Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 30

A fundamental flaw in the Australian retirement system?

Written by John Evans

Most Australians accept that during their working life, some earn more than others. But will they accept that the compulsory Superannuation Guarantee Levy system could deliver very different post retirement incomes to those who had similar pre-retirement incomes?

The Australian retirement system, consisting of the Age Pension, the SGL system and personal savings has one serious flaw that will only start to emerge once the system has matured in 2020.

Almost all analysis done on the retirement system uses ‘on average’ assumptions in relation to periods of contribution, investment returns, costs and period of retirement and usually concludes the system is ‘adequate’. But this analysis fails to consider that over a typical working life of 40 years, a lot can vary. In particular, all SGL contributions go into some type of investment vehicle where the member’s accumulated retirement benefit is a function of investment markets. Naturally, these include significant ‘shocks’ from time to time, such as the recent global financial crisis.

The consequence of investing SGL contributions in market-linked securities, regardless of the capabilities of the fund managers, is that workers are going to have very different retirement incomes depending on how ‘lucky’ they were in not being subjected to market shocks during their working life. My own research, conducted with colleagues, shows that even without any market shocks, the typical worker could end up with a replacement ratio (the ratio of post retirement income to pre-retirement net income) ranging from around 45% to almost 300%. With even a modest number of market shocks, this range could extend down to almost 35%, and that includes the Age Pension.

This range in post-retirement standards of living is highly likely to be viewed as unacceptable by retirees who have been forced to defer part of their income to retirement savings. This will not only create unanticipated demands for the Age Pension, but possibly social unrest.

The solution to this issue already exists and was a fundamental part of the industry fund philosophy when first established. The solution is to go back to the concept of the SGL contributions being invested in a common pool, but to credit the member account with an interest rate, much the same as occurs with bank deposits on a regular basis. The interest rates would reflect the underlying earnings of investments in the pool, but would be smoothed by creating reserves to balance the poor times with the good times.

This is not a new concept and has been practised in investment-related insurance contracts for many years. It is, of course, not perfect and if mismanaged can create problems and failures as it did with Equitable Life in the UK. But if properly managed, it can create much smoother returns to members of retirement funds and reduce the effect of market shocks and the impact of market volatility.

One of the reasons that industry funds abandoned this concept was that they were expanding very rapidly, and $100 worth of reserves at the beginning of a year had considerably less impact in smoothing returns during the year when assets doubled to $200. But industry funds are now much more mature and this issue can be managed.

The interest rate concept would create more significant financial risk for the Boards of superannuation funds, and greater financial skills would be required than are currently needed. But the result would be less volatile retirement benefits for members who are already pooling their contributions and are expecting some level of retirement income evaporation close to retirement. The regulation of superannuation funds would also need greater attention, but the regulator already has similar issues with the few remaining defined benefit funds.

A return to a more stable distribution of investment returns is socially desirable and will help to avoid the negative results of the current system. Without it, many people will find they reach retirement without much of the money that they thought they would have.

John Evans is an Associate Professor in the Australian School of Business at the University of New South Wales, and chairs several Risk & Compliance Committees for financial institutions. This article originally appeared in The Conversation.

 

RELATED ARTICLES

Getting the most from your age pension

Behavioural reasons why we ignore life annuities

Why we overlook lifetime annuities

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.