A More Flexible and Adaptable Retirement Income System
People should develop realistic expectations and plans for retirement. The age pension will ensure that those who have not been able to save will not be left in need. But many people will want a higher level of retirement income than the age pension and compulsory superannuation provides. People who have higher retirement income expectations need to develop plans to achieve them.
As a first step, people should consider their financial goals for retirement and likely expenses.
Many retirees have a lower gross income in retirement than in their last few years in the workforce, but find their day-to-day spending needs are also lower. For example, fully retired people face lower expenses for clothing and transport than while they were working, while the major costs of raising children and paying off the mortgage generally are in the past. Tax bills also are generally lower, not just because incomes are lower, but also due to Government policies such as the Senior Australians' Tax Offset, which reduces the tax paid by Australians of age pension age.
The second step is to consider the likely level of retirement income based on current saving levels and other circumstances. Retirement income can include a mixture of a full or part-rate age pension, superannuation, income from non-superannuation investments, and any employment income.
The Superannuation Guarantee system in conjunction with the age pension will provide a single male on median earnings (approximately $35,000) with a spending replacement rate of 76 per cent after 30 years of contributions, or 85 per cent after 40 years of contributions. Spending replacement rates compare a person's spending power in retirement with that before retirement.6
The third step is to consider whether the expected level of retirement income based on current circumstances will be enough to satisfy the goals identified in step one. If not, then people will need to consider making changes to their circumstances in order to bridge the gap between retirement expectations and likely retirement incomes. These changes could include making additional savings or deferring retirement.
The Government co-contribution for low and middle income earners enacted in 2003 will significantly benefit eligible low and middle income earners who make additional contributions to superannuation. Under this measure, the Government will provide a matching co-contribution of up to $1,000 per year towards the superannuation savings of eligible people who make personal contributions to superannuation. A contribution of $1,000 a year would require a saving of $20 a week. However, it can substantially increase a person's standard of living in retirement.
As an example of the value of the co-contribution, a single male with a current income level (for co-contribution purposes) of $32,500 who makes voluntary post-tax contributions of $1,000 per annum over a 30-year working career can improve his projected replacement rate from 79 per cent to 86 per cent.7
Another option may be to have an employer pay part of a pay rise into a superannuation fund. It is estimated that an average wage earner who salary sacrifices 1 per cent of a pay rise would have an additional $23,000 in their superannuation balance after 30 years.8
Individuals not wanting to remain in full-time employment may choose to gradually withdraw from the workforce through working part time. This means they would defer having to draw down on more of their retirement savings.
People should go through these steps on a regular basis to monitor whether their likely retirement income matches their retirement income expectations. They could do this around their birthday or when they receive their superannuation or other financial statement.
6 Treasury’s RIM Unit projections. Based on a single male who retires in 2034 after 30 years of contributions and retires in 2044 after 40 years of contributions.
7 Single male, assumed to retire in 2034 at age 65, with a 30 year working career. The minimum taper point of the co contribution is assumed to be indexed at 4% pa from 2007/08 onwards.
8 Assumes a person diverts 1% of a 4% increase in wages. Salary sacrifice contributions do not qualify for a co contribution as they are made by an employer. However, a person on average earnings would have to pay tax of 30% if they took the money as cash. If the money is paid as a contribution to a superannuation fund it will only be taxed at 15%.
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Commonwealth of Australia 2004
ISBN 0 642 74231 6