What is the purpose of superannuation in Australia?

By Gary Anders

Just a week after the World Health Organization declared COVID-19 a global pandemic in mid-March, the Australian Government gave a green light to those financially affected by the crisis to tap into their retirement savings.

The government announced that those made redundant, or those whose working hours had been reduced by 20 per cent or more, could apply to access up to A$10,000 of their superannuation tax-free in the 2019-2020 financial year.

It also sanctioned a further A$10,000 super fund withdrawal between 1 July 2020 and 24 September 2020 for those eligible and who were still experiencing financial hardship.

This was an extraordinary measure designed for extraordinary times, not least being the fact that it was introduced without consultation with Australia’s A$3 trillion superannuation sector.

What has ensued since has, once again, brought into question the stated purpose of superannuation.

By early June, more than 2.1 million Australians had applied to the Australian Taxation Office (ATO) to draw on their superannuation, with approvals granted for about A$15 billion in withdrawals – representing an average payout amount of A$7,500.

The withdrawals coincided with large-scale deposits into banks and other financial institutions, as some individuals took the opportunity to move previously untouchable retirement cash back into their savings accounts.

What others have done

In the US, the Coronavirus Aid, Relief and Economic Security Act has enabled affected individuals aged under 59 and a half to take out loans of up to US$100,000 (A$150,700) from tax-advantaged retirement funds without facing a 10 per cent early withdrawal tax penalty.

Account holders are then able to repay the distributions over the next three years and make extra contributions to repay the tax owed.

Malaysia has gone about things differently by announcing a temporary reduction in the statutory contribution rate by employees to its Employees’ Provident Fund from 11 per cent to 7 per cent.

Singapore’s solution has been to provide employers with temporary financial support to continue paying employee contributions into its Central Provident Fund.

Interestingly, the two countries with the highest-ranking pension systems in the world on the Melbourne Mercer Global Pension Index – the Netherlands and Denmark – have not permitted any pre-retirement withdrawals without tax penalties applying. Although under public pressure to do so, nor have many other countries, including the UK.

In Australia, the big question about the ultimate purpose of superannuation is being asked on multiple levels.

Some believe the COVID-19 pandemic will lead to further legislative reforms, including revised superannuation contributions rules, changes to the management and liquidity guidelines governing superannuation funds, and even potential tax reforms.

 

"If the superannuation system is to be tapped in the future, the industry needs to know the parameters, the key signals and the criteria that would trigger accessibility." 

 

There is also industry discussion around either leveraging the financial resources of the government’s A$160 billion Future Fund should another major crisis occur, or establishing a new national emergency fund that would hold and invest capital to provide financial support to Australians when needed.

This would negate the need for future Australian governments to use the retirement savings system as a back-up pool of emergency capital that can be opened and closed at will under crisis conditions.

“This has created a form of regulatory risk in the super system that we’ve probably never seen before, and now we’re completely aware of and cognisant of,” says David Elia, chief executive officer of industry super fund Hostplus.

His fund, whose members predominantly work in the hard-hit hospitality industry, was caught off guard by the government’s decision, but quickly responded to meet a flood of more than 170,000 withdrawal applications.

At the time the superannuation measure was activated, Hostplus had almost 600,000 members with account balances below A$10,000, and a further 160,000 with balances below A$20,000.

“It comes back to the debate we’ve been having for quite some time, and we still have not settled on it – what is the purpose of super?” Elia says.

“We’ve always assumed it’s all about retirement, to look after people’s retirement wellbeing.

“What could the government possibly allow super to be used for the next time around, whether it’s in the form of accessing super in the context of a pandemic or just the government finding other uses for super?”

Elia says the new uncertainty that super funds are now having to live with will invariably filter through to investment strategies and where money is placed.

“It will ultimately lead to higher levels of liquidity in the super system and, given the current investment environment, that simply translates into lower returns,” he adds.

“If the superannuation system is to be tapped in the future, the industry needs to know the parameters, the key signals and the criteria that would trigger accessibility,” Elia says.

Tackling the structural issues

Dr David Knox, senior partner and senior actuary at global financial services group Mercer, agrees the dialogue around the primary purpose of super has been reignited.

“If we can get a clearer understanding on what the purpose of the system is, then I think we could see some reforms.

“Certainly a focus on retirement income products and retirement income generally would be a good outcome,” Knox says.

“I think this may be an opportunity, in the post COVID-19 environment, to take on board the review of retirement income, take on board the government’s current debt situation, and to take on board lower investment returns.

“Of course, we’ve still got an ageing population, we’ve still got increased life expectancy. We need to think about how the coverage of compulsory super needs to be expanded, because we’ve got gig workers out there who don’t necessarily have any super, and we’ve got the self-employed, who don’t have to put it aside.”

Richard Webb, CPA Australia’s policy adviser, financial planning and superannuation, also agrees the purpose of the retirement income system needs to be addressed.

“Is it for people who just hit the age of 67 and then apply for the Age Pension? Or is it more broadly for a whole range of other things?

“Once we have determined what retirement is, we need to ask, ‘What are things such as the release of funds during global pandemics doing in there necessarily, and is that consistent with the objective of superannuation and the objective of the retirement income system?’.”

Webb says there is also a key issue for super funds around their future asset allocations – to ensure that there is sufficient liquidity, especially in smaller funds, to accommodate large government-induced cash withdrawal programs.

“Obviously, the situation going on at the moment, where trustees are already expected to do some fairly ornate risk management planning, probably can’t continue without further adjustment.”

Webb says having a funding vehicle in place that can be used as an emergency supply of cash does make sense.

“There is a general consensus in the financial sector and among our members that superannuation itself is probably not a good fit for this, and there will be collateral damage as a result of what has happened.”

Dealing with the collateral damage

What that collateral damage looks like is impossible to assess in fine detail at this point.

For one thing, the government’s measure was launched at the point when values on global financial equity and bond markets, where the bulk of superannuation money is invested, had dropped by more than 25 per cent.

Those who took superannuation money out early in the process effectively crystallised the largest capital losses and have missed out on the gains in investment markets that have occurred since April.

In addition to this immediate financial cost, there is also the longer-term wealth cost from forsaking future compound returns.

Since the measures were announced, multiple calculations have been done of the potential long-term financial impact on individuals from withdrawing A$10,000 or A$20,000 from their superannuation account.

These calculations involve a lot of assumptions around forecast investment returns and inflation, with the predicted net effect over time ultimately coming down to a person’s age and how much they have withdrawn.

Based on an average compound net return of 6 per cent per annum, the value of a A$10,000 withdrawal for an individual in their mid-40s, with 20 years until retirement, could be worth about A$32,000 (today’s dollars) at retirement.

For a younger person in their mid-20s, the impact of a A$10,000 withdrawal on a retirement balance climbs to almost A$103,000 over the course of 40 years. Taking out a further A$10,000 could reduce their retirement balance by more than A$205,000 over the same period.

“The point I would make about younger members is that they have more opportunity to catch up in the future, and I think therefore there is an argument for encouraging catch-ups,” Knox says.

“Obviously, if people needed the money now, I can understand why they withdrew it. The upside of this is that members are probably more engaged with their super fund than they were.”

Opportunities post-pandemic

Playing catch-up with retirement in mind

Dr David Knox says that after the current crisis, there will be an opportunity for super funds to re-engage with younger members to encourage them to top up their accounts through additional contributions and by using the existing super catch-up rules.

“It’s an opportunity down the track to say, ‘OK, you needed the money then. You’re still going to need money in retirement. When your circumstances improve, think about putting aside A$10 a week or A$50 a monthor whatever it might be to reinstate where you would have been.’”

Knox says online retirement calculators allow people to work out what they would need to re-contribute over time to be in the same financial position.

He adds that there is also an argument for older members who may wish to contribute more into their super, and whether the concessional cap of A$25,000 should be increased again, at least for a limited time, to help them catch up.

“If one thought broadly, this has affected the superannuation outcome of nearly two million Australians.”

Knox also points to the government being in deficit more in the future than it has been in the past, which will likely bring about changes in terms of what will be provided in retirement income benefits.

“People are probably going to need to be more self-reliant than they were, and the real rates of return, at least over the next five years and maybe longer, are probably going to be lower than we’re accustomed to.

“I think, for both of those reasons, superannuation is probably going to be needed more in the future than it has been previously.”