4 Objectives and principles of the Australian superannuation system
The Charter Group considers that the ‘values’ of the super system are inherent in its objectives and principles. For this reason, it has not attempted to identify separate values.
Having reviewed the primary and secondary sources at the time the Superannuation Guarantee was established, and subsequent materials, the Charter Group has concluded that, at a high level, the objectives of the Australian superannuation system are to:
- provide an adequate level of retirement income;
- relieve pressure on the Age Pension; and
- increase national savings, creating a pool of patient capital to be invested as decided by fiduciary trustees.
During the consultation process, it became obvious that there is a range of views on what super is for. Some see its purpose as alleviating poverty (not a widely held view) while some see super more as wealth-building and even as building intergenerational wealth. The great bulk of opinion is somewhere in the middle; that is, that super is intended to provide more dignity in retirement, giving people a standard of living above the safety net afforded by the Age Pension.
At its simplest, in the early years of superannuation in Australia, including when the Superannuation Guarantee was first introduced, superannuation was seen as a supplement to the Age Pension. As Superannuation Guarantee rates have increased, as the system has matured and as a strong community of academics and other superannuation experts has developed, our system is now more inclined to be described as having ‘retirement income’ as its purpose.
A commonly expressed aspiration for adequacy is for a superannuation balance large enough to provide an income stream (including capital drawdown) of around 60-70 per cent of pre-retirement income over a 25-30 year period. However, very few people view superannuation as having an unambiguous aim of providing a certain replacement rate19 of income for the rest of people’s lives. This mismatch most likely flows from the fact that a lump sum defined contribution system like Australia’s does not necessarily target any particular level of replacement income in retirement.20 In other words, the replacement rate concept might not fit a defined contribution system or, at least, it is not a natural fit.
Also, superannuation is still not a mature system. Retirees have not had the benefit of Superannuation Guarantee contributions for their entire careers. This will not occur until the 2030s. Even then, those retirees will not have enjoyed Superannuation Guarantee contributions at the full 12 per cent rate for long enough. Through that lens, a mature system will not arrive until the 2060s.
Further evolution of superannuation
Our superannuation system is not fully mature from a contribution perspective and is likely to need further substantial policy and industry reform in the retirement area.
In June 2012, the OECD Working Party on Private Pensions issued a 10-point roadmap for the good design of defined contribution pension (that is, superannuation) plans.21 Australia scores about 6 or 7 out of 10 on these measures, with the key deficiencies being in the retirement phase. What this means is that the Australian superannuation system has a way to go in its evolution and will continue to change if it is to meet the principles laid down by the OECD. As a compulsory system, there is a very high onus on both policy makers and industry participants to meet world’s best practice or have a good reason for not doing so. In simple terms, Australia is part way down the track of turning a lump sum defined contribution savings system into a retirement income system and so further change will be inevitable.
The role of the Charter is to create a state of affairs where those changes are made methodically and in accordance with the Charter principles, so that people can participate more confidently even though the system is not static.
Four principles have informed the Charter Group’s work in recommending the form of a Charter. The terms of reference required the Charter Group to develop and recommend a Charter which embodies the principles of certainty, adequacy, fairness and sustainability.
The terms ‘certainty’, ‘fairness’, ‘adequacy’ and ‘sustainability’ when expressed as principles are abstract terms that are very general in nature unless used in a context that enables the terms to be given a specific meaning. It was left to the Charter Group to provide a context in which these four core principles, which are not mutually exclusive, operate. The Charter Group has developed and recommended a Charter that embodies these four principles. But it is not possible to list all the circumstances in which it can be said that a particular policy proposal will be certain, fair, adequate or sustainable in that context.
It is best left for the Council to consider the matters arising within its area of operation against the principles of the Charter and, where appropriate, to consult with those interested in, or having a stake in, those matters.
Discussion on principle 1: Adequacy
Adequacy measures the degree to which the retirement income system enables people to achieve a sufficient standard of living in retirement relative either to the standard they enjoyed while working or as compared to an objective budget standard for retirees.
At a basic level, the retirement income system (which includes the Age Pension and superannuation) aims to ensure that people who can no longer support themselves by working can maintain a level of security and dignity in retirement.22 It also reflects the community’s belief that older Australians should not be required to work for their whole lives.
The Age Pension provides a basic safety net retirement income which is not directly linked to income earned over a working life, other than via the social security means tests. The role of the superannuation system is to enable people to build savings, through compulsion and voluntary incentives, that will allow them to achieve a standard of living in retirement above that which the Age Pension alone can provide.
No single retirement income target will be appropriate for all groups, and it should not be the role of the retirement income system to guarantee that everyone’s retirement income expectations will be met.
Adequacy can be measured in different ways and there is no consensus as to what measure is most appropriate. Measures of adequacy include:
- replacement rates;
- budget standards; and
- broader wellbeing measures.
The replacement rate concept is a widely used benchmark which compares a person’s spending power before and after retirement. As noted earlier, a commonly expressed aspiration for adequacy is for a superannuation balance large enough to provide an income stream (including capital drawdown) of around 60-70 per cent of pre-retirement income over a 25-30 year period. The underlying proposition is that a person’s standard of living in retirement should be a reasonable proportion of their standard of living during their working life. As a policy benchmark or target, replacement rates become less relevant the higher the level of pre-retirement income becomes.
Personal budget standards estimate the level of income needed, on average, to live at a certain standard or lifestyle in retirement. However, the standard will be affected by what is included in the basket of goods and services which makes up the standard budget, and the circumstances of the benchmark household will affect whether a particular standard is applicable to other groups.
While replacement rates measure the effectiveness of the system in generating an income in retirement, they do not capture other factors such as the value a retiree places on not having to work. Wellbeing measures look beyond people’s income needs to how they perceive their retirement. However, measuring the value of non-monetary benefits is more difficult than a replacement rate or budget standards because valuations differ significantly between individuals and groups. As a result, wellbeing tends to be measured through research surveys.23
Discussion on principle 2: Sustainability
Government expenditure, both actual and notional (through tax concessions) on the retirement income system (that is, the Age Pension and superannuation) must be affordable over the long term.
Successive intergenerational reports (IGRs) have concluded that population ageing will place substantial pressure on Australia’s economy. As the ratio of working age people to people over 65 falls, potential economic growth rates will also fall and with them Australia’s capacity to fund spending pressures associated with an ageing population.
In this context, it is crucial that future changes to retirement income policy not exacerbate future spending pressures, but rather contribute to fiscal sustainability. The Charter Group went through these issues in detail in section 2 of the report.
Discussion on principle 3: Certainty
Certainty requires that the general concepts and core workings of superannuation are sufficiently clear for an ordinary person to understand. People should have sufficient confidence in the regulatory settings and their evolution to trust their savings to superannuation, including making voluntary contributions.
Superannuation by its nature is a long term proposition. Superannuation savings made over a person’s working life are likely to remain in the superannuation system for up to 40 years before retirement and 20 years or more post retirement.
While public policy, including superannuation policy, must be able to respond to changing economic and other circumstances and to continue to improve and evolve, uncertainty created by the pace or direction of change risks undermining confidence in the system.
Too much change can also impose unnecessary costs on funds, employers and members, which may ultimately come at the expense of lower retirement incomes.
Relevant considerations, when assessing policy against the principle of certainty, include the ability for people to plan for retirement and adjust to superannuation policy changes with confidence. People should have sufficient time to alter their arrangements in response to proposed policy changes, particularly those people nearing retirement who have made long-term plans on the basis of the existing settings.
While a number of submissions raised the issue that changes to super policy or rules should not be retrospective,24 there is a need to be clear about what ‘retrospective’ means in this context. Some submissions seemed to assert that if a certain amount of retirement savings are already accumulated, any change to the way that capital, or the income from it, is taxed is retrospective. The Charter Group considers that such changes might be grounds for grandfathering existing capital, as with the capital gains tax regime introduced in 1985, where assets owned on or before 19 September 1985 (the commencement date) were not subject to the tax but assets acquired or deemed to be acquired after that date were.
Having said that, a change will only be retrospective where the rules that applied at a particular point in time (point x) are later changed so that a different rule applies at point x. That is not what happened in relation to the introduction of capital gains tax in 1985. If the introduction of capital gains tax in 1985 had been expressed to apply from 1 January 1983, then it would have been retrospective.
People should be able to participate with confidence. Proposed changes, taken together with existing rules, ought not create a system that is too complex for an ordinary person to participate in with confidence.
Certainty does not imply that there should be no changes to superannuation. The superannuation system must continue to evolve and improve. It is likely that there will always be a need for change. However, there are different types of changes. Changes that involve rules relating to taxation or people’s entitlements (for example, a change to the preservation age) have much more potential to affect confidence adversely than administrative or machinery changes such as the modernisation of the ‘back office’ contemplated by SuperStream. Of course, too many administrative changes can also have the same cumulative effect.
Also, instability in superannuation policy settings can reduce certainty and lead to behavioural change in relation to decisions about investments in various retirement income products and voluntary contributions. People should feel confident that the broad direction of superannuation policy is clearly understood and stable, and that any changes will be consistent with that direction.
Discussion on principle 4: Fairness
A fair superannuation system is one that treats people in the same circumstances equally and is perceived to be fair by the community. Given that building up superannuation is connected with employment, regard has to be had to those, who for a variety of reasons, have not fully participated in the workforce and therefore have less superannuation than others in their age cohort.
Different people have different views about what fairness is and any assessment of fairness is likely to involve trade-offs between different dimensions of fairness.
While it is broadly accepted that a fair tax system would feature a progressive tax rate structure, it does not necessarily follow that every tax or tax expenditure should be progressive. Typically, Australia has relied on the progressive rate structure of the personal income tax system, combined with means testing of income support payments to deliver distributional fairness. In the context of superannuation policy, it follows that redistributive fairness in the tax and transfer system as a whole does not necessarily require a progressive tax rate structure for superannuation. Superannuation has, in recent times, moved from a purely flat tax regime to a more progressive structure, with measures designed to assist lower income earners and reduce the tax concession available to those with high incomes (that is, above $300,000 per annum).
The discussion paper sought to identify principles in addition to those outlined above. A number of submissions put forward suggestions.25 The Charter Group was attracted to various suggestions about simplicity and efficiency, for example, but believes that these can be adequately covered as sub-sets of the four principles.
The Charter Group formed the view that the four principles outlined above covered the issues adequately and that additional stand-alone principles were not warranted.
Balancing the principles: is there a hierarchy?
There was a range of views on the relative importance of the principles. One submission,26 for example, suggested the Charter should present the principles in an order that reflects their relative importance, and make clear that the principles of adequacy and fairness are paramount.
However, the Charter Group has come to the conclusion that the relative importance of the principles will depend on the circumstances applying at the time the Council is examining an issue, and on the nature of the issue the Council is examining. It will almost always involve a balancing act, trading off certain principles against others.
For this reason, the Charter Group has chosen not to rank the principles and considers that particular principles should not be singled out in the title of the Charter either.
19 The replacement rate is the ratio of a person’s (or a given population’s) (average) pension in a given time period and the (average) income in a given time period. OECD Working Party on Private Pensions Private Pensions: OECD Classification and Glossary, 2005 edition, OECD, 2005, Paris.
20 ERISA Advisory Council Examining income replacement during retirement years in a defined contribution plan system, 2012
< http://www.dol.gov/ebsa/publications/2012ACreport3.html >.
21 Organisation for Economic Co-operation and Development The OECD roadmap for the good design of defined contribution pension plans June 2012. < http://www.oecd.org/daf/financialmarketsinsuranceandpensions/privatepensions/50582753.pdf >.
22 ASFA submission p. 4.
23 For example, see the National Seniors Australia Seniors Sentiment Index (December 2012). < http://www.nationalseniors.com.au/icms_docs/143311_Dec_2012_NSPAC_Challenger_Report.pdf >.
24 SMSFOA submission p. 2, CBUS submission p. 2, SPAA submission p. 3, AustralianSuper submission p. 2.
25 AFA submission p. 2, AIR submission p. 2, ASFA submission p. 3, Ai Group submission p. 1, AIST submission p. 6, AustralianSuper submission p. 1, Cbus submission p. 2, COTA submission p. 3, CPA Australia submission p. 1, FPA submission p. 2, FSC submission p. 2, ISN submission p. 3, LCA submission p. 5, NFAW submission p. 2, SMSFOA submission p. 4, SPAA submission p. 3, WIS submission p. 2, Cuffe submission p. 1, Prudames submission p. 1, Confidential submission.
26 ACTU submission p. 3.
5 The Charter and Council
3 Constant change?