The backstop society – default super

Below the fold a column for the Fin which appears tomorrow. It outlines the argument for an increase in the ‘default’ rate of super. I posted early drafts of the essay on which it is based on Troppo – here, and here.

The essay is being launched as one of four Progressive Essays tomorrow. Anyone who wants a full copy should be able to download one from the site linked above from 11.00 am tomorrow. In the meantime, the Fin article’s below the fold.

Default Super and the backstop society

Compulsory superannuation sees nine percent of workers wages put aside for super. It’s a great start. But unless you’ve been salary sacrificing a fair bit more again, you’re probably saving too little.

Why do so many of us save too little for retirement? We ‘rationally’ under-save because we know we can fall back on the pension. ‘Behavioral economics’ has also recently begun filling in the irrational side of the story.

Knowing how much to save is a difficult business. Only forty percent of Americans for instance seek to work out how much savings they require for retirement not really knowing where to begin. Only slightly more still a minority have the basic knowledge to make good investment decisions for instance the knowledge that equities tend to outperform bonds over time.

Even with compulsory super at nine percent, studies suggest that a majority of Australians will be disappointed with the amount they have saved for retirement.

In situations of great uncertainty we procrastinate. We put off facing the discomfort of our own ignorance till tomorrow. We’re unusually susceptible to suggestion, and influenced by what seems ‘normal’.

That’s not just the poor and the uneducated. A Harvard University savings plan yielded no return until employees chose between two investment options. Yet most junior employees delayed doing the paperwork long enough to lose hundreds of dollars.

This is typical of millions of us. We intend to save more, but we put off the decision making not to mention the paperwork. But if our tendency to take the line of least resistance looks like a problem, it’s also a big opportunity. We just have to rearrange what the line of least resistance is!

Enter the backstop society.

A good software program comes with default settings suited to the average user which can nevertheless be overridden should they wish. The backstop society would do the same for saving. Citizens would be free to make their own arrangements secure in the knowledge that should they not actively exercise that freedom they will fall back on designed rather than undesigned ‘defaults’.

Consider this. In the US new employees’ participation in tax privileged ‘401K’ savings schemes can be as low as 26 percent though this rises over time. When firms enroll employees by default but let them opt out, participation jumps to over 85 percent and stays there.

We can improve Australians’ savings habits, and so their lives, in the same way.

We’d begin by getting experts to recommend some target level of default salary sacrifice above the compulsory rate say six percent bringing total super contributions to fifteen percent of wages. Where employees’ existing salary sacrifice contributions were below that target, and they had not ‘opted out’, their employers would deduct an additional say one percent of their wages as a salary sacrifice contribution to employees super accounts.

The process would be repeated each year until the target was reached.

As ‘default salary sacrifice contributions’ rose, employees would receive written explanation of:

1. what had happened;

2. why (in the absence of financial analysis of the employee’s individual circumstances) the target rate of savings seems prudent;

3. how to opt out and

4. how to opt up increasing saving faster than the default rate of increase.

The latter course could involve immediate further increases and/or setting aside some additional proportion of future wage rises. Those responding to such approaches in the US have increased their savings rates from four to twelve percent over 28 months.

Time was when we led the world in economic reform. We’ve barely begun discussing ‘default super’. Meanwhile it’s become Government policy in New Zealand though their need is admittedly greater in the absence of any compulsory savings.

Announced in this May’s budget, ‘KiwiSaver’ requires employers to divert four percent of wages into super with employees free to opt-out or opt-up. Participants benefit from a modest $1,000 government contribution followed by first home ownership assistance.

The National Party plans to abolish KiwiSaver to fund tax cuts. But KiwiSaver has won international acclaim and will no doubt be emulated elsewhere.

And it need not wait for government endorsement or enforcement. Many employers would do it of their own accord if they appreciated how much good it could do their employees all for the cost of rejigging the administration of existing super payments.

Unions (and fund managers) could serve their members by helping persuade employers not to procrastinate (!).

Paraphrasing Churchill, rarely before in the field of collective decision making has so much improvement been offered with so little coercion or risk of harm.

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Cameron Riley
2022 years ago

Nicholas, Your argument is incomplete. Australians pay high incomes taxes by world standards through which they expect to receive pension and unemployment benefits if they need it. Taking people’s income and putting it into government enforced savings plans will only serve to reduce people’s take home income. This will not be feasible without taxes being dropped for everyone. If people are going to have 15% of their income taken from them, then taxes are going to have to drop by 15% across the board, and for lower income workers, it will have to be more to make up for their lost income.

In the US 401ks get used for all sorts of things. Emergencies such as unemployment, or as down payments for a house. In Australia the government pays for these, unbelievably, the federal government pays for people’s first house down payment.

I dont see this as feasible until taxes decrease in Australia at the federal level (they take all income taxes) and Australians get antsy about the government ability to provide pension and unemployment benefits. I also dont see this as feasible while the government takes so much tax from people. It will shrink an already depleted take home pay cheque.

A third issue is diasporans. At any one time approx 5% of Australians work overseas. They will most likely have “mandatory” savings plans in Australia that are not having anything added to the principle. [I have superannuation in Australia that is getting fees leveraged against it]. There will need to be a way for diasporans to liquidate it entirely, or add to it from overseas.

Cameron Riley
2022 years ago

Forgot to add, high taxes also foster an attitude of entitlement. Australian taxpayers have every right to expect a pension, since they pay such high taxes. This makes them pay for a pension twice, once to the government, and once to themselves – so why should anyone support it.

Paul Watson
2022 years ago

“In Australia, . . . unbelievably, the federal government pays for people’s first house down payment”.

Cameron, whatever the $7,000 first home-owners grant might be or do, one thing it is plainly NOT is a 10% deposit on even a worst-house-in-the-worst-suburb home anywhere (bar a few dying country towns). In terms of capital cities, $7,000 is not even close to being a 5% deposit, in fact.

Also, as far as “emergencies such as unemployment” go, in Australia, there is a de facto allowance of this, via early release provisions (of which the main req is for 6 months unemployment).

Nicholas, one thing that you don’t seem to be considering is the interaction of home ownership with working-life retirement savings (forced or otherwise), and standard of living within retirement. My generation’s (b. 1963-1978) having significantly lower levels of home ownership than those older http://www.abc.net.au/am/content/2003/s990533.htm (a situation that was entirely predictable as a matter of tax and higher eduction policy, but which was only belatedly communicated to us), marks our retirements as going to need a lot more cash/other-assets than previous generations. This is not because of grandiose anticipated lifestyle, but simply because home ownership (which is something even the very poorest of Australia’s current retirees usually enjoy) provides an important financial buffer.

Compounding this (although it could also be said to be a predictable policy outcome), my generation’s actual savings rates have been abysmal http://www.aph.gov.au/house/committee/efpa/super/index.htm , despite 12 years of compulsory super. The reasons for this are multi-faceted: enforced

Cameron Riley
2022 years ago

Paul, When the policy of a grant to first home buyers was implemented there were developments in Western Sydney which would use it to do a deal. House prices have inflated a bit since then. Even so, I know of folks that have taken the money and then gone and bought furniture.

I dont see why government should pay for this. In the US mortgages for $300,000 USD can be had for $6,000 down. They are brutal mortgages after three years, moving to variable interest rate. But the market has supplied a product in that instance. The other option in the US is to raid the 401K for the house deposit. Which is also common.

But a grant for first home buyers? That has nothing to do with ensuring a safety net. I would rather Nicholas’ default saving scheme which can be raided to buy property or in emergencies than the government giving grants.

blank
blank
2022 years ago

Is it true that in the US the interest paid on a home mortgage is a deduction against income tax?

Is there any comparison between total US taxes and total Australian taxes?

As I understand it, US property taxes are very high.

Cameron Riley
2022 years ago

Blank, Yes, you can deduct your mortgage interest from your taxes. That includes any additional loans you bundle under the mortgage. We have our cars on the mortgage for that reason. You can also get credit cards on your mortgage so you can spend against the equity in your house and have the interest tax deductable. I think the last is insane. I cut them up when the mailed them to us.

Had a quick check on the tax difference. At the federal level, there there is an 8% difference in income tax, with the US being lower. The state I am in also collects about 5% of my salary in income tax. Which NSW wouldnt. The state I am in also has a 4.5% sales tax, while the feds in Australia leverage a 10% GST. America is far more federalist than Australia, so you can pick and choose your states. Several US states dont have income tax (Fl, NH, NM etc). There isnt that diversity in Australia as the federal government is the dominant taxing authority.

Property taxes where I am are leveraged by the county and town. County takes about 1% for real estate, while town takes about 0.2% for real estate. There are also a million and one fees, like what the Australian states do.

The real estate property taxes differ drastically from place to place too. In West Virginia they complain about paying $200 a year, while in New Jersey the same property has to pay $8,000. Counties pay for schools in the US, so having schools being built locally means property taxes go up quickly.

The main advantage of the US is the diversity of the states because of the federalist system. You can pick and choose which state, or city you want to live in by balancing jobs, lifestyle, remuneration, cost of living and taxes. There isnt that diversity in Australia because Canberra is anti-federalist.

ctd
ctd
2022 years ago

All the above arguments really come down to: ‘if you make people voluntarily contribute to super then you reduce take home pay’ (which people might want for things such as home purchases); then asking the question ‘is this fair or should we compensate people in other ways’.

But I understand Nick’s argument to be along the lines that people won’t adjust their current expenditure patterns to increase their super (or, even, take steps to increase their super), but probably are likely to adjust their expenditure patterns if you reduce their take home pay automatically. Its a pretty standard savings tip to take the amount you want to save out of your day to day bank account on pay day and put it into another account that is hard to access.

In other words, most people have a level of discretionary expenditure that can relatively easily be adjusted. For those that don’t, then they can opt out (or, possibly, the scheme could have a minimum income threshold).

I don’t see how tax is relevant to this issue, although I can appreciate that the people who will benefit from lower taxes (if the demand for pensions drops) are the people paying income tax in 20+yrs time rather than the people sacrificing their current expenditure.

As to the culture of expectation re pensions – does that really still exist amongst younger people (I am in my 30s?) I am of the ‘have always had compulusory super’ generation, so its fairly well entrenched that retirement income is substantially my obligation. Not to mention that lifestyles are now such that the expectations of retirement involves travel etc, and not the (traditional – or at least my grandparent’s) view that after retirement you stay at home, play bowls and eat out only when the club has pensioner special day. The pension won’t fund what I want/hope to do (having said that – confess to being a higher income earner, so can appreciate my attitudes on this may significantly differ from a lower income earner).

Homer Paxton
Homer Paxton
2022 years ago

one of the problems of Super now is that most of the revenue is front-ended ie it comes in now as most of the reevenue is because of contributions and to a lesser extent earnings.
It is very easy not to pay the tax on benefits.

change the taxation structure so it is only on benefits and it is at the person’s MTR thus it is aligned with the tax system.
Make it 15% and suddenly most of the problem dissapears particularly when voluntary super has no tax.

you not only have money for retirment but also for health purposes.

This is what Keating and then Howard should have done.

derrida derider
derrida derider
2022 years ago

Cameron Riley has hit on the real problem with super – it is taxation, and as it happens highly regressive taxation, by stealth. The pension means test differentially takes the returns from super away from lower income workers.

I could make a long post here about why compulsory super reduces social welfare. Some hints: taking money from punters when they need it most – raising a family, buying a home – and giving it back (minus taxes, reduction in pension and management fees) when the home is bought and the kids have left it aint always sensible. And to the extent you do it, said punters will compensate by taking a bigger mortgage and more credit cards, knowing they’ll get the money back to pay them off.

But you really should have pointed out the conflicts of interest here. Increasing flows into funds and the market for advice will benefit what is already a very influential (because well funded – funny about that) lobby.

Nicholas Gruen
2022 years ago

I see the issue of default super as separate from the myriad problems of the super system. I agree with DD that there are plenty of problems. I am sufficiently hostile to the provision of sales patter as advice that I started a business to do something about it.

But it’s a column . Conflicts of interest in giving advice are an entirely different subject to what I was on about.

Likewise Cameron and others, the points you make about tax are valid. But the gentle nudging of people towards better savings habits by setting defaults to rise is doing people a favour and if they don’t like it for whatever reason, they need only fill in the form.

trackback

[…] I’ve suggested that policy makers think about trying to engineer a situation where ‘defaults’ – what happens when we do nothing – are considered and set to optimise outcomes rather than just be allowed to happen. Thus without infringing anyone’s freedom of choice we could specify that, if they do nothing 6% of employees wages will be paid as ’salary sacrifice’ into their super fund alongside the 9% compulsory employer contribution – with employees free to opt out. […]