Getting comfortable on the super sofa

When former prime minister Paul Keating introduced the superannuation guarantee in 1992, super’s premise was that it would be a support system to age pensions, one of three pillars providing Australians with retirement income.

Seventeen years down the track, superannuation’s achievements are impressive. Assets have pushed through the $1 trillion mark and the industry can boast significant and positive legislative reform in Choice of Fund, Better Super and the Government’s co-contributions scheme.

But in the wake of the biggest financial crisis since the Great Depression, it seems pertinent to ask how well those achievements have provided for retiring Australians. With account balances suffering, how well is superannuation achieving its desired objective?

Work in progress

According to Craig Day, technical services manager for Colonial First State, though Australia’s superannuation guarantee system may have made significant strides since inception, it remains a work in progress.

“Many people now approaching retirement haven’t had the advantages of the superannuation guarantee throughout the course of their working life,” he said.

“The industry has certainly reached a point where more people have more super, but average retirement balances are still low at around $90,000.”

Looking at the distribution of the industry’s assets, Day said the concern lay in the fact that most super account balances were at a level significantly less than the average.

“Quite a few people are reaching retirement with quite a bit less than $90,000 and it means that they will still be very reliant on the age pension,” he continued.

“On that basis, super may be a supplement to the age pension but it isn’t a replacement.”

“Superannuation figures will improve,” Day added. “But will they improve enough for people to have a comfortable retirement?”

Safety net

Richard Gilbert, chief executive of the Investment and Financial Services Association (IFSA), said Keating’s superannuation reform had been envisioned as a support system for retirement.

“It was always intended to be a safety net,” he said. “And as things stand, that safety net is very much in place.”

“Right now, the Henry tax review is looking closely at the adequacy of the support it provides and if the Government wants to go into the next poll with popularity, then it will need to look very closely at the interaction between super and the age pension, at ensuring that Australians’ retirement needs are adequately met.

“At the moment, the 9 per cent superannuation guarantee is there and, for the most part, the industry has enjoyed positive returns across the 17-year period that it’s been in place,” Gilbert continued. “But remember that when compulsory contributions were first brought in, it was envisaged that an additional 3 per cent would be in place at this point.”

He added that superannuation’s objective had been achieved, but perhaps only partially.

Modest vs comfortable lifestyle

For Pauline Vamos, chief executive of the Association of Superannuation Funds of Australia (ASFA), the partial fulfilment of superannuation’s objective comes back to the adequacy of retirement savings and whether those savings are funding a comfortable or merely modest means of living.

“In combination with the age pension, superannuation provides a modest retirement and certainly goes somewhere towards meeting Australians’ retirement expectations,” she said.

“But if we’re talking about a comfortable retirement, then it is generally acknowledged that contributions at a rate of 9 per cent aren’t enough.”

“Over a 30 to 35-year working life, that level of contribution can provide a modest retirement, but in 2009, people are retiring in greater debt,” Vamos said. “Their expenses nearing retirement are that much greater.”

“For most people, 9 per cent won’t provide the comfort they’d like in those sorts of circumstances.”

Looking at data released by ASFA in its Age Pension, Superannuation and Australian Retirement Incomes research paper, Day said the adequacy of a 9 per cent compulsory contribution was difficult to measure.

“If you look at the research released by ASFA this January, then $26,000 per annum is the level at which a couple can achieve a modest retirement lifestyle,” Day said. “And that means a lump sum of just $100,000 in combination with the age pension.”

He added: “But for a comfortable retirement that figure rises to $500,000 and when compared with a $90,000 average account balance, that’s a significant shortfall.

“It means a lot of people will be falling short of what they might expect to need for a comfortable retirement.”

The key question, according to Vamos, and the one yet to be answered, amounts to how default contributions to superannuation are to be increased.

“As a compulsory contribution from employers, 9 per cent is a good starting point,” she said.

“The next step is getting to a minimum of 12 per cent and soft compulsion might be the means to achieve that. Mandatory salary sacrifice, pay rises going into super on an opt-out basis, even removing the 15 per cent contributions tax on lower income earners,” Vamos said.

“There are many methods available for soft compulsion and a lot of options in terms of incentive.

“But one way or another, the industry has to encourage employees to put in that extra 3 per cent.”

Agreeing that extra contributions were necessary to bridge the gap between modest and comfortable retirements, Day warned that finding the right method coupled with the right amount was a difficult balancing act.

“You have to look carefully at having people saving too much for their retirement and impacting their day-to-day living,” he said. “And while lobbying for increases in the superannuation guarantee might assist in the short term, the cost burden it would place on employers and the money it would be taking out of the economy is significant.

“Australians reaching retirement may not be able to rely on super and the age pension alone. But any solution will require much more than a simple increase in the superannuation guarantee.”

The reality, pointed out by Gilbert, is that the industry is well aware of super’s contributions conundrum.

“At a rate of 9 per cent we have lower income earners — the bottom 20 per cent of Australia’s population — forced to rely almost fully on the age pension,” Gilbert said.

“While our top income earners probably don’t need more than 9 per cent based on the weight of their voluntary contributions.

“For the rest, 9 per cent is clearly inadequate.

According to Gilbert, the problem lies with where those additional contributions will come from.

“Employers will vigorously fight the onus being placed upon them and employees will be reluctant to increase the weight of their voluntary contributions, particularly if after tax.

“There’s no magic pudding here but the contributions have to be found somewhere,” he said.

Taking what seems a problematic increase to default contributions out of the equation, an employee’s voluntary contributions to super, whether through salary sacrifice or otherwise, are the obvious means of supplementing retirement income.

Planning advice and super

Yet while voluntary contributions may provide an answer to the comfortable retirement question, Gilbert said that encouraging Australians to shoulder the immediate burden in favour of the long-term advantage remained a challenge.

“The best means of encouragement is advice,” said Gilbert.

“All the evidence shows that when people get advice, their super contributions increase.

“It grieves me when attitudes towards the entire financial planning community are impacted by something like the Storm incident,” Gilbert continued. “It hinders the advice equation when the industry needs it to be as accessible and cost-effective as possible.”

Echoing Gilbert, Vamos said there were two ways the super industry could further encourage voluntary contributions.

“The first is giving people access to independent, cost-effective advice,” she said. “If people are encouraged and helped with their financial needs then they will put in extra.

“Adjusting the tax incentives that are already in place will help as well. We went a long way with Simpler Super but the system could be made a lot more understandable, a lot less complex. That is what the Henry tax review is trying to achieve now.”

The super psyche

Alternatively, Bill McMillan, chief executive of TWU Super, said although he felt member education on the importance of voluntary contributions held the answer, he had doubts over how much traction education efforts were getting.

“The super industry is continually trying to educate its members and aid their understanding of super as a tax effective investment,” McMillan said. “But I don’t think we’ve succeeded with that yet.

“We’re probably a couple of generations away from the kind of understanding we’re looking for.”

McMillan said his view was that unless messages on the importance of retirement savings were getting through as early as possible, from a primary school level and upwards, then the messages’ traction was doubtful.

“People remain uninterested in superannuation and they remain uninterested in providing for their own retirement,” he said. “I often think that education efforts aren’t achieving a great deal at all.”

McMillan believes the industry may be better off with a return to a more paternalistic system, where members had to rely on their funds to take care of them.

“It’s a question of how much traction education efforts are getting.

“Funds are sending out brochures and conducting seminars but are people truly listening?”

Paul Little, financial adviser for Landmark Financial Management, suggested that some of the answers might lie overseas, where systems similar to soft compulsions were already in place.

“I think the super industry already does a very good job of educating people on the importance of retirement saving,” he said. “But there may be other approaches to encouraging additional contributions.

“One approach used well overseas works on the basis of behavioural finance. The theory behind it is that people are essentially underweight on long-term issues and that, for various reasons, they are far more focused on their immediate concerns.”

Little said that in this instance, overseas employers had entered an agreement with their employees stating that as tax cuts and salary increases came through, one half would be paid direct to the employees and the other would be contributed to super on a voluntary basis.

“It’s about giving people the chance to agree to look at their long-term needs,” Little added. “And if you put it in place automatically, it makes it easier for people to do what they’d really like to be doing anyway.”

“That is, providing for their own retirement.”

Being strategic with super

Outside of voluntary contributions and looking at the strategies fund members should be adopting to get the most out of their super, Day said he urged people to look at the ways in which their super was being invested.

“People need to ensure that their super will reach a level that gives them the best chance of achieving their retirement goals,” he said. They should be answering simple questions like, ‘If I need X amount of income for retirement, then I’m going to need a Y level of contribution until I reach age 55’.

“And for those who have never really looked at it, they need to be looking at where their money is being invested,” Day continued. “It’s important to look at it and see that they’ve chosen the best option with respect to their retirement goals and with consideration for the risk involved.”

For Vamos, the main strategy was members staying conscious of their superannuation investment’s time horizon and the advantages available through the Federal Government’s co-contributions scheme.

“The co-contributions scheme is the first thing they should be looking at,” she said. “But they should also be looking at where their money is being invested and what is dictating their time horizon to retirement.

“Superannuation is about time in the market and there are three things people need to be doing in order to take maximum advantage of that fact,” Vamos continued.

“First and foremost, they need to be putting in as much as possible early on. They need to be in the investment portfolio that suits their needs and is right for them and they need to be getting the right advice for their contributions strategies.

“If those strategies are in place, members should find themselves well-prepared upon retirement.”

McMillan said that he would ask fund members searching for superannuation strategies to remember two aspects of their accounts in particular.

“I’m talking about the effects of compound interest and the effects of growth strategies versus conservative strategies,” he said. “Because those are the two major determinants on a member’s final account balance.

“The other issue to keep in mind is how much members might be paying in fees,” McMillan continued. “People ought to be able to see what fees they’re paying and have in mind that if they’re paying much more than 1 per cent then they are probably paying too much.”

McMillan said that the effects fees had on a member’s final account balance emulated the effects of compound interest in reverse.

“And it comes back to members’ understanding of the system,” he added.

“If we can get that message across — that how they control their super and the strategies they employ have a major impact on their final balance — then we will certainly have placed them in a better position.”

Economic reality

But as the industry heads towards the middle of 2009, the unfortunate reality is that the effectiveness of many superannuation strategies has been diminished. Like it or not, the current financial environment has meant significant concern from members and many will have looked at shifting allocations, moving funds or both.

However, despite that concern, Vamos said most members were keeping themselves well informed.

“The key strategy being followed by most members is finding out what’s going on,” she said. “And that’s great.

“People are looking at how much time they have left until retirement and asking whether their balances are sufficient,” she said.

“On the whole, the industry has been pleasantly surprised by the level of understanding that it has seen in its members. It hasn’t stopped some people panicking, but there is an acceptance out there that this is a ‘once in a lifetime’ event and that the value of the assets remain.”

From the fund perspective, McMillan said it was gratifying that the financial crisis hadn’t precipitated a lot of change within members’ asset allocations.

“One per cent of TWU Super’s members were in cash about a year ago,” he said. “And that figure is now at 2 to 2.5 per cent.

“There’s been some movement but not a lot and that is at least partly due to the financial planning services available to members. People have been able to ring up and ask those sorts of questions and we’ve been able to encourage them to think hard about that sort of move.”

Hard lessons

In terms of what could be learned from this financial crisis, Day hoped people would take note of what the market could do.

“I hope that they realise exactly how far the market can go in either direction,” he said. “And I hope that they understand that though returns may go up and down, the best course of action is to identify a long-term strategy and stick to it.

Little warned that the biggest risk lay in fund members dropping their voluntary contributions to super.

“People haven’t panicked and most haven’t switched to cash,” he said. “No Australian will be enjoying dropping balances, but they’re staying firm.”

“The risk lies in falling voluntary contributions,” Little continued. “Doing so may be tempting in this kind of environment but it isn’t doing people any favours.

“Superannuation strategies need to be reviewed regularly, every year if possible and certainly not as a reaction to current events.”

Though he did not advocate wholesale strategic changes, McMillan hoped the time was ripe for people to take a greater interest in their super.

“Hopefully this is a good time for them to take a greater interest in their retirement strategies and to think about the future a bit more,” he said.

“There won’t be too many benefits coming out of this financial crisis but if people are thinking a bit harder about their super, then that might be one of the few.”