Retirement: future-proofing your nest egg

A perfect storm of ageing populations, low interest rate environments that stymie compound interest, and high government debt is placing enormous pressure on many retirement systems.

Public pension schemes are coming under pressure in many countries, raising questions about how people will fund their retirement lifestyles. Here are some steps to future-proof your nest egg.

Think of Denmark and your mind is likely to turn to Lego, bicycles and pastries – or, if you are an economics aficionado, a world-leading retirement income system.

As economies around the world grapple with ageing populations, ensuring the elderly can be financially comfortable in retirement is a priority, and this Scandinavian nation offers lessons for others. 

Indeed, the Melbourne Mercer Global Pension Index (MMGPI), which scores pension systems on their adequacy, sustainability and integrity, ranked Denmark number one for six years straight, with the nation finally falling behind the Netherlands in late 2018 by the slimmest of margins.

What makes the top-ranked systems so good? Dr David Knox, a senior partner at Mercer Australia, says the best retirement income systems have several sources of income for retirees. “As a result, most people in those systems aren’t relying on future taxpayers for a pension, so it becomes much more sustainable,” he says. 

In Denmark’s case, it has the complementary benefits of a public basic pension scheme, a means-tested supplementary pension benefit, a fully funded defined contribution scheme and mandatory occupational schemes.

Many other countries are seeking to improve the lot of retirees, with an Organisation for Economic Cooperation and Development (OECD) report in 2017 finding that assets in funded and private pension arrangements topped US$38 trillion in OECD member countries at the end of the 2016 survey period, the highest level recorded. Pension assets exceeded US$1 trillion in Australia, Canada, Japan, the Netherlands, the UK and the United States.

Nevertheless, Knox warns that a perfect storm of ageing populations, low interest rate environments that stymie compound interest, and high government debt is placing enormous pressure on many pension systems. Unless addressed, this could cause intergenerational equity issues and disgruntled retirees.

Pension systems: the good, the bad...

In the 2018 MMGPI report, the Netherlands, Denmark, and Finland fill the top three spots. Australia slipped to fourth place, from third in 2017.

Despite being economic powerhouses, Asian countries such as China, Japan, South Korea and India don’t perform well in the rankings. They might be well advised to take cues from Singapore, which Mercer credits with having the best pension system in Asia.

Under its Central Provident Fund, all employed Singaporean residents receive benefits that can be withdrawn at any time for specified housing and medical expenses, while other benefits are preserved for retirement. A prescribed minimum amount must be drawn down in the form of a lifetime income stream.

The outlook is not so bright for middling performers such as Austria, Italy and France, where most retirees are caught in unsustainable models relying on social security from government. Knox says there is a real risk in those countries of a lack of assets being set aside for the future because people are making pay-as-you-go contributions that essentially support the previous generation. “With an ageing population and declining birth rates, that can’t keep happening.”

Japan also serves as a warning for other nations. Despite having a large pool of pension assets, it has very high government debt levels, a rapidly ageing population and minimal immigration. Knox says while there is a government pension scheme, it can cost anywhere from 8 per cent to 12 per cent of gross domestic product, compared with about 3 per cent in Australia.

“Something has got to give there,” he says.

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The Australian retirement story

Although Australia has consistently ranked highly on the MMGPI, there is consensus that further improvements can strengthen the long-term sustainability of the nation’s retirement income system.

Griffith Centre for Personal Finance and Superannuation at Griffith University director professor Robert Bianchi highlights two weaknesses – a rising gig and contractor economy, in which the onus will be on individuals rather than employers to make super contributions, and low superannuation balances for women.

Regarding the casualisation of the workforce, Bianchi says the prospect of any government mandating that all contractors must make superannuation contributions is all but inconceivable. 

“Can you imagine either [prime minister] Scott Morrison or [opposition leader] Bill Shorten introducing a new policy that forces all contract workers to put away 9.5 per cent of their wages and that it’s going to be collected by the Australian Taxation Office?” he asks. “It’s just unpalatable.”

A 2017 report known as HILDA (Household Income and Labour Dynamics in Australia) reveals that Australian women retire with an average super balance of A$230,907, about half that of men.

Bianchi says income inequality, interrupted careers because of caring duties and self-selection into modestly remunerated careers such as nursing and teaching, put many women behind.

“We do need to develop a dialogue around the issue,” Bianchi insists.

To address the gender superannuation gap, Knox advocates payment of super for women on maternity leave, along with consideration of following the lead of some Scandinavian countries, so that the super guarantee would apply to income support payments, such as carers’ leave.

No cookie-cutter solutions

The MMGPI notes that each country’s economic, social, cultural, political and historical circumstances can affect the design and implementation of retirement income systems. Simply transplanting one successful system to another country is not always feasible. However, cherry-picking the best features of successful systems could lead to better financial outcomes for retirees.

With many international governments carrying significant debt, Knox says one logical response would be to defer pension ages. Politically, however, such a move is likely to be unpopular in the electorate. 

As Knox explains: “People tend not to like it when they’ve been expecting to retire at 65, let’s say, and suddenly the government wants to raise that.” 

Whatever the solutions may be, Knox says catching up to nations such as Denmark, the Netherlands and Australia will take time and considerable planning.

“Pension systems don’t evolve quickly,” he says.

Is Australia's retirement system still fit for purpose?

A A$2.7 trillion superannuation war chest is at the core of Australia’s highly regarded retirement income system.

Nevertheless, amid reports of fee gouging by some super funds and the modest performance of many retail funds, question marks remain about the super system and the financial future of the country’s retirees. A Productivity Commission review is critical of superannuation fees, rates of return and inefficient multiple accounts that cost fund members dearly.

CPA Australia general manager, external affairs, policy and advocacy, Paul Drum FCPA says such findings “call into question” the strength of Australia’s superannuation sector.

“But without savings of this type, I’ve no doubt that people would not have saved their money – they would have consumed it,” he says. “That’s certainly been a benefit.”

Revelations at the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry that funds have charged fees for no service and on deceased accounts demonstrate the need for change, according to Drum. He cautiously supports recent proposed changes to superannuation announced in the Federal Budget, such as a ban on exit fees on any super account.

Some retirees appear not to have confidence in the system, with an analysis of Australian retirees’ spending by actuarial services firm Milliman finding that more than half of retirees are spending less than the age pension each year. For all the consternation, Nga Pham, a senior researcher at Monash Business School’s Australian Centre for Financial Studies, believes Australia’s retirement income system is in relatively good shape.

“We are in a fairly safe position with publicly financed pension systems, as well as private savings,” Pham says. 

In terms of the public component, she says asset test changes introduced in 2017 will open the way for more people to access full or partial age pensions, although average income earners may receive less under part pensions.

One challenge for Australia, she argues, will be ensuring that older people can get work that allows them to participate in a digitally advanced workforce and receive employer-funded superannuation. “We need to make sure they have the skills required to actually keep working,” Pham says.

To further shore up superannuation funds and retirees’ incomes, Mercer’s David Knox supports an increase in the compulsory employer contribution rate from the current 9.5 per cent to at least 12 per cent. Recent criticisms notwithstanding, he maintains that many superannuation funds are “doing a good job”.

“I’m not suggesting the system’s perfect, but we have to be careful not to break something that’s actually working,” Knox says.

Cracking the nest egg conundrum

It is the perennial question for retirees: how much will they need to live comfortably after they quit work?

The answer is complicated. Some economists believe the sweet spot between superannuation assets and pension income is a lump sum in the range of A$350,000 to A$400,000.

Robert Bianchi, at the Griffith Centre for Personal Finance and Superannuation, says the figure will depend on multiple factors, including whether people are relying on superannuation savings alone, or if they possess significant savings, own other assets such as property and shares, or stand to gain from an inheritance.

“Everyone is trying to find this one number, but the truth is that the number is different for everyone depending on their finances at the point of retirement,” he says. 

The Association of Superannuation Funds of Australia (ASFA) publishes retirement standard benchmarks, estimating the budget Australians will need in their post-work years. For a “comfortable lifestyle”, ASFA suggests a couple will need a lump sum of A$640,000, while a single person will require A$545,000. The sums assume retirees will draw down all their capital and receive a part age pension. 

The lump sum needed by couples and singles for a “modest lifestyle” will be just A$70,000 because the base rate of the age pension, plus other pension supplements, is sufficient to meet most needs at this budget level.

What is clear, according to CPA Australia’s Paul Drum FCPA, is that perceptions by some people that they will need A$1.6 million – the superannuation transfer balance cap that an individual can transfer into retirement phase accounts – is unlikely to be true. Most couples, he agrees, will probably need around the A$400,000 mark each in their super to live well and benefit from a combination of super and pension income.

“Based on what we know at the moment, the magic number is going to be around this ballpark figure,” Drum says.

Top 10 pension systems

  1. Netherlands
  2. Denmark
  3. Finland
  4. Australia
  5. Sweden
  6. Norway
  7. Singapore
  8. Chile
  9. New Zealand
  10. Canada

Source: Melbourne Mercer Global Pension Index 2018

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