Components of current retirement income provision First Pillar: The Age Pension

The Age Pension was introduced in 1909 as a general-revenue financed, means tested, safety net payment for the retired. The Age Pension is universal to the extent that all residents of qualifying age are eligible, but targeted to the extent that it is subject to income and assets means tests.

For most of the period since its commencement in 1909 the Age Pension has served as the social welfare safety net for the elderly and, in the absence of a mandatory retirement savings pillar until the final decade of the 20^th century, has been the main source of retirement income for most retired people. In 2006 around 80% of the retired of eligible age received some Age Pension – of which around two thirds were paid at the full rate (Department of Family and Community Services and Indigenous Affairs 2006).

The Age Pension is payable to elderly Australians who satisfy residency, age and means test requirements. Women can claim the age pension from age 63 years (increasing to 65 by 2014) and men from age 65 years. The Age Pension is means tested by either a person’s income or assets - whichever determines the lower rate of pension. It is indexed to the greater of the growth of the Consumer Price Index (CPI) and male average earnings.

A higher rate of pension is payable to a single person than to each member of a married couple. In January 2007 the annual Age Pension will be $A13,314.60 for single persons (around 25% of average male earnings) and $A11,120.20 (around 20% of average male earnings) for each of a married couple. Net replacement rates are higher (closer to 40% for single retirees) as the Age Pension is exempt from income tax.

Eligibility for the Age Pension brings with it access to other payments and allowances, including: a pharmaceutical allowance, the pension concession card, rent assistance, remote area allowance, telephone allowance etc.

A recent initiative is the Pension Bonus scheme, which is designed to encourage persons of retirement age to defer claiming the Age Pension. Under the scheme a tax-free lump sum bonus is

38 A detailed discussion of the historical background can be found in Bateman and Piggott (1997) and Bateman and Piggott (1998).

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available to those who defer claiming the Age Pension for a minimum of 12 months, up to a maximum of 5 years. When the person finally retires they receive the bonus and the Age Pension.³⁹ Current means testing

As noted earlier, the Australian Age Pension is means tested by both income and assets. Under the current income test the Age Pension is withdrawn at the rate of 40 cents for each dollar of private income above a free area of $A64 per week (or $A114 per week for a pensioner couple). Private income includes: income from financial investments, cash, bank accounts, bonds, managed funds, shares, deferred annuities, business income, and income from trusts, property and superannuation. For simplification purposes, the income test applies to ‘deemed’ rather than actual income for many financial investments. Under the current rules no part pension is available under the income test once annual income exceeds $A36,991.50 pa for a single person (around two thirds of male average earnings) or $A61,906 pa for a couple.

The assets test reduces the Age Pension by $A1.50 per week for every $A1,000 of assets above statutory thresholds. Currently these are $A161,500 for a single homeowner, $A229,000 (married homeowner couple), $A278,500 (single non-homeowner) and

$A346,000 (married homeowner couple). The retiree’s own home is excluded. Assets included are home contents, cars, boats, rental properties, the capital value of investments, money in the bank, outstanding loans, the value of a business, and gifts in excess of

$A10,000 in any financial year (or in excess of $A30,000 over a 5 year period). The test paying the lower rate of Age Pension applies.

A rationale for means testing

As noted earlier, the Australian public Age Pension has been means tested against both income and assets for nearly 100 years.

However, means testing is often criticised on the basis that it results in high effective marginal tax rates, the intrusion and stigma associated with determining eligibility, and the possibility of a weakening of the political power of the poor. On the other hand, means tested public benefits are more sustainable, as less government revenue is required to finance poverty alleviation, and

39 Eligibility for the Bonus Scheme includes a 20 hours a week work requirement.

When paid the bonus is equal to 9.4% of the Age Pension for each year the Age Pension is deferred – eg single person eligible for full age pension and defer one year, bonus is $A1,135, 5 years - $A26,363.

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may actually result in less overall distortions and less tax revenue is required to finance means tested as opposed to universal pensions (Mitchell et al 1994).

However, public policy design can reduce the impacts of means testing. For example, under the Australian Age Pension, the income and assets tests apply above thresholds, the income test taper is 40 cents per dollar of private income (not dollar for dollar) and the Age Pension is tax free (so the withdrawal of public benefits is not associated with simultaneous taxation of private benefits). In Australia, the maximum effective marginal tax rate for age pensioners is 40%.

Second Pillar: Mandatory Private Retirement Saving – The Superannuation Guarantee

The Superannuation Guarantee was introduced in 1992. Under the Superannuation Guarantee employers are required to make superannuation contributions of at least 9% of earnings on behalf of their employees to a superannuation fund. The arrangements apply to all employers and to almost all employees earning more than

$A450 per month (around 10% of average male earnings).⁴⁰ The self-employed are not covered by the mandatory arrangements,, although tax concessions apply for voluntary contributions. The mandatory contributions are fully preserved until the statutory preservation age for access to benefits is reached – currently age 55, increasing to age 60 by 2024. Superannuation contributors can choose the superannuation fund into which there contributions are made, and many superannuation funds offer considerable choice of investment options and strategies. In this regard, the Australian superannuation industry is characterised by its diversity, with contributors able to choose between non profit and for profit funds;

single employer, multi employer (industry) funds or funds offered in the retail sector; or may choose to manage their own superannuation fund. The current superannuation industry is summarised in Table 1 below.

40 This decision was made largely on the grounds of high administration costs on small amount accounts.

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<Table 2-1> The Australian superannuation industry at June 2006

Assets($A billion) Number of funds Fund type

- Corporate 54.3 557

- Industry 154.6 84

- Public sector 152.3 42

- Retail 294.6 187

Sub total (large funds) 655.8 870

Self managed * 258.1 326,962

Total 913.9 327,832

*Includes self managed superannuation funds and balance of life office statutory funds

Source: APRA Quarterly Superannuation Statistics, June 2006 – APRA (2006)

The superannuation funds are managed by boards or trustees who are subject to the prudent person rule. As a result, there is little regulation of fund investments (with the exception of a 5%

maximum invested in in-house assets) and no rate of return requirements. The superannuation industry is supervised by the financial industry regulator – the Australian Prudential Regulatory Authority (APRA).

However, superannuation saving is subject to a complex tax regime whereby:

… Employer contributions are generally tax deductible, employee contributions are not tax deductible but may be eligible for tax concessions or government co-contributions, and special tax concessions apply for spouse contributions;

… Superannuation fund earnings are taxed, but at different rates depending upon the income type; and

… Until June 2007, benefits are taxed at different rates depending upon type of benefit, age of taxpayer and size of benefit, and an annuity rebate is available to offset tax on some retirement income streams. From July 2007, all superannuation benefits taken after age 60 will be free of tax.

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Third Pillar: Voluntary Retirement Saving

Voluntary retirement saving includes voluntary occupational superannuation, personal superannuation and other forms of long term saving through property, shares, managed investments and home-ownership. Voluntary occupational superannuation is long standing and has been available to public sector workers and middle to high-income workers in the private sector for many decades. In the past benefits were based on defined benefits, but these are increasingly being replaced by defined contribution schemes.

Voluntary superannuation is reasonably prevalent. In 2000 around 36% of employees made voluntary contributions to superannuation (ABS 2000a). Interestingly, coverage is higher for older than younger employees with around 7% of 15-19 year olds and 46% of 45-54 year olds making personal contributions. Other data suggests that around 27% of employees receive employer contributions greater than the Superannuation Guarantee level, while 20% of all employees make voluntary post-tax contributions (Bingham 2003).

Homeownership is probably the most important non-superannuation asset for most Australians: in 2003, dwellings accounted for 65% of total Australian household assets, with around 85% of retirees owning their home.

For the self-employed, concessions under the capital gains tax exist to encourage rollover of the proceeds of the sale of a business into superannuation. However, the extent of take-up of this incentive is unclear.