Many international comparisons of expected pension replacement rates use just pension wealth – social pensions and compulsory Tier 2 arrangements. PensionReforms has questioned the utility of such comparisons because so much is missed out: see here, here and here for examples.
PensionReforms thinks that the only thing that matters is retirement wealth, not even just financial wealth. Retirement wealth takes into account a number of things normally missed in these types of calculation – the selected retirement date (not the State Pension Age), business investment, second homes, work in retirement, trading down the family home and all other forms of saving. Such comparisons are hard to do well but they are all that matter.
This 2014 report from Australia takes a step along that path. It uses data from a longitudinal survey of household finances called HILDA. It tries to project retirement saving ‘adequacy’ based both on consumption levels during retirement and guessing when retirees might run out of money. It uses a group of Australians aged over 40 and that cover 5,001 households.
By way of background, Australia has a relatively generous Tier 1 pension that is both income- and asset-tested. Tier 2 requires employers to contribute, now. 9.25% (rising to 12%) of covered pay to a tax-favoured, Defined Contribution, pre-funded ‘superannuation scheme”. Tier 3 is everything else but includes generous tax subsidies for formal retirement saving schemes.
The report concludes that all this might leave future Australian retirees short. The test is an “adequate level of consumption during retirement”:
“Indeed, based on our sample population, saving at this rate generates a median consumption level during retirement significantly below half of the median equalized income of the overall population, a commonly-used measure of relative poverty.”
Voluntary savings make up a significant proportion of current savings. They are expected to constitute about 40% on average of “consumption levels in retirement”.
The compulsory Tier 2 will have the effect of reducing the “…relative contribution of the government pension to retirement income while increasing the contribution of (largely defined-contribution) retirement savings accounts. This means that the proportion of consumption from potentially risky assets, in particular retirement savings accounts, is increasing.”
There are unsurprising, wide variations in the results across the population. So rules that apply to everyone are likely to be “inappropriate”.
Such forward projections depend crucially on the assumptions:
“The projection of consumption levels during retirement of course depends on a large set of assumptions about individual, household and market factors, including wages, salaries and other income across the life cycle, real wage growth, employment status, marital status, home ownership status, retirement age as well as asset returns and their temporal patterns.”
The final overall conclusion is that there seem to be “significant gaps between the level of income individuals expect to need during retirement for a satisfactory lifestyle and their projected income in retirement.”
The report suggests that people need more information and accessible tools to “…help people assess the adequacy of their own retirement savings using metrics like the ones we present in this article.”
Whether other measures such as more tax breaks, increasing the State Pension Age and the “promotion of appropriate investment strategies” might help needs “further investigation.”
PensionReforms has several observations on the report’s findings:
(1) It is really difficult to look at whole communities on the basis adopted in the report but it’s the only kind of examination that can establish whether a retirement income system is ‘working’.
(2) It would be good to model changes in the Tier 1 pension to address the expected ‘inadequate’ levels of post-retirement consumption.
(3) Modelling changes in the retirement age would also be interesting – a later age has the triple effect of increasing the working period (extra growth for the country), also the saving period while at the same time reducing the number of years over which savings are decumulated.
(4) It is interesting to see the large share of expected savings that voluntary savings are expected to play. The government has a significant ‘investment’ in this sector through generous tax breaks. However, if the answer to apparent saving inadequacy is a higher contribution to Tier 2, we should expect a significant displacement effect between Tier 3 (lesser savings) and Tier 2 (higher savings).
(5) Such long-run projections depend completely on the underpinning guesses about returns and behaviour. (File size 770 KB; 44 pp) 705