Can you afford to live longer?
Increasing longevity is good news, but it poses difficulties as society and our retirement system adjust, particularly for those who outlive their money and have to rely on the uncertain future of the age pension.
John Piggott is a scientia professor at UNSW Business School and director of the ARC Centre of Excellence in Population Ageing Research (CEPAR). A leading authority on retirement and pension economics and finance, he has been widely published, advised the World Bank, and actively contributed to government policy in Australia and internationally. Piggott spoke to Julian Lorkin for the UNSW’s BusinessThink. An edited transcript of the interview follows.
BusinessThink (BT): I’ve seen various figures for how much we should be putting away for retirement – $1 million, or even $2 million, while others simply say, “As much as you can afford.” What should we really be looking at?
John Piggott: Well, it depends how well you want to live in retirement. It also depends on how long you are willing to work before you start to rely on your retirement accumulations.
If your salary is not that high, you will be able to do it on the aged pension. In fact, three-quarters of the retired population currently draw on the aged pension, at least in part; half draw the full aged pension. So that gives lower income individuals a lot of income security. The aged pension in Australia is wage indexed – indexed to community standards – and so it’s a very important form of longevity insurance for your old age. It goes on until you die; it’s there for both you and your partner, so it’s got many strengths.
If you are in the upper half of the income range and you want to maintain that standard of living, you need a remarkably large amount of capital. In many countries this is expressed in terms of what you would be able to draw down in a form of income for the rest of your life, but in Australia we express it as wealth and so the wealth seems very large. But people are going to live a long time and they are going to need a lot of wealth to maintain a commensurate standard of living through their retirement if they have been earning well through their lifetime.
BT: At the same time, when they have been earning well they have had huge expenses: think of the mortgage, raising children, all those extra expenses. Should people be thinking they should only retire once these are paid off, and therefore they just need the money to live?
Piggott: Well, patterns are changing. Now there is family breakdown which occurs much later than what was once the case. So people are now approaching their retirement window with debt that they once would not have had and some of their superannuation accumulation is often used to retire that debt, so they are at least secure in their own home and they have what’s left to supplement their aged pension, whatever it may be.
BT: People don’t seem to think about how long they are going to live. It used to be three-score years and 10; now, that is almost treated as your working age.
Piggott: People almost always underestimate how long they might expect to live. A male in Australia aged 65 could expect to live past 90.
BT: And that’s with current age spans which are, of course, increasing as medical care keeps getting better.
Piggott: Generally speaking, people need to be conservative in terms of how much they might need to get them through retirement.
BT: Particularly for those who get to retirement. They have a great celebration in the office at 65, and they are presented with a huge pot of money – they think – from their superannuation fund. What should they actually be doing with it?
Piggott: I think people like to have some control over the capital they receive and I think that’s reasonable. There are all sorts of uninsurable events that happen later in life, they could be medical or something to do with their children and they want to have a discretionary pool of capital to draw on.
One possible way forward to combine that discretion with some longevity insurance is to insure late in life. There are some retirement products beginning to appear in Australia now, and I think there are policy initiatives afoot that will make them more accessible and more affordable. These are called deferred annuities. So, you can hang on to most of your capital, but for a relatively small sum of money you can buy an income stream which starts at, say, 85, supposing you live that long. One reason it’s a small sum of money is that some people die and that becomes part of the pool for the payout. Another reason is you’re putting this money in at, say, 65 and it accumulates until you are 85. So for maybe 15% of your superannuation capital you can buy something that gives you a respectable standard of life when you’re older and that means you can plan what’s left.
So when people ask, “What are you going to do with your retirement income?” the first question is: “Well, how long am I going to live?” But if you buy one of these things you only have to plan for 20 years – or whatever the gap may be – and that then becomes a well-posed question that you’re able to answer. I think these kinds of products are a good half-way house between giving people some discretion over their retirement resources and some insurance, when they really need it.
BT: Other countries have had annuities for many years, and they seem to be much more popular, particularly in Europe, than they are in Australia. However, many Australians have never heard of an annuity.
Piggott: Well, that is true. The UK, in particular, had a very strong annuity market that was supported by very strong tax incentives and compulsion for some period. That has now been removed and it will be interesting to see what happens to retirement incomes and the annuity market with that withdrawal – whether new retirees end up buying annuities or buying some other kind of retirement income product, like what we have, which is account-based pensions that a lot of people use in Australia.
BT: Equally, if people don’t have annuities they may try to stay in the workforce longer. This would have huge advantages for people who get a bit bored in retirement, but is it good for the country to have an older working force?
Piggott: Yes. I think policies everywhere are being devised to encourage mature labour force participation, to find ways of encouraging firms to keep workers on later. There is an argument which says these people are squeezing out the young but this is fallacious. The way to think about an economy is like a balloon that goes up and down with the amount of economic activity, and so in some sense, labour supply at mature ages creates its own demand.
Now if you’re used to operating in an office which has 30 employees, you are thinking about a crate [and] you have to remove someone before somebody else comes in. That’s not true of the economy as a whole. It’s called the lump of labour fallacy and it’s been around for 100 years.
There is nothing but upside to mature labour force participation. It’s a matter of finding appropriate incentives and appropriate workplace conditions so that workers can manage continued employment into a later age, at which point many people have other responsibilities, such as to their elders or their grandchildren. It’s not a matter of taking leisure when you retire, it’s a matter of family becomes more important. So workplaces have to devise mechanisms for accommodating that, in much the same way as a generation or two ago they had to devise mechanisms for coping with women with young children coming back into the workforce. They had special conditions.
BT: One thing that certainly was looking at policy was the Henry Tax Review, published in 2010, of which you were on the panel. I know it looked at the budget both state and nationwide. It seems to be implying we are heading for a larger structural deficit, which would of course make affording an older population more difficult. Is that really the case?
Piggott: Oh yes. I think a lot of it is driven by the ageing demographic. There’s no question that per capita government expenditures will be going up, and those outlays will have to be financed. And, sooner or later, they are going to have to be financed by taxes. You can run deficits for a little while – our national debt is not a disaster by any means, yet – but there’s only one direction with our tax reform.
So what should those reforms be? That’s something that I think the tax white paper will address. On the table is an increase in consumption taxation – increasing the rate of the GST – [and] maybe increasing the progressivity of the personal income tax. People have talked about the top rate of personal income tax going to 51%. It’s currently 49%, it was 47%, but then there was a levy. A deficit emergency levy. It could go up further. Personally I would not be opposed to that but I think that is an issue for the community and community consensus.
BT: But in all of this, we are missing that one piece of good news, which is that we are living longer.
Piggott: It’s a victory for humankind and it’s all happened in the past 200 years. We are in a lucky time to be alive.
This article originally appeared in The UNSW Australia Business School’s online business journal, BusinessThink. It is reproduced with permission. It is subject to UNSW’s usual disclaimers.
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