Retirement Saving Flashcards
life cycle
individuals ability to work declines with aging and continue to live after they are unwilling/unable to work
standard life-cycle model prediction
absent any government program, rational individuals would save while working to consume savings while retired
actual retirement programs
all oecd countries implement substantial government funded retirement programs, started in first part of 20th century and have been growing
common structure of retirement programs
individuals pay social security contributions while working and receive retirement benefits when they stop working till the end of their life
two forms of retirement programs
funded and unfunded
unfunded (payg) programs
benefits of current retirees are paid out of contributions from current workers
current benefits = current contributions
funded programs
workers contributions are invested in financial assets and will pay for benefits when they retire
current benefits = past contributions + market returns on past contributions
e.g. superannuation
objective of retirement incomes in australia
to deliver adequate standards of living in retirement in an equitable, sustainable and cohesive way (Retirement Income Review, 2020)
three pillars of retirement income in Australia
private voluntary saving
means tested age pension
compulsory employer-contributed superannuation
goal of superannuation
reduce reliance on public pension by encouraging saving
three primary saving encourage devices for super
mandatory contributions: super guarantee
concessional tax treatment of contributions
concessional tax treatment of investment earnings
mandatory contributions: super guarantee
employer must remit 10.5% of earnings to employee’s super fund
SG rate legislated to rise to 12% by 2025/26
concessional tax treatment of super contributions
concessional contributions to super funds are taxed at flat 15% rate up to a total of $27,500 per year
large benefit to high income earners. Division 293 surcharge of 15% on Super contributions for those earning above $250,000
concessional tax treatment of super investment earnings
earnings of assets in Super funds taxed at 15% rate. lower than tax on income held outside of super funds. Can make non-concessional contributions to super fund of up to $110,000/year
accessing super
from the preservation age if fully retired (55 if born before 1 July 1960, increasing to 60 if born after)
from 65 years even if working
under a transition to retirement arrangement
withdrawals from super
either an income stream or lump sum amounts
superannuation costs: tax expenditures
foregone taxes on labor income
foregone taxes on investment income
indirect costs of superannuation
inability to withdraw restricts consumption smoothing
potential unintended distributional consequences
means tested public pension age range
available from from 65.6 if born before 1953 to 67 if born 1957 onwards
basic pension rate
$971.5 per fortnight for singles or $1464.60 for couples
means testing for pension
based on non-housing assets and income:
full pensioner if assets under $280k for single or $419k for couple
no pension if assets above $634.5k for single or $954k for couple
pension cut off if income above $2318 per fortnight for single or $3544 for a couple living together
pension phase out implications
creates an implicit tax on saving
family home exemption creates a bias toward housing consumption
evidence for myopia and adequate savings
Diamond (1977): old age poverty has fallen in the US as social security expanded
poverty for other groups has not fallen nearly as much
fall in consumption during retirement: Hamermesh (1984) shows that consumption falls by 5% every year for the elderly
Fall in consumption at retirement: Bernheim, Skinner, Weinberg (2001) show that drop in consumption is significant for all groups except the wealthiest (consistent with myopia)
default behaviour in retirement saving
Madrian and Shea (2001)
- private retirement saving plan participation is substantially higher under automatic enrolment
- a substantial fraction of people retain the default contribution rate and fund allocation
implications of default behaviour in design of retirement plans
powerful role of inertia
perceptions of defaults as investment advice
do automatic contributions crowd-out private saving
little evidence that increase in offset in lower saving elsewhere
price subsidies have little effect
longevity risk: market failures
adverse selection: people who expect to live longer are more likely to buy an annuity
moral hazard: those with an annuity may invest more in health to live longer
moreover, there is aggregate risk that insurance companies cannot diversify against: general underestimation of expected longevity
demographic changes and effects on retirement saving
pensions and super are strongly affected by changes in demographics (increased life expectancy, declining fertility, declining labour force participation)
increases in retirement ages to offset these issues
need to lower benefits, increase contributions, reduce length of retirement, or increase labour productivity beyond growth of life expectancy to deal with funding issues
