The COVID-19 pandemic highlighted that we live in an uncertain world where our financial position and lifestyle can change quickly. Of course, these changes can be caused by many events including unemployment, sickness or an unexpected financial shock, such as a medical bill or home repairs.
Many Australian households live from one pay packet to the next, with no savings that are easily accessible for emergencies. In such circumstances, it is not surprising they need to borrow funds, often through their credit card, and so can begin a debt spiral with significant long-term consequences.
Is there a better way?
Trials in the UK and the US are developing an emergency savings account linked to the individual’s superannuation or pension account. The idea is simple.
Behavioural economists discuss the concept of mental accounting. That is, we have different buckets of money for different purposes. Unfortunately, many households have only two buckets – the immediate bucket for today’s needs and the longer-term bucket for their retirement through superannuation.
What’s missing is the emergency savings account representing a third bucket, which has funds available to respond to those unexpected costs.
An important feature of these 'rainy day' accounts is that they are not as easily available as cash in the bank. They are slightly different and so there needs to be another step in the process. For example, millions of Australians accessed some of their superannuation in 2020 by applying through the Tax Office. A similar process could work with these accounts.
This emergency financial buffer is likely to provide many households with improved wellbeing as they know that some funds are available, if and when the money is needed. Without access to such funds, these unexpected and costly events can lead to additional adverse outcomes such as mental stress, relationship issues or reduced productivity at work due to the individual’s financial concerns.
An important question related to savings, highlighted by the pandemic, is what is the best balance between short term and longer term savings? This is a current policy debate around the world and there is no 'correct' answer. However, a binary answer of either the 'now' or the “longer term” is not the best solution for many households. There is need for some middle ground.
Further, behavioural science has repeatedly demonstrated the power of defaults. That is, a good outcome happens without the need for a personal decision.
As noted above, these emergency saving accounts are now being developed overseas. So, how might Australia do it?
Another use of the SG increase
One approach would be to direct some of the increase in the Superannuation Guarantee (SG) planned for 2021-2025 into an individual’s emergency savings account. Call it a sidecar, if you like, operated by the individual’s super fund.
The emergency savings account would be invested for the shorter term, say in a typical conservative fund, whereas the existing retirement account would continue to be invested for the longer term, say in a balance fund. Individuals would be able to access their savings account at any time, subject to a minimum withdrawal of $1,000, and no questions would be asked about reasons for the withdrawal, which could also include housing costs.
For example, let’s assume an individual is earning $80,000 pa and the increase in the SG from 10% to 12% (i.e. 2% of their income) is saved through the sidecar account. At the end of the year, this would represent at least $1,600 ignoring earnings. Even allowing for a 15% tax on withdrawal, this would provide them with available funds of $1,360.
Individuals, who wish to save these additional contributions for the longer term could transfer funds from their savings account to their retirement account at any time. However it would then be subject to the standard rules and preservation that apply to superannuation. A cap could also be applied to the savings account to ensure that significant investment income was not lost.
Of course, the tax treatment of the withdrawals would need to be considered to make sure there is no tax avoidance. However an application through the ATO using existing technology would make this feasible with a tax rate on withdrawal linked to the individual’s marginal tax rate (which is known by the ATO) less the 15% tax already paid on concessional contributions.
The concept of a second account in the pension system is not new and would not be unique to Australia. Singapore's Central Provident Fund has three accounts (or buckets) for different purposes. Its experience is that the savings account is often left unused during the working years and is subsequently available to increase the retirement benefit. It's a win-win; some cash is available during the working years, but otherwise, the savings are invested for retirement.
The introduction of this 'superannuation sidecar account' will require imagination, political will, industry commitment and clear communication. But it’s worth it for the benefit of our community.
We'll achieve greater flexibility for individuals and households and ensure more Australians can save for their future.
Dr David Knox is a Senior Partner at Mercer. See www.mercer.com.au. This article is general information and not investment advice, and does not consider the circumstances of any person.