After almost 30 years since the introduction of compulsory superannuation in Australia, many practitioners have called for a review of the superannuation guarantee (SG) system before the legislated increase in employers’ compulsory contributions from 9.5% to 12% by 2025. These increases are:

 Period Super Guarantee (%)
 1 July 2002 – 30 June 2013 9.00
 1 July 2013 – 30 June 2014 9.25
 1 July 2014 – 30 June 2021 9.50
 1 July 2021 – 30 June 2022 10.00
 1 July 2022 – 30 June 2023 10.50
 1 July 2023 – 30 June 2024 11.00
 1 July 2024 – 30 June 2025 11.50
 1 July 2025 – 30 June 2026 onwards 12.00

Source: Australian Tax Office

The case against

The Grattan Institute recently published research showing that higher SG contributions would not be in the interests of many working Australians as many middle-income workers would give up wages of up to 2.5 per cent while working, in exchange for less than a 1 per cent boost to their retirement incomes. Grattan argues almost all the extra income from a higher super balance at retirement would be offset by lower age pension payments, due to the pension assets test. Pension payments themselves would also be lower under a 12 per cent super regime, because they are benchmarked to wages, which would be lower if employers contributed more to super. Grattan calculates that lifting compulsory super from 9.5% of wages to 12% would make the typical worker up to $30,000 poorer over their lifetimes.

Not surprisingly, these findings have sparked fierce debate amongst industry practitioners, with some questioning the assumptions made by the Grattan Institute, contending their calculations are based on people working until age 67 when in fact many retire before this for numerous reasons. The adequacy of the ASFA retirement standards is also a point of difference between protagonists. Grattan contends the ASFA retirement standards would mean many retirees would be significantly better off in retirement and this was not the purpose of super. Grattan’s research showed that most people reaching retirement would achieve 70 per cent of the income they had while they worked, a reasonable outcome given that in retirement most people have lower costs with children having left home and many without mortgages.

The case for

According to the Committee for Sustainable Retirement Incomes analysis, for those not eligible for an age pension (likely to be at least 40% of retirees into the future), maintaining pre-retirement living standards will require contributions of 15-20% (18% is the OECD average); for those eligible for some age pension, the contribution rate required will be lower but, even at typical earnings, would most likely be more than 12%.

Mercer contends Australia’s retirement system is not up to the standard of better systems overseas and still required the SG to move to 12% to provide comfortable retirements. Despite being compulsory, Australia’s super system covers only 75.7% of the population while comparable systems covered 80 to 90% of the population. Mercer also believes Australia’s SG contributions need to rise to 12% to ensure retirement income levels reach OECD averages. International comparisons showed Australia’s pension and retirement system in a positive light, with the Melbourne Mercer Global Pension Index in 2018 listing Australia at No.4 out of 34 countries examined. However, once the net replacement rate of pre-retirement income is factored in Australia does not compare so favourably. The OECD said Australia’s average net replacement rate was 40.7%, while for the OECD it was 65%.

No discussion could be complete without the views of former Prime Minister Paul Keating, the architect of the current SG system whose frustration at the current discourse was evident recently. He heavily criticised Liberal MPs proposing to scrap a plan to raise the SG, saying the suggestion that an increase would stifle wage growth was a ‘great lie’ and likening those against the SG increase to climate change deniers and anti-vaxxers.

What’s next?

There are many critics that suggest a redesigned assets test could help ensure increased savings boost retirement incomes. Grattan’s findings that an increase in savings through the SG would lead to a reduction in lifetime incomes is true of a voluntary increase in savings in any form other than increased investment in the family home. A better designed assets test, perhaps even a merging of the income and assets tests, could help ensure savings are not unduly penalised.

What would be beneficial is if industry practitioners articulated what they consider to be the objective of the retirement incomes system, and focused analysis on whether increasing the SG would or would not help to achieve that objective, and at what cost. A good starting point would be that Australians have secure and adequate incomes at and through retirement. ‘Adequacy’ would seemingly have two components, though there appears to be debate around the send point:

  • sufficient to ensure no aged person lives in poverty (the role of the age pension); and
  • sufficient to maintain pre-retirement living standards (the role of superannuation and other savings)

Only when there is broad agreement on these points can the problem of how to best achieve them can be solved.

 

With the Reserve Bank of Australia (RBA) cutting the official cash rate to just 1.00% on 2 July, retirees and investors face increased challenges in deriving enough income from their investments to meet their needs. This is an ongoing issue with more interest rate cuts forecast by financial markets. The following chart puts this challenge in perspective.

Key rates are on the way down in the world’s largest economies


Source: Reserve Bank of Australia, June 2019

Lonsec’s Retirement Lifestyle Portfolios are objectives-based portfolios focused on delivering a sustainable level of income in retirement, as well as generating capital growth. Specifically, the portfolios are designed to assist advisers in constructing portfolios to meet retiree essential and discretionary income needs, while generating some capital growth to meet lifestyle goals.

Differences to Lonsec’s core accumulation model portfolios are:

  • Income objective of 4% p.a. for all portfolios
  • Greater bias to AUD denominated assets – historically higher dividends, franking credits
  • Greater focus on absolute rather than relative performance
  • Constructed to manage capital drawdown risk
  • Fixed income allocations have less duration and greater credit exposure
  • Key building blocks are Yield, Capital Growth & Risk Control

With 10 year Australian government bond yields currently less than 1.50% p.a., Lonsec has opted for a diversified approach to meeting this income objective. Income in these portfolios is generated by the following funds:


Equity funds
Legg Mason Martin Currie Real Income Fund

 

A portfolio of listed companies that own ‘hard’ physical assets, like property, utilities and infrastructure (e.g. A-REITs, airports, toll roads, electricity and gas grids). Real Asset companies like these are an integral part of everyday life and are often monopolistic in nature. Their demand profile is, therefore, relatively inelastic and not pegged to the business cycle, hence these companies have more predictable free cash flow and dividends. The typically long-term nature of their cash flows (underpinned by long term contracts and favourable regulatory structures) also offers protection during market downturns, as well as upside growth potential from population growth. This means Real Asset companies typically have a low beta versus the broader equity market and can provide low-volatility, regular and dependable income streams.
Plato Australian Share Income Fund

 

A tax effective, income focused, ‘style neutral’ Australian equity portfolio that is broadly diversified (50-120 stocks) and seeks to generate income through investing in fully franked dividend yielding stocks in the run-up period to the ex-dividend dates. The Fund has been specifically designed to be tax effective in the hands of a 0% rate tax payer by capturing franking credits and exhibits a high portfolio turnover (circa 150% p.a.).
IML Equity Income Fund

 

An equity income strategy that seeks to generate income through investing in dividend yielding stocks and an options strategy. The options strategy generates income through buy-write and covered call option strategies and selling put options.
Grant Samuel Epoch Global Equity Shareholder Yield Fund

 

A long-only, benchmark unaware product that aims to invest in global companies assessed as generating free cash flow which supports both a sustainable ‘shareholder yield’ and some cash flow growth. Its objective is to generate a target return of 9% p.a. or greater over ‘a full market cycle’, expected to be derived from dividends (4.5%), share buy-backs and debt pay downs (1.5%) and cash flow growth (3%).
Talaria Global Equity Fund

 

An active long-only, ‘benchmark unaware’ investment product that invests in large cap securities within developed and emerging markets. The Fund is relatively concentrated, targeting 25-40 ‘quality’ companies that are purchased at ‘reasonable’ valuations. Approximately 50-70% of the Fund is committed to equities, with the residual reserved as option cover for put options sold. Stock positions are entered (and exited) via the sale of fully cash backed (covered call/put) stock options. The option premium earned provides an additional source of return beyond capital growth and dividends and creates a ‘buffer’ against losses by reducing the cost of stocks purchased.
Fixed Income Funds
Schroder Fixed Income Fund A Diversified Fixed Interest product normally invested in Australian and global (hedged) government and non-government debt markets and may have material exposure to credit assets, including up to 20% sub-investment grade sectors.
PIMCO Global Bond Fund

 

A Global Fixed Interest fund normally invested in a mix of bonds paying fixed rate (predominantly) coupons such as those issued by sovereign governments, corporations and other structured securities like mortgage bonds. Lonsec notes that PIMCO’s total return approach implies a degree of indifference as to the source of returns either from income / distributions (e.g. coupons) or growth (e.g. asset price growth).
Janus Henderson Tactical Income Fund

 

The Fund will normally be invested in a mix of bonds or debt securities paying fixed and/or floating rate coupons issued by Australian governments and corporates, residential mortgage backed securities and hybrid securities. The Fund is designed to actively allocate between Australian cash, Australian fixed interest and Australian credit, providing greater scope than traditional bond funds to protect capital in a rising yield environment.
Macquarie Income Opportunities Fund A relatively conservative credit fund with short duration fund which uses a core/satellite approach and distributes income monthly. The ‘core’ is a portfolio of predominantly ‘investment grade’ floating rate securities and ‘satellites’ exposures of Global High Yield and Emerging Markets Debt.

 

These funds provide a diverse source of income for retirees, though this does not come without risk. With equities generating a significant portion of the income it is imperative that equity market risk is managed through allocating to more traditional fixed income funds and funds able to play a Risk Control role in the portfolios.

Important information: Any express or implied rating or advice is limited to general advice, it doesn’t consider any personal needs, goals or objectives.  Before making any decision about financial products, consider whether it is personally appropriate for you in light of your personal circumstances. Obtain and consider the Product Disclosure Statement for each financial product and seek professional personal advice before making any decisions regarding a financial product.