Flexibility key to fixing super
THE global financial crisis did not just impact individual investor portfolios, it also provided a severe stress test to our entire superannuation system.
As a sense of equilibrium returns to financial markets, the debate on how well our super system stood the test is set to heat up.
Funds with heavy exposures to unlisted asset valuations are coming under increasing scrutiny as valuations are updated and impact returns, but possibly the biggest issue to be resolved between now and the end of the year is what the contribution level to super should be.
The Federal Government’s Henry Review is due to report on its wide-ranging review of our tax system - including retirement incomes - by the end of the year. Yet it has already signalled in an interim report that it believes the existing 9% super contribution level is adequate for most people.
Given the portfolio returns of the past year that is clearly open to debate - particularly when under our super rules contributions are now capped - making it much harder for people to catch up later in life if the portfolio balance is falling short of expectations.
A key consideration is that the impact is far from uniform across the super system.
The Henry Review’s assertion that 9% is adequate is probably reasonable for people just starting out on their working careers - assuming they can find a job at the moment.
But the big losers are those people who have not had the full benefit of 9% super contributions for most of their lives - and they are the demographic group now close to retirement. So the inflexibility of the system regarding contributions is really the fundamental issue here.
But other groups are also disadvantaged - for lower income workers the tax incentives with super that are meant to compensate you for the fact that your money is locked up until retirement are either non-existent or far from compelling. Then people who have interrupted working lives - women who have extended time out of the workforce for family reasons for example - also suffer by not being able to catch-up with higher contributions later on.
To illustrate the point take a 30 year old person earning $50,000 a year and only contributing the mandatory 9% to super. They retire at 65 after earning an annual investment return of 8% with a super benefit of $338,000*. If they wanted to draw down an income of $30,000 a year it is estimated it would last until they were 84.
Consider the same situation for a woman who takes 10 years out of the workforce to raise a family between the age of 35 and 45. When she gets to 65 the super benefit using the same return levels is just $214,000 - and would give the same annual income until age 74- or eight years less.
You can make the case that when combined with the age pension the first scenario is adequate but clearly the impact of taking time out of the workforce and then not being able to ramp up contributions later in life disadvantages that person.
At the Investment and Financial Services Association conference earlier this month, there were calls for more flexible contribution caps to super - and even perhaps having flat dollar benefit targets for some people. For example an argument is being mounted to allow a single person to make flexible contributions up to (say) a $500,000 account balance. The $500,000 limit being generally regarded as the amount that would provide a single person with a reasonable or comfortable retirement income.
The super system has come through the global financial crisis relatively well but the impacts on portfolio balances and what that means for an entire cohort of retirees in the near future should not be ignored.
The Henry review’s final report will be eagerly awaited to see if it heeds the calls for more flexibility in the contribution levels of the system.
* Calculated using Vanguard’s Retirement calculator -
Robin Bowerman is Head of Retail at index fund manager Vanguard Investments Australia.