Prof Bob Officer - Acorn Capital; University of Melbourne
Funding an aging population
Josh Funder: It’s a real pleasure to welcome Professor Bob Officer to the 2020 Third Pillar Forum. Bob started his career dabbling in agricultural economics and has never stopped. He did his PhD in the Chicago School of Economics some time ago, and since then has been a leader in the international understanding of financial economics. Bob served Australia in a number of significant ways beyond his academic research. He is a founder and entrepreneur of Acorn Capital, JCP, and other major enterprises. He’s been on the board of VFMC and the Bank of Melbourne. Bob’s also a leading thinker in what an aging population means for our financial economics. In addition to that, he’s actually taught a large number of Australian thinkers from his base in the University of Melbourne Business School and Finance. Bob, a warm welcome to the 2020 Household Capital Third Pillar Forum, great to have you with us.
Bob Officer: Thanks very much, Josh. I’ll launch into my talk. To get a good understanding of how people are going to prepare for retirement, we do need to understand the economic environment that they’re likely to retire into. And of course, the budget this week has set the scene for the future, at least for probably a couple of decades. Let me examine the issues facing the economy in the light of the budget.
We are in a recession, which is obvious, the first for nearly 30 years. The Australian economy shrank by about 7% for the June quarter, that followed a smaller drop in the March quarter. It’s the second consecutive quarter of contraction, and the sharpest on record. We have yet to see the September quarter numbers but the expectation is that they’ll be low, or negative rather. It’s not expected that GDP or growth will come into the economy until the second quarter of next year. The forecast, I think it was from the World Bank, is a fairly optimistic 4.75% growth for the ’20/’21 year, ’21/’22 year. Unemployment has been over 7%, but it appears to be receding, it’s the highest in 20 years. The federal government with the assistance of the Reserve Bank has adopted a number of measures aimed at lessening the impact of the recession, and positioning the economy to recover quickly from what has been the sharpest economic downturn in our history brought about by the COVID-19 pandemic.
The measures that they’ve adopted have been wide-ranging, and those taken including those announced in the budget can be expected to reduce the personal trauma that could be expected from such a sharp downturn, at least in the short term. The long-term economic effects depend on how successful expenditures are in kick-starting growth in the economy. Further, this is very dependent on the course of the pandemic worldwide, and if and when a vaccine becomes available. However, what we do know is the cost of the government actions will have significant long-term effects.
Expenditures of the scale adopted by the government cannot be paid by immediate tax receipts, obviously in the recession. Therefore, the government must incur debt. The level of debt that has been incurred is unprecedented since the Second World War. The funding of the government debt is largely through the sale of security sales, the banks and the general public, which mop up liquidity and idle reserves. However, the purchases of such securities by the Reserve Bank of Australia, directly or indirectly, sometimes known as quantitative easing, will increase the money supply and can be inflationary. The national debt is expected to peak at about 46% of GDP, or close to a trillion dollars. Now, that’s one, followed by 12 zeros. This is not high, actually, by international standards. The budget measures are about 500 billion, and they amount to about 26% of GDP. Again, relatively modest compared to other countries in the developed world.
Despite the followers of modern monetary theory, deficits can keep accumulating, so they’ve got to stop at some stage and preferably the debts start being paid off. If the growth in the economy is sufficiently large, we might optimistically see the government debt being paid off through this growth. If we don’t get that, then the debt will need repaying. As I said, it can continue to expand. And the debt can only be repaid by taxes, inflation or expropriation, which is the equivalent of defaulting.
In these circumstances, we can expect pressure on the real value of Australian disposable incomes, which raises the obvious question of how Australians will be able to afford or live in retirement with such a debt overhang. It is expected that the current generation will spend more than a quarter of their life in retirement. The expected age for males currently is 86 years, and 89 years for females. By the year 2050, it’s expected to be 91 for males and 93 for females. As a generalisation, then people will need a lot more money for retirement than they currently have saved. It’s not expected that the age pension will be able to be increased to the extent that the majority of Australians would consider a reasonable standard of living. Super can help, but the majority of Australians, their current level of superannuation savings is insufficient to maintain their current level of consumption in retirement.
According to the Association of Superannuation Funds of Australia, a comfortable retirement standards at current level is about $62,000 a year. If we assume a 4% yield over 20 years, this means you need about $840,000 in the retirement super fund. The average balance on the other hand for males is $300,000 and females, $180,000, a total of $480,000, a considerable gap in the order of $300,000 if a comfortable retirement is to be funded from superannuation. As a comparison, a single-age pension is 22,000, and for a couple about $34,000. Relying on an age pension and retirement is not going to give you a comfortable living, nor can we expect any significant increase in the light of the enormous debt overhang, increase in age pensions. For the average couple the obvious question is, unless they expect a considerable drop in their standard of living, where is this money to come from?
If we look at the average net worth of Australian households, it is over a million dollars, parenthetically of course, there is a wide disparity between families. Typically over half of their net worth is tied up in the family home, which is valued usually well above their average super balances. Further, about 70% of households own their own home, and about 30% without a mortgage. The figures are substantially higher for upper and middle income families of course. Very clearly, the pressure on retirement savings can be alleviated in part or totally by making use of the net worth that is tied up in the family home, a source of family savings that is either not used for retirement income or is currently used very inefficiently.
The primary reason it is not used or it’s used inefficiently to generate income is because people are understandably reluctant to sell and move out of their home, particularly if you’ve got an expectation of at least another 20 years of life after retirement. In these circumstances, the obvious way of releasing some of the wealth tied up in that to fund retirement is through a reverse mortgage or something akin to one. For example, a couple aged 77 and 75, they want to top-up super by about $255,000 over the next 10 years. If they invested that at a yield of 4% per annum, they could expect to top themselves up with their super balance or top the super up by about $31,500 a year, a very useful supplement to their current retirement income.
They could expect to raise this money by a reverse mortgage if the house was worth at least $850,000. And at the end of 10 years, they could expect to have at least 63% of the value of the house, assuming a 3% increase in house values. Of course, it will be much simpler if that $255,000 could be put directly into their superannuation account. Unfortunately, current government legislation does not permit such a transfer. It would be better for all concerned, including the government, if such transfers were permissible. The pressure of government debt on the government welfare payments, such as the age and invalid pensions, would be greatly relieved if people were encouraged to release some of the equity in their homes into superannuation. Let me briefly…
Josh Funder: Hey Bob, can I just ask you there… Bob, on that specific point you made, in terms of transfer from home equity into savings, into investing, savings and superannuation, five years ago there was a dispensation for retirees to be able to transfer $300,000 of the proceeds of home equity from downsizing into their superannuation as an exception to the caps on superannuation. And it was a policy environment where the government was promoting downsizing as the solution to our aged housing and aged funding challenge. Of course, most Australian retirees don’t want to downsize, that’s been very clear. That incentive has been very poorly taken up by Australians. And in the middle of COVID, Australian retirees want to stay safe at home, they want to stay at home as they always did, and they don’t want to go into aged care. So, is one outcome of your analysis to suggest that we should probably allow retirees to transfer up to $300,000 of home equity regardless of the source, downsizing, partial sale, equity access, reverse mortgage, into superannuation to alleviate the burden on the government purse, to improve their superannuation adequacy, but to do that in a tax equivalent way? Is that the sort of direction you’re headed in terms of a simple policy…
Bob Officer: The direction, I’m not sure… I would like to think you could put more than $300,000. Because at the moment of course, you can sell your house tax-free, people are reluctant to move out of their house, and I think from a government’s point of view, the longer they can hold them in their house in retirement, the cheaper it is for government and the better it is for the welfare of the people concerned, so then I wouldn’t necessarily limit the $300,000.
Josh Funder: Okay. Well, that’s interesting. It’s a pernicious situation where the moment you do the right thing and downsize, according to the old policy, you’ll lose your pension ’cause you’ve got an asset. And then at the moment, it’s cheaper for the government and better for retirees to age in home with in-home care, but we’re not letting them fund that by transferring it to the super and funding their own retirements with their own savings. So I think it’s a deadlock we’ve really got to unlock.
Bob Officer: Well, I think you’re right. I think common sense really will compel any government to start looking at this. It’s a real waste of equity. I think having it sitting… I mean, there’s anecdotal evidence of people living extremely poorly and sitting on homes in the city in areas worth several million dollars, and not aware that they could still stay in the home, which they’re very reluctant to leave, without being able to generate the equity from it.
Josh Funder: And, Bob, can you talk about one other aspect of this in the current environment, which I think you’ve really mapped out very well, which is, we need to stimulate the economy. And we know from the GFC stimulus that retirees, when they have additional funding and available money, spend it locally on their needs, so they’re not living impoverished lives in their homes. They can actually get out and about, meet their needs and have some simple pleasures. And they also tend to spend it on their kids and their grandchildren, helping them get through COVID or fund education. So what would you say would be the sort of… Is there a multiplier here in the UK, the multiplier is that for every dollar drawn of home equity, it’s a 2.3 to 2.6 multiplier in the real economy. And in a low growth environment, there is a trillion dollars of home equity, and some billions of that every year distributed through retirees to meet their needs locally might have a stimulatory effect and might start to regrow the economy as well as meet those needs. How do you start to see the financial economics of stimulating the economy through accessing home equity at a national level and really getting the third pillar working for Australia?
Bob Officer: Well, I think all the points you made are very valid. It’s unquestionable that people in retirement, and I can speak to a degree personally on this, you’ve got more time for travel and expenditures, and you’re very conscious of how your children and grandchildren are going. So to have those extra dollars without having to wait till you pass on to the next world is very useful, and certainly they’ll be spent.
Josh Funder: Bob, I think we’re out of time, but thanks again.
Bob Officer: No problem.
Josh Funder: Your contribution to the national debate about aging, the economy, finance, your teaching of that to generations of people who now are part of the debate and your contribution to our specific area of meeting the challenge of longevity, housing and aging has been superb, and we thank you for it. Thank you very much, Bob.
Bob Officer: Thank you, Josh.