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A Swiss makeover for Australian super

by Geoffrey Kingston | 12 Jun 2015

Superannuation policy is tired. Yawns greeted the recent seven-year freeze of our compulsory contribution rate, and that’s been just one sign of malaise. Switzerland is renowned not only for high-end spas and wellness clinics, but good retirement policy. It’s time we signed up for a Swiss makeover.

In 1972 Switzerland came up with the useful principle of organising retirement income policy into three pillars:

Social safety net.
Compulsory occupational super. It reduces free riding on the first pillar by affluent households, helps ensure a decent proportion of wage income is replaced in retirement, and boosts national savings ahead of baby-boom retirements.
Incentives for voluntary contributions by people seeking comfortable self-funded retirements. More controversially, it also helps retirees to build up an estate for their children.
Since 1992 Australia too has had three pillars, but each needs re-sculpting.

Updating Australia’s three pillars

Our first pillar, the age pension, goes back to 1909. It has increasingly become not just a safety net but a middle-class entitlement. Seven out of 10 retirees rely primarily on the pension. Nine out of 10 draw some pension during part of their retirement.

Since 2009 the pension for a single retiree has stood at 28% of male average earnings. That’s the highest percentage since World War II, and possibly pre-war as well.

In its first budget the current Government tried to phase in reduced indexation of the pension. Indexation was to be wound back to growth in consumer prices alone, instead of the maximum of growth in wages and growth in consumer prices. The Senate blocked this measure.

The Government could return to the Senate with the relevant Swiss policy, namely, indexation at the average of growth in wages and growth in consumer prices. This would amount to a compromise whereby pensioners are generally protected in real terms but do not participate fully in the growth of community living standards.

Our second pillar is also dilapidated. At 9.5% of wages the compulsory contribution rate leaves us snookered. On the one hand it’s too low to counter pervasive pension dependence. On the other hand, and to the extent employers are unable to pass the compulsory levy on to employees, it jeopardises the competitiveness of Australian workers, particularly young ones. To the extent employers are able to pass on the compulsory levy to employees, however, young workers struggle to pay down study debts and put together a deposit on a home.

Swiss policies towards the second pillar can get us out of this bind.

The lifetime compulsory contribution rate in Switzerland averages about 12% of lifetime wages. This rate would be high enough for our second pillar to make worthwhile inroads into pension dependence.

Because young workers need to pay down study debts, raise a home deposit and avoid being priced out of a job, compulsory contributions on their behalf should be cut. In Switzerland the mandatory contribution rate for workers aged between 25 and 34 is just 7% of wages, compared with 15% in the case of workers aged between 45 and 54. Compared with Australia’s flat 9.5%, Switzerland’s age profile for compulsory contributions is closer to what an intelligent and far-sighted household would voluntarily choose in the absence of compulsory super and the age pension.

To support the competitiveness of Australian workers, future rises in compulsory contributions should fall on employees. This would take us part-way towards the Swiss policy whereby employers are allowed to pay as little as one half of second-pillar contributions.

Employer contributions to our super are generally taxed at a flat 15%, as are fund earnings before retirement. In this way, there is no progressivity in our super taxes, apart from contribution limits and a higher tax on employer contributions on behalf of those with salaries exceeding $300,000 per annum. Wealthy families use housing investments outside super to avoid tax, access the pension and protect planned estates. This diverts savings from productive investments, and props up house prices.

In Switzerland and most other countries, by contrast, super taxes are delayed until retirement. Retirement income is taxed in line with the regular progressive rate scale. So lifetime taxation of super is effectively a progressive consumption tax. This promotes fairness and efficiency.

Then there is the worrying fact that Australian super funds have the highest exposure to growth assets within the OECD. Switzerland, by contrast, caps equity investments at 50% and real estate investments at 30%.

New type of super account

We need a new kind of super account alongside the familiar one paying lump sums after retirement. These new accounts would be reserved for lifelong income streams, again echoing Switzerland, which encourages annuitisation of second-pillar benefits. Precise specification of eligible lifelong income streams — life expectancy products versus full life annuities, minimum annual escalation rates, etc. — is of second-order importance, and is best left to another occasion.

Like existing accounts the new ones would be subject to contribution limits. Indeed, these limits would initially need to be low, to protect the budget in the short term.

The new accounts would be tax-free until retirement, at which point annuity income would face the regular rate scale. Exposure to growth assets within the new accounts, once annuitised, would be capped at 50%.

Super contributors could open either or both types of account, in this respect echoing the United States and Canada. (Good as it is, Swiss policy isn’t the answer to all our problems). Over time, however, changes in contribution limits would redirect compulsory contributions into the new Swiss-style accounts. Likewise, compulsory contributions on behalf of new workers would go into the new accounts.

The old-style accounts would still be taxed upfront, largely free of asset restrictions and eligible for lump-sum withdrawals. But they would eventually be reserved largely for third-pillar retirement savings.

About the author

Geoffrey Kingston is a professor in the Department of Economics at Macquarie University. He would like to thank the Centre for International Financial Regulation for research support.

This article was first published by Cuffelinks, proudly supported by Finsia.

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