Articles for Advisers

The federal government has appointed a panel to undertake a review of the three pillars of the Australian retirement income system: the age pension, the superannuation guarantee (SG) and voluntary contributions. Here are the key issues I believe the review panel should highlight for further attention.

I must admit that I am not convinced that the retirement income review will deal with anything that the Morrison government deems remotely problematic for its re-election prospects, such as the inclusion of at least a portion of the family home in the pension assets test, increasing the age pension eligibility age and increasing the superannuation guarantee (SG) beyond 9.5 per cent.

Lifting the SG gradually to 12 per cent, as proposed, would increase fund flows to industry super funds, whose values are aligned with those of the unions – a group whose influence this government would very much like to diminish.

Having said that, it must be acknowledged that this review is an opportunity to confirm the baseline information on which future policy decisions can be made to deliver a much-needed reset of aspects of our retirement income system.

I don’t pretend to have all the answers but I do know that the best way forward involves strong political leadership and industry consultation, which will hopefully follow this fact finding review. Here are some points I urge the review panel members to consider.

Shifting the focus from accumulation to draw down

The focus of the Australian superannuation system until now has been on the accumulation phase – and that has been successful. Recent research has shown more than half of Australians aged 66 are not accessing the aged pension at all because their assets and incomes are too high, and only 20 per cent are on a part pension.

Regardless, both self-funded retirees and those entitled to the age pension need support, education and appropriate retirement-income solutions. The focus now needs to shift to helping all Australians achieve their income needs and goals in retirement.

There are a number of obstacles that need to be removed, or at least addressed, in order to optimise superannuation savings for the average Australian such as housing affordability, wages growth and persistently low interest rates. There is also the issue of too many women still retiring with inadequate superannuation balances.

The first generation of contributors to our compulsory superannuation system is about to hit retirement. Super funds must be prepared to meet the retirement income needs of this group.

The age pension system is outdated

Since the Commonwealth age pension was introduced in Australia back in 1909, life expectancy has gone up 25 years for men, to 80.5 years, and 26 years for women, to 84.6 years. Yet the age pension eligibility age has increased by just one year for men and six years for women.

With many Australians now enjoying a good 30 years of retirement, clearly, something’s gotta give. The age pension framework has simply not kept pace with Australia’s changing lifestyles and demographics. Its original role as a safety net has been transformed. The age pension now primarily serves as a supplementary source of income to superannuation savings.

Improve incentives to keep seniors working longer

People are living longer and the age pension eligibility age is increasing, albeit far too slowly, but incentives to keep working are not developing quickly enough.

People aged over 65 are healthier than ever before and, increasingly, want to continue to work in some capacity. My experience with elderly people also has shown that they are generally happier and healthier when they are productively contributing to society so long as the work is not too stressful. But financial incentives such as the Pension Work Bonus need to be improved and employers’ attitudes towards older workers must change. Tax incentives to employers of seniors would also encourage them to employ older Australians or keep more retiree-age people in the workforce.

Strategies to increase the ratio of workers to people on welfare

As the Australian population continues to age, the ratio of workers to people dependent on welfare falls. The vast majority of welfare payments are made to age pensioners and people on disability pensions; a relatively small amount goes to unemployment benefits. This trend is largely due to the fact that people are living longer but also due to the natural phenomena that as societies become more affluent, their citizens have less children per capita. This trend is obviously unsustainable and needs to be reversed if possible.

A significant lever to correct this imbalance is immigration. There is never a shortage of people wanting to migrate to Australia, and generally migrants are young people (the median age in 2017-18 was 26), often with families, ready to work and spend and contribute to GDP growth.

Sadly, more recently, there has been populist rhetoric against immigration and, as a result, the number of migrants and people with temporary visas allowed into Australia has dropped significantly in the past few years.

I have no doubt that this is one of the factors causing our economy to slow. The most counter intuitive reason I have heard is that immigration puts strain on our infrastructure therefore we should slow it down for a while. This is an infrastructure problem not an immigration problem.

If some of the lifts in a building broke down, you would not stop new tenants moving in or existing tenants from hiring new staff until the owners got around to fixing the lifts. You would fix the lifts immediately, make do with what you have in the meantime so long as it was safe and allow business as usual. It is absurd to suggest that because our infrastructure needs to be enhanced we should reduce population growth. The very core of GDP growth is population growth.

With interest rates at record lows, now would be a great time to borrow to fund massive infrastructure enhancements, creating jobs and GDP growth. A new influx of immigrants could help do much of the work, and at the same time increase the ratio of workers to people on welfare.

Instead, the government has taken a populist approach and fought to keep our budget in surplus, potentially missing a once in a century opportunity to borrow money for next to nothing to fund much needed infrastructure enhancements.

Former political foes, Paul Keating and John Hewson, have both spoken about the opportunity for an infrastructure-led recovery. I hope the government takes notice rather than taking the road that secures the most votes in the short term.

Increase the superannuation guarantee

Labor introduced legislation in 2012 to increase the super guarantee to 12 per cent by this year. The timetable was subsequently changed by the Abbott government with the SG now set to hit 12 per cent by 1 July 2025.

However, the Morrison government is facing increasing pressure from its own MPs and senators to delay or abolish the planned increases. Those on the other side of the debate such as Rice Warner are saying that a higher SG would alleviate pressure on the age pension system and grow capital markets, which would benefit the entire economy.

In my view, any increase to the SG rate equates to money out of the economy in the short term. The government has said that the current precarious state of the Australian economy is the reason for delaying this.

However, I suspect that the real reason is that it would see more money flow into the coffers of industry super funds, some of which would inevitably find its way to the Labor Party.

Address housing affordability

Another major issue that directly impacts the pension system is housing affordability. Our retirement system was built on the assumption that most people would own their own home by the time they finished working. As it currently stands, an increasing number of Australians are likely to be paying rent in retirement, placing greater pressure on the pension system.

Recent modelling from the Grattan Institute found that the number of people aged over 65 who own their own home will fall from the current 76 per cent to 57 per cent by 2056. For low-income retirees, it will be well under half. The pension system, as it currently stands, is simply not equipped to manage these pressures. Rents have been outpacing the CPI-indexed government rent assistance payments for some time now, particularly in the major cities. There is a definite need to increase assistance for the growing number of retirees who do not own their own homes as well as thinking outside the box on housing affordability.

Treatment of the family home

Is it time for the high-value family homes to be included in the age pension assets test? Again, the likelihood is that no politician would touch this with a barge pole. Just look at what happened to Labor after it took the removal of franking credits to the last election.

Be that as it may, I don’t believe we should throw our hands in the air and give up on the implementation of big picture policy reform in this country. As Paul Keating recently remarked, large scale reform will be necessary to halt the increasing levels of inequality in our society.

There are clear anomalies with the current system. For example, a retired couple with a home worth $4 million and $245,000 in assets is eligible for a full pension, while a couple with a home valued at $500,000 and $860,000 in assets will receive no pension at all.

However, there are two sides to this issue. The above example shows an extreme situation that I am sure most would consider to be quite unfair to the second couple. Others would say that it is equally unfair that a couple who have lived their lives in an affluent area and are entrenched in that community, are forced to downsize to the point of having to move to where housing is more affordable.

So, this is certainly a tricky one. Innovation and competition in the home equity release product market may result in retirees being able to remain in their homes, but to cheaply and efficiently access some of the equity to top up their retirement incomes.

Conclusion

In any case, these changes are going to be unpopular. Whichever way you look at it, they will take money out of the pockets of elderly Australians, which are a large and growing portion of the voter base. However, the longer this issue is left, the worse it will become. Slow and steady change over the next 10 to 20 years will be much more palatable than large sudden shocks. This is also why we should look to employ other mechanisms such as migration to minimise the impacts on the elderly.

The federal government might have voted against a royal commission into misconduct in the banking and financial services industry 26 times but it’s making up for lost time.

This month the Senate passed the first substantive stand-alone piece of legislation relating to issues raised by the royal commission. The bill ends the payment of product commissions from fund managers, super funds, insurers and other financial product providers to financial planners and advisers.

The financial services industry is warning that, ironically, higher fees – not lower – could be one of the “unintended consequences” of the legislative change. 

If that sounds a bit like deja vu, you’d be right. In 2012, the then Labor government banned commissions for advisers as part of the Future of Financial Advice reforms.

This represented an overhaul of the mainstream remuneration practice in the industry, meaning consumers, and not product manufacturers, would have to pay for the provision of advice. The thinking was that removing this “conflicted remuneration” would allow consumers to get more objective, impartial advice.

But the rule was not applied retrospectively, which meant advisers could continue to receive any ongoing commissions relating to investments they made before the legislation’s effective date of July 1, 2014, under a so-called grandfathering clause.

After evidence to the royal commission that consumers had been charged “fees for no service”, Commissioner Kenneth Hayne concluded that the carve-out allowing these grandfathered commissions should be “repealed as soon as reasonably practicable”.

After the Parliament did exactly that on October 14, Financial Services Assistant Minister Jane Hume said one of the key benefits of the reform is that it will end the conflict whereby some advisers may have been hesitant to move clients into newer, better-performing products because they were receiving an ongoing commission on the old one. “Consumers will benefit from lower fees following the removal of conflicted remuneration for financial advice,” Hume said.

Higher fees

But the financial services industry is warning that, ironically, higher fees –not lower – could be one of several “unintended consequences” of the legislative change.

Phil Anderson, a policy expert at the Association of Financial Advisers, says advisers have been reviewing whether their clients should be switched into newer products ever since the FoFA reforms, and the total size of the pool of commissions paid to advisers has been diminishing as a result.

But there are important, technical reasons why it might not be in the client’s interest to switch to a newer or cheaper product, he says, even though that seems counter to the government’s thinking and conclusion of the royal commission.

GCT and Centrelink triggers

He says there are certain circumstances where the stopping of grandfathered commissions could actually leave a consumer worse off.

“The requirement to move product could trigger a capital gains tax liability,” Anderson says. “In some cases, the client may be advised to defer the recognition of a capital gain to a later time, when they have a lower taxable income.”

In addition to CGT concerns, advised consumers could also lose Centrelink benefits. In 2004 and 2007, the federal government made changes to the assets test for eligibility for social security payments to include income streams such as annuities and account-based pensions, which were previously exempt.

But these changes were grandfathered so that people relying on the previous rules in planning for their retirement were not disadvantaged.

“If they were moved to modern products now, this grandfathering would be lost and the income stream would be fully included in the asset test,”  Anderson says.

Another potential pitfall could face Australians in superannuation products that include a life insurance policy.

Switching super

Switching to a new super fund could cause them to lose cover which might not be attainable at the same rate or in the same form if the client’s health circumstances have changed over that period.

If rebates of commissions that would have otherwise been paid to advisers are passed on to clients directly – as some of the large bank-owned wealth management companies are already implementing – this could also have implications for older clients.

“A rebate will in many cases be taxable income and in the case of partial-age-pension clients may reduce the client’s pension by 50¢ in the dollar,” Anderson says. “In a limited number of cases it may push the client above the maximum income test threshold for the pension.”

Regardless of age or life stage, switching to a new investment product could also result in hefty exit fees, Anderson adds.

Although exit fees have been banned in the superannuation system, they still exist on some other financial products.

John Ardino, chairman of Lifespan Financial Planning, agrees that clients could face Centrelink and CGT consequences, which could make switching them into newer products problematic.

Aside from these technical issues that could create unintended costs or losses in some circumstances, the industry also warns that ending commissions will simply push up the price of advice, making it more expensive for those who already have an adviser and less accessible for those who don’t.

“The result of all this for consumers is that it will raise the costs of advice, reduce access to advice and leave thousands of clients orphaned without any access to advice,” Ardino says. “This is a major disruption for clients
needing financial advice and a major disruption to the practices of advice providers.”

Anderson warns that if some clients whose advice is now subsidised by product commissions decide they cannot afford a fee for service, their investment portfolios and financial lives could be adversely affected.

“If clients lose access to advice, then they may find over time their asset allocation progressively moves away from their target asset allocation,” he adds.

Beware the warnings

But consumer advocacy group Choice, which has long argued that the grandfathered commissions carve-out should be repealed, said consumers should be wary about warnings from industry bodies and lobbyists.

“There have been countless instances where the industry has squealed about unintended consequences to prevent and slow down reform and there has been no basis to the concerns,” says Choice campaigns manager Erin Turner.

While she doesn’t dispute that switching products could result in complexities and even financial losses, she says that is precisely why conflicted payments needed to end.

“A good, holistic, expert adviser is going to consider those issues and will consider the costs as well as any potential benefits,” she adds. “At least you can now know that the conflict is not there and they can give you a more objective assessment.”