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For retirees, nothing is certain but debt and taxes

A quarter of retirees are using their superannuation lump sum to pay off debt: is this poor planning or the result of tax incentives?

Will extra debt neutralise increases in the superannuation contribution rate? Studies of retirees’ financial positions show that many people accumulate debt faster than they add to their super.

Once they are old enough to access to their superannuation, they pay off their debt rather than create retirement income. Is this poor planning, or are incentives at work that make superannuation unappealing?

By 2020, most workers will be paying at least 12% of their earnings into their superannuation accounts instead of the current 9%. The Federal Government expects that this increase in compulsory savings will mean higher retirement incomes and less pressure on the Federal budget.

In coming decades, the number of over-65s will rise from three to over eight million, dramatically increasing the cost of the age pension. Aggregate savings is projected to rise to $500 billion or 0.4% of GDP - but this comes at a cost to taxpayers via concessions for superannuation savings (hence the mining tax furore).

The problem is that many people don’t seem too happy about being compelled to save even 9% into superannuation accounts, let alone 12%. A report prepared by Simon Kelly for CPA Australia showed that the average pre-retiree appears to be neutralising their compulsory superannuation savings in two ways: first by adding to property-related debt and second, by decreasing savings in other areas.

In 2010, pre-retirees (50-64 years) had average debt levels almost as large as their superannuation balances, mainly due to rising home mortgages and rental property borrowing. The same age group added virtually nothing to financial assets outside their superannuation between 2002 and 2010.

An ISN Research Report into retirement intentions released in 2010 showed that around 16% of the 50-70+ group surveyed had debts (mainly property-related) at least as large as their superannuation savings.*

The average debt of couples was 88% of their combined super. Unsurprisingly, when asked what factors influenced use of their superannuation payouts, the most common choice (after plans for travel and leisure) was “I needed to pay off existing debt”.

Acquiring debt to pay for houses or holidays is a “work around” for compulsory superannuation. People cannot draw on a superannuation balance to move to a better suburb or renovate the kitchen or purchase a boat. However they can still access cash or “rebalance” their portfolio by borrowing now and paying the debt with a lump sum later.

Alex Malley, CEO of CPA Australia, wants the government to “break our love-affair” with windfalls by limiting the amount of superannuation that can be taken as a lump sum.

Malley says that retirees should be compelled to take up income streams that deplete retirement nest eggs slowly. (It is worth pointing out that much of the retirement wealth management and advice industry is populated by CPAs. Advisor fee income relies on building on-going relationship with clients, which is hard to do if the clients have no retirement wealth left to manage. Retirees who take out a lump sum to pay off a mortgage, then live out their days on the age pension, do not need much financial advice.)

Superannuation funds are also concerned about the looming possibility of a mass exodus of the fattest account balances into self-managed funds or property investments.

So are the baby boomers simply profligate and short-sighted? Have they watched too much “Home Improvement” or are they also responding rationally to some powerful economic incentives? First, some people simply do not want the additional retirement savings they are being compelled to store up as superannuation so they arrange their finances to accordingly. Second, more fundamental tax incentives are playing a key role.

Consider tax concessions for the family home. At any stage of life, capital gains on the family home are not taxable as income. This, along with negative gearing rules on investment property, and the generally strong growth in real estate values over the past decade, has ensured that housing and property wealth dominate household balance sheets.

Further, family homes provide a flow of services, including security of tenure, that renters in Australia do not enjoy. The dangers of property bubbles notwithstanding, tax structures and the risks of tenancy encourage heavy investment in property before retirement.

But more critical is the importance of the family home in retirement. Age pension means tests do not count the value of principal residences as an assessable asset against pension payments. All other assets, with the exception of a few concessions for income streams, will result in lower payments once total wealth rises above a certain threshold. (Non-homeowners get a more generous allowance for assets before the pension payment begins to decline.) Other financial assets like term deposits or shares are also “deemed” (assumed) to be earning assessable income which can also reduce the pension.

The family home acts as a tax-and-means-test-free store of wealth, typically used for bequests and contingencies or to provide a bond for an aged care residence. It is not surprising that Australians build up value in their principal residence before retiring and then do not run down their housing assets afterwards.

If government wants to see less superannuation accumulations used to extinguish debt and more used to generate long-term incomes, they need to look to their own house first. We need to address the totality of incentives now in place.

*Since publication this sentence has been amended to correct an inaccuracy.

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