Paul Keating appeared on 730 last night, arguing the case for an increase in superannuation contributions from 9.5% to 12.5%.
He is saying that 9.5% will not be enough for people to retire on, given increased longevity.
Superannuation is a complex topic and not many people who are under the age of about 50 are really interested in it.
Employer superannuation contributions are compulsory for all workers in Australia. This means that every worker contributes 9.5% of the annual salary into superannuation account. This amount of money will grow by some compounding rate, usually the rate at which the stock market grows. When the worker turns 65, they can begin drawing against their accumulated superannuation at a rate that they will decide, usually 5-6% of their accumulated capital.
All of this is complicated by varying rates of return in the stock market over the period of contribution, salary increases, or in the case of many women, absences from the workplace to have children and variations of the taxation rates.
But if we want to examine the case for leaving the contribution rate at 9.5%, we can build a very simple model stripped of the complications of specific individuals.
In this model, the superannuation account builds up through an inflow consisting of 9.5% of the worker’s salary plus accumulating and compounding interest on the balance of their account.
When they retire, the worker will draw down a percentage of the accumulated balance. This is shown as an outflow from the superannuation account.
It is this compounding factor that makes a 9.5% contribution rate a minor factor in the balance of the superannuation account. In the final year of contribution, the worker superannuation account will grow by $27,000 but only $9500 of that will be the worker’s contributions.
In the model, I have simplified a lot of the variables in the superannuation mix and calculates the superannuation savings and payouts using current prices.
My model worker begins work at the age of 20, earning an average salary of $100,000 a year for the rest of their life until they are 65. During that period of time, they will pay $24,700 a year in tax at current tax rates, giving them an income of $75,000 year
During that period of time they will contribute $2.1 m to their fund.
When they retire, they will begin drawing down on that superannuation fund at the rate of 6%. This will give them an annual pension of $127,000 (tax free) a year as soon as they retire, nearly $50,000 a year more than they were earning while they were working.
The model assumes that the average rate of return in the stock market is 7%. This means that the superannuation fund will grow at 1% per annum until they die at the age of 80 when their average pension will be $147,000, still tax-free.
In addition, the retiree has not drawn down the superannuation account at all. When they die at the age of 80, their superannuation balance will stand at just over $2.5 million which they can leave to their children.
This is the graph of the withdrawals that the worker makes from the fund. They continue to increase because the withdrawal rate is less than the earning rate of the fund. The next graph shows the balance of the fund continues to increase for the same reason.
The model makes no allowance for inflation or for cost of living increases, on the assumption that these will cancel each other out over time.
If, as Keating suggests the contribution rate is listed to 12.5%, the model indicates that the worker would retire on a pension of $165,000 a year (more than twice what they were earning) at today’s prices and leave their children $3.4m.
The question is whether employers can afford to contribute another 3% in superannuation to provide pensions far in excess of the money workers were earning in the workforce.
The answer is probably no.