Lessons From Australia’s Retirement System

When it comes to retirement savings, the U.S. could learn a few things from The Land Down Under.

Australia’s retirement system consistently ranks among the best in the world, making it a great model for the U.S. Compared with other industrial nations, Australia has low public spending on old-age pensions, according to a paper from the Center for Retirement Research (CRR) at Boston College, “Australia’s Retirement System: Strengths, Weaknesses, and Reforms.” It also has high individual savings rates and rapidly growing retirement savings, according to the paper’s author, Julie Agnew, associate professor of economics and finance at the College of William and Mary, Mason School of Business.

Australia’s system consists of three main components that contribute to its success: the means-tested age pension, mandatory retirement saving program and voluntary savings. Introduced in 1908, the Age Pension is a means-tested benefit funded out of general revenues. It provides basic income to those with earnings and assets less than specified threshold levels. Singles can get a benefit equal to about 28% of the average male wage, and couples about 41%, with benefits reduced or eliminated as incomes or assets increase beyond the threshold, the CRR paper explains.

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The second part of the retirement system is the mandatory “Superannuation Guarantee” program, created in 1992. The program requires employers to pay a proportion of an employee’s salaries and wages; the current mandatory savings rate is 9% but it is rising to 12% by 2020. More than 90% of employed Australians have savings in a Superannuation account, according to the paper.      

The last component of Australia’s system is voluntary savings, which includes additional contributions to a Superannuation Fund, called “salary sacrifice,” as well as savings outside these tax-advantaged funds.

“One might say that Australia has a good balance between mandatory private savings and targeted public support,” Rafal Chomik, senior research fellow at the ARC Centre of Excellence in Population Ageing Research in Sydney, told PLANADVISER. “Those who work need to put away money for their retirement, but where these are insufficient for whatever reason, there is a large safety net in the form of the Age Pension.”

Sources say the idea behind Australia’s retirement system is something that the U.S. can learn from. When it comes to saving for retirement, participants’ behavior is largely influenced by the default rate, said Josh Cohen, defined contribution practice leader at Russell Investments.

Australia has recognized participants’ inertia and has responded with its move to a higher mandatory savings rate. “When individuals are defaulted into savings rates, they tend to stay with the default,” Agnew said. “Many behavioral factors can drive inertia including procrastination and status quo bias. Another explanation is that individuals view defaults as implicit advice to be followed.” 

Australia’s System Still Needs Work  

Despite many successes in its retirement system, Australia still has shortcomings. Over the past five years, the government has conducted thorough reviews of its system to identify areas to improve. Some of these efforts have been on strengthening the Superannuation Guarantee program, with many reforms designed to help individuals make better investment decisions, the CRR paper says.

The Australian government is promoting an expansion of low-cost “simple advice” and rethinking of advice delivery models, according to the paper. It has also imposed a fiduciary mandate requiring financial advisers to act in their clients’ best interest, which will go into effect July 2013.

Another problem lies in the means-tested Age Pension, which may create incentive to reduce one’s means (by spending savings or investment in assets excluded from the means test) in order to collect a higher means-tested benefit, the paper says. However, it is unknown how large an issue this is.

Both the U.S. and Australia struggle to improve the financial literacy of investors. A recent LIMRA survey that asked 2,000 Americans a series of basic financial and retirement questions found that one-third failed the test (see “LIMRA Reports Financial Literacy Failings”). According to CRR’s paper, more than half of Australian survey respondents incorrectly thought a balanced mutual fund was composted of risk-free assets or replied, “don’t know.”

The Future of U.S. Retirement Reform  

As for retirement reform in the U.S., Cohen said he does not foresee mandatory savings adoption in the near future, but he does think there will be increased focus on automatic features and more attention to proposals like Senator Tom Harkin’s (D-Iowa). Last year, Harkin released a report titled "The Retirement Crisis and a Plan to Solve It.” The heart of his plan is a new system of privately run hybrid pension plans, which incorporate many of the benefits of traditional pensions while substantially reducing the burden on employers (see 
"Harkin's Privately Run Pension Proposal Receives MixedReviews"). Harkin’s proposal requires that individuals who are not covered by an employer-sponsored retirement plan be automatically enrolled in regulated, privately run retirement funds.   

Going forward, the U.S. needs a comprehensive solution to retirement savings that includes some form of mandatory retirement savings, BlackRock Chairman and CEO Laurence D. Fink said during a recent talk at the New York University Stern School of Business. “Given the massive amounts of savings needed – as well as investor psychology and the reality of risk aversion – we need a comprehensive solution to retirement savings that includes some form of mandatory retirement savings, similar to Australia’s successful superannuation system or the new pension requirements in the UK,” he said.

Superannuation in Australia has been a huge success in supplementing the government pension scheme and taking the strain off it, which Fink said is an attractive prospect as the U.S. thinks about how to relieve the burden on Social Security. A mandatory retirement savings system would need to be phased in gradually in order not to create a shock to the economy, he said.

The U.S. also has some good models, Fink said, such as the pooled fund for small employers managed by the California Public Employees Retirement System (CalPERS).  “Perhaps we could do something similar nationally by opening the highly successful Thrift Savings Program for federal employees to all workers,” he suggested. “That’s the model being adopted nationally in the UK with the creation of the NEST (National Employment Savings Trust) plan." NEST is an automatic enrollment pension scheme for UK employers of any size (see "100 Plan Sponsors Register With NEST").  

Fink said the U.S. could also model a solution on successful pools already created for small employers and non-profits. 

“But the point is the current system is broken,” Fink concluded, “and we need a comprehensive approach that includes some form of mandatory savings in addition to Social Security … The current system simply isn’t working, and the longer we wait to fix it, the tougher the task becomes. We need to start the debate today."

Accumulation’s Done. Now What?

How much, and when, to make withdrawals from individual retirement accounts (IRAs) in retirement was studied by the Employee Benefit Research Institute (EBRI).

More Baby Boomers are entering retirement with large portions of their retirement savings in individual retirement accounts (IRAs), EBRI pointed out in “IRA Withdrawals: How Much, When, and Other Saving Behavior.” In other words, people’s financial security in retirement may depend on how they manage these accounts post-retirement.

Some could be sacrificing a more enjoyable retirement by exercising too much caution in drawing down IRA balances. Others may jeopardize retirement security by spending too much, too soon.

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EBRI examined different withdrawal patterns with households not yet subject to the requirement minimum distribution rules (RMD). Those households with members between the ages of 61 and 70 that made withdrawals even though they were not yet required to take IRA distributions made larger withdrawals than older households, both in absolute dollar amounts as well as a percentage of IRA account balance.

The bottom-income quartile of this age group had a very high percentage (48%) of households that made an IRA withdrawal. Their average annual percentage of account balance withdrawn (17.4%) was higher than the rest of the income distribution.

Among households with members between the ages of 71 and 80 that are subject to RMDs, those that have a withdrawal exceeding the RMD amount had average withdrawal amounts that were more than double the amounts taken by those that withdrew only the RMD amount. The percentage of account balance withdrawn was also much larger for households that withdrew more than the RMD amount.

Younger households (61 to 70) that made IRA withdrawals spent most of it, while for those between 71 and 80 there was some increase in savings (in CDs and similar holdings) associated with an IRA withdrawal.

Different Ages, Different Withdrawals

The percentage of households making an IRA withdrawal increased with age, and spiked around ages 70 and 71. This is likely a direct result of the RMD rules in the Internal Revenue Code. These rules require that traditional IRA account holders begin to take at least the minimum withdrawal specified from their IRA no later than April 1 of the year following the year in which they reach age 70-1/2. (Otherwise they incur a tax penalty.)

At age 61, only 22% of households made an IRA withdrawal, which slowly increased to 40.5% by age 69 before jumping to 54% at age 70, and to 77% at age 71. By the age of 79, almost 85% of households with an IRA took a distribution.

Although the RMD rules require households to start taking distributions after age 70-1/2, not everyone with an IRA who reached that age made a withdrawal.

Reasons for this can vary. The account could be a Roth IRA, which is not subject to the RMD rules, or the account belonged to a spouse who was still under the age of 70-1/2.

Some households reporting taking the RMD only in order to avoid a tax penalty, and the percentage of these households also rose with age. At age 71, 71% of households took the RMD. This increased to 77% at age 75; 83% at age 80; and 91% by age 86.

Age, Income and Withdrawal Behavior

One of the important advantages of traditional defined benefit (DB) pensions is that when an annuity option is chosen, the benefit amounts are generally adjusted for mortality risk and protect the beneficiaries from longevity risk. There is no need for beneficiaries to calculate the complex withdrawal rates. But as individual accounts such as IRAs and 401(k)s become more prevalent, withdrawal rates and strategies are becoming more complicated and more important. 

EBRI’s report showed that IRA withdrawal rates clearly decrease as income increases. In the bottom-income quartile of households with members between the ages of 61 and 70 that made an IRA withdrawal, nearly half (48%) of the households made an IRA withdrawal, as did those in the second-income quartile (48%). But the next two quartiles showed significant drops in IRA-withdrawal rates: 43% of retired households in the third quartile and only 29% of retired households in the top-income quartile made an IRA withdrawal.

This highlights the first area of potential concern: More people in the lower-income groups withdraw money early, i.e., before the RMD kicks in. This should not be surprising, since lower-income households could be expected to be in greater need of money. But are these low-income households withdrawing too much too soon?

The percentage of households making an IRA withdrawal before the RMD kicks in is very high in the bottom-income quartile, EBRI found, and these households are withdrawing money at a much faster rate than the higher-income households. While households in the bottom-income quartile have the majority of their total assets outside of IRAs, this pattern of withdrawal could be another area of concern.

Among households between ages 71 and 80 that are subject to RMDs, there are also some important patterns. Households that have a withdrawal exceeding the RMD amount had average withdrawal amounts that were more than double the amounts taken by those that withdrew only the RMD amount. The percentage of account balance withdrawn was also much larger for households that withdrew more than the RMD amount. Finally, younger households (ages 61 to 70) that made IRA withdrawals spent most of it. For these households, an IRA withdrawal was not associated with an increase in any other type of savings. On the other hand, for those between 71 and 80, there was some increase in savings (in CDs and similar holdings) associated with an IRA withdrawal.

The University of Michigan’s Health and Retirement Study (HRS), which is sponsored by the National Institute on Aging, supplied the data for this study. HRS is a biennial national survey of older Americans, with primary respondents who are at least 50 years old, along with their spouses.

“IRA Withdrawals: How Much, When, and Other Saving Behavior” can be downloaded here

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