Australia
compiled by Allianz Global Investors
Pension System Design
Australia operates a three-pillar pension system that very much resembles the World Bank model. The public pillar is composed of a means-tested, tax-financed Age Pension that provides subsistence-level benefits. The pension system is predominantly based on a mandatory second pillar consisting of funded individual pension accounts provided by superannuation funds. In addition, individuals may contribute voluntarily to their superannuation funds or to Retirement Savings Accounts; in both cases, plan members enjoy tax advantages.
In July 2007, the compulsory superannuation system saw its biggest reform since its inception in 1992. The reform was intended to remove some of the weaknesses of the old system. In particular, the complicated taxation system was simplified, incentives for the self-employed to join the system on a voluntary basis were strengthened and the eligibility age for superannuation benefits increased to the age of 60.
Next to the United States and Canada, Australia belongs to the group of traditional immigration countries that are less affected by the demographic challenge than most OECD countries. Thanks to high net immigration rates, Australia will not see its population decline over the next four decades. Nevertheless, Australia’s population is ageing. Low fertility rates of 1.79 children per woman (below the natural replacement rate of 2.1) and increasing life expectancy will increase the median age from 36.7 years today to 43.4 by 2050. During the same period, the old-age dependency ratio will worsen from 19 to 41.
Although assets in the superannuation system amounted to EUR 606.7 billion at the end of 2006, we expect a CAGR of 10.3% in the projection period until 2015. This increase will mainly stem from a growing number of employees and a high equity portion in pension portfolios.
Public Pensions
Australia’s state pension system operates on a non-contributory basis and is financed by general tax revenues. The Age Pension provides means-tested benefits for men over 65. Women currently qualify for the Age Pension at different ages, depending on their date of birth. By 2014, the age limit will be set at 65 for both men and women.
Eligibility for Age Pensions is subject to income and asset tests. The asset test foresees that Age Pension payments are reduced by EUR 0.9 (AUD 1.5) (pension taper rate) per fortnight for every EUR 598 (AUD 1,000) of assets above the relevant threshold. The asset test was reformed in September 2007. Previously, the Age Pension was reduced by EUR 1.8 (AUD 3) per fortnight. Asset limits range from EUR 311,513 (AUD 520,750) to EUR 566,196 (AUD 946,500), depending on family status and home ownership. The reduction of the pension taper rate automatically increased the pension payments of many retirees. The income test foresees that singles/couples with additional income of up to EUR 79/139 (AUD 132/232) per fortnight qualify for a full pension. Additional income of up to EUR 873/1,459 (AUD 1,460/2,439) partially reduces the Age Pension with a full reduction for earnings exceeding these limits. About 75% of retirees receive an Age Pension.
The Future Fund, established by the Future Fund Act 2006, aims at funding costs arising from unfunded public sector superannuation liabilities. These liabilities will become payable to public servants and defence personnel from 2020 onward. Current unfunded liabilities, which amount to EUR 2.7 billion (AUD 4.5 billion) per annum, are covered by the government budget. Liabilities are expected to grow to around EUR 88.5 billion (AUD 148 billion) by 2020 and to more than EUR 119.6 billion (AUD 200 billion) by 2046.
The Future Fund is funded by budget surpluses and privatisation revenues. Its balance in August 2007 was approximately EUR 35.9 billion (AUD 60 billion). It is expected to hit its planned asset target of EUR 88.5 billion (AUD 148 billion) in 2020.The investment strategy is determined by the Future Fund Board of Guardians, an independent body subject to an investment mandate given by the Australian government. The targeted long-term average return should be at least 4.5 to 5.5% per annum, and the stake in foreign equities is limited to 20%.
In response to the growing fiscal burden, most public defined benefit superannuation schemes are now closed to new members and have been replaced by fully funded accumulation schemes. Only the Military Benefits Superannuation Scheme will continue to exist on an unfunded, defined benefit basis.
Occupational Pensions: Superannuation
In 1992, Australia successfully implemented the superannuation system, a mandatory, earnings-related pension scheme. The public old-age pension was considered insufficient in providing adequate retirement income. Prior to that, superannuation was largely optional and confined to bigger corporations. Recent amendments that came into force in July 2007 focused particularly on the tax treatment of super payouts, super withdrawal, deduction limits for super contributions and on easing account consolidation.
Institutional framework
Above a certain income level, employers in Australia are obliged to make superannuation contributions of 9% of their employee’s wages to a fund that is chosen by the employee. These mandatory contributions, which are fully vested, portable and generally fully funded, are placed in individual accounts. Additional voluntary contributions by employers and employees are possible, and individual choice was introduced in 2005. Employees can switch funds once within a 12-month period.
Defined contribution funds are the dominating form of pension plan in Australia with a market share of approximately 80%. Before the compulsory superannuation system was introduced, defined benefit plans were the prevalent form of occupational pension provision.
Superannuation funds are predominantly provided through a trust structure within which trustees hold superannuation assets on behalf of members. Different types of pension schemes operate in the Australian superannuation market. Entities can be classified in two categories. While regulations stipulated by the Superannuation Industry Supervision Act classify superannuation entities in terms of public or private offerings, responsible regulatory authority and size, the functional view is more common. The following types of funds exist:
• Corporate funds are usually single-employer sponsored superannuation funds that can either be public or non-public offer. A group of related companies may also offer corporate funds to their employees
• Industry funds encompass a range of employers within a specified industry
• Public sector funds are sponsored by government agencies or state-owned enterprises
• Retail funds are independent entities not related to a specific employer. Large financial institutions offer these funds to the public on a commercial, for-profit basis
• Small superannuation funds include small APRA funds (SAFs), single-member approved deposit funds and self-managed superannuation funds (SMSFs). APRA stands for Australian Prudential Regulation Authority. Alongside the Australian Taxation Office (ATO), it is the regulatory authority responsible for SMSFs. Both SMSFs and SAFs are superannuation entities with less than five members. In a self-managed fund, the individual is his own trustee and therefore legally responsible for the fund and the investment strategy.
Many funds offer a choice between different investment options within the superannuation fund. For instance, 80% of funds with assets of at least EUR 59.8 million (AUD 100 million) do so. This group represents around 60% of superannuation assets. 45.2% of individuals make use of their right to choose. Since 2005, employees have been allowed to choose the fund into which employer contributions should be paid. Should an employee disregard his or her right to choose, assets are allocated to a default investment strategy chosen by the employer. For the vast majority of funds, the default strategy is a balanced growth option with 60 to 75% of assets in high volatility, high expected return asset classes. The proportion of assets invested in the default strategy is lowest for retail funds. In contrast, industry fund members are most likely to pick the default option.
There are 30 million superannuation accounts for a workforce of 10 million people. On average, members have three accounts each with current or former employers, and some people have additional individual accounts. The reform that came into effect in July 2007 has made the process of pooling assets from different funds into one easier. This reform may reduce the large number of superannuation accounts.
Investment regulations
Investment regulations in Australia follow the prudent person principle. Hence, pension fund managers do not face quantitative investment regulations on specific asset classes. Only a few restrictions apply to the investment of fund assets:
• Up to 5% of total assets may be invested in the sponsoring employer or a related party
• Superannuation funds are prohibited from borrowing
• Restrictions apply on lending to members and on acquiring assets from members
Asset allocation
Much like in most Anglo-Saxon countries, Australian superannuation entities have a high exposure to equity. Superannuation funds own around one third of the Australian stock market; superannuation funds outside life offices have EUR 503.1 billion (AUD 841 billion) assets under management, with an average allocation to domestic equity and unit trusts of 50.6%. This is followed by overseas assets, with a share of 21.6%.
Pension benefits and taxation
Pension benefits are available either as a lump sum or as a life annuity, or a mix of both. Fund governing rules stipulate how benefits will be paid. Lump sum payments are the most popular payout option. Pension payments from public sector funds are usually paid out as lifetime annuities.
In terms of taxation, there are two types of superannuation funds that can be distinguished: taxed and untaxed funds. Taxed funds are the most common. The main difference is that the taxation of taxed funds takes place only on the fund level. Contributions, investment earnings and losses are considered as taxable income to the fund. Earnings on assets segregated to provide pension payments are tax-exempt. In the case of untaxed funds, only the pension benefits are taxed.
Compulsory employer contributions are tax-exempt, as are employee top-up contributions up to EUR 29,910 (AUD 50,000). Until 2011-2012, individuals over 50 may make additional contributions up to EUR 59,820 (AUD 100,000) on a tax-exempt basis. From 2012-2013, the lower limit will apply. The contribution limits for voluntary top-up contributions were only recently increased. Changes were part of the superannuation reform. Self-employed people are now able to claim a full tax deduction for their superannuation contributions.
Pension benefits from taxed superannuation funds up to EUR 598,200 (AUD 1 million) are not taxed, provided that the retiree receives the benefits after the age of 60. Benefits in excess of that sum are subject to the top marginal tax rate. Federal and state governments and some large companies offer their employees untaxed super funds. The assets in these funds are not taxed until the benefit is paid.
Superannuation funds that are in compliance with the Superannuation Industry Supervision Act (SIS Act) and that have opted to be regulated receive favourable tax treatment. A lower tax rate of 15% applies to income received by taxed superannuation funds. Income received from untaxed super funds is taxed by the individual at a rate of 15%, which applies to lump sum payments. Benefits taken as regular income are taxed at the individual tax rate, less 10%. Funds, either taxed or untaxed, that do not comply with the regulatory provision as defined in the SIS Act and that have not opted to be regulated, are subject to a tax rate of 45%.
Prior to the reform, superannuation benefits were split up into eight different parts, which were then taxed in seven different ways. Simplifying tax rules for superannuation was one of the core elements of the current reform. People in untaxed super funds, such as public servants, have to pay tax on their payouts. However, the applicable rate was reduced in July 2007, for those taking their pension after the age of 60.
Outlook
Besides India, Australia is the only country covered in this study for which demography does not pose a severe problem, as net immigration helps ensure that the population ages slowly. The Australian pension system is often considered a role model not only for Asia, but for other countries around the world as well. Thanks to its well-established and mandatory occupational pillar, Australia has one of the most developed pension markets worldwide.