Chapter 2: The policy and institutional context


Australia's three-pillared retirement income system is well known. The three pillars comprise the means-tested Age Pension and associated social security arrangements, compulsory employer superannuation contributions through the Superannuation Guarantee (SG), and voluntary private savings including through superannuation. A key policy objective of this system is to enable Australians to achieve a higher standard of living in retirement than would be possible from the publicly funded Age Pension alone. The World Bank has broadly endorsed Australia's general approach to the provision of retirement incomes. The individual elements of the retirement income framework are discussed further below.

The Age Pension

The Age Pension provides a means-tested safety net for individuals who have had limited opportunity or capacity to save for retirement prior to reaching Age Pension age. The Age Pension is available to individuals who have been resident in Australia for at least ten years (at least 5 of these years in one period), and have reached the qualifying age (currently 65 for men and 62 years for women (rising to 65 by 2014)). The maximum fortnightly rate of the Age Pension is currently $421.80 for singles and $352.10 each for couples. The Service Pension provides a similar income support payment to veterans, and is available five years earlier than the Age Pension.

The rate of the Age Pension is adjusted every March and September in line with movements in the Consumer Price Index (CPI). Additionally, payment rates are indexed in line with wages growth, with the maximum single rate of the Age Pension maintained at (at least) 25 per cent of Male Total Average Weekly Earnings (MTAWE). Pensioners are, therefore protected against price increases, and also share in improvements in living standards, as measured by wages.

The value of the Age Pension in real terms has been boosted in recent years through a number of initiatives, including legislating to link the full rate of pension to 25 per cent of MTAWE. This policy has meant that the value of the Age Pension has grown in real terms by 1.19 per cent per year since 1996 (on average) and is expected to grow by 1 to 1½ per cent a year on average into the future. In addition, as part of the introduction of the new tax system in July 2000, the real value of the pension was increased and the pension income test withdrawal rate reduced (from 50 cents in the dollar to 40 cents in the dollar). The second of these measures, in particular, has made the Age Pension more accessible to partly self-funded retirees, and added to the incentive for individuals to save for their retirement by boosting the returns from such saving at the time of retirement.

Eligibility for the Age Pension also brings with it a number of ancillary benefits. People in receipt of either the Age Pension or Service Pension are entitled to a Pensioner Concession Card (PCC). Those of Age Pension age who do not qualify for either a Service Pension or Age Pension because of assets or income levels may qualify for a Commonwealth Seniors Health Card (CSHC).

The holder of either a PCC or CSHC is entitled to pharmaceutical medication under the Commonwealth's Pharmaceutical Benefits Scheme. This is at the concessional rate of $3.60 per script. State and local governments also use the PCC card as a way of identifying people to whom they offer services at a concessional rate. These concessions are in areas such as transport, utilities, motor vehicle registration, and water and property rates.

The Government has recently widened eligibility for the CSHC. Singles with incomes below $50,000 and couples with incomes below $80,000 are now eligible for the card. Senior Australians who hold the Commonwealth Seniors Health Card have also been extended the same concessions as pensioners on telephone costs. They are entitled to a Telephone Allowance of $18 per quarter. The Commonwealth has also opened negotiations with the States with a view to extending other pensioner concessions to cardholders over time.

Approximately 54 per cent of individuals of Age Pension age currently receive a full rate pension, another 28 per cent receive a part-rate pension, and 18 per cent are not eligible for the Age Pension. By 2050, after the SG system has reached maturity, it is expected that the proportion of people aged 65 and over receiving a full rate pension will fall to around one third, and that the proportion of people not receiving the pension will rise to around 25 per cent. The proportion of people receiving a part-rate pension is expected to increase to around 40 per cent. The Age Pension is therefore likely to remain an important feature of the retirement income framework into the future.

The Budgetary cost of the Age Pension (including the Aged Service Pension) currently accounts for around 2.9 per cent of Gross Domestic Product (GDP) per annum. This cost is expected to increase to 3.6 per cent of GDP by 2021 and 4.6 per cent of GDP by 2041, reflecting the ageing of the Australian population.

Compulsory superannuation - the Superannuation Guarantee (SG)

An important part of Australia's superannuation system is the provision of compulsory employer contributions through the Superannuation Guarantee (SG). The SG arrangements were introduced in 1992 to ensure that employees are provided with adequate levels of superannuation support from their employer. Under the SG arrangements, employers are required, with very few exceptions5, to provide a prescribed minimum level of superannuation support each financial year for their employees. SG contributions are tax deductible to employers.

The phasing in of the compulsory SG arrangements was over a ten-year period completed on 1 July 2002. For 2002-03 and subsequent years, the prescribed minimum contribution rate is 9 per cent of the employee's 'notional earnings base'.

Employer contributions made under the SG must be fully vested in the employee and are fully preserved (except in limited circumstances such as death and disability) until retirement on or after preservation age (currently 55 but gradually rising to 60 between 2015 and 2025).

From 1 July 2003, employers will be required to make SG contributions on behalf of their employees at least quarterly. This measure is designed to better safeguard employees' superannuation entitlements in the event of their employer becoming bankrupt or insolvent. As approximately 85 per cent of businesses currently make superannuation contributions quarterly or more often, this measure will ensure greater fairness between employees in relation to the security of their superannuation entitlements.

The coverage of superannuation in Australia has grown significantly as a result of the introduction of the SG and the fact that the legislation provides for very few exemptions. In 1986, only around 40 per cent of Australian employees had superannuation coverage. The ABS Survey of Employment Arrangements and Superannuation indicates that superannuation coverage now extends to some 98 per cent of traditional employees with leave entitlements and 72 per cent of casuals. Table 1 shows the historical changes in the coverage of employees.

Table 1: Historical Changes in Employee Superannuation Coverage
Year Employees: % covered
Full Time Part Time Total
1986 46.5 7.0 39.4
1989 55.1 17.8 48.1
1992 88.0 54.1 80.3
1995 94.4 71
1999 96.9 76.3 91.0

Source: ABS Employment Benefits Surveys 6334.0, 6310.0

Self-employed persons are excluded from the requirement to make mandatory superannuation contributions through the SG. This group is encouraged to save for their retirement through the availability of tax deductions for personal superannuation contributions and tax concessions for saving through a small business. Around two thirds of the self-employed have some superannuation coverage.

Voluntary private savings

In addition to compulsory employer contributions, some employers make above SG contributions for their employees. Individuals can also save voluntarily for their retirement through superannuation and/or other savings vehicles outside of superannuation such as property investment, (including owner-occupied housing) shares and financial securities. Voluntary retirement savings are primarily encouraged through the provision of taxation incentives for superannuation.

Employees can make voluntary member contributions to superannuation from post-tax income. While such contributions do not benefit from the concessional tax rate applying to superannuation contributions, they still benefit from the concessional tax rate applying to the earnings on benefits inside the fund (details below). Salary sacrifice arrangements enable many employees to exchange part of their gross (pre-tax) salary in return for their employer contributing money into superannuation on their behalf. Salary sacrifice arrangements enable employees to effectively substitute the concessional tax rate applying to employer superannuation contributions for their own marginal tax rate. Special taxation arrangements apply to self-employed people for their superannuation contributions.

The superannuation changes contained in the 2002-03 Budget are designed to enhance retirement incomes and further increase the incentive to contribute to superannuation. These measures include a Government superannuation co-contribution of up to $1,000 a year for low income earners, an increase in the fully deductible threshold for superannuation contributions made by self-employed persons, a phased reduction in the superannuation surcharge and a measure allowing couples to split their superannuation contributions.

Voluntary member superannuation contributions, other employer contributions above the SG, and other non-superannuation savings are important determinants of the adequacy of retirement incomes. More than half of all employed people aged over 40 with taxable incomes above $30,000 have made some additional provision for their retirement.

Saving through home ownership also has a direct bearing on the adequacy of retirement incomes by significantly reducing the cost of accommodation in retirement. In this context, the majority of older people in Australia are homeowners. The Australian Housing Survey 1999 showed that 80 per cent of households in which the reference person was aged over 65 owned their home outright and a further 4 per cent were purchasing. Where the reference person was aged 55 to 64, 66 per cent of households owned their home outright and 17 per cent were purchasing.

Preliminary estimates suggest that households headed by persons over 65 have 45 per cent of their private wealth in housing and land, 40 per cent in financial assets such as deposits, shares, securities, and insurance reserves and 15 per cent of assets in funded and unfunded private pension funds.

While the SG system has facilitated wide superannuation coverage of the Australian population, a number of new measures are designed to broaden access to superannuation by extending the circumstances in which voluntary contributions to superannuation can be made.

  • Consistent with the need to promote superannuation as a lifetime savings strategy, from 1 July 2002, parents, grandparents, other relations and friends will be able to contribute to superannuation on behalf of children. Under this measure, contributions of up to $3,000 per child per 3-year period can be made on behalf of a child under the age of 18. Superannuation for life will help create a culture that gives priority to planning ahead and achieving financial self-reliance in retirement.
  • In addition, the accessibility of superannuation will be widened by allowing working people aged over 70 but less than 75 years of age to make personal contributions to superannuation. To be eligible individuals must be working at least 10 hours per week. This measure recognises the choice made by some people to continue working past the age of 70.
  • Another measure will also allow recipients of the Baby Bonus to contribute the Baby Bonus and any other amount to superannuation, even if they have never worked before. This initiative provides a new mechanism for parents at home caring for children to continue to save for their retirement.

The Government has restrictions on contributions past age 65, and compulsory cashing at age 65 if the member is no longer working part-time, to reduce the risk that concessionally taxed benefits are used for estate planning and not genuine retirement income purposes.

Taxation arrangements for superannuation

The taxation arrangements applying to superannuation are designed to encourage the accumulation of superannuation savings during an individual's working life for the purpose of drawing on those savings as a source of income in retirement. The main elements of the taxation regime applying to superannuation are outlined below.


The taxation incentives available for superannuation include a concessional tax rate on employer and deductible member superannuation contributions of 15 per cent for low to middle income earners, and 15 per cent plus the surcharge of up to 15 per cent for high income earners. These tax rates compare favourably with the marginal tax rates, which apply to equivalent amounts of earnings subject to income tax.

In relation to the superannuation surcharge, the Government has introduced legislation into the Parliament to reduce the maximum surcharge rate by 1.5 per cent in each of the next three years. Under this measure, the maximum surcharge rate will fall to 10.5 per cent in 2004-05. The Government has also committed to review the surcharge arrangements at that time to determine whether any further changes are required.

The Government has announced the introduction of a superannuation co-contribution for low income earners to replace the current taxation rebate for superannuation contributions by low income earners. The maximum co-contribution of $1,000 a year will be payable in respect of personal contributions made by people on incomes up to $20,000. A reduced co-contribution will be payable to those on incomes up to $32,500. The co-contribution is designed to enhance the retirement savings of low income earners and to increase the incentive for this group to contribute to superannuation. In this context, the maximum co-contribution of $1,000 is significantly more generous than the maximum $100 rebate it is replacing.

As noted earlier, tax deductions are made available to self-employed persons to encourage this group to contribute to superannuation. The fully deductible amount for superannuation contributions made by self-employed persons is $5,000. Contributions above this amount are 75 per cent deductible, with a maximum deduction equal to the taxpayer's age-based deduction limit. Tax deductibility for the self-employed is designed to enhance the superannuation savings of self-employed persons by providing them with an increased incentive to contribute to superannuation.

Many self-employed persons who own a small business choose to save for their retirement by building up the value of their bus
iness in addition to or instead of contributing to superannuation. In recognition of this, the Government has implemented a number of initiatives to allow small businesses meeting the eligibility criteria to significantly reduce, or eliminate, their capital gains tax (CGT) liability when selling a small business or part of a business. For example, a small business can disregard a capital gain when an active asset that has been held continuously for 15 years is sold. Furthermore, a small business can disregard a capital gain where the proceeds of the sale of an asset are used for retirement (up to a lifetime limit of $500,000).

Tax deductions are available for employer and deductible member (self-employed) contributions to superannuation. Age-based limits apply to the amount of deductible contributions that can be made to superannuation and are indexed annually to movements in Average Weekly Ordinary Time Earnings (AWOTE). The age based limit system, together with the Reasonable Benefit Limit (RBL) arrangements, is designed to impose limits on the amount of superannuation which can receive concessional taxation treatment. The policy intention behind these limits is to ensure that superannuation is used for its intended purpose of providing for genuine retirement income, and not as a wealth creation or estate planning vehicle.


A 15 per cent tax rate applies to the investment income of superannuation funds. This rate compares favourably with the rate of tax applying to earnings obtained from most other savings vehicles. Only two-thirds of qualifying capital gains are taxable, reducing the maximum effective capital gains tax rate for superannuation funds to 10 per cent. Superannuation funds are also entitled to imputation credits, which can be refunded.


Retirees have the choice of taking their superannuation benefit either as a lump sum or as an income stream.

Tax and social security incentives are provided to encourage retirees to purchase income stream products, which meet the Government's broad retirement income policy objectives. In particular, incentives are afforded to income stream products that provide for an orderly, regular draw down of the capital underlying the product over the expected duration of retirement. Where individuals take at least 50 per cent of their total benefits in the form of a pension or annuity which satisfies the pension and annuity standards (commonly referred to as 'complying' pensions and annuities), they qualify to be assessed against the higher pension RBL. The pension RBL of $1,124,384 for 2002-03 compares with the lump sum RBL of $562,195. In contrast, lump sum benefits and pensions and annuities not meeting these standards are assessed against the lump sum RBL.

'Complying' lifetime and life expectancy pensions and annuities are also exempt under the social security assets test. All other income stream products, including allocated pensions and annuities, are asset tested. One of the Government's election commitments was to examine whether 'complying' status should be afforded to a new class of market-linked pension known as a growth pension. Unlike existing complying income streams, the annual level of income from growth pensions would be dependent on the performance of the underlying portfolio of assets.

Superannuation pensions up to the value of the taxpayer's RBL which are paid from a taxed source are also eligible for a 15 per cent tax rebate (the pension and annuity rebate). The rebate was introduced to compensate for the introduction in 1988 of the 15 per cent tax rate on complying superannuation funds.

For lump sum benefits taken on or after age 55, the first $112,405 (indexed annually to AWOTE) of the post-June 1983 component is tax free if paid from a taxed fund, or taxed at a maximum rate of 15 per cent if paid from an untaxed fund. Any remaining post-June 1983 component (up to the individual's lump sum RBL) is taxed at a maximum rate of 15 per cent if paid from a taxed fund or 30 per cent if paid from an untaxed fund. (The Medicare levy applies in addition to these tax rates.) The part of a lump sum benefit which represents the return of an individual's own after tax contributions is not subject to further tax.

In addition to the concessions available through superannuation, the Government has implemented a number of other initiatives which directly benefit people's living standards in retirement. These initiatives include the various concessions available to people of Age Pension age, as well as the Senior Australians Tax Offset (SATO). The SATO ensures that single senior Australians can have income up to $20,000 without paying income tax or the Medicare levy. While the rebates phase out over the income range $20,000 to $37,840 (for singles), taxpayers in this range still pay less tax than previously. Similarly, senior couples can have combined incomes of up to $32,612 without paying tax (depending on their income split). For couples, the rebates phase out at combined incomes up to $58,244.

Adequacy and the taxation of superannuation

Notwithstanding Australia's approach of taxing superannuation at all three stages (ie contributions, earnings and benefits), research undertaken by Treasury's Retirement and Income Modelling (RIM) Unit indicates that superannuation is a tax preferred investment over a working lifetime for persons in all marginal tax brackets. (This research is summarised in Chapter 4 of this submission.) The aggregate size of the tax expenditure associated with superannuation is projected at approximately $10.3 billion in 2002-036.

The taxation of superannuation can affect the adequacy of retirement incomes in a number of ways. In a direct sense, the concessional taxation treatment of superannuation increases the amount of a contribution which is available to be invested (after tax) compared with alternative forms of saving - for example, shares or property acquired out of after tax income. This advantage continues during the accumulation phase of superannuation reflecting the concessional tax rate applying to investment earnings on superannuation account balances. The concessionality of superannuation also has an indirect impact on the adequacy of retirement incomes to the extent that it encourages individuals to undertake retirement savings.

Some commentators have suggested that the complexity of the superannuation taxation arrangements detracts from the adequacy of retirement incomes by imposing costs on superannuation funds, which are passed on in higher fees and charges to members' accounts. The impact of the complexity of the taxation arrangements applying to superannuation funds is clearly an important issue. However, it also needs to be recognised that these arrangements are designed to meet specific public policy objectives, and some level of cost is inevitable as a trade-off for meeting these policy objectives.

It has also been suggested that complexity can impact indirectly on adequacy by reducing the incentive to contribute to superannuation. However, it is arguable that much of the complexity of superannuation is hidden from members, and that for most employees the actual process of making superannuation contributions is not complex. For example, for employees whose only interaction with the superannuation system is through the SG in a defined contribution scheme, superannuation is relatively straightforward with contributions made on their behalf by their employer. Employees who wish to make additional voluntary contributions can either choose to have these deducted regularly from their after tax pay, or arrange with their employer to have regular contributions made from their pre-tax salary. Moreover, in contrast with non-superannuation investments, superannuation requires little or no involvement from fund members once the contributions have been paid into the system. Unlike other investments, the earnings on superan
nuation investments do not have to be included in a person's annual tax return but are subject to a concessional taxation regime inside the fund.

Trends in superannuation

Superannuation assets totalled $527.7 billion in December 2001, over double their level of 6 years ago, making superannuation by far the largest component of household financial assets.

APRA statistics7 show strong growth in superannuation contributions, with the flow of member contributions increasing by around 30 per cent over 3 years and employer contributions by about 25 per cent over the same period. After some years of very strong growth member contributions appear to have reached a plateau with no growth over the past year, while employer contributions have continued their steady growth growing about 7 per cent over the year.

Modelling by Treasury's RIM Unit projects that superannuation account balances will increase substantially in the future as the SG system matures. Currently, the average superannuation balance per person is about $62,000, with a wide variation about this average depending on years of membership and levels of contributions. By June 2005 this average balance is projected to increase to $70,000, by June 2010 to $84,000 and to $113,000 by June 2020, all in today's dollar values. These estimates are based on conservative assumptions about fund earning rates.

Average superannuation payouts at age retirement are also estimated to increase. These payouts are currently around $72,000 per person rising to $83,000 in June 2005, $100,000 in June 2010 and $136,000 in June 2020 (all in today's dollar values). There will be wide variations around all these averages, but the strong improvement in benefits as the system matures is clear.

The economic and fiscal context

The Intergenerational Report which was presented with the 2002-03 Budget highlighted the need for sound and sustainable economic policies, including retirement income policies, in the face of the budgetary pressures associated with an ageing population. At a broad level, policies which maximise sustainable economic growth, as well as overall economic and social participation directly benefit living standards in the community, including among retirees. In the retirement incomes context, increasing longevity has direct implications for the level of savings people need to accumulate prior to retirement in order to fund income in retirement. As most people's capacity to accumulate retirement savings is dependent on their participation in the workforce, this in turn has implications for policy in areas such as labour force participation (including among mature age people) and the related issue of the preservation age for superannuation.

Any analysis of the appropriateness of the retirement income system needs to have regard to the broader economic and fiscal framework within which it operates. Any analyses or proposals in this area which do not have regard to this broader context are of limited use in informing the policy debate. For example, proposals to increase the adequacy of retirement incomes by significantly reducing, or eliminating the taxation of superannuation during the contribution and accumulation stage must be assessed against the fiscal implications of such proposals, and the associated trade-offs.

Superannuation is taxed concessionally in Australia with the aggregate size of the tax expenditure associated with superannuation projected at $10.3 billion in 2002-03. Nevertheless, Commonwealth taxation revenue from superannuation contributions and earnings is significant - in 2002-03 this revenue is estimated to comprise:

  • $3.8 billion from the taxation of superannuation funds;
  • $0.8 billion from the superannuation surcharge; and
  • an amount from the taxation of statutory funds of life insurance companies under the company tax head of revenue, which is currently not estimated separately.

Viewed in this context, proposals to defer the taxation of superannuation entirely to the benefit stage (that is, when people retire and receive their accumulated superannuation benefits) involve trading off a significant deterioration in the budgetary position over the medium term, and resultant higher Government debt and public debt interest costs, for increased taxation revenue in future years when the current working generation moves into retirement. The alternative to such a trade-off would be the introduction of significant offsetting fiscal measures to leave the Government's overall budgetary position no worse off.

5 Those exempt include employees earning less than $450 per month, part-time employees under 18 years of age and employees aged 70 and over.

6 Budget Strategy and Outlook 2002-03, Budget Paper No. 1, 14 May 2002. For methodology and other related issues see: Appendix B: Superannuation Benefits, Tax Expenditures Statement 2001.

7 APRA statistics are relatively up to date and are well established as the authoritative figures for asset levels. However, the levels of inflows and outflows as measured by APRA are consistently higher than those determined from ATO data (some time later) and other ABS survey data. Rothman (1996) discusses possible reasons for the differences, which have continued.