University of New South Wales Faculty of Law Research Series
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University of New South Wales Faculty of Law Research Series |
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Superannuation and lifelong saving
Julian Disney[∗]
SUMMARY
The current superannuation system is excessively inefficient, unfair and complex. It involves hugely generous subsidies to many wealthy people but little, if any, net assistance for many lower-income people. It also unduly reduces governments’ capacity to strengthen national development, especially through investment in long-term infrastructure.
The system is targeted excessively towards older people at the expense of younger people and towards needs in old age at the expense of those arising earlier in life. In these and other respects, the scheme does not adequately promote efficiency or inter-generational equity.
The superannuation system would be substantially improved by taxing all superannuation contributions at the beneficiaries’ marginal income tax rates but then reducing their tax liability by a proportion of the contributions up to a modest level.
This approach would create a much simpler, fairer and more efficient system, especially if complemented by removing the age pension means test. Some early withdrawals could then be allowed from superannuation accounts in order to meet mid-life needs, preferably without limiting the purposes for the withdrawals.
A medium-term goal could be to establish a system of subsidised Lifelong Savings Accounts (LiSAs) which includes government contributions at birth, compulsory superannuation contributions in the workforce years and also voluntary contributions from the beneficiaries or other sources. Tax exemptions or concessions could apply to phased withdrawals from the accounts up to fixed limits.
A significant proportion of moneys held in superannuation accounts or LiSAs should be made available for national infrastructure investment which may not maximise direct profit to individual members but improves the economic and social strength of the community as a whole. This could be achieved by vesting some contributions in a government fund with a guaranteed rate of return and/or vigorously encouraging national infrastructure investment by private funds.
The failings of the current superannuation system can readily be obscured by vested interests. Reform should be a very high priority for people who are concerned about social justice and alleviating hardship, as well as for those who are concerned about efficient and sustainable economic development.
During the last twenty years or so, a number of government-subsidised savings account schemes have been established in Australia and elsewhere. Public subsidies for them are provided in a range of different ways, including direct contributions, tax concessions and guaranteed rates of return.
Some schemes are entirely voluntary while others involve compulsory contributions from or on behalf of a substantial proportion of the population. Some are available to the general population and can be drawn on for a wide or unlimited range of purposes. Others are restricted to particular types of people and/or particular types of withdrawal.
This paper focuses on ways in which public subsidies for saving accounts can be designed to provide appropriate benefits for savers, households and the community. The design must recognise, of course, that opportunities and needs for saving vary widely between different life stages, households and generations.
The paper does not focus on subsidies for other forms of saving such as buying a home, investment property or shares. It also does not focus on other forms of public assistance such as social security, subsidised loans or insurance, free services or infrastructure. But it does consider ways in which these types of assistance may interact with subsidised savings account schemes.
Superannuation is the only major scheme of subsidised savings accounts in Australia. Since compulsory contributions began almost twenty years ago, superannuation accounts have grown exponentially in number and value. Total holdings have risen to $1000 billion (equal to our annual GDP) and will continue to grow substantially for at least another 20 years.
Superannuation accounts already hold more than three times as much as is held in bank accounts. They constitute almost a quarter of our total household wealth, second only to home ownership and more than the combined total of shares and rental properties. Superannuation funds are now responsible for a very large part of all Australian investment.
After initial resistance, the current scheme has attracted broad acceptance, at least in principle. Criticism of particular elements has tended to grow, however, as have suggestions to substantially expand or contract its ambit. Several other types of subsidised account have been proposed, often drawing on schemes or proposals from other countries.
The following sections of the paper look at ways of reforming the superannuation scheme; complementing it with other subsidised savings account schemes; or broadening it into a lifelong savings account scheme. Abolition of the scheme is not considered as, even if it were desirable in principle, it is not even remotely feasible from a political viewpoint.
There is a powerful case for compulsory saving to help people meet the costs of living in their old age. It is clear and understandable that in the absence of compulsion many people under-prepare for these costs because they under-estimate them or do not fully appreciate the difficulty of meeting them without substantial saving over a lengthy period.
Voluntary subsidised schemes for retirement saving may be preferable in theory. But in practice they tend to be of little benefit to many lower-income people and to be over-generous to the wealthy. Moreover, it is unrealistic for low-income people to rely solely on the age pension to meet the escalating costs of living longer in frail health with highly expensive medical treatments.
The case for compulsory saving is strengthened when, as in Australia, overall household saving is at low levels and there is little sign of substantial and sustained recovery. Moreover, there is clearly great cause for concern when household and foreign debt levels are higher than in all other OECD countries except the United States.
A compulsory scheme can reduce pressures on the public purse, especially if any budget savings are invested in areas such as employment generation and preventive health which further reduce dependency in old age and earlier. It also can increase the supply of household savings for investing in ways which cut foreign debt and boost the economy.
Compulsory superannuation can provide many low-income people with their only asset of substantial value, albeit one that may not be available until their later years. Asset ownership can greatly improve opportunities and security yet it is even more unequally distributed in Australia than income.
These potential benefits of compulsory superannuation are of great importance but the current scheme in Australia is gravely flawed. It is inefficient in meeting its espoused goals and is inequitable within and between generations. It also does not sufficiently enhance long-term national development in the circumstances that are likely to prevail in coming decades. These problems are outlined further below.
Household savings: The scheme does not efficiently increase household savings. It provides very large subsidies for saving by high-income people, both per dollar contributed and in total. Yet most of these people would have saved heavily in any event so their subsidies are largely unnecessary and wasted for this purpose.
On the other hand, the subsidies available to many low- and middle-income people are too small to encourage much voluntary saving or to justify a higher compulsory rate. This applies especially to people who already benefit from subsidies such as the low-income tax offset and principal family tax benefit.
Budget pressures: The scheme does not efficiently reduce budgetary pressures arising from an aging population. Changes in the 2006-7 Budget (referred to below as the “2006 changes”) may encourage some people to keep working for longer, thereby paying more tax and receiving less public assistance. But they also create new opportunities for “double-dipping” on pensions and avoiding income tax in both mid-life and old age.
The superannuation scheme already costs almost $20 billion per year. This expenditure will rise very considerably as the scheme matures in 20 years or so, especially in consequence of the 2006 changes. There appears to be no published evidence that the scheme will eventually reduce age pension costs by a commensurate amount.
Moreover, the age pension has become less tightly targeted since the scheme was introduced, as has the availability of tax offsets and concession cards for older people, including those too wealthy to receive any age pension. These changes might be desirable in themselves but they further weaken the case for retaining such highly expensive superannuation subsidies for wealthy people.
Retirement security: The scheme does not efficiently enhance secure levels of income and living standards in old age. For example, its lax rules about withdrawal of benefits provide undue encouragement for the savings to be expended at the onset of retirement, or passed on to relatives for tax avoidance purposes, rather than used for ongoing retirement needs.
The scheme may provide most older people with substantially more income than they would have obtained from a full age pension. But many others will inevitably suffer from the vagaries of economic cycles and the inefficiency or dishonesty of their fund managers. Prudential regulation of funds is deficient and, except amongst “industry funds”, management costs are often excessive.
Some of the most severe inefficiencies in strengthening income and living standards affect low- and middle-income people and those people (often women) who have lengthy periods outside full-time paid employment. These people tend to have less opportunity to accrue substantial savings and subsidies, while also often facing greater complexity and management fees.
Simplicity: The scheme does not achieve an efficient level of simplicity for contributors, fund managers or regulators. Major simplification was promoted by the Government and many media commentators as being the principal merit of the 2006 changes, especially the removal of taxation on benefits. But even if that were enough justification in itself, the changes actually achieve little overall improvement in simplicity.
There continues, for example, to be a highly complex system of taxing contributions according to whether they come from employers, employees or self-employed persons. Moreover, the changes create much greater scope for complex schemes to avoid tax on work income, manipulate pension eligibility and help relatives avoid income tax.
Investment: The scheme is artificially diverting a very large share of national resources into the hands of one particular type of investor with a particular profile of investment constraints, including the special duties of a superannuation trustee. This major distortion in the overall investment market has adverse impacts on diversity and innovation.
The scheme also inhibits the potential for “community investment”; that is, investment which may not maximise direct short-term profit for investors but will provide substantial benefits for the broader community. Superannuation funds generally regard themselves as being more strictly debarred than other businesses from investing for anything less than maximum returns.
Some large superannuation funds are controlled jointly by business and union nominees from a particular industry. In marginal cases, they may be more receptive to an element of investment in the interests of the broader community. But they remain largely inhibited by their perception of trustee duties and of their members’ expectations.
Lower-income people: The scheme impacts unfairly on lower-income people. The value of the tax concession for each dollar of their compulsory contributions is 50-95% less than for higher-income people. Unless they can call on wealthier relatives, most of them cannot afford to make the voluntary contributions which attract a further subsidy by government “co-contribution”.
The severe regressivity of the tax concessions arises principally from the flat-rate tax of 15% on contributions and fund earnings. This provides relatively little or no subsidy for people in lower income tax brackets (especially if their age pension will be reduced by superannuation entitlements and/or they are eligible for low-income tax offsets and family tax benefits). But it provides huge benefits for people in the higher tax brackets.
The problem is greatly aggravated by the fact that compulsory contributions almost certainly depress the level of wages which employers are willing to offer, especially to their lower-paid employees. Yet many of these people simply cannot afford to receive superannuation contributions in lieu of the wage income on which they rely to meet their immediate needs.
Wealthy people: The scheme provides huge subsidies for wealthy people while public expenditures for much greater needs, whether in retirement or earlier, are severely constrained. This inequity and waste of public resources is greatly increased by the 2006 changes which remove all tax from superannuation benefits up to exceptionally generous limits.
The problems are aggravated by allowing substantial contributions to be made to relatives’ accounts, thereby evading even the higher limits on personal contributions and consequential public subsidies. Moreover, “over-limit” contributions can be made by passing them to an older person who parks them in their superannuation fund for a while before returning them with the subsidised earnings.
The 2006 changes will also enable many wealthy people over 60 years old to divert a large part of their income into superannuation, thereby reducing their marginal income tax rates from 40-45% to only 15% or less. Not even a flat-rate income tax system would be as generous to them and as disadvantageous to people of more modest means.
Mid-life needs: The scheme unfairly favours people whose need for savings arises in their retirement rather than only or also in earlier years. Many people may have at least as great mid-life needs in the event, for example, of ill-health, unemployment or child-rearing as they may have in retirement Moreover, many may wish to use savings for mid-life home purchase or re-training in order to reduce their vulnerability in later years.
This problem is of little significance to most higher-income people, who can readily meet the costs from mid-life income flows or relatively liquid savings. But it can cause considerable hardship amongst lower- and middle-income people, both before and during retirement, as well as increasing their calls on social security and other forms of public assistance.
Workforce participation: The scheme is unfair towards many people who have multiple employers during their working lives, especially if they are casual workers or their employers are not in the same industry. Many of them may experience great difficulties when trying to ensure that appropriate contributions are made by their employers, keep track of entitlements scattered across a number of different funds and avoid excessive erosion of small accounts by funds’ administration charges.
These problems discourage workforce participation by women, in particular. Workforce flexibility also suffers from the tax subsidies for superannuation being generally lower if people are self-employed rather than employees. Workforce flexibility for some older people is enhanced by aspects of the 2006 changes but income-tested age pensions continue to be a substantial deterrent.
Future generations: The scheme does not sufficiently address inter-generational inequity by restraining the costs that younger taxpayers in future decades will have to pay for the living and health costs of older people. As mentioned earlier, it also unduly reduces the resources which the younger generation will have available to meet their own mid-life needs.
The scheme threatens deeper intra-generational divides between rich and poor people, aggravated by greater inherited inequity. For reasons outlined below, it also threatens adverse impacts on the scope and effectiveness of long-term investment, economic development and employment opportunities for future generations.
This section focuses on priorities for modest reform of the superannuation scheme in order to improve its impact on the interests of individual Australians and the broader community. They involve reforms concerning contributions; withdrawals of benefits; fund earnings; and interactions with social security.
Recent Australian policy discussion in this area has tended to be so narrowly-focused that the reforms may seem radical. But they are modest when compared with complementing or replacing superannuation through schemes of the kinds that have been introduced or strongly supported in other times or places. These include, for example, schemes to provide “participation income”, lifelong savings, national compensation or social insurance.
The reforms canvassed below seek to
- improve the superannuation scheme’s ability to ensure decent living
standards (not just income) for all older Australians;
- improve its responsiveness to diversity and transitions in life
circumstances (not just traditional male careers); and
- strengthen national savings and investment (not just private savings).
Ever since the current scheme was proposed in the early 1990s, the Australian Council of Social Service (ACOSS) has pointed out the huge unfairness, inequity and complexity of the contributions tax system. As it predicted, the problems have worsened over time as key weaknesses have been exploited and complex but ineffective patch-ups have been adopted.
ACOSS proposal: ACOSS proposed a different and much simpler system which has been subsequently refined and provides an excellent basis for reform. In essence, it would require all contributions to be taxed at the marginal income tax rate of the particular beneficiary but with a “tax offset” to reduce the beneficiary’s liability.
Taxation at the beneficiary’s marginal rate of personal income tax already applies, in effect, to contributions by self-employed people and direct contributions by employees. But contributions by employers on behalf of employees are taxed at the flat 15% rate, even if they are in the top income tax bracket with a marginal rate well above 40%.
It is employer contributions, of course, which constitute the vast majority of superannuation contributions. This is partly because of compulsory employer contributions but also because of the spread of so-called “salary sacrificing” by which employers provide part of an employee’s salary income as a voluntary superannuation contribution, thereby reducing the employee’s tax liability.
The ACOSS proposal removes these unjustifiable discrepancies and distortions both between different types of contributions and by comparison with taxation of other forms of income. It also creates a sound foundation on which a clearer, better-targeted and more efficient system of tax subsidy for superannuation can be provided.
The subsidy is provided in the form of a simple “tax offset” which is a specified proportion of the size of all contributions by or for the beneficiary, up to a modest ceiling value. The proportion might be higher for, say, the first $500 of contributions. This offset is then paid into the beneficiary’s superannuation account at the end of each year.
Key impacts: The proportion and ceiling in ACOSS’s proposal substantially change the pattern of subsidies. They significantly increase subsidies for lower- and middle-income people, even for most of those who can attract government co-contributions under the current scheme. Wasteful subsidies for high-income people, however, are cut considerably.
Amongst other advantages, the proposal promotes national development through extra incentives for voluntary saving by sectors of the community who might not otherwise be able or likely to undertake it. It also cuts public expenditure on ineffective incentives to high-income people whose high level of saving is unlikely to increase commensurately.
The need for reforms along these lines is increased by the 2006 decision to remove tax on superannuation benefits. The waste and inequity arising from that decision are aggravated by the similar impacts which, as described above, flow from the system for taxing contributions.
The ACOSS reforms would provide much greater simplification than the 2006 changes. Amongst other things, they would reduce the types of contributions from four to one and thereby remove the current differences in rates, ceilings and co-contributions.
If the reforms are not adopted, at least the permissible level of voluntary contributions should be reduced considerably and should include all such contributions, whether salary-sacrificed or otherwise. This would help to moderate the waste and inequity which already exists and is aggravated by the overall effect of the recent changes.
The recent changes substantially increase the scope for tax avoidance by diverting income into relatives’ superannuation accounts. This is due especially to the removal of tax on benefits and of limits on lump sum withdrawals. The ACOSS proposal would reduce some of these problems but extra restrictions would remain necessary, especially for contributions to older relatives.
The 2006 changes not only remove the general 15% tax on benefits but also remove a number of rules about the size and timing of withdrawals. This includes removing the limits on withdrawal of lump sums and the requirements to make certain withdrawals upon retirement and reaching the age of 75.
The changes may have desirable impacts in some cases by facilitating phased retirement and/or more efficient use of accumulated benefits. But they will also help many wealthy people to avoid more tax by “washing” work income through superannuation and to obtain even larger public subsidies through “double-dipping” on age pensions. By contrast, the changes make low-income people more vulnerable to withdrawing too much too early.
These problems could be reduced by modifying, rather than removing, some of the previous restrictions. The lump sum limit could be raised rather than abolished or, preferably, could trigger a tax on withdrawals above the limit. The previous requirements to drawdown benefits on retirement and reaching 75 could be relaxed rather than abolished.
Similar problems arise from the slow pace at which the “preservation age”, after which some superannuation benefits can be withdrawn, is being raised from 55 years. An immediate increase in the age to 60 years would be logical and simpler, now that tax-free benefits are available from that age, as well as being less profligate with public resources. Exceptions would remain possible in cases of special need.
These options provide considerable flexibility without as much waste, unfairness and vulnerability as would flow from the recent changes. Crackdowns of this kind on abuse of the current system are fully compatible, however, with allowing some mid-life access to savings in an efficient, equitable and transparent manner. Options for doing so are considered later in the paper.
The 15% flat rate of tax on fund earnings greatly increases the wasteful and unfair discrepancies arising from the tax regimes for contributions and benefits. This arises from being a much lower rate than those which high-income people might face on many other types of investment but little, if any, lower than those which are likely to face lower-income people.
The system also aggravates undue distortions and inefficiencies in the investment of national savings between different types of investment vehicle and business enterprise. These problems arise especially from differences between superannuation funds and those entities which are subject to the usual corporate tax rates and impacts of dividend imputation.
These problems are important but are complex to address. They would be of much less concern if the regimes relating to contributions and benefits were reformed along the lines discussed above. On balance, adoption of those changes should be a higher priority.
Weaknesses in the superannuation system are greatly aggravated by weaknesses in the social security system, especially the age pension. Despite recent relaxation, the pension means test continues as a significant deterrent to phased retirement and to efficient investment of retirement savings, especially for middle–income people.
The avowed purpose and effectiveness of the means test has been further eroded by extending most pensioner concessions for medical and other expenses to almost all other old people. The same is true of the special income tax offset for “senior Australians” which now effectively relieves almost all older people of any income tax liability.
A simpler, more efficient and fairer approach would be to abolish the means test, tax the age pension and adjust superannuation concessions to create an overall pattern of subsidies which is fairer and more efficient. The changes could include the ACOSS-type of tax offset and could be designed to reduce the overall Budget impact of the pension and superannuation systems or to leave it broadly unchanged.
Problems also arise in relation to the eligibility age for the age pension. Fixing a high age can impact more harshly on people who have few realistic work options in their later years. The problem is aggravated by the fact that social security payments for people who are unemployed or have a disability have declined considerably in value and accessibility compared with age pensions.
The best response may be to reduce this decline in relativities rather than, for example, to have differential ages for age pension entitlement which might readily become unduly complex and unfair in operation. Adoption of a universal age pension, as proposed earlier, would increase the need to improve the value and accessibility of other mature age entitlements.
These problems of interaction exemplify the increasing inappropriateness of drawing a rigid distinction between so-called “retirement” and earlier stages of life. In this and other respects, key elements of the current age pension system and compulsory superannuation scheme reflect economic and social circumstances which no longer apply and will not return.
Other possible responses include, of course, moving towards a “participation income” system. These are, however, beyond the scope of the current paper.
Substantial reforms of the current superannuation scheme have been outlined above. Whether or not they are made, should the scheme be complemented with other subsidised savings accounts from which withdrawals can be made for purposes which are not limited to, perhaps do not even include, retirement ?
The superannuation scheme requires and encourages saving for income needs in old age, especially after retiring fully or substantially from paid work. There is no comparable scheme of subsidised savings accounts for major causes of mid-life expenditures such as child-rearing, ill-health, unemployment, housing or education.
As mentioned, however, the superannuation scheme does provide considerable scope for subsidised pre-retirement expenditure by wealthy people, without any restrictions on purpose. It also provides much scope for many of them to increase mid-life incomes for their relatives.
Middle- and low-income people, on the other hand, are much less likely to be able to take advantage of these opportunities. Moreover, they are required to forego wage income which might otherwise have been available to them in mid-life. Access to tax-free benefits at age 60 will usually be too late to help with entry into the housing market or raising children.
These problems are aggravated by the over-taxation of savings in bank accounts, to which reference has been made earlier. They are also aggravated by the adverse impacts on options for saving by younger generations that are flowing from house price inflation, large tertiary education debts and greater insecurity in the labour market.
The need for subsidised savings schemes is reduced by public provision of social security payments for families, unemployed people, people with disabilities etc, and also of free or subsidised health care, child care, education and rental housing. It is also reduced by income tax benefits for families and homebuyers and by loans for tertiary education fees.
Many of these measures are also adopted in other countries but at least two substantial differences should be noted. First, most European countries require saving for mid-life needs through social insurance contributions to a public fund which returns them with interest, and often a subsidy, in the event of ill health, unemployment etc.
Second, a number of countries have created subsidised savings account schemes which allow withdrawals for unlimited purposes or for specified purposes which may or may not include retirement needs. Some of these schemes are summarised below, together with others which have been proposed in recent years in Australia or elsewhere.
The United Kingdom now has three subsidised savings schemes. They include a scheme which is open to everyone (Individual Savings Accounts), a scheme which can be commenced on behalf of any child (the Child Trust Fund), and a scheme which applies only to some low-income people (the Saving Gateway).
Individual Savings Accounts (ISAs) are officially prescribed types of account with banks and other financial institutions. Any adult can open an ISA and pay in up to a fixed annual limit, either in one account or split between an interest-bearing account and an investment account. Competition to offer them has meant that fees are often lower, and interest higher, than for other accounts.
The accounts must be managed by an approved ISA manager, which can include banks, building societies or other types of financial institutions. No tax is payable on income or capital gains accruing to the account and unlimited tax-free withdrawals can be made at any time.
The Child Trust Fund (CTF) is sometimes called a “nest-egg account” scheme. It is based on tax-free government payments to special CTF accounts which can be opened for each child at birth. The payments occur at birth and age 7, and they are twice as high for lower-income families. Extra payments can be made by relatives or others up to an annual limit per child.
Funds in CTF accounts are invested in specially approved types of interest-bearing or investment accounts with a bank or other financial institution chosen by the parent. They do not affect eligibility for other benefits and cannot be withdrawn until the age of 18. Withdrawal or transfer to an ISA will then be tax-free.
The Saving Gateway (SG) is sometimes called a “matched savings account” scheme. It is being piloted in several different regions and enables low-income people aged 16-65 to open SG accounts with the officially designated bank. Contributions are matched by the government at a specified rate, and up to a specified limit, depending on the region.
The pilot SG accounts operate for 18 months, during which financial education is made available without charge. Participants’ contributions can be withdrawn at any time but the matching contributions are available only after the 18 month period and are based on the balance then in the account. The scheme does not involve any tax benefits.
Singapore has a long-standing Central Provident Fund (CPF) scheme for almost all workers. The savings are managed by the Fund, which is an official agency, rather than by private sector entities. Mandatory tax-free contributions by employers and workers are set at high percentages of wages but are reduced for older people.
The Government currently makes a small annual contribution, which is higher for low-income people, and voluntary contributions are permissible up to an annual level. The CPF pays tax-free interest to beneficiaries at fixed sub-market rates. These rates, and the levels of mandatory contribution, may vary according to prevailing economic conditions.
Subject to detailed limits on amount and timing, withdrawals may be made for specified types of health care, education, home purchase and low-risk investment. Some must be taken as low-interest loans or to pay for insurance. Withdrawals after 55 for any purpose are tax-free but must not reduce the balance below set amounts reserved to provide an age pension and health care.
The Netherlands is establishing a Life Course Plans scheme and phasing out the previous subsidy scheme which was aimed solely at saving for retirement. The voluntary scheme allows workers to save up to a standard percentage of their wages each year, with tax concessions applying to their contributions and also to any made by their employers.
Withdrawals can only be used to finance periods of leave from work or early retirement. The leave may be for education, caring for children or parents, ill-health or any other reason. Withdrawals attract tax concessions, with extra concessions being available if withdrawals are being used for parental leave.
A number of other schemes for subsidised savings accounts have been proposed in Australia during the last twenty years or so. In 2002, for example, a Senate Committee recommended consideration of a “tax preferred medium- to long-term savings vehicle” which could be accessed for purposes such as health, home purchase and education.
The Centre for Independent Studies recently proposed universal Personal Future Funds with initial flat-rate government contributions and annual compulsory contributions from the beneficiary (matched by tax cuts). Unemployment benefit would be abolished and Fund accounts could be drawn on during unemployment, sickness or retirement.
Voluntary contributions could be made to the Fund account to help meet health and retirement expenses. They would be facilitated by providing special tax concessions for people who opt out of entitlements to the age pension and government health benefits. Withdrawals could then be made for medical expenses as well as when out-of-work or retired.
The Chifley Research Centre commissioned reports several years ago on possible “nest-egg” and “matched savings” accounts. The options canvassed were broadly similar to the Child Trust Fund and Saving Gateway in the UK but with withdrawals possibly being limited to specified purposes such as education, housing, computers or starting a business.
Some non-government organisations have established small schemes for matched saving accounts. For example, the Brotherhood of St Laurence’s Saver Plus program involves selected low-income savers contributing to special bank accounts to pay agreed education expenses. No public subsidies are involved but several financial institutions are involved with the program and match contributions to the accounts which they hold.
In the US, a number of matched savings accounts have been established by non-government organisations with contributions from their own and other resources, sometimes including public subsidies. Often called Individual Development Accounts (IDAs), they are targeted at low-income people and usually involve personal advice and oversight.
The US is developing Health Savings Accounts which are available on a voluntary basis to people without Medicare or major insurance cover. The contributions, earnings and withdrawals attract tax concessions up to an overall limit. Unlimited withdrawals are permissible at any time but if made for non-medical purposes attract a tax liability.
Two US Senators recently introduced a Bill to establish Lifelong Learning Accounts which would attract tax concessions for voluntary contributions from employers and employees. They would be available to low- and middle-income people, with withdrawals being permissible for a wide range of educational activities.
China is developing a medical savings account scheme which attracts tax concessions. It is compulsory for workers and involves specified proportions of wages being contributed by them and their employers. It is used to pay smaller medical expenses with larger ones being met through a broader social insurance system.
In the UK, a forerunner of the Personal Future Fund proposal was outlined by the Adam Smith Institute and called Fortune Accounts. The Conservatives recently suggested Life Savings Accounts with voluntary contributions matched by government up to a fixed limit. Withdrawals could be for any purpose but lose some or all matching if made before age 65.
The Institute of Public Policy Research has canvassed ways of augmenting the Child Trust Fund scheme. Options for additional government or local council contributions include more progressive contributions as children get older, extra contributions if children are in care or doing voluntary work and matching contributions for saving by low-income families.
The main strands of argument for establishing these kinds of subsidised saving scheme are closely related to major changes in economic and social circumstances in recent decades. This applies especially to changes in technology, globalisation and roles for women that have greatly increased opportunities and vulnerabilities for many people in mid-life and old age.
Many people, for example, have benefited or will benefit from increased opportunities for education, work, parenting, leisure, mobility and independence. But many people have or will become more vulnerable to unemployment, under-employment, over-work, inadequate wages, family breakdown, loneliness and lengthy periods in frail health.
The first strand of argument emphasises that the independence and flexibility achieved by having substantial personal savings can greatly increase many people’s capacity to maximise opportunities and reduce vulnerabilities. Amongst other things, they may be less constrained by inadequacies or rigidities in government programs of assistance.
The second strand emphasises that, especially with an aging population, free or highly-subsidised public programs may become increasingly inadequate and unaffordable. Subsidised saving schemes can combat this risk, especially if designed to reduce public provision for higher-income people and maintain or increase it for lower-income people.
At a level of generality, the first two strands attract considerable agreement across a wide spectrum of political opinion. Very divergent views, however, are often exposed when considering detailed questions of design, especially in relation to desirable and likely impacts on lower-income people.
Common concerns are that, whether deliberately or otherwise, savings account subsidies can tend to favour the already wealthy, provide little if any help for the poor, and reduce both the resources and community support for direct public assistance. The design of subsidies and limits on withdrawals can also unduly constrain or distort life choices.
The third strand argues that public provision of services like health and education is often less effective than providing subsidies to help people save enough for delivery by the private sector. It is based on a belief that the efficiency and productivity of the general economy and of service delivery would benefit if the private sector had a greater role.
Critics argue, however, that the public sector is often more efficient than the private sector at delivering some key services itself or buying private services on behalf of consumers. They also regard further “crowding out” of public investment, especially for infrastructure, as harmful to long-term economic development.
These criticisms receive strong support from, for example, the comparative provision of health care in the United States and Canada. Moreover, recent expansion of private sector involvement in education in Australia and the United Kingdom appears to have benefited some families, often already wealthy, but aggravated the disadvantages of many others.
General purpose accounts: One option in the Australian context is to establish a general savings account scheme with tax concessions, broadly similar to the UK’s Individual Savings Accounts. Unless very highly subsidised, however, this would be too burdensome for many low- and many middle-income people if it was compulsory and very impractical or unattractive for them if it was voluntary.
Interaction with the superannuation scheme would need very careful attention to avoid undue complexity, rigidity and inefficiency. If the accounts were held with private sector institutions, this would be even more difficult to achieve than has been possible through Singapore’s single, publicly-managed Central Provident Fund.
The risk of cost and inequity might be reduced in some ways if participants had to “opt out” of some other forms of public assistance, as in the proposed Personal Future Fund and Fortune Account schemes. But those proposals would involve very considerable complexity, rigidity and disincentives as well as undue damage to other public programs of special importance to lower-income people.
Specific purpose accounts: A second option is to subsidise savings accounts for specific purposes such as medical or education expenses. The case for doing so is much weaker in Australia than in countries which do not have close equivalents of our Medicare, compulsory superannuation and extensive public education. Moreover, the interaction with superannuation could create major complexity and inefficiency.
Some people argue that the ambit of our public provision should be reduced or involve larger contributions from users. These trends are occurring anyway and may require greater emphasis on private saving. But there are great risks of aggravating over-consumption and over-charging in services for which the savings may be used, as well as eroding public programs of great value to low-income people and to social cohesion.
Subsidies for specific rather than general purpose accounts may improve some people’s willingness to save. But they would reduce it for other people who do not have the same risks or interests and prefer greater flexibility. They also raise substantial risks of depriving people of access to their savings when unexpected problems arise in other areas of their lives.
Children’s accounts: Another approach is to subsidise saving accounts for all children, along the lines of the UK Child Trust Fund. This would reduce problems of interaction with schemes for adults, such as superannuation, while helping low-income people to develop enough savings to take advantage of those schemes after reaching adulthood if they wish to do so.
The CTF’s universal approach is costly but it is moderated by progressive elements and increases the prospect of broad political support and sustainability. It also provides a basic framework into which targeted “top ups” from government and other sources can be contributed.
Matched savings: A fourth option is to focus especially on low-income people by creating a voluntary matched savings account scheme broadly similar to the UK’s Saving Gateway. It would not be a substitute for direct income support and services but it could be cost-effective if limited in size and duration and managed by local welfare agencies.
Summary: There is much to be said for the “nest-egg” and “matched savings” approaches outlined as the third and fourth options above. Both could help to strengthen the effectiveness of the superannuation scheme while not creating complex interactions with it in either policy or administration.
In particular, a “nest-egg” scheme along the general lines of the CTF could strike a balance between universalism and targeting that is constructive, affordable and politically sustainable. It could stimulate and facilitate top-up contributions from government or other sources to assist lower-income and other disadvantaged people.
Important issues, arise, however, about how the “nest-egg” funds should be held and used before withdrawal. Low-income people, in particular, may be much better served by publicly-held interest-bearing accounts (perhaps with a guaranteed interest rate) rather than, as in the CTF, having to choose a private manager and consider investment risks.
There is widespread agreement that low-income people need further assistance to strengthen their assets through subsidised saving. Even if reformed along the lines proposed earlier in this paper, the superannuation system would remain insufficient for that purpose unless it was also broadened to address their mid-life needs.
There is also a strong case for providing middle-income people with more flexibility to draw on subsided savings accounts for some mid-life needs. This should be achieved efficiently, equitably and transparently rather than, as now, through lax superannuation rules about pre-retirement withdrawals, lump sum withdrawals and intra-family transfers.
These arguments will become even more pressing as a substantial proportion of people in the superannuation system accumulate savings that will enable them to enjoy very comfortable living standards in retirement - better perhaps than in mid-life. They, and their children, will become much less willing to be precluded from some early access.
Closer attention also needs to be given to the security of subsidised accounts held by the private funds and to distortions in national investment arising from their increasingly commanding share of Australian financial resources. A greater element of government involvement could address both of these concerns, which also will increase as the current scheme matures.
Two possible ways of addressing these needs are outlined below, each of which also involves reforming superannuation as proposed earlier. The first essentially broadens the availability of superannuation accounts for mid-life needs. The second builds on the superannuation system to develop an integrated scheme of lifelong savings accounts.
These changes would further strengthen the case for enabling or requiring portion of the funds held in these accounts to be utilised for investment in national development, whether through direct public management or otherwise. The section concludes by looking briefly at ways in which that approach could be implemented.
A general proposal: In the early 1990s, when compulsory superannuation was being introduced, ACOSS clearly identified the failings which remain at the core of the system today. It proposed restructuring the tax concessions along the lines outlined earlier in this paper. It also proposed broadening superannuation to allow some withdrawals for mid-life needs.
As subsequently refined, the latter proposal involves allowing one-third of a person’s superannuation account balance to be withdrawn for any purpose after at least five years of saving. This “early access” would be subject to limits on the amount of any one withdrawal and on the overall amount withdrawn before retirement.
The proposal has some similarities to the rules for withdrawals from Singapore’s CPF but without any limits as to the purpose for withdrawals. Limits on purposes may reduce some unwise use of savings but they are also likely to prevent some very wise use and also be expensive to administer. Moreover, they do not effectively restrict many wealthy people who can call on other resources which are held elsewhere.
Early withdrawals could generate public expense by increasing eligibility for pensions and other assistance in retirement. However, the means tests have already been effectively relaxed very considerably and, as proposed earlier, a universal age pension could be introduced in conjunction with tighter limits on high-end superannuation tax concessions.
Purposes for withdrawal: After much debate, neither the Child Trust Fund nor Saving Gateway schemes in the UK was introduced with limits on purpose. Some of the possible limits which were canvassed, such as allowing withdrawals for “gap years” or for spending in the Christmas period, exemplify the risk of excessive rigidity and unfairness.
A much-discussed option in Australia has been to allow early access only for the purpose of home purchase, partly because it would tend to reduce income needs in retirement. On the other hand, it would discriminate against the increasing number of people who still could not afford to buy or for whom home ownership is inappropriate. It might also aggravate house price inflation
Many other types of mid-life expenditure could also substantially reduce retirement pressures on both private and public resources. They include preventive health care, child rearing, education and re-training. The Central Provident Fund allows withdrawals for some purposes of these kinds, although they are subject to complex and somewhat arbitrary limits and differentiations.
Additional contributions: ACOSS envisaged that if its early access reforms were adopted the current 9% compulsory contribution could perhaps be raised gradually to 12%. This was to be heavily conditional on also restructuring the tax subsidies as it proposed. Nevertheless, many low-income people could still be seriously disadvantaged by an additional 3% requirement unless, of course, it was provided by the government.
Amongst other things, appropriate options for early access could provide more potential than the current scheme for lifting voluntary saving by low- and middle-income people and for reducing opposition to a higher compulsory rate for middle and high-income people. It would be much more efficient, fair and sustainable than the current system.
Insurance and loans: Consideration could also be given to encouraging or requiring superannuation funds to offer some kinds of insurance or loans to account holders. Small risks of major expenses, whether in mid-life or later, are often best handled by insurance rather than over-provision of savings. Mid-life loans, such as for housing, may help to reduce outgoings in retirement.
Insurance or loan options might or might not involve withdrawals from superannuation accounts. Singapore’s CPF allows withdrawals for some forms of health and housing insurance. Withdrawals for insurance are also involved in some proposals for medical savings accounts and “opt out” schemes like the Personal Future Fund.
Some Australian superannuation funds arrange housing loans or insurance for account holders at concessional rates obtained through the fund’s bargaining power or equity-holding in the lender. They cannot generally allow early access to accounts for such purposes but Labor has proposed allowing them to be used as security for some loans.
An integrated system: An integrated lifelong savings system could begin with establishment of Lifelong Savings Accounts (LiSAs) for all newly-born children. Phased Government contributions could be made up to the age of eighteen, with a modestly progressive rate structure. Voluntary contributions would be permissible up to a low limit.
The commencement of phased payments from birth enables the system to be introduced in a more affordable, flexible and politically feasible manner than if they were made in full when people reached adulthood. It may also facilitate a more flexible and calibrated balance between universality and targeting.
When the beneficiary enters the workforce, superannuation contributions could also start being directed into the account. The balance would then become subject to the superannuation regime but early withdrawals would be allowed along lines broadly similar to those proposed by ACOSS. Limits on withdrawals would be more flexible in a lifelong system of this kind than if it was just a broadened form of superannuation.
This lifelong savings system extends the ACOSS proposal for early access by establishing a flow of contributions from birth which is then joined by the flow of superannuation contributions to provide a stock of mid-life and retirement savings. If properly designed, this would improve both equity and efficiency.
The system has some similarities with Singapore’s Central Provident Fund scheme. It could have greater breadth and flexibility than that Fund, however, and savings could continue to be held and invested by the private sector rather than the kind of official entity which manages all of the CPF.
Options for expansion: Matched savings account schemes could also be linked with the LiSA system. For example, all or some of the savings generated by them could be compulsorily or voluntarily transferred to a LiSA. The transfer could be to the saver’s own account or to that of a dependent.
LiSAs could also be used as a vehicle for receiving other forms of targeted public assistance without unduly aggravating rigidity, complexity and administrative cost for both the sources and recipients. The likelihood of opposition or stigma arising from these kinds of assistance might be reduced significantly by the basic universality of the system.
As canvassed above in relation to early access to superannuation, the general monetary limits on withdrawals from LiSAs could be relaxed where the purpose is to obtain certain types of insurance. Concessional loans or other special benefits might be obtained for account holders but tight regulation might be necessary to prevent abuse or inequity.
The current superannuation system is gradually being expanded and exploited to allow greater scope for contributions while not working, for pre-retirement withdrawals and for purposes such as home purchase and health insurance. It would be more rational, efficient and equitable to transform it into a LiSa system along the lines described above. It would also create a much simpler system to understand and operate within.
Investment in national infrastructure may not maximise direct profit for investors but will provide substantial benefit for the broader community to which they and their families belong. The investment may be made by governments, non-profit entities, “ethical investors” etc, and may include public-private partnerships.
The private superannuation funds control a very large and rapidly growing share of Australian savings and investment. This is almost entirely due to government intervention through compulsion and, to a lesser extent, incentives. The capacity of governments and individuals to direct investment into national infrastructure has been commensurately reduced.
The extent to which superannuation savings may be vulnerable to market volatility, incompetent or dishonest management, high administration charges and lost accounts is not yet widely understood in Australia. This is due largely to the unbroken run of economic growth over the period since the compulsory scheme was established. But a different picture is likely to emerge when that run comes to its inevitable end.
National Development Bonds: One response to these issues is to require the funds to invest a specified proportion of all annual contributions in government bonds (which could also be directly available to the public). The government bonds could carry a guaranteed rate of return relative to market interest. They could be called National Development Bonds and be earmarked principally for long-term infrastructure. Utilisation of the revenue could be the direct responsibility of government or an official entity such as a revamped Future Fund.
This approach reduces the adverse impacts on security of accounts and efficiency of investment markets which would arise from the further concentration of savings in private funds which is occurring as the compulsory system matures. The value of savings controlled by superannuation funds has been predicted to quadruple in little more than a decade from now.
If compulsion is eschewed, a substantial incentive for this type of investment could be provided. This approach was formerly by the so-called “30/20 rule” by which certain tax concessions for life assurance or superannuation funds were dependent on at least 30% of their assets being invested in public securities, including at least 20% in Commonwealth securities.
Lifelong Savings Accounts: A second approach is for the proposed Lifelong Savings Accounts (LiSAs) to be managed by a public agency until the beneficiary turns 18. Subject to the government guaranteeing a rate of return relative to market interest rates, the trustee constraints on investment would not apply fully to the agency.
Adult beneficiaries could be entitled to transfer to a government-run Personal Savings Fund. This could be of special interest to people who, for example, are likely to have many different employers and not necessarily remain in the same industry. It could substantially reduce their administration charges and risk of lost contributions, as well as increasing governments’ ability to influence and regulate private funds appropriately.
Trustee obligations: A third option is to require private fund managers to establish specified types of national infrastructure accounts into which beneficiaries can choose to place all or part of their contributions or accrued entitlements. Managers could be required to publish their levels of investment in these accounts for comparison with voluntary benchmarks developed by governments or community organisations.
This approach could include clarifying and/or modifying the application of trustees’ duties. For example, it could be officially emphasised that those duties do not preclude investment which, although not necessarily maximising direct returns to members, strengthens the economic and social strength of the nation in which they live. A rebuttable presumption could be established that up to a specified proportion of total assets can be appropriately invested in this way.
The current superannuation system is excessively inefficient, unfair and complex. It involves hugely generous subsidies to many wealthy people but little, if any, net assistance for many lower-income people. It also unduly reduces governments’ capacity to strengthen national development, especially through investment in long-term infrastructure.
The system is targeted excessively towards older people at the expense of younger people and towards needs in old age at the expense of those arising earlier in life. In these and other respects, the scheme does not adequately promote efficiency or inter-generational equity.
The superannuation system should not be a magic pudding for the wealthy, a straitjacket for middle-income people and an unreasonable burden for the rest. It would be substantially improved by taxing all superannuation contributions at the beneficiaries’ marginal income tax rates but then reducing their tax liability by a proportion of the contributions up to a modest level.
This approach would create a much simpler, fairer and more efficient system, especially if complemented by removing the age pension means test. Some early withdrawals could then be allowed from superannuation accounts in order to meet mid-life needs, preferably without limiting the purposes for the withdrawals.
A medium-term goal could be to establish a system of subsidised Lifelong Savings Accounts (LiSAs) which includes government contributions at birth, compulsory superannuation contributions in the workforce years and also voluntary contributions from the beneficiaries or other sources. Tax exemptions or concessions could apply to phased withdrawals from the accounts up to fixed limits.
A significant proportion of moneys held in superannuation accounts or LiSAs should be made available for national infrastructure investment which may not maximise direct profit but improves the economic and social strength of the nation in which members live. This could be achieved by vesting some contributions in a government fund with a guaranteed rate of return and/or vigorously encouraging national infrastructure investment by private funds.
The failings of the current superannuation system can readily be obscured by vested interests. Reform should be a very high priority for people who are concerned about social justice and alleviating hardship, as well as for those who are concerned about efficient and sustainable economic development.
NOTES ON SOURCES
INTRODUCTION
For details of a range of subsidised savings account schemes, see “Complementing Superannuation” below.
For superannuation holdings and other household wealth, see eg, ABS 2003; APRA 2007; Headey et al 2005; Willis 2007.
For tax subsidies to different kinds of saving, see, eg, Yates 2003; Productivity Commission 2004; Commonwealth Treasury 2006b.
REFORMING SUPERANNUATION: SOME KEY PROBLEMS
The current scheme
For household saving and debt levels, see ABS 2007; OECD 2006.
For future public costs of an aging population, see the Intergenerational Reports (Commonwealth Treasury 2002a and 2007b); FitzGerald 1996; Dowrick and McDonald 2002; Mitchell and Mosler 2003; Access Economics 2006.
For relative distribution of income and assets, see, eg, ABS 2003, 2004, 2006.
For descriptions of the 2006 changes, see, eg, Commonwealth Treasury 2006a, 2006d, 2007a; ACOSS 2006; Mackenzie 2006; Bateman and Kingston 2007.
Problems of inefficiency
For impacts on household saving, see, eg, ACOSS 2006, Antolin 2005; FitzGerald 1996.
For Budget pressures and costings, see, eg, Commonwealth Treasury 2006b, 2006c; ACOSS 2002, 2006; Institute of Actuaries 2006; FitzGerald 1999; Bateman and Kingston 2007.
For uncertainty of final benefits, see, eg, Mack 1996; McAuley 2006; ACOSS 2002, 2006; Davidson 2003; FitzGerald 1996.
For examples of the complexity of the scheme, see, eg, ACOSS 2006; Commonwealth Treasury 2006a, 2006d.
For tax avoidance options under the 2006 changes, see ACOSS 2006; Mackenzie 2006; Bateman and Kingston 2007.
For impacts on investment and trustee duties, see, eg, Kates, 1996; McAuley 2005, 2006; Willis 2007; AIST 2005.
Problems of inequity
For retirement living standards and the impacts of superannuation, see, eg, Commonwealth Treasury 2002b, 2006a, 2006d, 2007a; FitzGerald 1996; ASFA 2002; Senate 2002a; Saunders et al 2004; Rothman and Bingham 2004; CPA Australia 2004; ASFA 2005b; Kelly and Harding 2006; Westpac-ASFA 2006; WatsonWyatt 2006.
For impacts on low-income and wealthy people, see, eg, ACOSS 2002, 2006; McAuley 2006; Mackenzie 2006; Bateman and Kingston 2007.
For impacts on mid-life needs, workforce participation and women, see, eg, Fitzgerald 1996, 1999; ACOSS 2006; Mack 1996.
REFORMING SUPERANNUATION: SOME OPTIONS FOR ACTION
Changing the contributions tax
For the ACOSS proposals, see ACOSS 2006. For earlier versions, see Disney 1993, 1996; ACOSS 1988, 1989.
For other proposals, see, eg, FitzGerald 1996, 1999; Knox 1996; IFSA 2006; ASFA 2005a; Clare 2006; Bateman and Kingston 2007; AI Group 2007.
For the incidence of salary sacrificing, even prior to the 2006 changes, see ANOP 2006.
Phasing withdrawals
For the impacts of the recent changes, see, eg, Commonwealth Treasury 2006a, 2006d, 2007a; ACOSS 2006; McAuley 2006.
For other proposals, see FitzGerald 1996, 1999; Bateman and Kingston 2007; Mackenzie 2006; ACOSS 2006.
Interactions with social security
For a universal age pension, see, eg, Knox 1996.
For relativities between social security payments, see, eg, ACOSS 2005
For “participation income” proposals, see, eg, Atkinson 2007.
COMPLEMENTING SUPERANNUATION: CURRENT SCHEMES AND PROPOSALS
Some current schemes
For UK schemes, see, eg, Child Trust Fund 2007; UK Treasury 2007a, 2007b; Institute for Fiscal Studies 2006.
For other schemes, see Central Provident Fund 2007; Netherlands Ministry 2005a, 2005b; Balkenende, 2005; van der Meer and Leijnse 2005.
Other schemes and proposals
For Australian proposals and schemes, see, eg, FitzGerald 1999; Senate 2002a; Saunders 2005, 2007; Allen Consulting Group 2003; IPPR 2003; Brotherhood of St Laurence 2007; Richardson and McAuley 2005; Howe 2007.
For other proposals, see Allen Consulting Group 2003, 2004; Butler and Pirie 1995; Maxwell 2005; Maxwell et al 2006; CAEL 2007.
COMPLEMENTING SUPERANNUATION: SOME OPTIONS FOR ACTION
The case for change
For discussion of the arguments, see, eg, FitzGerald 1999; Kelly and Lissauer 2000; Bynner and Paxton 2001; IPPR 2003; Allen Consulting Group 2003, 2004; Saunders 1994; Saunders 2004; Saunders 2005; Paxton et al 2006; Howe 2007.
Options for action
For Individual Savings Accounts, Saving Gateway and Child Trust Fund, see references for UK schemes in preceding section
For Personal Future Fund and Fortune Accounts, see Saunders 2005, 2007; Butler and Pirie, 1995.
For Central Provident Fund, see Central Provident Fund 2007; FitzGerald 1999.
BROADENING SUPERANNUATION
Extending access to superannuation
For the ACOSS proposal, see ACOSS 2002.
For discussion of other early access options, see, eg, Senate 1994, 2002b; Commonwealth Treasury 1997; Disney 2003.
Developing a Lifelong Savings System
For references to possible lifelong systems and other forms of integration with superannuation, see, eg, ACOSS 2002; Emmerson et al 2005; IPPR 2007; FitzGerald 1999; O’Donnell 2001; Shirlow 1992.
Strengthening community investment
For trustee’s duties, see, eg, Willis 2007.
For predicted size of superannuation fund holdings and its implications for investment patterns and trustee responsibility, see,eg, Weaven 2007.
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[∗] Julian Disney is Professor and Director of the Social Justice Project at the University of New South Wales. Research assistance for this paper was provided by Jason Siu.
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