Much of the discussion about raising the pension age has ignored the impact that the compulsory superannuation scheme will have on retirement savings. Media coverage has not indicated whether raising the pension age to 70 will mean that contributors to the compulsory superannuation scheme will not have access to their funds at 65.
The compulsory superannuation scheme was introduced in 1992. What many people did not realise was that it would be a full 45 years before workers would have access to the full benefits of the scheme. People retiring in 1993 would only have accumulated one years’ superannuation: 9% of their salary, probably about enough for a couple of economy class air fares to the UK.
The problem with the slow transition of the working population to the benefits of the compulsory superannuation scheme was that, because the retirement sums were so small, people tended to spend them on overseas trips, debt reduction, new cars etc and then go on the pension. This will continue to be a problem although one assumes an ever decreasing one as we approach 2037.
However, it is worth looking at what the superannuation scheme actually does. To simplify matters, the modelling that I have done has kept wages at current levels and has limited capital growth in superannuation to 5% (the average 8% growth in the stock market less 3% for inflation). The model also assumes that the pension will be 5% of the total accumulated fund. While this is a gross simplification it does help us understand what the big picture looks like. It also assumes that the individual will live to be 80.
This first graph shows the basic mechanics. An individual’s superannuation builds up over the 45 years of their working life. After 45 years, they retire, contributions stop and pension begins.
Superannuation with 6% average capital growth and a pension of 5%
The interesting thing about this graph is that the take-home salary is around $48,000 and the pension is around $53,000. If we assume that the individual pays off their mortgage around the time they retire, then they will have more money in retirement than they had while they were working. By world standards, that’s a pretty good outcome. And under this scenario, the retiree will leave a lump sum of around $800k to his or her beneficiaries.
The final scenario is where the government increases the compulsory employer contribution to 12%.
In this case, a withdrawal rate of 5% maintains a pension well in advance of final take-home pay (FTP = 47k, pension = 71k). This leaves over $1.5m in the estate after the death of the pensioner.
The caveat to this modelling is that it will only come into effect when the compulsory superannuation scheme is been running for 45 years, in 2037. But that’s the thing about planning for pensions and superannuation, it’s about long-term planning. It looks as if, in the long term, it will be possible to have the bulk of the population, namely those who have had continuous full-time employment, retire at the age of 65.