Productivity Commission provides policy signpost

Mike Taylor writes that despite the discussion prompted by the release of a Productivity Commission research paper, it represents a signpost to the big policy changes for superannuation which will occur after the next Federal Election.

While the Federal Opposition last month sought to use the Productivity Commission's research paper, ‘Superannuation Policy for Post-Retirement', to extract a further Government commitment to no further changes to super it was all just political rhetoric.

Both the Prime Minister, Tony Abbott and the Shadow Treasurer, Chris Bowen, know that the Australian electoral clock has reached a stage where there will be no changes of significance to the superannuation settings in the life of the current Parliament.

So the Productivity Commission's research paper should therefore be viewed for what it really is - a policy input to be read alongside the recommendations flowing from the Financial Systems Inquiry (FSI) and those which will ultimately flow from the Tax White Paper process.

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But whereas the FSI recommendations and those of the Tax White Paper can be taken as dealing with component part issues, the PC research paper has succeeded in identifying precisely how the Government can move to ensure that its underlying superannuation policy approach is sustainable over the long term and therefore consistent with the pursuit of the type of "declared objective" recommended by the FSI process.

Preservation and age pension triggers

Given that the recent intergenerational report canvassed the challenges still confronting Australia in the form of an ageing population, it is hardly surprising that the top-line focus of the PC research paper was the consequences which would flow from lifting the superannuation preservation age.

However it would be wrong to interpret the PC document as a ringing endorsement of lifting the preservation age. Rather, it argues that the perceived benefits are offset by many negatives, not least the reality that many people have no choice in the timing of their exit from the workforce.

The PC research paper noted that, "along with the Age Pension age, the preservation age is considered by some to be an important policy lever in managing the transition to an older Australia. The preservation age provides both a financial incentive and a signal to retire".

"The preservation age is legislated to gradually increase from 55 to 60 years in 2025. However, with policy measures in place to raise the Age Pension age to 67 years, and a stated policy goal to increase it further to 70, debate has once again been prompted about where the preservation age should be set," the PC report said.

"All else being equal, the larger the gap between the preservation age and the Age Pension age, the greater the opportunities that individuals have to run down their superannuation before reaching Age Pension age."

The research report acknowledged that, on their face, the arguments in support of raising the preservation age were relatively straightforward — "the expectation is that individuals will delay their retirement if they are unable to access their superannuation. The longer individuals remain in the workforce, the larger their superannuation balances will be when they do retire, reducing calls on the Age Pension".

However it noted that, in practice, "there are a number of reasons why these expectations may not be fully realised".

All else being equal, the larger the gap between the preservation age and the Age Pension age, the greater the opportunities that individuals have to run down their superannuation before reaching Age Pension age.

"More years of work also mean fewer years of retirement. Those with a strong preference for leisure are unlikely to delay their retirement if they have the financial means to retire when they choose. Some individuals who retire do not do so of their own choosing, but do so because of caring responsibilities or poor health. Data suggest that around 28 per cent of men and 25 per cent of women aged 60-64 who retire do so for these reasons. Others have their employment terminated, and/or have difficulty finding new work (this represents a further 20 per cent of men and 11 per cent of women). Raising the preservation age is unlikely to fundamentally alter the retirement behaviour of these individuals."

The bottom line of the PC analysis was while there were definite Budget benefits likely to flow from raising the preservation age, there were many other issues that needed to be considered including providing a safety net for those who found themselves being involuntarily retired.

Lump sums — good or bad?

The taking of superannuation lump sums has generated plenty of criticism from lobby groups, but the PC research suggests that the negative perceptions have been significantly overblown.

Indeed, the document expressly stated "There is little evidence that lump sum behaviour is problematic for individuals".

In fact, what the PC analysis found was that where lump sums were being accessed, they were being taken for sound and logical reasons such as low balance superannuation fund members seeking to pay down debt before moving to access age pension benefits.

The PC report noted that only around 16 per cent of benefits are taken as lump sums and that the bulk of individuals who take lump sums are aged between 55 and 70 years — the median value they take is around $20 000.

"Lump sums are more likely to be taken by people with relatively small superannuation balances — more than 90 per cent of people with up to $10,000 in superannuation assets take their benefits as a lump sum at retirement compared to around 30 per cent of people with assets between $100,000 and $200,000. When individuals with low balances take a lump sum, they typically exhaust all of their superannuation savings."

The analysis went on to say that where lump sums were being taken, "there is little evidence to suggest that they are being squandered".

"Individuals can set themselves up for retirement in many ways. In addition to retiring debt (particularly housing debt) many individuals use their lump sums to modify their primary residence and/or invest in consumer durables to see them through their retirement years."

"For those who have had an interrupted work history or were relatively low-income earners, their lump sums (while relatively meagre) provide an opportunity to self-finance ‘lumpy' consumption."

The PC analysis substantially concludes that while the taking of lump sums can, indeed, allow individuals to restructure their wealth holdings to maximise access to the Age Pension, this is really not a major issue because those with very little savings are likely to receive the pension anyway.

"Concerns are most relevant for those retirees with superannuation savings (and other assets) close to the Age Pension means test thresholds," it said.

Transition to retirement

Where the Productivity Commission analysis took a relatively benign view of lump sums and how they are being utilised, it was less benevolent about transition to retirement pensions — suggesting they are being mostly used by the wealthy to obtain a tax advantage.

The PC report said that transition to retirement pensions, though intended to encourage a gradual shift from full-time work to full-time retirement, could be used to reduce a worker's tax liability.

What is more, the report said such arrangements appeared to mostly the preserve of the wealthy.

Discussing those likely to be utilising transition to retirement arrangements, the report said they were "more likely to be working full-time and earned higher incomes than those not using transition to retirement pension arrangements".

"In terms of the households discussed earlier and used in the Commission's modelling, those using transition to retirement pensions were almost exclusively in the two wealthiest quartiles of couple households," it said.

"While the data are imperfect, the available evidence does tend to suggest that transition to retirement pensions are used almost exclusively by the wealthy."

The PC report even obliquely points to the likelihood that those accessing transition to retirement arrangements are doing so on the basis of financial advice, stating: "Why this should be the case is unclear. From the age of 55 years onwards, the tax incentives are strong enough that most who are employed and facing a marginal tax rate of greater than 15 per cent should avail themselves of the transition to retirement pension".

"It may be a case that those with lower incomes have less of an incentive to do so relative to those facing higher income tax liabilities, or it may also be the case that many are unaware of the transition to retirement pension arrangements that currently exist."

Holistic view required

Importantly, the PC research suggests that the various elements of superannuation policy cannot be appropriately considered in isolation.

In fact, the PC analysis suggested that, too often, policymakers had taken a piecemeal approach to addressing the problems - "tackling different policy pieces at different times".

"But the three pillars that make up the system are inextricably linked — changes in each can, and often do, affect the others. Indeed, some of the concerns raised by stakeholders about the retirement income system have arisen due to failures to account for the way that incentives inherent in each pillar combine — and conflict — with one another."

"While it is possible to consider each piece of the system separately, there is merit in a holistic review that examines reform of retirement income policies collectively. Not only would such a review be able to address some of the policy questions¨ in the detail they deserve, it could also serve to explore other broader issues, such as the adequacy of retirement incomes and the sustainability of the system under demographic change," the PC paper said.

It said that, ultimately, such a review could determine what the future role of the retirement income system should be — "a question that is best informed by considered and extensive community consultation".