Compulsory super: the scheme that failed

A new report reveals deep flaws in Australia’s compulsory superannuation scheme, writes Michael Gill

05 October 2012



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Super review in mind: Treasurer Wayne Swan (shown here with British PM David Cameron).
Photo: Prime Minister’s Office

ABOUT $30 billion will go missing from the federal budget this year to pay for the incentives built into Australia’s compulsory superannuation scheme. Within a few years, according to Treasury, that number will exceed $40 billion.

The purpose of the scheme, which is now twenty years old, is to improve the savings of Australians for retirement. But according to research published this week by CPA Australia, the nation’s largest accounting body, the scheme has failed. People approaching retirement are typically no better off than they would be if the scheme didn’t exist.

Coming after recent inquiries into savings and investment in response to financial scandals and widespread public concern, the evidence that this gigantic scheme doesn’t do its job is remarkable but perhaps not surprising.

One of the curious features of compulsory super is its sanctity. Considering the sums involved, it’s subject to very little debate – not nearly as much as the defence budget, which is about $20 billion a year, and nothing at all like the national broadband network, which is forecast to cost the same as a single year of superannuation concessions. For many reasons, the national savings plan needs a serious review – starting with its most basic premise.

Economist Simon Kelly, who undertook the study, identified a number of issues of concern. The highlights for me were these three findings:

• People near to retirement have typically accumulated debts that will consume their superannuation.

• Each dollar directed to compulsory superannuation reduces other savings by about 30 cents.

• People whose work life typically is disrupted and people who rent their home are severely disadvantaged.

There are very good reasons why we need to be certain that compulsory superannuation is at the very least delivering a level of household savings that warrants the massive cost to the budget. The first reason is the cost of an ageing community.

Treasury’s last Intergenerational Report, published in 2010, estimated that by 2050 the costs of ageing will add roughly $60 billion a year to the federal budget in today’s terms. That’s a 50 per cent increase on today’s social security and welfare costs – or very close to double the current health budget of the Commonwealth.

What we know already is that, regardless of their savings decisions, the average person approaching retirement expects a substantial rise in living standards in retirement. The behaviour of the baby boomer generation to date certainly suggests this feeling is widespread.

It seems clear that the typical or average approach of retirees has been to consume the “windfall” of compulsory super and then fall back on a comfortable pension. This is not a long way removed from the underlying causes of the fiscal stress that has put public finances in many European nations into crisis.

Hang on, you say. Australia is a world champion at private savings. Our $1.4 trillion super account represents one of the biggest global savings pools. That’s true. Yet for most of the time we’ve had compulsion, total household savings have been in decline. And in the period when share prices peaked – from around 2005 onwards – household savings were briefly negative.

Get the picture? What we appear to have created is a Potemkin village. There’s the façade of a gleaming financial bulwark against the challenges ahead, yet the reality for the villagers is that nothing much has changed at all.

It’s fair to assume that the strongly rising value of their superannuation accounts in years up to around 2007 would have excited a lot of people. When their super balance arrived in the post, they might well have thought it was time to buy a new boat or take a holiday. And, of course, they would have started feeling queasy when, soon after, the GFC not only cut down asset prices but also changed global credit conditions very sharply.

Of course some people are saving heaps. The fact that most of the tax expenditures are either exemptions for tax on employer contributions or exemption for tax on the income earned from investment is one guide. The size of total balances is another. But we really need to look at average behaviour.

When super started, it was a compulsory 3 per cent claim on earnings. That rate is now 9 per cent and from 2013–14 it will be 12 per cent. People who have the means may add up to $50,000 a year to the compulsory amount and all of that income will be taxed at just 15 per cent. All of which is fine if you’ve enough room in disposable income to absorb that loss of spending power. But a lot of people do not.

The CPA study strongly suggests that average people, who might need incentives and assistance, don’t benefit from the scheme. It seems therefore safe to assume that the bulk of the benefit is a tax bonus for people who don’t need an incentive to save. In fact, what we seem to have is a compulsory savings regime attached to what used to be an elective superannuation market. The more you look at it, the less it looks like a savings policy for an ageing population.

You would think that the design of a savings policy would start with the people who need it most: those whose ability to save is most constrained. Given that most people’s primary savings asset is their home, savings policy might then focus on housing affordability. And given the need to promote self-directed and adequate retirement incomes, you’d think that measures to promote savings over consumption would be a priority.

If we focused on the people who need help to avoid serious financial stress in retirement, we’d look at home affordability. We might well look at the effect on house prices of the over-investment caused by the exemption for capital gains tax. We might look at better town planning and transport relationships. And if we wanted to improve their ability to save we might switch the emphasis of tax policy away from income to consumption.

People in the industry and its adjacent interests might well object to this sort of approach. But the evidence is in, and it’s plain that they haven’t covered themselves in glory. The facts suggest that we need to spend our $30 billion a year a lot more effectively.

On the other side of the ledger, the management of the $1.4 billion acquired by compulsion in super funds is not a whole lot more publicly accountable than the Vatican Bank. It is somewhat ironic to see the funds that press so hard for performance and disclosure by the major listed companies don’t themselves generally don’t comply with much of what is required of those corporations. And of course no one makes you buy a share in BHP.

It would be a good thing if, instead of being the beneficiaries of compulsion, those who want to earn a living by managing savings were forced to demonstrate superior relative performance that is suited to the risks and rewards chosen by the investor. And, while we’re about it, it would be great if someone would have a good look at what happens to the compulsory flow of funds. Because on some of the raw evidence it does appear that quite a lot of what we enforce as savings is actually being shaved away as fees and other costs.

At any rate we know that both Treasurer Swan and Shadow Treasurer Hockey have reviews in mind. The government seems to be looking at reining in the tax benefits. The opposition has flagged a broad but unspecified financial sector review.

Whatever we end up with, we shouldn’t keep handing out $30 billion a year for a nil score line. •

Michael Gill is a former CEO and editor-in-chief of the Financial Review Group. He has contributed to recent policy development at CPA Australia.

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11 Comments

  1. Joshua Greenwood added this comment on 9 October 2012 | Permalink

    I very much agree. I wrote of a similar sentiment in my honours thesis:

    http://ses.library.usyd.edu.au/bitstream/2123/7238/1/Honours%20thesis%20-%20Joshua%20Greenwood%20(2010).pdf

    We need to admit that the current system has failed and needs to be re-worked.

  2. John Riley added this comment on 9 October 2012 | Permalink

    Michael Gill, how close are you to retirement? I am about 1 year away and fall into the first finding from Simon Kelly.
    Like many others super/retirement will not be a gravy train for me so leave alone all who are in the oldest preservation age group.

  3. Michael Gill added this comment on 9 October 2012 | Permalink

    I am 59 John.

  4. Maureen McInroy added this comment on 9 October 2012 | Permalink

    I retired at 60 more than 10 years ago. I had no debts and I owned both my car and house.

    At retirement I was in a compulsory industry superannuation scheme and had also been a Commonwealth public servant so had a small preserved CSS policy too. I have been drawing on the CSS policy since retirement. The income is small – about $1100 per month. But the payments have increased steadily over the years.

    I am a divorced woman and for twenty years I went without quite a lot in order to boost the amounts in my industry scheme by such actions as making extra contributions when allowed and affordable and by using salary sacrificing when that became an option. My contributions were paid on my after tax income and they were also subject to tax when they went into the industry superannuation scheme.

    I retired on a package and put more money into my industry scheme. For that I paid a fairly hefty super surcharge because I had had nine months of contributions in the same tax year before my retirement. At that time any withdrawal was also subject to tax.

    My mother lived into her nineties, her sisters into their eighties and my female cousins are all now in their eighties. So I tried to leave my industry superannuation untouched for as long as possible.

    Along came the GFC and my industry scheme, which had always been rated in the top three nationally in terms of returns, lost about 23% of its face value. In the time since then it has several times risen to a level regaining about half of what was lost. Then it drops again. It has bounced around between 23% and 13% lower than the level reached in 2007 and never looked like regaining its old level.

    What was lost did not just include 23% of my regular contributions, but 23% of my former employer’s contributions and 23% of all those extra contributions that I made by going without holidays, home refurbishments, changing cars regularly and suchlike.

    The CEO sends me trite little email messages at regular intervals that tell me absolutely nothing. In my view, he is too well paid for the scheme’s performance and I wonder what he does to earn so much. I seem to have no representative voice on the board.

    So much for my hopes that the amount might gently increase over the years I left it untouched and that I would be able to remain an independent, self-funded retiree.

    My advice to others – spend it while you have it. Because if you try to be a good citizen and look after yourself, someone else will just cream the top off your money in some way that is perfectly legal. My going without in order to increase my savings and then to over-pay a whole office of paper shovers who add no value is not what I understood superannuation to be intended for. But it has become just another money product for insiders to milk as they choose.

  5. Caroline Romeo added this comment on 9 October 2012 | Permalink

    What a good article that resonates with my attitude and experience to compulsory superannuation. I have not and will not contribute voluntarily since 2000. In fact I care very little about where this money is invested. I would agree with Maureen…spend it all. The value has been in decline for years. What gripes me more is the inability to get my voluntary contributions. I have worked for over 20 years where that super is just under $64K of which at least 1/3rd of it is voluntary contributions. I have another 15 years left to retire but will expect no substantial growth because of the industry (care sector) I work in. Compulsory superannuation has failed and it fails segments of the population. I’m particularly thinking single women in the care sector. The only incentive to save is to plug it into less regulated sectors like the share market. At least you can see the value grow or not and have some level of control of the investment. There is no control in super, it fails those who most need it.

  6. Stephen Prowse added this comment on 12 October 2012 | Permalink

    I am approaching retirement and am on track to retire and remain independent of the aged pension, primarily due to the super system. So while I acknowledge that it has failed some, especially the lower paid workers, I would like to see a better analysis of the cost of not having the scheme and having people like myself on the aged care pension in retirement. Such an analysis needs to take into account all the costs such as health care, not just direct pension costs. I have not seen such an analysis.

  7. David Collett added this comment on 13 October 2012 | Permalink

    Great article. I am 30 and will keep my Super as 100% cash for quite a while yet.

    Touching on the housing side is interesting. To me it seems Super is something that should be done after one has paid off the home.

    An interesting metric for superannuation could be the percentage of people reaching retirement age who own their own home outright.

    That metric is something we could be increasing by addressing all the artificially created economic forces that increase house prices.

  8. Andrea Watherston added this comment on 13 October 2012 | Permalink

    I agree with comments above. The thing that annoys me most is that most Australians don’t realise that this is 12% of their income, they think it is money for nothing, therefore they don’t fight hard enough to protect it. It is money we have earned by working hard. Imagine if someone took the same amount of money out of their working bank account, as their super fund has lost for them, without any explanation. We would hear a very loud protest.
    I personnally believe in investing in real estate. Real Estate has historically kept pace with the economy. I don’t understand why, instead of giving my money to a faceless superannuation fund to “play with”, I can not deposit the same funds into a bank account which offsets my mortgage. I wouldn’t mind if it had to stay there for the rest of my life, at least a super fund wouldn’t be gambling my money away.
    In summary, I think the current scheme pressumes we are all incapable of saving. Historically Australians are very good at saving.

  9. Keith Lassiter added this comment on 17 October 2012 | Permalink

    The author writes:

    “People who have the means may add up to $50,000 a year to the compulsory amount and all of that income will be taxed at just 15 per cent.”

    As I understand it the current gov’t has restricted concessionally taxed contributions (i.e. 15% rate) from the employer and individual (via salary sarifice) to a combined total of $25,000 a year, and not $50,000 above employer contributions This is a tough figure to target even if you have the means, as one must understand exactly what amount your employer will contribute in a given year (too bad if your income varies), and when those payments will be received by the fund (I believe employers only need to make contributions quarterly). The penalty for exceeding the limit is a higher rate of tax paid (top rate I believe), although the tax office appears to allow one instance of overpayment (perhaps not officially though). In practice many will likely stay beneath the $25,000 threshold just to be safe.

    So, $25,000 a year over 40years and you’ve got yourself a million in contributions along with (hopefully) some increase in value from the investment. At current interest rates that’s unlikely to lead to a luxury lifestyle in retirement on its own.

  10. Michael Gill added this comment on 17 October 2012 | Permalink

    @Keith Lassiter: apologies, you are quite right. The policy changed this year to cap $25,000. And I might add that I was penalised heavily one year because my employer had one pay cycle too many in the fiscal year and even though my authority to them capped the contribution, the actual contribution went over by one pay period.

  11. Bill Marshall added this comment on 24 October 2012 | Permalink

    I appreciate all of the former comments on your thesis but one glaring thing has been omitted. Wouldn’t it be helpful to all who contribute to Super to have at least a rudimentary knowledge of the history and progress over the years of this scheme.By this I mean a “signpost”for every change of government and their effect on schemes?We were always admonished to “save for the future”but a timeline would bear examination to see when new schemes came in and old ones were discontinued. I retired in 1960 after working for 42 years so I have been living on a fully funded super pension but not one supplied by the government and to which I still have to pay 15% tax so I am well aware of how my scheme is viewed by present day superannuants as one made in “heaven”
    I remind others that all contributions are proportional to the time and value of the currency in which they were made so a comparison chart say over the last 50 years would be interesting.

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