Why superannuation is not sustainable

David Chaston at interest.co.nz writes:

The experts say that without changes – like raising the retirement age – the present system is not sustainable for people who think they are paying into it now.

But the big failure – the really big failure – has been our longterm affection for ‘pay-as-you-go’ systems to fund basic and universal retirement superannuation. Pay-as-you-go approaches only work with positive trending demographics. But we have now converted to negative trending demographics where the proportion of claiming retirees rises and the proportion of working age payers diminishes.

The result will a disaster. People will get hurt.

I’ve said many times – the current super scheme should be locked off and guaranteed for those who reach 65 before say 2025 or even 2030. But a more sustainable scheme that takes account of initiatives such as KiwiSaver should be designed for those retiring after 2025.

Basically, someone who finished high school with the School Certificate qualification in 1962 will be aged 65 in 2011, and eligible for NZ Super.

Statistics NZ has relevant data of earnings and taxes from 1962 and we can use that data to track the earnings in that working life – and from that data determine the taxes paid over that period.

Essentially, our statisically average person will have earned about NZ$1.4 million and paid about NZ$342,000 in tax, taking home a pay packet of a little over NZ$1 million over those 50 years.

Converting these raw earnings and taxes to 2011 dollars, they earned NZ$2.7 million, paid NZ$620,000 in taxes, and had take-home pay of a bit more than NZ$2 million.

However, for the next 20 years of retirement, they will claim in 2011 dollars NZ Super to the value of NZ$544,000 – or almost 88% of all the taxes they have ever paid.

If they live for 30 years in retirement, they will claim almost a third more than they paid in a lifetime of taxes. They ‘break-even’ after 22+ years.

That is a very valuable calculation. The income tax paid by the average retired person will only cover 22 years of super.

That essentialy means someone else has to pay for their lifetime use of all other public services, including their health care needs as they age.

So how do you pay for that? Do you tax the rich pricks?

Even if that other 10+% were taxed at a much higher rate, it is unlikely to generate the funding required to pay for a long-but-normal life in retirement at current NZ Super rates; there are just far too many people about to become retired and eligble for their ‘fair share’.

Nope.

Our only option is to raise the retirement age.

We have left our run too late to adopt a fully-funded approach for people who will retire in the next twenty years. We are stuck with pay-as-you-go over that period.

I agree we need to increase the age. But not just look at that issue. I think we should have a fundamental debate about what should NZ Superannuation look like for those born after 1960. Should it be inflation adjusted or average income adjusted? Should it be income or asset tested? Should there be options such as a smaller amount if you retire earlier and a larger amount if you retire later?

Due to the political necessity to neutralise this issue in 2008, the PM has vowed no changes to super or the age while he is PM. While that means any changes are unlikely to be agreed upon in the next six years, it doesn’t mean political parties can’t start talking about what superannuation should look like for those born after 1960. We can’t afford to delay the decisions by a decade or more, as that won’t give enough time to implement changes.