Why is Australia’s Retirement System Better than America’s? – Center for Retirement Research

Our Social Security system is well built, but it has one major flaw.

I’ve been scratching my head since President Trump announced in early December that the administration is considering developing a national retirement savings plan similar to Australia’s superannuation system. Yes, our system is not perfect, but it is not clear what we are getting in Australia at this stage of the game.

That’s not to say the Australian system doesn’t deserve high marks. In fact, Mercer’s latest Global Pension Index awards the Australian system a B+, while the US system only gets a C+. It is clear why we get low marks. By 2033, Social Security’s retirement trust fund will run out, and the government will be forced to cut benefits by 23 percent. This is not new news. The end of the trust fund has been on the books since the early 1990s (see Figure 1), but, in the last 35 years, we have not taken a single step to end the conflict. That’s funny. But the immediate crisis reflects a failure of Congressional will, not a failure of program design.

The US Social Security system has been the most successful social program in the nation’s history. It is funded by a tax on workers’ earnings and provides guaranteed income for life to retirees, spouses and survivors. Benefits are structured so that low earners receive proportionally higher benefits than high earners, and high earners’ benefits are also subject to federal income tax. This progressive profit design undermines, however, the fact that high earners live forever while low earners die early.

A major criticism of the Social Security system, however, is that it operates on a pay-as-you-go basis, making it highly vulnerable to turnover. That provision was not the original intention; a 1935 law called for the creation of a trust fund – like an insurance company. But the 1939 amendments changed the nature of the program, making it easier to provide full benefits to veterans, many of whom had fought in World War I and endured the Great Depression. These benefits paid to early retirees, did not come for free. If earlier cohorts had received benefits based on their contributions and interest, we would have a larger trust fund today and the rate of payroll taxes would be about 4 percent lower than needed.

On top of Social Security, we have a layer of employer-sponsored retirement plans — primarily, 401(k) plans that allow workers to accumulate large amounts of assets. This section of the amendment may impact our bottom line because any time a portion of the private sector workforce participates in this program. In addition, the financial services industry is doing all the restructuring of the distribution from the asset pile to the retirement income stream. But people don’t buy annuities and are always reluctant to get their accruals. In addition, we save a lot of tax money by offering favorable tax treatment for saving through funded retirement plans.

So, if that’s why we get a C+, why do Australians get a B+? Australia’s system is simply the opposite of ours. Their basic plan, established in 1992, is a defined contribution plan where employers currently pay 12 percent of taxable income to funds that invest in stocks, bonds, and other assets. Some voluntary contributions can be paid into these funds in a tax-deductible manner by high-income earners and the self-employed. Participants have full access to their pension assets at age 65 or at any time after age 60 (earlier if born before 1964) if they stop working. Those who end up with insufficient resources in retirement can receive income from the means-tested Australian superannuation, which was first established in 1908.

The appeal of the Australian system to organizations that rank national retirement plans is that the main plan is fully funded and protected from population change, and the Age Pension ensures that no one falls below any adequate standard of living. On the other hand, one could argue that the extensive reliance on balance accumulation obscures the goal of achieving a secure stream of income and combining the income from the basic plan with the Age Pension seems too complicated.

I’m happy to give the Australians their due, but I’m pressed to see if their design provides any guidance for improving the US system. It’s clear what we need to do – restore balance to Social Security and expand coverage into more savings for all workers. We, too, should be able to get a B+.