Australia’s retirement income system is built on three pillars: the age pension, the superannuation guarantee (or “super” as it is commonly known in Australia), and voluntary savings. This structure is also present in many developed and developing countries. The superannuation guarantee for most employees is a mandatory defined contribution of 9 percent of salary, and has been widely acclaimed around the world. Australian employees can now choose their superannuation funds, their voluntary contribution levels, and their investment strategies pre- and postretirement, as well as their drawdown strategies.

However, after a long period of calm and growth, Australians are for the first time in many years feeling uncertain about their superannuation schemes and their confidence in the broader retirement income system. Market volatility and negative returns have shaken consumer confidence. This has been exacerbated by legislative change. In the 2009 Commonwealth Budget, the maximum level of superannuation contributions eligible for concessional tax rates was halved, which has diminished the appeal of superannuation schemes for many people. These changes, coupled with a number of government reviews of the superannuation system currently being undertaken, have created a “perfect storm” for change. The Australian public, the superannuation industry and the government are all united in their beliefs that the Australian retirement system is ready for reform. It’s now time for the government to make decisive change and not merely tinker around the edges of the superannuation system. 

Mercer’s recent report Securing Retirement Incomes: Risks and opportunities for Australia’s retirement income system examines the risks that threaten the adequacy and sustainability of Australia’s retirement income system. The report suggests several key areas for reform and recommends that superannuation funds should review their default investment options to incorporate a whole-of-life outlook, and develop additional, and more diverse, postretirement income investment products.

The impact of the global financial crisis (the crisis) on Australians’ attitudes toward retirement and superannuation

Most Australians’ superannuation savings have been negatively affected by the crisis, which has shaken confidence in the superannuation system. It’s important for funds, employers and the government to understand Australians’ changing attitudes toward retirement and superannuation throughout the recent economic downturn.

Mercer surveyed 519 working Australians aged 40 - 65 to better understand current attitudes toward superannuation and retirement. We discovered that the number of people who expect to defer retirement until age 70 or older has nearly doubled since 2006 due to the impact of the crisis. The survey also found that 40 percent of participants said they will delay their retirement as a result of the crisis. Sixty percent aged older than 60 years will delay retirement. Nineteen per cent said the crisis could extend their time in the workforce by at least six years and 33 percent said by up to four years.

Given that superannuation remains the No. 1 source of anticipated retirement funding for most Australians, it is not surprising to see that people are planning to delay retirement in the current economic environment. It is the extent of the delay that is surprising as well as the speed of the change. These changing attitudes will have implications for employers and superannuation funds and potential implications for member engagement and retention. They could also influence productivity in the workforce, if older workers are delaying retirement, particularly if they would prefer not to be working.

Both superannuation funds and employers have an important role to play in communicating with and educating their members and employees about the role of superannuation when planning for retirement. Understanding these changing attitudes toward superannuation and retirement is essential when approaching this communication.

Retirement investment options need a “whole of life” perspective

One of the key issues that needs to be addressed in any retirement income system is adequacy: How much is enough to ensure adequate income to last retirees for the remainder of their lives, once they have finished working?

Many Australians spend their entire working lives contributing to the default investment option in the superannuation fund selected on their behalf. A standard default for all fund members doesn’t accommodate the different needs that, for example, a younger member may have compared to someone approaching retirement.

A “choice-of-fund” environment in Australia has also increased sensitivity of superannuation funds to peer-group risk. Funds can be inclined to place excessive focus on minimizing short-term peer-group risk rather than maximizing long-term returns.

We believe funds should consider adopting whole-of-life target date approaches for their default investment strategies. By this we mean that investment target or maturity dates should be focused not on retirement dates, but instead beyond retirement – designed to produce returns for the whole-of-life. After all, the average Australian will live for at least 20 years after retirement. Ideal strategies would allow younger members to exploit their tolerance for investment risk to gain additional returns while defaulting older members to strategies that address their needs for lifetime income in retirement, still recognizing that there may be a need for some capital shortly after retirement.

The importance of this is illustrated by Mercer’s modeling that shows that 66 percent of people’s retirement income will come from postretirement investment returns, whereas only 6 percent will come from contributions and 28 percent from preretirement returns.

Figure 1. Anticipated sources of retirement income

Target date default strategies with a whole-of-life outlook could permit seamless transition from the accumulation phase of retirement planning into the retirement income phase, where the retiree’s superannuation fund is used to supply an income while the money remaining in the pot continues to produce investment returns.

Longevity risk and income streams for retirement

The age pension is currently the mainstay of longevity insurance in Australia, and as retirees age and reduce their postretirement assets, the importance of the “first pillar” the age pension, increases.

Taking a whole-of-life view of retirement savings is difficult when you do not know how long you are going to live. Longevity risk – the risk that your savings will run out before you die – is naturally a key concern. Australia needs a system that enables people to maximize contributions and returns throughout their contributing lives (accumulation) and mitigate longevity risk in their retired lives (decumulation). 

Australia’s superannuation system is not yet fully mature and most funds have focused on the accumulation phase only. Sometime in the next 10 to 15 years, as the superannuation guarantee system matures and as the Australian population continues to age, there is an expectation that benefits payments will start to be larger than contributions. This will necessitate a shift in how funds operate and engage their members.

In terms of product design, protecting against longevity risk is a difficult problem to solve. An “average” life expectancy cannot be used – very few people are average.

Ultimately funds will need to find product solutions that offer three main benefits: access to capital with flexible income options, protection from risks such as longevity and inflation, and good investment returns. No one product is going to meet these needs, and some level of compromise will be required.

Australians cannot rely on the age pension alone as a fallback to guard against longevity risk. Australia’s annuity market is severely underdeveloped. A greater range of retirement income products needs to be developed to ensure that all Australians have increased financial security in retirement and that taxpayers aren’t left carrying an unsustainable burden as the population ages. 

Addressing risks, challenges and opportunities

Possibly more than ever before, with an aging population, and in the wake of the crisis, Australia needs to address the risks, challenges and opportunities to ensure a secure retirement income system and thereby improve the adequacy of Australians’ retirement savings. For the rest of the world, many aspects of the Australian system have been viewed as a forerunner of best practice. So many countries will no doubt be watching closely to see what Australia does.

Australians are ready for change. The time is right for the government and superannuation funds to step up and grasp the opportunities to create products and tools to empower people to maximize their retirement income throughout both their working and retired lives.