By David Clark*
June 2006

The Howard Government's radical simplification of the super system was long overdue and rightly applauded.

But we simply do not know whether Australians will indeed work harder and longer and save more for a rainy retirement day, as the Government claims.

Indeed, a closer look at this issue suggests that what they do with any extra saving will be far more important.

Professor John Head of Monash University has argued that the Government has thrown money to the age group least likely to increase savings or its workforce participation.

However, acting on the old saying "Always let the facts get in the way of a good story/academic press release", the Institute of Actuaries has rightly pointed out that the impact on most retirees will be minimal.

It notes that under the current system about half of all retirees receive their lump sum benefits free of tax anyway, because they fall below the tax-free amount of $129,751.

Moreover, retirees receiving the average retirement benefit - about $160,000 - can take the first $130,000 free of tax and commute the remainder to a pension.

The Institute also estimates that even in 20 years time the average retirement balance will increase to only about $260,000 - but this can only be a mere guess.

What retirees will do with their higher retirement incomes is an even greater unknown.

Unfortunately, there has been little research done on why different groups of Australians save and how much they save.

A 1999 Melbourne Institute study found that the distribution of income and wealth is a key influence and the authors suggested that a more equal distribution of both would very likely raise the overall household saving rate.

But there were no "Robin Hood"-style measures in this direction in the 2006 Budget. In fact, as the following example illustrates, the Government's proposed changes have quite the opposite effect.

In the first graph, a retiree with a $100,000 lump sum benefit receives no benefit from the new changes given they would not have paid any tax on their benefit anyway under the old arrangements. On the other hand, a retiree with a $400,000 benefit will be $43,522 better off with the the axing of the lump sum benefit tax.

The second graph shows the difference in the final lump sum benefit for two employees aged 45, one earning earning $800 a week and the other earning $2,000 a week. Both are planning to retire in 20 years time and receive the minimum 9% super guarantee contributions over this period. Under the Government's new super rules, the lower income earner ends up only $2,400 better off over 20 years while the higher income earner ends up more than $50,000 ahead. This example assumes an annual investment return of 7% after fees, wage growth of 4% a year and CPI of 2.5% p.a..

What we do know, from some very interesting data provided in the Reserve Bank's latest Monetary Policy Statement, is that the financial wealth of the average Australian has increased dramatically over the past decade, despite a fall in their cumulative saving level.

Why this has happened should be of great interest to all investment advisors.

The much quoted household saving rate is calculated from the household income account in the national accounts and does not include in income (and therefore saving) that part of the return on investments that comes in the form of capital gains.

For share investments, for example, only the return that is in the form of dividends is included as income.

But dividend income has accounted for only about 30 per cent of the overall return on Australian equities in recent decades.

However, share holdings have become a far more important part of household investments.

The household saving ratio thus gives a false impression of saving trends and particularly hides the increase in financial wealth among better-heeled and smarter Australians.

A much more meaningful measure of household saving is thus the change in household net financial wealth, defined as household financial assets (bank deposits, bonds, equities and unit trusts) less non-housing debt.

This measure focuses only on financial wealth and abstracts from wealth in the form of dwellings and the household debt used to fund that investment in dwellings.

To the extent that households borrow against dwellings to buy financial assets (i.e. engage in housing equity withdrawal) this measure of financial wealth is an overstatement but in recent years the RBA believes that this does not change the main message of the following graph.

The main reason for the gap between the two lines has been capital gains on equities.

True, they can be volatile but the solid upwards trend clearly shows the value of investment in equities, rather than leaving ones savings in bank accounts.

In sum, the Federal Government has given a big windfall tax cut for high income retirees but its economic impact will not de-stabilise the economy nor raise Australian saving levels significantly.


*Dr David Clark teaches Business Economics at the University of NSW and is an investor educator.