Why is Australia's retirement system better than the United States? – Center for Retirement Research

Our Social Security program is well structured, but it has a major flaw.

I've been scratching my head since President Trump announced in early December that the government was considering a national retirement savings system like the Australian Superannuation Scheme. Yes, our system isn't perfect, but it's unclear what we're getting out of Australia at this stage of the game.

That's not to say Australia's system doesn't deserve high marks. In fact, Mercer's latest Global Superannuation Index rated the Australian system a B+, while the US system only received a C+. It's obvious why our scores are low. By 2033, reserves in the Social Security Retirement Trust Fund will be exhausted and the government will be forced to cut benefits by 23%. This isn't new news. The depletion of trust funds has been documented since the early 1990s (see Figure 1), yet nothing has been done to prevent conflict over the past 35 years. This is ridiculous. But the looming crisis reflects a failure of congressional will, not a failure of program design.

The U.S. Social Security system is the most successful public program in U.S. history. It is funded by taxes on workers' income and provides guaranteed lifetime income to retirees, their spouses and survivors. Benefits are structured so that low-income earners receive a greater proportion of benefits than high-income earners, and high-income earners are also subject to federal income taxes on their benefits. However, this progressive benefit design suffers to some extent because high earners live forever while low earners die young.

However, a major criticism of the social security scheme is that it operates on a pay-as-you-go basis, making it vulnerable to demographic changes. This arrangement was not the original intention; Legislation in 1935 required the establishment of trust funds—just like insurance companies. But amendments in 1939 changed the nature of the program, making it easier to provide comprehensive benefits to earlier groups, many of whom had fought in World War I and lived through the Great Depression. However, these benefits paid to early retirees are not free. If earlier groups had received benefits based on their contributions and interest, we would have a large trust fund today and the payroll tax rate would be nearly 4 percentage points lower than required.

In addition to Social Security, we have a layer of employer-sponsored retirement plans—primarily 401(k) plans—that allow workers to accumulate substantial assets. This supplemental layer may also contribute to our low rating, since only half of private sector workers are participating in such a program at any one time. Additionally, the financial services industry is making every effort to restructure allocations from a pile of assets to a stream of retirement income. But people don't buy annuities and remain reluctant to dip into their savings. In addition, we give up significant tax revenue by providing favorable tax treatment for savings through retirement funding plans.

So if that's why we get a C+, why do Australians get a B+? Australia's system is exactly the opposite of ours. Their basic plan, established in 1992, is a defined-contribution system in which employers currently contribute a tax-advantaged 12 percent of employees' income into funds invested in stocks, bonds and other assets. Highly paid employees and the self-employed can make some voluntary contributions to these funds on a tax-advantaged basis. If a participant stops working, their pension assets can be fully accessed at age 65 or any time after age 60 (or earlier if born before 1964). Those who end up with insufficient resources for retirement can receive income from Australia's means-tested Age Pension, which was first established in 1908.

The appeal of the Australian system to organizations that rank national retirement systems is that major schemes are fully funded and insulated from demographic changes, and age pensions ensure no one falls below any adequate standard of living. On the other hand, one might say that the widespread reliance on balance accumulation obscures the goal of achieving a stable income stream, and that combining the benefits of the basic system with pensions appears to be very complex.

I'm happy to give the Australians their due, but I struggle to see how their design provides any guidance for improving the American system. It’s clear what we need to do – restore the balance of Social Security and expand coverage to provide supplemental savings to all workers. We should also be able to get a B+.