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a blog from young economists at Nova SBE

The Australian Social Security System

Many experts point to Australia and its mandatory system of funded pensions as a model for other countries to study, but how does it really work?

The retirement income provision in Australia is involved into a three pillar arrangement comprising Age Pension, Superannuation Guarantee and other long term savings through property shares and managed funds.

The Australian Age Pension is a welfare program targeting old-age poverty. It is given when retirement income and assets provided under the other pillars exceed statutory thresholds. In this way, it is a means-tested program, meaning that eligibility depends on the current income or assets of the elderly, ensuring that government transfers are received by the poorest aged, generating significant redistribution.

Age Pension is payable to women and men aged 65 years and over. A higher pension is payable to a single person than to married couples; this tries to solve the fact that married couples usually have higher social security wealth than single people, but it can create moral hazard problems, couples might get divorced or stay single in order to have a higher pension.

Most Australian retirees source of income today is age pension, but this will change over the next decades as more Australians reach retirement with longer periods of Superannuation Coverage (the legislation that imposed Superannuation Guarantee was just approved in 1992).

The Superannuation Guarantee (or Super as Australians call it) emerged in response to lengthening retirements and a general demand for more ample retirement incomes. Government initially expanded the Age Pension, but to boost retirement incomes, increase national savings and control the growth of government expenditure (indeed, guarantee the sustainability of social insurance) it created the Superannuation Guarantee.

The Super mandates employers to contribute a percentage of the worker’s earnings to a superannuation fund of the choice of the employee (9% every month); if they fail this, they will be subjected to the Superannuation Guarantee Charge. It applies to all employers and employees from 18 to 65 years old. Contributions are fully vested (meaning that the member has right to all accrued benefits), fully preserved (the benefits must remain in a fund until the retirement) and fully funded (today’s savings are invested in various assets in order to pay future benefits). Retirees can opt by lump sum pensions or an annuity with tax/transfer incentives to encourage income streams.

A problem with the Super is the low preservation age (55) together with the rule that workers need to leave the labor force to access funds, creating an incentive to retire early and increasing the risk of inadequate income late in life. There is even one more benefit to early retirement in Australia. Earning tax bites more severely in the ages of retirement; by retiring, Australians can avoid paying this tax; the net result is that people in Australia lose money by working past age 55. This social security system that penalizes additional work beyond the retirement age ends up being very costly. The Australian government will rise the low preservation age to 60 in 2015, but it should also adjust the system to reward work at old ages in order to mitigate the moral hazard effect of social security.

Currently, most source of income for retirees is Age Pension, current generations of workers need to save money for their own retirement while they need to support the current generation of retirees. Since the Age Pension is funded by general revenues and if the government decides to increase revenues to finance the system by increasing taxes, it will offset the saving benefits promised by privatization, Australians will be increasing national borrowing and saving with no effect on capital stock. If the government achieves in the next decades the goal of providing Age Pension just to a few percentage of the population, this problem will disappear.

Indeed, the Australian social security system seems more sustainable than most part of social security systems in developed countries, but it is without doubt that some changes are needed and just time will say its viability.

Marli Fernandes

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Author: studentnovasbe

Master student in Nova Sbe

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