Omar´s Outlook - Apr 2017
Challenges to Comfortable Retirement
The other day I came across an interesting article dealing with the various aspects of the slow economic recovery in the USA.
While the article itself is from 2013 and therefore somewhat dated, the topic it’s addressing has not really become any less relevant in the interim. The US economy is still growing rather slowly and living standards of many ordinary Americans have suffered.
This is relevant also in Australia, because quite a few of the same trends can now be observed here. Income growth – at least in the private sector – has been flat. Costs of basic necessities, like electricity for example, have been sky rocketing.
The significant increase in the number of US-based respondents, who thought their chances of ever attaining comfortable retirement have been getting worse, is therefore hardly surprising:
Despite the fact that according to some, Australia is apparently second only to New Zealand when it comes to being the best country in the world to be retired in, there is no doubt that the challenges to the status quo are becoming ever more significant.
There are at least four broad areas where this can be readily identified.
Two of those are the result of changes to the relevant government rules and regulations, while the other two relate to the investment environment supporting retirement incomes.
Of course, given the huge size governments take up in modern developed economies, we can probably safely say that both of the above go hand-in-hand!
We’ve all heard the story:
We live longer and today’s young people have fewer children. Therefore the number of future taxpayers has been decreasing in proportion to the number of retirees.
The following two charts from the Australian Institute of Family Studies (AIFS) illustrate the point.
This particular trend has been plainly evident for quite some time and preparing for its long term effects was a major part of the reasons used by Paul Keating, then Australian Treasurer, to introduce in 1992 the system of compulsory private pensions, otherwise known as superannuation.
The express purpose of superannuation was to, over time, significantly reduce the number of retired people who are dependent on the taxpayer-funded Age Pension system.
It can now safely be said that the measure has largely failed in that objective – as illustrated by the following chart from Australian Institute of Health and Welfare (a Federal government department):
While it is now clear that the vast majority of retired Australians will continue to at least partially depend on government support for their living expenditures, the government has been gradually tightening the rules that apply to their eligibility.
Thus we have, over the last two or so years, had changes to both the Income and the Asset Tests.
In the case of the former, deeming rules have been brought in, which have meant that superannuation pension assets held by retirees are now effectively double-counted when being also assessed for the Assets Test.
For the latter, several hundred thousand recipients of part Age Pension have seen their eligibility disappear, thanks to the doubling of the taper rate - i.e. at the rate at which the fortnightly pension payments are reduced once the lower threshold, determining full eligibility, has been reached.
Here is one of many charts showing the effect of this particular change:
For those retirees who have done well enough for themselves to not depend on the public system at all, the government has now prepared a separate challenge.
This involves the reintroduction of taxation of earnings and/or capital gains accrued on assets supporting individual superannuation pension balances above $1.6 million.
I guess we can safely say that now that it’s clear superannuation is unlikely to ever significantly displace the public pension system, the politicians have come to the conclusion that they may as well grab some of that money for other uses!
While many people as well as much of the media have stated that $1.6 million is not exactly a low amount, it needs to be remembered that the change is effectively retrospective.
In other words, affected retirees have made investment choices throughout their working lives, which were based on the implicit promise of the then governments, that in return for these people’s providing for their own retirement via long-term savings, they would be rewarded by not being taxed after age 60.
Furthermore, and perhaps even more worryingly, now that the proverbial tax door is open again, who’s to say that the next government may not declare that $1.6 million is too much, and drop the threshold down to whatever arbitrary limit they may think of?
It’s worthwhile to mention here that Australia is one of only few countries with mandatory private pension systems.
Of those, we are also the only ones that tax our superannuation at all three levels: Entry (15-30% depending on income), earnings (10% capital gains on assets held over one year & 15% on everything else) and now also after retirement (15% on earnings of balances over $1.6 million).
To add to this, our political masters also tax the taxable component of any “leftovers” passed on to adult children at 15% plus Medicare levy.
Add to all this that most developed countries – for the closest example, we can look at New Zealand – do not means test public retirement pensions (the equivalent of our Centrelink Age Pension), and you can see that it’s been a rough ride for many of our retirees.
In addition, the constant changes to the system have predictably impacted negatively on confidence that Australians have in it.
As if all of the above was not enough, our retirees have also been subjected to ongoing reductions in interest rates to artificially low levels:
This has had the effect of reducing income from safe assets like term deposits, while at the same time, due to means testing I mentioned earlier, not being compensated by any increase in the public Age Pension eligibility.
The declining rates of return on safe assets have then flown on to the rest of the investment universe, as investors chase yield and in the process push prices up across the spectrum.
Where some 4-5 years ago, with term deposits yielding around 7%, one only needed to add 2-3% of “risk premium” in order to obtain double-digit returns, these days much higher proportion of risky assets, with a corresponding increase in the probability of significant, or even catastrophic, portfolio losses, has to be taken on to achieve comparable expected returns.
In other words, investors have been forced to move significantly up the risk-return “ladder”:
Why and how this is a potentially risky strategy can be seen in the following data points. For example, Japanese investors who bought into shares in December 1989 saw their investment fall by 60% once the peak of the bubble had been reached. Worse, those who have held till now are still 50% down on the bubble top!
In Australia, the situation has not been quite so dire, but even so, the investor who went “all in” at the market peak in November 2007 is now, almost 10 years later, still down some 14% on the value of the original investment:
Can we hope for better times ahead?
As much as I’d like to be optimistic, I find it difficult to see how the trends discussed above, all of which are long-term in nature, can be reversed in the short to medium term.
One solution which I think would have a good chance to achieve a substantial improvement, if of course not immediately, would be a dramatic cut in taxes and regulations. This would encourage investment in new business ventures, rather than consumption and speculation, which is the inevitable outcome of “stimulating” the economy by forever decreasing interest rates.
However this would not require the sage advise of various government gurus and assorted academics who so like to “manage” things that can’t apparently be left to the market - in other words almost everything.
Hence the chances of such positive reform happening are unfortunately rather slim.
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