Retirement report card: Does your country make the grade?

Relax review retire?

A new study gives governments a report card on how well they prepare people for life after work. The big news: almost every country needs to do more homework.

And the winners are … Denmark and the Netherlands, with Australia a close third. As nations around the world grapple with ageing populations and ensuring financial security for retirees, government leaders face a disturbing truth.

Only Denmark and the Netherlands have retirement systems worthy of an “A” mark, according to the Melbourne Mercer Global Pension Index, a comprehensive international analysis of such systems.

Although Australia fares well, too, powerhouse economies such as the US, France and Japan are lagging behind, while many Asian nations are playing catch-up after only recently embracing broad retirement systems.

“Many Asian nations are playing catch-up after only recently embracing broad retirement systems.”

There are some clear lessons to be learnt from the Danes and Dutch, whose sophisticated public pension and occupational schemes feature wide population coverage and extensive contribution rates.

“They cover most people, they’ve got money set aside and therefore they are well positioned for the future,” says the index’s lead author, David Knox, a former university expert on retirement systems and now a senior partner at Mercer.

Highlighting their strength, Denmark and the Netherlands have between 160 and 170 per cent of GDP in current pension assets, compared with about 120 per cent for Australia and just 1.8 per cent for Indonesia. 

Under the pump

Pension systems around the world are exposed to a perfect wave of bad news: generally rising government debt, widespread economic fragility, low interest rates and a shift towards more individual responsibility through defined contribution plans – plus, of course, ageing populations. The World Health Organization forecasts that between 2015 and 2050, the proportion of the world’s population aged over 60 will almost double, from 12 per cent to 22 per cent.

International leaders are responding. The Organisation for Economic Co-operation and Development (OECD) recently reported that about half of its 34 member countries have taken measures in the past two years to make their systems more affordable. One in three has sought to strengthen safety nets and help some vulnerable groups of pensioners. 

Retirement ages have risen, too, with retirement at 67, rather than 65, becoming the new norm in many countries, and others, such as Australia, planning to move towards 70.

“The concept of stopping work when you’re 65 and sitting around and living out your golden years for the next 25 years isn’t realistic anymore.” Paul Drum, CPA Australia
The OECD nevertheless believes a serious risk of pensioner poverty remains and that in some countries it is getting worse. 

One answer is for countries to reassess their safety nets for pensioners who have not contributed enough for a minimum pension. Across the OECD, these provide 22 per cent of average earnings, ranging from a miserly 6 per cent in South Korea to 40 per cent in New Zealand (the Australian figure is about 25 per cent). 

The world's population of pensioners is expected to almost double.

The world's population of pensioners is expected to almost double.

Knox says there is always tension in pension systems between “adequacy and sustainability”. Some, like the infamous Greek pension system, provide great benefits to citizens but cost too much to stay in place for long. Others are sustainable but deliver poor benefits.

“Getting that balance right is important,” says Knox, who advocates a mix of government social security and private market solutions.

Global snapshot

The Mercer Index measures 25 retirement income systems against more than 40 indicators. In the 2015 report, Denmark secured the top position for the fourth consecutive year with a score of 81.7, ahead if the Netherlands (80.5) and Australia (79.6).

Japan, Austria and Italy are among the rich countries that score poorly because of high levels of government debt, inadequate pension assets and ageing populations. Major reforms are required, according to the report, to improve the pension systems of lower-income populous countries such as China, India and Indonesia.

The 11 countries that have been part of the report since it began in 2009 have all experienced a rise in the expected length of retirement from 2009 to 2015, with the average length up from 16.6 to 18.4 years. Five countries – Australia, Germany, Japan, Singapore and the UK – have increased their pension age to counter higher life expectancies.

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Paul Drum, head of policy at CPA Australia, says there is “no silver bullet” to fix pension systems and that a suite of strategies is required.

“The original retirement age of 65 was set over 100 years ago when life expectancy was in the 50s,” he says. “Now we’re looking at life expectancy in the 80s, so the concept of stopping work when you’re 65 and sitting around and living out your golden years for the next 25 years isn’t realistic anymore.”

In the 1980s, Australia added a system of compulsory private superannuation contributions to its means-tested government pension. Drum says that Australia needs to shift its system further towards retirement self-sufficiency to ease the unsustainable pressure on Australia’s public purse. That pattern, he adds, is being echoed in other countries.

Australia can do better

To reduce the risk of retirees outliving their savings, Knox and his research team argue that Australia’s pension system could benefit by requiring part of any retirement benefit to be taken as an income stream, rather than a single lump sum. Measures such as the indexation of the public pension also deserve consideration.

The 2014 Financial System Inquiry (FSI), led by banker David Murray, has also brought down its conclusions about Australia’s system, observing that the retirement phase of superannuation is underdeveloped and “does not meet the risk management needs of many retirees”. The upshot, the FSI concludes, is that many retirees make critical decisions regarding drawing down their savings without sufficient knowledge.

Australia has increased its pension age to offset the tax burden of retirement.

Australia has increased its pension age to offset the tax burden of retirement.

Macquarie University economist Professor Geoff Kingston is also concerned that Australia’s system still falls short. Kingston believes that, notwithstanding planned increases in the future, Australia’s current compulsory contribution rate of 9.5 per cent of wages is too low to overcome pension dependence and needs to match that of Switzerland, where the compulsory contribution rate averages about 12 per cent of lifetime wages. (Australia is not slated to reach this 12 per cent level until 2025.)

Kingston also advocates a Swiss-style delay in taxing superannuation earnings until retirement – when, he says, it should be taxed in line with the regular progressive rate scale.

Asia makes a move

The Mercer report underscores the challenges confronting pension systems in many Asian countries. While Singapore scored a C+ grade in the report, Indonesia, China, Japan, South Korea and India received Ds. The report questions their efficacy and their sustainability.

Knox says China, India and Indonesia are paying a price for having very limited pension systems to date, while unreliable incomes and large informal labour markets mean that many workers do not benefit from employee pension schemes or any employer contribution schemes that may exist. “So that’s a big challenge for them,” says Knox.

Pete Gunning, Russell Investments’ CEO Asia-Pacific, agrees that there is recognition among most Asian nations that it is time to take action on pension systems. To that end, Hong Kong has announced a major review of its retirement system policy (see breakout above right), while Malaysia has introduced a GST and India is on the cusp of doing so as they seek to bolster government revenues and fund future national pension needs.

Singapore is pursuing changes to provide minimum pension top-up amounts for the poorest individuals and greater flexibility in drawing down retirement pension amounts, while Indonesia last year launched a defined benefit scheme funded through employer and employee contributions.

“Pension systems around the world are exposed to a perfect wave of bad news.”

The way forward

Economic superpower status does not exclude the US from retirement system concerns, with the International Monetary Fund warning that underfunded pension funds could chase returns through riskier investments. That, in turn, could raise the level of systemic risk in financial systems, it said last year.

While Knox agrees the US faces challenges, he doubts that American pension funds will face the sort of rapid withdrawals of funds that commonly create systemic risks. Baby boomers, for instance, will be gradually paid out over the next two decades or so.

The US and others might nevertheless do well to consider the Mercer report’s blueprint for countries seeking to bolster their retirement savings systems. That blueprint tells governments to:
  • increase the state pension age and retirement age
  • promote higher labour force participation at older ages
  • encourage or require higher levels of private saving
  • expand the coverage of workers and the self-employed in the private pension system
  • review the level of public pension indexation

Knox says it is obvious that in future years, most – if not all – governments will be less prepared to unconditionally support older populations, so individuals will have to make sure money is set aside for their retirement years. Are they getting the message? 

“Some are,” says Knox, “but I’m not sure that everyone is quite there yet.”

Hong Kong is getting serious about pension reform – and it has sparked a war of words.

Last December, the government launched a six-month public engagement exercise to consider two retirement protection options: a controversial universal scheme for public pensions, or a means-tested option that would offer additional benefits to elderly people with assets worth less than HK$80,000.

Under the universal scheme, the government has proposed raising profit taxes by 4.2 per cent, or lifting salaries tax by 8.3 per cent. Big business, in particular, is opposing such tax hikes and says it would break the bank.

The OECD is deeply concerned with a risk of pensioner poverty.

The OECD is deeply concerned with a risk of pensioner poverty.

Hong Kong’s move follows a call from the former CPA Australia chief executive Alex Malley, in a South China Morning Post opinion piece in January, urging Hong Kong to address its “volatile tax base” and implement a comprehensive tax reform agenda. The article suggests that a goods and services tax at a low rate with suitable compensation mechanisms “should be part of Hong Kong’s tax mix”. 

Malley also notes that an over-reliance on property taxes contributes to concerns about the affordability of retirement protection. Hong Kong’s six-month public engagement exercise will end on 21 June.

EET tax model a super idea

If the so-called EET tax model is good enough for most advanced nations, why not Australia? The system sees superannuation contributions and fund earnings being exempt from tax (“exempt-exempt” or “EE”), with only benefits being taxed (the “T”). Australia is on its own in running a TTT system, which taxes retirement savings at all three points.

In its submission to the government’s Tax White Paper last year, CPA Australia suggested an EET system deserves consideration as part of a broader review of Australian retirement savings policy.

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