The Great Debate – Is 9% Enough?
By Andrew Boal, Managing Director, Watson Wyatt in Australia
At a recent Association of Superannuation Funds of Australia (ASFA) luncheon.
So, is 9% enough? Well, yes it is: 9% is enough for our second pillar, mandatory savings. Of course, the SG was not designed to be “enough” in its own right. But, as part of a three pillar system, 9% is an adequate level for the second, mandatory pillar.
When it comes to saving for retirement, there is no “one size fits all” solution. There are simply too many variables for one number to be the right number that will suit everyone. The biggest issues are:
How old a person is at retirement.
How much they choose to spend each year.
How they invest their savings, both before and after retirement.
How long they live.
How can one number suit all the different possible scenarios? That is why we need to maintain a degree of flexibility in our retirement system. Because the superannuation guarantee is compulsory, its level should not be excessive. Low income earners should not be forced to save more than they need, because ultimately it will impact more heavily on their current standard of living, before they retire. Of course, the combination of the age pension and compulsory superannuation should still be sufficient to provide a reasonable retirement for everyone.
For low income earners entering the workforce now, a full career of 9% SG is expected to produce net replacement rates above 67%; on top of that, the absolute level of retirement income is above the “modest” level, even with relatively poor investment outcomes. For very low income earners, the net replacement rate at age 65 is actually expected to be 100%. In other words, if very low income earners were forced to save more than the current 9%, their retirement income would be expected to be higher than their current standard of living. Wouldn’t they prefer to enjoy some of those benefits now, rather than having to wait? That is why the SG should remain at 9%.
The World Bank and the OECD agree that a reasonable net replacement rate for mandatory systems is around 55% of final wage for middle income earners. Any additional savings required to reach a desirable income level should allow for individual circumstances, through more flexible, voluntary systems. For a middle income couple entering the workforce now, the net replacement rate at age 65 is expected to be around 55% if they switch to stable investments at retirement. Even at higher income levels of say $80,000, the 9% SG is still expected to produce a net replacement rate above 50%. Importantly, in dollar terms, the income level in retirement in all these cases for a middle income couple is above the “comfortable” level of $51,000 a year, and this provides for “occasional international travel”. From our existing mandatory system, with the SG at 9%!
For those that can afford to save more, they can of course do so using the third pillar, voluntary savings. We could even encourage them to save more in super, through enhanced government co-contributions and soft compulsion schemes. I know of one employer that has already introduced a 3% soft compulsion scheme and, more than a year on, 84% of members have retained the contributions. That’s a great outcome, especially for the 16% who had the flexibility to opt out because it did not suit their individual circumstances. But to help people make these important choices, we do need to improve member awareness, using tools like annual projection statements and on-line calculators to educate them about whether or not they are on track to meet their own retirement expectations. That way they can refine their savings strategies as their experience unfolds, rather than being locked into an unnecessarily high fixed rate. That is why the SG should remain at 9%.
It is also time we moved on to more important topics, like how to help people make the most of what they have saved. Investment markets are volatile, and some people will live to 100. How do we help people cope with longevity and market risk in retirement? How do we improve retirement outcomes for everyone by pooling risks and reducing “leakage” from the system? It is important that we also examine any disincentives in our system that discourage people from working longer. For example, under the current means tests and age pension structure, there is little incentive for most people to continue working beyond pension age, even if they can and want to.
To sum up: 9% is enough for our second pillar; mandatory savings. We need to keep some flexibility in the system, while still encouraging voluntary savings through co-contributions, soft compulsion and a greater focus on education and self help tools for members to track their progress.