Super Doesn’t Add Up

This article from the Summer 2019 edition of the IPA Review is by then IPA Campus Coordinator for Generation Liberty Program (now a Research Fellow), Cian Hussey.

Young Australians are an aspirational bunch. Despite the vocal minority of pessimists who are upset by different opinions on campus, or who believe their lives are somehow worse than their parents’ or grandparents’, most of us are pretty upbeat about the future. Those of us on the cusp of finishing uni, in particular, are thinking about our career aspirations and are excited about getting out into the workforce and the ‘real world’.

Recently, I have been thinking about this a lot. For the first time in my life, I will be earning a decent amount of money. I am lucky enough to be moving from my native Perth to Melbourne, so I have had to seriously consider costs of living and what kind of lifestyle I will be able to afford. Naturally, this requires me calculating what my take-home pay is going to be. One of the first things I realised is that a huge chunk of money will be paid into my super account. Just under 10 per cent of my pay each fortnight will be sent straight to my super, where I cannot access it for at least another 40 years. I have been discussing this with my friends and family recently, and looking into the system to determine whether it is actually beneficial. The short answer is it is not, and I am not very impressed. When I talk to other people about this, they quickly express their frustrations with the system.

Australia relies upon three ‘pillars’ for its retirement income system: the Age Pension, compulsory superannuation contributions, and voluntary savings. This mix of public, quasi-private, and private pillars is complicated. Notably, it creates moral hazards, such as people nearing retirement age spending big on house renovations or overseas trips to reduce their wealth and qualify for a larger Age Pension payment. The public pillar (Age Pension) has become extremely expensive for taxpayers and is quite misleading. Older retirees who started their working lives long before compulsory super was introduced believe that, having paid taxes all their life, they can have some expectation of a pension on which they can live. Instead they find it is not particularly generous, but also that they have not had the opportunity to accumulate much of a supplementary superannuation balance. They also see many people the same age who never seemed to work, who may not ever have had much interest in work, and who paid far less in taxes, get exactly the same amount of pension in retirement.

The quasi-private pillar (Superannuation Guarantee, or SG) has reduced working life wages by siphoning off a portion into a pool of forced savings, from which industry superannuation funds and private financial service providers gladly take their share. The interaction between these two pillars creates its own issues. While, at least in theory, expenditure on the Aged Pension should decline as super reaches maturity, this has not been the case. Australia’s non-contributory Age Pension system is currently experiencing a significant demographic challenge.

An ageing population results in the ever-increasing cost of pensions falling on a proportionately smaller pool of workers. In 1988, annual social security spending on the aged cost every worker $1,822 (2018 dollars). By 2018, this had risen to $5,238 per worker. The chart, on the next page, tracks the change over the last 30 years, showing the steadily rising costs of Aged Spending to workers and to the total Social Security budget.

The Keating government established the compulsory superannuation system in 1992, in part to deal with this issue, and in part to provide a wage increase without stoking inflation. Since then it has remained largely unchanged, aside from tinkering with the tax treatment of funds and contributions. One of the most significant changes to super is legislated to occur by 2025—increasing the contribution rate from 9.5 to 12 per cent. To many this change sounds like a good thing, but increasing the rate would be a horrible mistake. Vested interests assert the increase will be beneficial for workers. That it is mainly the super fund managers and union beneficiaries making these claims is illustrative. These groups and individuals are claiming the changes will be better for workers in retirement. In reality, they will further reduce workers’ wages, which have been growing sluggishly for far too long. This will reduce living standards over the course of the working lifetime, putting added pressure on the already-strained family budget.

Veteran women’s activist Eva Cox had stark words for these vested interests earlier this year. Principally speaking of the ALP,
she said they should “get [their] snouts out of the trough”, urging it to give up support for the increase in the super contribution rate. Cox explained:

There are so many people in superannuation who are ex-Labor and ex-union people. It’s a revolving door that doesn’t go very far because everyone is well paid.

This revolving door has a clear incentive to back the increase in the SG rate, and it is not concern for workers. As Adam Creighton explained in The Australian, they “want even greater compulsory contributions to shore up their power and influence as each declines”. For ordinary Australians, there will be no free lunch as increased super contributions are taken from their wages. A significant portion of these lost wages will end up in pockets in the financial services sector, super industry bodies, and unions. In the words of the Treasurer, there has been “a pattern of behaviour from the superannuation industry that any time ideas are raised that go against their vested interests they seem to complain very loudly about it.”

The contribution rate should go no higher than 9.5 per cent. Some backbenchers have asked the government to hold off on the legislated increase to 12 per cent. Some have even been so radical as to suggest superannuation should be voluntary, at least for lower income earners. As someone who will be in that category for at least the early years of my working life, I believe I should have that choice. As my income grows, I can judge for myself when to begin the process of saving. I might want to focus first on buying a house, but the current super system will make this harder for me.

My brother recently purchased his first home, but without access to the money sitting in his super he has had to take out a higher mortgage. This will do serious harm to his finances over the course of his life, costing him tens of thousands of dollars in higher repayments, along with bringing the stress
of more debt.

In a research essay for the IPA in 2016, Rebecca Weisser and Henry Ergas argued “paying off the family home is a tax-effective way of reducing retirement expenses by obviating the need to pay rent or a mortgage. As well as reducing income needs in retirement, it also serves as a means of transferring consumption from working life to the retirement years.”

Weisser and Ergas go on to highlight that owning a home is an essential fourth pillar of Australia’s retirement system. I spoke to my parents about this and they agreed. My Mum recently entered the workforce after raising five children over the past 25 years. She is frustrated that she is forced to contribute a noticeable chunk of her weekly earnings to an account she cannot access for a number of years, while mortgage payments and school fees loom large. She would much rather contribute to her and Dad’s ‘fourth pillar’, or to address other cost of living pressures.

It is no wonder vested interests want to keep, and even extend, the current system. Instead of paying off debt and actually becoming financially independent, my parents and brother—along with hundreds of thousands of people like them—are forced to take out and live with bigger mortgages, meaning bigger interest payments to banks, while having their super balance eroded by fees. It is a win-win situation… for financial institutions, at least. One permissible argument for increasing the rate is that it will help keep more retirees off the Age Pension, assisting the federal budget.

However, an analysis from the Treasury Department published in 2013 highlighted the move would drive immediate costs through tax concessions, and would not prove to be a net benefit until at least 2050. At present the government spends around $36 billion in tax concessions to make a saving of around $9 billion in Age Pension outlays. This argument doesn’t seem to hold much water. The current system disadvantages lower and middle-income individuals by locking away their money and allowing vulture-like financial companies to extract their share, and advantages high-income individuals by giving them a concessional tax instrument. Low and middle-income earners will most likely draw on the pension anyway.

So what should we do? There are a number of practical policy options that could be pursued. First, the government must focus on reducing the burdens of red tape and regulation, reduce and flatten personal income tax, and lower business tax to one uniform rate below 20 per cent. These policies will help revive wage growth, create jobs, allow workers to keep more of their hard-earned money, and ensure goods and services become more affordable. Enabling wage growth will benefit workers in the immediate future. Combined with a reduction in prices, workers will be able to set aside the extra money they need for retirement. Second, superannuation should be made voluntary. This will disproportionately benefit low-income workers who will see an immediate increase in their incomes, and will not have their retirement fund (which they cannot afford to pay into currently) raided by gouging financial services companies. Finally, and at the very least, the threshold for superannuation contributions should be indexed to inflation and the rate absolutely not increased to 12 per cent.

The current contribution threshold of $451 earned per month has not been changed since 1992 when compulsory super was introduced. During this time, inflation and wage growth, including mandated increases in the minimum wage, have seen more people forced into super, even if they are not earning any more in real terms. In real terms, people earning almost half as much now are forced to contribute. This is pointless as the amounts contributed will be eaten up by fees long before retirement age. Low income earners would be better off receiving this money in their weekly pay cheques. Increasing the contribution rate to 12 per cent would be a costly mistake. Vested interests are pressuring the government to not delay or abolish this increase. The government must not give in to this pressure.

In 2011 The Economist ran a story on Australian superannuation claiming that under the system “everyone’s a winner”. This analysis was far from the truth. Workers are denied wages to meet current expenditure, with the lowest income earners suffering the most. Super tax concessions are four times larger than the savings on Age Pension expenditure they induce. And individuals are, at best, incentivised against and, at worst, denied the ability to make decisions about their own future and retirement. As it stands, Australian super is a pernicious transfer of wealth from ordinary workers to a small group of financial services companies. Additionally, it has given strength to the unions’ vice-like grip on the economy.

There are many ways to ensure Australians can maintain their living standards in retirement. Forcing wages down by siphoning off an extra 2.5 per cent each year into super is not going to help anyone except those lucky souls in the Labor/union/super “revolving door”. Focusing on policies that reduce the costs of living, increase wages and investment, and allow Australians to take responsibility for their own retirement, would be far better for current and future generations throughout their working life and retirement.

Cian Hussey at the time of writing was a Campus Coordinator in the IPA’s Generation Liberty program at the University of Notre Dame in Perth, where he was completing his Bachelor of Arts. He joined the IPA as a Research Fellow in 2020.