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Chapter 1: Determinants and measures of living standards in retirement

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The level of income which people have available to them in retirement will be a key determinant of their retirement living standard. Most people's income in retirement will be funded from a combination of superannuation assets, other private savings and a full or part-rate Age Pension. In combination with the taxation system, these income sources will endow retirees with a particular level of spending capacity.

Any assessment of the adequacy of retirement incomes therefore needs to have regard, as far as possible, to all of the various income sources available to retirees. At a minimum, no discussion of adequacy can be considered complete without incorporating the contribution from both superannuation and the Age Pension. However, the living standards and wellbeing of retirees will also be affected by factors outside of the retirement income system. These include tangible factors such as home ownership and the level of public services and government benefits and subsidies, as well as less tangible considerations such as family relationships and social contact.

The ability of Australians to accumulate private retirement savings will be influenced by various factors. These factors include, for example, Government policy in relation to compulsory superannuation, the period of participation in the workforce, the level of remuneration, investment returns on retirement savings (particularly superannuation assets) and the level of fees and charges imposed by superannuation providers.

Labour force experience has a major impact on the ability of individuals to save and hence on their retirement incomes. This experience varies across the community. While some people experience periods of 40 years or more in stable full-time employment, others experience long periods of unemployment or of casual or part-time work. Early retirement has also become increasingly common, although the gradual increase in the superannuation preservation age (applying to people born after 30 June 1960) to age 60 may have an impact on this in the future. Income obviously also varies across the pre-retirement population.

The level of retirement income available will also be affected by earnings achieved on savings balances and by fees and charges incurred in generating these earnings. The costs incurred relate to a wide range of services provided, including fund administration and trustee costs, asset management charges and the provision of financial advice. While different studies report different levels of fees and charges, it is clear that they are significant and can have a sizeable impact on retirement incomes3. Small differences in investment returns, sustained over the accumulation period, can also have a major impact. Government policy is not to regulate the specific investments that can be made by funds, nor the permissible level of fees and charges. In this context, trustees are obliged by law to prudently manage funds in the interests of members, while the efficiency and competitiveness of the superannuation sector is an important element in minimising fees and charges.

One of the key regulatory tools for ensuring that consumers are in a position to make well-informed decisions is the licensing, conduct and disclosure framework that applies to providers of financial product services and advice. The Government has recently undertaken significant legislative reform to ensure the improved disclosure of fees and charges through the Financial Services Reform (FSR) Act 2001. The FSR Act provides a harmonised disclosure regime that obliges providers of financial services, products or advice to supply consumers with improved and more readily comparable information on the relevant fees, charges and other costs associated with those services or products.

In conjunction with improved consumer disclosure, the Government considers that choice and portability of superannuation will increase competition and provide benefits to fund members. The Government recently reaffirmed its commitment to its choice of funds policy which is designed to increase competition and efficiency in the superannuation sector, leading to increased returns on superannuation savings for members and placing downward pressure on fund administration fees and charges.

The adequacy of retirement incomes is usually assessed using both poverty alleviation and replacement rate concepts. The level of the Age Pension is assessed against an objective benchmark (currently 25 per cent of Male Total Average Weekly Earnings), while overall retirement income, including superannuation, is most often assessed using a replacement rate concept. The replacement rate is defined as the ratio of a person's income or spending power after retirement to before retirement. The basic proposition behind the replacement rate concept is that a person's standard of living in retirement should be a reasonable proportion of their standard of living during their working life.

Treasury's preferred replacement rate measure is based on a comparison of potential net expenditure before and after retirement. The expenditure replacement rate is an after tax measure which takes account of the drawdown of capital during retirement. Replacement rates based on income only do not take account of draw-downs of capital. As a result, these measures understate the contribution of retirement savings to maintaining living standards in retirement.

By taking account of drawdowns of capital, expenditure replacement rates are consistent with the aim of retirement savings policy - that is, to defer some consumption during a person's working life in order to help fund consumption in retirement. In the Australian context, expenditure replacement measures are also able to capture the effects of the income tax concessions (viz the Senior Australians Tax Offset) which apply to people of Age Pension age.

Whether or not a particular expenditure replacement rate is optimal is a matter for judgement. It seems generally accepted, however, that for most persons, a replacement rate of less than 100 per cent will be appropriate. This is because retirees do not face some major expenses, (eg home mortgage costs, the cost of raising children and even the cost of commuting to and from work) which are faced by people of working age. It is also likely that different replacement rates will be optimal for different individuals.

The Government has not set an explicit benchmark replacement rate. Research by Association of Super Funds of Australia (ASFA) has indicated that the average net replacement rate from public income maintenance schemes in nine OECD countries is 53 per cent4.

Any analysis of replacement rates and associated policy should necessarily take account of individuals' needs in both their retirement and pre-retirement years. Proposals designed to increase gross savings in pre-retirement years with the aim of increasing retirement incomes involve trading off higher consumption in retirement for lower consumption while working. This trade off needs to be kept in mind when assessing the merits of such proposals.


3 See for example:

Are administration and investment costs in the Australian superannuation industry too high? Ross Clare, Association of Super Funds of Australia (ASFA) Research Centre, November 2001;

Disclosure of Superannuation Fees and Charges. Hazel Bateman, School of Economics, The University of New South Wales, 2001;

Superannuation Fees and Competition. Phillips Fox Actuaries and Consultants for Investment and Financial Services Association (IFSA), April 2002; and

Expense disclosure for Superannuation Funds. Access Economics for The Industry Funds Forum, August 2001.

4 Achieving an adequate retirement income -
how much is enough? Summary of research findings and issues for discussion. Ross Clare, Association of Super Funds of Australia (ASFA) Research Centre, October 1999;