The age old problem of old age: fixing the pension

27 Apr 2015

This report argues that reforming the pension could deliver income gains of more than $5,900 a year to almost 98% of pensioners. These reforms would also reduce the cost of the pension by $14.5 billion a year.

Executive summary

At $42 billion this year, the Age Pension is the largest single payment made by the federal government, exceeded only by combined grants to state governments. Annual expenditure is predicted to rise to nearly $50 billion by 2017–18. The cost of assistance to the aged has risen by more than 50% in the decade to 2013– 14, outstripping real GDP growth, while the cost of the Age Pension alone has increased by 35% in real terms between 2007–08 and 2014–15. In part the growth in pension expenditure has been driven by the fact that most people of retirement age (80%) receive some form of pension.

The Australian Treasury’s Intergenerational Reports raise real questions about the affordability and sustainability of the nation’s retirement incomes system as the population ages. The 2015 Intergenerational Report predicts age-related pensions would increase from 2.9% of GDP in 2014–15 to 3.6% in 2054–55. Other predictions suggest that growth in Age Pension expenditure could be even higher.

The maturation of the superannuation system will not substantially reduce these fiscal pressures.

There are other problems with the pension beyond looming fiscal pressures. The exemption of the family home from the pension assets means test creates significant inequities between homeowners and nonhomeowners.

Homeowners tend to have more non-housing assets than non-homeowners. Hence, homeowners have substantially higher net worth, on average, than those who don’t own their homes. They therefore have a much greater ability to support themselves. Yet homeowner pension entitlements are often similar to those with few assets and no other income. Homeowners also face lower housing costs and other advantages over those with no housing assets.

In practice, the emotional connection to the family home, together with the perverse incentives created by the pension system, means the vast majority of pensioners do not use their home to support their retirement.

The solution to the underutilisation of housing lies in acknowledging and supporting the emotional connection to the home, while removing the distortions created by the family home exemption from the assets test and encouraging pensioners to access the equity in their homes over time.

Addressing this underutilisation would both substantially improve pension living standards — increasing income by thousands of dollars each year — and cut the government’s pension bill in half.

A three-point strategy is needed. First, the family home should be included in the pension assets means test and the homeowner/non-homeowner distinction in that means test should be abolished.

Second, the government should support pensioners’ accessing reverse mortgage products by legislating for a default reverse mortgage product. This product, provided by banks and superannuation funds but guaranteed or insured by government, would provide a regular annuity payment at a low interest rate up to a set equity limit (the greater of 80% loan to valuation ratio or $100,000 inflated at CPI). It would also ensure pensioners would never be forced to sell their home.

Third, the government should deem income from the default reverse mortgage for the purposes of the pension income test in the same way income from financial assets are treated. This would remove the distorting treatment of housing assets, provide a safeguard for pensioners and ensure the focus of the pension remained on raising living standards.

These reforms should be coupled with other reforms such as increasing the rate of rent assistance for non-homeowning pensioners, increasing the base rate of the pension for singles and couples in line with modest standards advocated by the Association of Superannuation Funds of Australia, and tightening the income means test taper from $0.50 in the dollar to $0.60 in the dollar.

This package of reforms would generate significant benefits to both pensioners and the wider community. Our modelling indicates:

  • Nearly 98% of pensioners would benefit, with the average benefit exceeding $5,900 a year; and
  • Only 2% of pensioners would be worse off with the average loss less than $875 a year

Importantly, by moving those with the means to support themselves off the pension the government can increase the base rate of the pension, providing benefits to those who are completely dependent on the pension.

Tangible benefits would accrue even if housing prices did not rise as fast as predicted, or if interest rates were higher, or if the equity limit were lowered.

The increase in pensioner income is so significant many pensioners would move off the full rate of the pension. More than 70% of single and couple pensioners would move off the full rate and onto the part rate, while more than 24% of single part-rate pensioners, and 32% of couple part-rate pensioners would move off the pension entirely.

In addition to this substantial increase in pensioner income, there would be a very large reduction in government pension spending, with annual expenditure under our simulation falling from $42.2 billion to $27.7 billion.

Reports that Australians do not save enough for their retirement typically ignore the impact the family home could have on lifting retirement incomes. Unlocking the $625 billion of home equity controlled by age pensioners has the potential to be the solution to the rising cost of the Age Pension as well as reducing poverty among pensioners.

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