Four things have combined to ensure that the family home will have to become a formal part of the retirement income system through some kind of national reverse mortgage scheme:
1. As Glenn Stevens said yesterday, the price of buying a flow of income has “gone up a lot”, which is another way of saying that the yields on low risk assets have fallen.
2. The government is struggling to meet the $42 billion annual cost of the age pension and will have to do something to at least restrain its growth.
3. Life expectancy is rising much faster than the retirement age, which means people are living much longer in retirement.
4. Because of conservative investment policies during the accumulation phase, superannuation funds are not making up the difference with lump sums.
On Monday, the Centre for Independent Studies proposed that the family home be brought into the equation. Simon Cowan and Matthew Taylor at CIS suggested two things to fix retirement incomes: that the family home be included in the pension assets test and that the government legislate for a default national reverse mortgage scheme, the income from which would be counted in the income test.
The result, according to their research, would be that 98 per cent of pensioners would be better off by an average of $5,900 a year and the government would save $14.5bn off the annual cost of the age pension, or about a third.
The cost, of course, is that the kids will get less inheritance because mum and dad have been living off the equity in the house.
Formally making the family home a retirement income asset, like super, would be a big social change: the system has always been that when you retire you live on the pension and/or savings and when you die the kids get the house.
But something has to give, because of the way the Howard government’s erosion of the tax base has coincided with a big fall in bond yields.
As treasurer during the temporary commodity boom, Peter Costello halved the capital gains tax rate, froze fuel excise indexation and made the retirement income system permanently much more costly by making super tax-free after age 60, loosening the means tests, removing the superannuation surcharge and implementing generous tax breaks in the years leading up to retirement — the “transition to retirement” rules.
The number of pensioners also increased from 1.8 to 2.3m over the past decade, or from 9.2 to 10.1 per cent of the population, massively increasing the cost of the age pension.
Over the same period, the age pension payment (single rate) has increased 71 per cent from $11,629.80 to $19,916 a year — a compound annual growth rate of 5.5 per cent, exactly double the inflation rate.
According to Cowan and Taylor’s research, two-thirds of the increase in the cost of the age pension has come from the rise in the rate and one-third from the increase in the number of pensioners.
Meanwhile over those same 10 years, the 10-year bond yield has more than halved from 5.3 per cent to 2.56 per cent as part of a general decline in the global interest rate structure.
As RBA Governor Mr Stevens asked in a speech yesterday: “How will an adequate flow of income be generated for the retired community in the future, in a world in which long-term nominal returns on low-risk assets are so low?
“Those seeking to (buy an annual flow of future income) -- that is, those on the brink of leaving the workforce — are in a much worse position than those who made it a decade ago.”
The fall in bond yields is not the only reason the cost of buying a low-risk retirement income stream has gone up: life expectancy is increasing rapidly as well, which means the length of annuities has increased as the return available has gone down.
And finally, retirement lump sums are smaller than they should be because during the accumulation phase, super funds employ asset allocation strategies to reduce their volatility at the cost of return.
Saving for retirement is a long-term investment game where short-term volatility is relatively unimportant, yet super funds put large allocations into fixed income and cash assets to smooth out the returns, with the result that end savings are less than they would otherwise be.
According to the CIS research, more than 80 per cent of retirees own their home and the overwhelming majority have no mortgage. They estimate the total value of pensioner home equity at $625bn — about a third of the superannuation savings pool. Pensioners in the “middle wealth brackets” have more than 70 per cent of their wealth tied up in the family home.
Essentially what the CIS is suggesting is that the government regulate a national reverse mortgage scheme in much the same way as private health insurance operates, while forcing pensioners to use it by including the family home in the means test — both asset and income.
It’s an idea whose time has just about arrived, because there’s nowhere else the money can come from.