 2012 to June 2013. Issued Dec 9 2013.
[iv] APRA, Annual Superannuation Bulletin for June 2015 (issued February 10 2016), Table 5.
about the author
Jeremy Cooper is chairman of retirement income at Challenger Limited, Australia’s leading issuer of annuities.
Prior to joining Challenger, Cooper was appointed by the Australian government to chair a wide-ranging review of Australia’s pension system; it is known as the “Cooper Review.”
Cooper was deputy chairman of the Australian Securities and Investments Commission (Australia’s equivalent of the SEC) for 5 years, from mid-2004.