Busting the superannuation ‘retirement trap’ myth

Jeremy Cooper, retirement income chairman at Challenger, has comprehensively debunked the myth of the ‘retirement trap’ – the notion that the benefit of having extra superannuation savings is more than offset by reduced access to the Aged Pension:

Age pension payments reduce at a rate of $3 per fortnight for each $1000 in assets over the thresholds. This amounts to $78 a year, or a rate of 7.8 per cent. It’s called the taper rate.

Many say it’s too hard to earn income at a rate of 7.8 per cent a year to replace the age pension for which wealthier retirees are being overlooked. They say retirees who have built up savings above the thresholds are worse off than if they hadn’t saved anything.

The “trappist” view wrongly compares investment returns on savings above the thresholds against the cash flows received from the age pension. They are not so easily compared. Using an investment return lens ignores how retirees can use their capital to their benefit.

Retirees don’t need a return as high as 7.8 per cent to beat the taper rate. They can spend some of their capital to match the age pension withdrawn. This has the advantage that they will get more age pension in future years, so they might eventually need to spend less capital over time.

Too right. Superannuation nest eggs are not supposed to be preserved so that they can be passed on to one’s heirs. They are supposed to be drawn down to fund one’s retirement.

Consider a 65-year old with a superannuation nest egg of $500,000 earning 5% per annum.

Someone with a ‘trappist’ mindset would argue that this nest egg would only provide $25,000 a year in income (i.e. 5% times $500,000), when in fact $38,200 is available over 20 years if principal is also drawn down.

We should also remember that the Coalition in 2017 merely returned to pension taper rate to the level that existed prior to Peter Costello halving it in 2006.

Costello’s changes had created the ridiculous situation whereby retiree home owning couples with $1.15 million in other assets, and home owning singles with $775,000 of other assets, could still qualify for the part Aged Pension along with the Pensioner Concession Card.

While some wealthy retirees would no longer keep receiving the part Aged Pension (but would keep their concession card) under the Coalition’s 2017 reforms:

ScreenHunter_7396 May. 22 11.38

The Government would provide additional funding to pensioners with fewer assets:

ScreenHunter_7397 May. 22 11.42

The reform package was projected to save the Budget (and younger Australians footing the bill) some $2.4 billion over four years, whilst improving the lot of pensioners without significant assets. On equity and sustainable grounds, it was a policy no-brainer.

As an aside, the best way to expand to Aged Pension without costing taxpayers is to abolish the compulsory superannuation system, whose concessions cost the Budget $43 billion a year and are poorly targeted to high income earners:

The obscene cost of Australia’s superannuation system is preventing the Age Pension from being lifted.

Unconventional Economist
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Comments

  1. Had this exact conversation with my 72 year old mother in law yesterday. She was worried that with dividends falling she might have to cut back on things like getting her hair done. I pointed out to her that she has a substantial nest egg (she doesn’t even qualify for the part pension) and shouldn’t be afraid to use that rather than cut back on things that make her happy.

    She was worried that she might need that nest egg for emergencies in case the house needed repairing etc. It a was as very hard to convince her that she should spend her savings on consumption.

  2. Mining BoganMEMBER

    That trap thing is “common knowledge” that is hard to dislodge. We’ve got redundancy sweeping through the place like a virus so many conversations amongst the older crowd about affording retirement. The idea of spending capital is absolutely abhorrent. They’ve always thought I’m wealthier than I am but once they found out I would ‘have’ to spend capital they don’t think I’m wealthy at all.

    There’s going to be a lot of disappointment in boomer retirements. Their sadness may be worse than the lives of the kids that Strayan greed has set up.

  3. Leith, not necessarily disagreeing with this article other than it is ignoring the consequences of inflation. Someone may have saved up $500k in shares when interest rates/yields were higher, and those shares may now be worth $1m now thanks to ZIRP. Let’s say they withdraw half of that over the next 10 years, and interest rates rise again over that time. In real terms, they now only have half the shares they were relying on for retirement.

    I know it sounds like crying wolf because I gave the baby boomer example. But consider that all the younger generations are currently saving for retirement with ZIRP. The big crisis will be a future inflationary shock to everybody’s retirement plans.

  4. Tassie TomMEMBER

    I think the taper rate is too high, not because of the “taper trap”, but because “cash under the bed” that the government doesn’t know about is now the best investment around. A guaranteed 7.8%pa after tax. Go long security systems and weapons.

    Just make it a universal basic income. No more pension age – everyone gets the age pension whether they’re 20 or 90. And pay for it by spreading the burden of taxation to capital, including super.

    • “but because “cash under the bed” that the government doesn’t know about is now the best investment around.”

      That is some outstanding pre-retirement financial planning right there.

  5. Que our entitled older Australian leaners….3…2…1

    How long till the next election? I envisage a campaign with tag line… “Their spending our money on that?!”

    Case study one; a younger working person (YWP) shown the ugly, tarted up bathroom of a millionaire friend.

    “Oh the government payed for it.”

    YWP: “You mean WE paid for this?”

    Case study two; retired person in Point Piper mansion to a younger working person (YWP) renovating their new indoor cinema-plex. “Yeh, I’m on the pension now.”

    Where are the ads like this? Sound economic managers meme can be totally killed off for the next generation.

  6. SoMPLSBoyMEMBER

    The Seniors Health card can still be obtained even if you have assessable assets above the upper threshold for receiving the Age Pension; ( single homeowner upper is $578,250 and couple upper is $869,500.)
    If the single’s income is below $55,808/yr or the couple’s is below $89,290, you’ll get the card.

  7. The problem with spending your capital is that you don’t know how long you are going to live, don’t know what expensive problems you are going to encounter along the way, and don’t know about any future risks to the economy that might make your investments worth a lot less. These risks would be pooled with a more generous universal pension instead of superannuation tax concessions, the benefits of which primarily go to the top 10%. Our aged pension is actually among the least generous in the OECD, which is why people are reluctant to rely on it completely, unless they have no choice. See

    https://data.oecd.org/socialexp/pension-spending.htm

    Most OECD countries also tax superannuation lightly or not at all in the accumulation phase and then tax withdrawals in the pension phase as normal income. We do the opposite, allowing very rich people to enjoy very generous (for them) tax concessions in the accumulation phase and then pay no tax in the pension phase.

    https://www.oecd.org/daf/fin/private-pensions/Tax-treatment-of-retirement-savings-Policy-Brief-1.pdf

    These other countries also tend to do a much better job of restraining fee gouging.

    https://read.oecd-ilibrary.org/social-issues-migration-health/pensions-at-a-glance-2017/operating-costs-of-private-pension-systems-and-fees-charged-to-members_pension_glance-2017-38-en#page1

  8. Good analysis till:

    ‘the best way to expand to Aged Pension without costing taxpayers is to abolish the compulsory superannuation system, whose concessions cost the Budget $43 billion a year and are poorly targeted to high income earners’

    Would that not be throwing the baby out with the bathwater? Simply pare back the concessions that presently allow wealthier to lower their taxes.

    The reason super exists is the increasing imbalance between (decreasing) tax paying working age population vs. (increasing) retirees in the permanent population; also using temporary migrant churn over as net financial contributors to support the tax base providing services accessed only by citizens.