Final Report: Detailed Analysis
A2. Retirement incomes
The Treasury uses two models, RIMHYPO and RIMGROUP, to measure the outcomes of the retirement income system. The replacement rate analysis in Section A2–2 (Chart A2–4 to Chart A2–8) has been calculated using RIMHYPO. The national saving analysis (Chart A2–9 and A2–10) has been calculated using RIMGROUP.
Replacement rate analysis
RIMHYPO produces retirement income projections for a hypothetical individual or couple, including all relevant combinations of life events, government policies and retirement income sources. It captures, in detail, the legislative structure defining the interactions between superannuation, taxation and social security legislation.
The growth assumptions used in this model reflect long-term trends.
- Inflation is 2.5 per cent per year, reflecting the mid-point of the Reserve Bank's medium term inflation target of 2 to 3 per cent, on average, over the cycle.
- Wages grow at 1.6 per cent per year in real terms, reflecting 30 year averages.
- Superannuation fund earnings are 6.5 per cent per year, reflecting 30 year averages.
The projections presented in Section A2–2 involve a range of additional assumptions. These assumptions are designed to provide a balanced view of possible outcomes for individuals. Actual outcomes could be higher or lower depending on the specific circumstances of the individual.
The base case is for a single person, who starts work in 2010 at age 30 years, and retires in 2047. A 37-year working life is an average working life for a primary earner, including periods outside the workforce (for example, study, care or travel). The replacement for the base case scenario is shown in Chart A2–4.
The base case assumes the hypothetical individual retires in 2047 and lives for a further 22 years (a total life expectancy of 88 years). This is based on Treasury projections of age-specific probabilities of death for each year of age, calculated using the 2005–2007 life-tables and various historical life tables published by the Australian Bureau of Statistics. The projections factor in improvements in mortality factors.
The base case assumes the person does not make any additional contributions to superannuation, beyond the superannuation guarantee. The exception to this is Chart A2–8, which presents replacement rates for an employee who salary sacrifices at the average rate for people in their age and level of salary and wage remuneration (including salary sacrificed amounts as remuneration).
The base case assumes the person does not access their superannuation before Age Pension age. The exception to this is Chart A2–5, which assumes a person retires at age 60. In this alternative base case, the individual is assumed to access either Newstart Allowance or Disability Support Pension and then draw down their superannuation to achieve a 50 per cent replacement rate of their income at age 60. At age 67 they purchase a lifetime annuity with their remaining superannuation.
Many people will work longer than 37 years. People who work longer than 37 years are projected to receive higher replacement rates. Chart A2–6 shows the replacement rate for a person with a working life of 42 years (that is, they commence work at age 25 in 2010 and retire in 2052).
The base case assumes that individuals use their superannuation to purchase a hypothetical lifetime annuity, which is indexed by wages. This is different to the traditional assumption used in Treasury analysis, that the individual uses an allocated pension to draw down their savings over their expected lifetime. A lifetime annuity indexed by wages has the most comparable characteristics to the Age Pension. This assumption reduces replacement rates compared to the projections generated by the allocated pension scenario.
The projections use consumer price inflation to determine the purchasing power an individual retains in retirement. Adjusting for consumer price inflation indicates whether an individual's real standard of living is maintained over time. Some groups argue that wages are a better indicator of living standards. Using wages reflects an individual's living standards relative to the (rising) living standards of workers, rather than their ability to purchase a particular set of goods and services. Chart A2–13 presents the base case replacement rate projections for the AFTS proposals using both methodologies.
Chart A2–13: Illustrative projected replacement rates
under the Age Pension and superannuation guarantee, deflated by wages and consumer prices(a)
- A replacement rate compares a person's spending power before and after retirement (that is, income and fringe benefits after tax is paid). For example, a replacement rate of 75 per cent would mean that a person would be able to spend in a given time period $75 in retirement for each $100 spent before retirement. The illustrative replacement rates are projected for a hypothetical single male who works for 37 years and retires in 2047. It is assumed that they use their superannuation guarantee benefit to purchase a lifetime annuity at retirement. The spending power used to calculate the illustrative replacement rates are deflated by the consumer price index or wages to 2008–09 dollars. Actual outcomes will vary depending on factors such as workforce participation, labour income patterns, investment performance, inflation, longevity and whether a person accesses their superannuation prior to Age Pension age.
Note: AWOTE is currently around $1,200 per week ($62,400 per year). Around half of workers earn less than three-quarters of AWOTE.
Source: Treasury projections.
National saving analysis
The national saving analysis has been calculated using RIMGROUP. RIMGROUP is a comprehensive cohort projection model of the Australian population which starts with a population and labour force model, tracks the accumulation of superannuation in a specified set of account types, estimates non-superannuation saving and calculates tax payment and expenditures, social security payments including pensions and the generation of other retirement incomes. The projections are done for each year of the projection period separately for each birth year gender decile cohort.
- Increases in compulsory saving are offset by a reduction of 30 per cent in other saving. This applies to the increase in contributions resulting from the removal of contributions tax as recommended in this Report and the increase to the superannuation guarantee rate to 12 per cent.
- Increases in saving resulting from halving the earnings tax rate are offset by a reduction of 5 per cent in other saving.
- In analysing the effects of a potential increase in the superannuation guarantee rate to 12 per cent, total remuneration has been kept constant in the base and new policy runs. The increase in superannuation guarantee contributions has been directly offset by a decrease in the growth of gross cash wages.
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