Australia's Future Tax System

Retirement Income Strategic Issues Paper

Appendix F: Modelling retirement incomes

The projections presented in this paper are based on the RIMHYPO model maintained by the Treasury. This model 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 paper 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 this paper 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 2000 at age 30 years, and retires in 2035. A 35 year working life is an average working life for a primary earner, including periods outside the labour force (for example, study, care or travel).

  • Many people will work more than the average. For example, a person who works full-time from age 20 years to age 65 years would have a 45 year working life. People who work longer are projected to receive higher replacement rates (see the projections for a person aged 20 years in 2008 in Table F.1).
  • Many people will work less than the average. The paper includes analysis of the outcomes for an individual with a broken work pattern, who works less than the average for a primary earner. Chart 4.4 presents projections for a person aged 36 years in 2006, who works part-time between ages 36 years and 44 years, full-time between ages 45 years and 59 years, and part-time between ages 60 years and 64 years.
  • Chart 5.2 and 5.3 present the impact of a 37 year working life, rather than a 35 year working life, to reflect the recommendations to increase the Age Pension age to 67 years and align the superannuation preservation age.

Table F.1: Illustrative projected replacement rates under the Age Pension and superannuation guarantee for people with different periods in the superannuation system(a)

Income as a proportion of AWOTE(b) Replacement rate by individual's age (in years) in 2009
(per cent)
20 30 40 50 60
0.75 81.5 77.7 76.4 67.6 58.1
1.00 70.7 67.2 65.9 57.5 49.8
1.50 59.3 55.4 54.7 47.0 39.9
2.50 52.9 47.0 42.4 34.4 27.6
  1. A replacement rate compares an individual's spending power before and after retirement (that is, after tax is paid). For example, a replacement rate of 75 per cent would mean that an individual would be able to spend in a given time period $75 in retirement for each $100 spent before retirement. The projections are for people of different ages, who spend different proportions of their working life covered by the superannuation guarantee. The scenarios are: male aged 20 years now who enters the superannuation system now; male aged 30 years now who entered the superannuation system in 2003; male aged 40 years now who entered the superannuation system in 1992; male aged 50 years now who entered the superannuation system in 1992; and male aged 60 years now who entered the superannuation system in 1992. In all cases, the person retires at age 65 years and purchases a wage indexed life annuity. This implies that the person aged 20 years has a 45 year working life covered by the superannuation guarantee. The incomes used to calculate the illustrative replacement rates are deflated by the consumer price index to 2008-09 dollars. Actual outcomes will vary depending on factors such as workforce participation, investment performance, inflation, longevity and whether an individual accesses their superannuation before Age Pension age.
  2. AWOTE is average weekly ordinary time earnings and is around $1,150 per week ($60,000 per year). Around half of workers earn less than three-quarters of AWOTE.

Source: Treasury projections.

The base case assumes the hypothetical individual retires in 2035 and lives for a further 22 years (a total life expectancy of 87 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. Illustrative projections that assume a different point of retirement (Chart 5.2, Chart 5.3 and Table F.1) use the projected life expectancy at the point of retirement for the individual's age at retirement.

The base case assumes the person does not make any additional contributions to superannuation, beyond the superannuation guarantee. The exception to this is Chart 4.3, 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 5.3, which includes an alternative base case of an individual who accesses their superannuation from age 60 years (but has the same working life pattern). In this alternative base case, the individual is assumed to access their superannuation in a way that provides a steady income stream that increases in line with wages through the rest of their lifetime.

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.

Replacement rates are generally calculated by comparing the average disposable income during a person's retirement to their disposable income in their final year of work. The exception to this is Chart 4.4, which uses average disposable income through a person's working life, rather than disposable income in their final year of work. Average disposable income through the person's working life provides a better indicator of the lifetime living standards enjoyed by a person with a variable work pattern. Average working life income balances their income from years where they work a large amount with their income from years where they work less. By contrast, their income in their final year of work can be significantly above their average lifetime income (if they work more than average in their final year) or significantly below their average lifetime income (if they work less than average). Chart 4.4 also includes the base case scenario recalculated on the basis of lifetime, rather than final year, income to provide an appropriate comparison to the broken working life 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. Table F.2 presents the base case replacement rate projections using both methodologies.

Table F.2: Illustrative projected replacement rates under the Age Pension and superannuation guarantee, deflated by wages and consumer prices(a)

Income as a proportion of AWOTE(b) Replacement rate by choice of deflator
(per cent)
Consumer Price Index Average Weekly Earnings
0.75 73.4 60.9
1.00 62.9 52.1
1.50 51.6 42.6
2.50 41.1 33.9
  1. A replacement rate compares an individual's spending power before and after retirement (that is, after tax is paid). For example, a replacement rate of 75 per cent would mean that an individual 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 person who works for 35 years and retires in 2035. It is assumed that at age 65 years they retire and use their superannuation guarantee benefit to purchase a lifetime annuity. In the two scenarios, the incomes used to calculate the illustrative replacement rates are deflated to 2008-09 dollars by using the consumer price index and average weekly earnings. Actual outcomes will vary depending on factors such as workforce participation, investment performance, inflation, longevity and whether an individual accesses their superannuation before Age Pension age.
  2. AWOTE is average weekly ordinary time earnings and is around $1,150 per week ($60,000 per year). Around half of workers earn less than three-quarters of AWOTE.

Source: Treasury projections.