Will I have enough money to retire? It’s not a question that many people think about until they near the end of their working lives. The question of how much to retire with is an important one. After all, everyone only has one chance to get it right. Most countries have a retirement income system in place to prevent retirees from slipping into poverty. But how does Australia’s system compare to the rest of the world?
Assuming self-sufficiency, all individuals must receive enough income over their lifetime to satisfy a lifetime of consumption/spending[i]. Modigliani’s Life-Cycle Hypothesis argues that individuals tend to spread out their consumption levels evenly across their lifetime[ii]. Despite its questionable assumptions, the theory suggests that individuals would want a stable transition to retirement. Living standards in retirement should be similar to living standards over one’s working life. Modigliani’s model has its limitations due to the amount of uncertainty in the real world. No one can be sure how long one’s life will be. However, we can use the idea that any spending done during retirement must be funded from sources other than employment income.
Overview of the sources of retirement finance available
The primary sources of income that retirees can draw upon are the Aged Pension, their superannuation and personal savings/investments outside of super. Other sources may include part-time earnings, bequests and financial support from family members, although these may not be available to everyone.
The Aged Pension is a fortnightly income supplement for people who have reached age 66[iii]. The pension system in Australia has been around for over 100 years[iv]. Of course, there have been numerous changes to the system since its implementation. These changes primarily took into account the financial impacts that a major disability had on expense requirements. The pension is not available to all retirees; only those below a certain standard of living are eligible for it. Qualification for the pension through an assets test is likely in place to reduce the wealth inequality between retirees. The Aged Pension supports lower-income retirees by giving them a constant income stream to draw upon. It also acts as a form of insurance in case retirees outlive their retirement savings.
Superannuation is a method of putting money aside for retirement[v]. The government provides tax discounts on contributions in the superannuation system to encourage Australians to save for their retirement (subject to various caps). The system was introduced in 1992 to offset the inevitable increasing pension costs associated with Australia’s ageing population. The rate of compulsory contributions has since increased from 3% to 9.5% of wages. As the super system matures, reliance on the Aged Pension will decrease because more individuals will have the capacity to finance their retirement.
Other benefits provided to retirees
Retirees on the Aged Pension also gain access to various benefits, including additional tax offsets and concession entitlements[vi]. Other healthcare benefits such as vaccinations and annual health assessments are provided free of charge to all retirees. These benefits help alleviate the additional medical costs that the elderly generally have to face.
Challenges associated with Australia’s retirement system
Managing retirement income systems is challenging because small changes have widespread implications for years to come. For example, increasing the Aged Pension by just $10 a fortnight for each eligible person would increase the cost to the government by over $600 million a year (2.5 million Australians are currently under the Aged Pension)[vii]. The government has the demanding task of ensuring all Australians meet minimum retirement standards while ensuring the system does not favour those already well off. Additionally, the government has to ensure that it can meet the costs of providing such a system in the decades ahead.
The government likely knows that any increase to the Aged Pension will be permanent in the medium-term. A government that commits to lowering the Aged Pension will most likely lose the votes of the 2.5 million Aged Pension recipients[viii]. There is also the risk that unhappy voters will protest or even riot in response to changes in the pension system. Protests have occurred in France, Russia, and, more recently, in Columbia[ix].
There are equity issues that the government could address to give allAustralians a baseline level of retirement income. The groups that are worse off in retirement are Aboriginal and Torres Strait Islander people, women and the disabled[x]. The inherent disadvantage stems from the lower amounts of time these groups spend in the labour force. Since most superannuation contributions depend on the number of hours worked, those who earn higher wages and have more years in the workforce will be better off retirement. However, addressing the gender imbalance in superannuation requires careful thought because couples could exploit any concessions given to women[xi].
So, how does Australia’s retirement income system compare to other parts of the world? Mercer rated Australia fourth in its 2020 Global Pension Index, noting that Australia could improve retirees’ income replacement rate[xii]. Despite the various issues and complexities, Australia has a robust retirement income system in place for its retirees.
[i] Cusack, T. (2019). Introduction to Financial Planning. Lecture, JH Michell Theatre, the University of Melbourne.
[ii] Pettinger, T. (2019). Life-Cycle Hypothesis – Economics Help. Economics Help. Retrieved 9 May 2021, from https://www.economicshelp.org/blog/27080/concepts/life-cycle-hypothesis/.
[iii] Age Pension. Services Australia. (2020). Retrieved 9 May 2021, from https://www.servicesaustralia.gov.au/individuals/services/centrelink/age-pension.
[iv] History of Pensions and Other Benefits in Australia. Australian Bureau of Statistics. (1988). Retrieved 9 May 2021, from https://www.abs.gov.au/ausstats/abs@.nsf/94713ad445ff1425ca25682000192af2/8e72c4526a94aaedca2569de00296978!opendocument.
[v] Your superannuation basics. Australian Taxation Office. (2017). Retrieved 9 May 2021, from https://www.ato.gov.au/General/Other-languages/In-detail/Information-in-other-languages/Your-superannuation-basics/.
[vi] Age Pension and government benefits. Moneysmart. Retrieved 9 May 2021, from https://moneysmart.gov.au/retirement-income/age-pension-and-government-benefits.
[vii] DSS Demographics – December 2020. Data.gov.au. (2020). Retrieved 9 May 2021, from https://data.gov.au/data/dataset/dss-payment-demographic-data/resource/0429d083-d8d2-4fff-bc75-f9100e1723ad.
[viii] Pape, S. (2017). The Barefoot Investor (1st ed., p. 223). John Wiley & Sons Australia, Ltd.
[ix] Colombia protests: What is behind unrest?. BBC News. (2021). Retrieved 9 May 2021, from https://www.bbc.com/news/world-latin-america-56986821.
[x] Commonwealth of Australia. (2020). Retirement Income Review (p. 39).
[xi] Coorey, P., & Mizen, R. (2021). Budget to bolster women’s super savings. Australian Financial Review. Retrieved 9 May 2021, from https://www.afr.com/politics/federal/budget-to-bolster-women-s-super-savings-20210415-p57jh4.
[xii] Mercer (2020), Mercer CFA Institute Global Pension Index, Mercer, Melbourne