One of the major remaining defects with Australia’s superannuation system is that it relies on retirees to actively decide when they move their accounts from accumulation to retirement mode.
Due to an understandable lack of knowledge about super among retirees and the continuing severe shortage of financial planners which I covered here, many retirees have been paying an incredible and totally unnecessary tax impost of $13.5 billion since 2017.
That figure was worked out in some excellent research by super fund HESTA and is calculated by adding up the tax-free investment returns forgone between 2017 and 2025.
That massive sum comes about because when a retiree stops work but doesn’t change their super account to retirement or decumulation mode, they continue to pay a 15% tax on earnings in the fund.
That tax paid is deducted from the fund so the cost accumulates and compounds over time due to tax-free returns that are not earned.
If this situation continues for many years, retirees can literally be costing themselves thousands and tens of thousands of dollars a year for no benefit at all.
Understandable Confusion
This costly confusion is understandable given that many retirees wrongly believe that they need to keep their super fund in accumulation mode in case they get another job so they can continue to make super contributions.
What should happen to maximise returns is that the long-term super account they have used should be switched to retirement mode as soon as they become eligible by turning 60 or retiring from full-time work or both.
Then a second super account should be set up to act as a repository for fresh super contributions while the bulk of their super savings is no longer subject to tax on investments.
The second account can also be switched to retirement mode down the track when there is no longer a need to have an active accumulation account for super fund contributions.
Retirees are also confused because once the change is made, they will begin to receive pension payments from the fund which they may see as eating into their super nest egg.
In reality, they would be much better off having this income – which can be saved or spent according to their needs – compared with continuing to pay a 15% investment tax on their super.
Heading for $5.5b per Year Mistake
HESTA’s excellent whitepaper Make the move: Guiding members to tax-free retirement found that last financial year 1.8 million Australians remained in accumulation phase despite being eligible to switch, collectively forgoing $2.5 billion.
By 2030, nearly three million Australians are projected to be missing out on $5.5 billion annually unless behaviours change.
“Retirement should be a time when Australians can enjoy the rewards of a lifetime of work. Yet too many Australians are not making the move from saving for retirement to actually living in retirement—and the cost of that inaction is significant,” HESTA chief executive Debby Blakey said in the research.
“Without reform, the problem will only grow. We need system-level change to make it easier for people to access tax-free income in retirement.”
The research found that all member groups irrespective of their balance, gender, homeownership, or marital status would benefit from transitioning to retirement products as soon as they become eligible.
Should Funds Prompt their Members?
“Every eligible member cohort analysed is better off when they have access to a retirement phase option rather than staying in accumulation,” said Blakey.
“That's why we're calling for a well-designed default mechanism that would seek to ensure no Australian is left behind simply because the system failed to guide them.”
Interestingly, the research found that women were disproportionately affected, with female HESTA members having a take-up rate of 29%, while for all eligible members it sits at 30% and the take-up rate for the overall super system is 45%.
“Women who have spent their careers caring for others often retire with more modest balances—and they are precisely the members least likely to make this transition on their own,’’ said Blakey.
By transitioning to a retirement income stream upon eligibility, members could boost total retirement income by up to 12% depending on their circumstances, compared to those who delay by four years, the research found.
HESTA has called for funds to be given the ability to actively prompt members to transition to appropriate specific fund retirement products, with the ability to opt-out.
It also called to allow default transition for eligible members into a retirement income stream, with an opt-out option for consumer protection.
