Let us start with a question. The U.S.A civil war finished on 26 May 1865. When did the last pension payment to soldiers or their dependents in that war cease? Incredibly it was in the first decade of this century, that is over 140 years later.
Current and future taxpayers can only hope that former federal politicians, bureaucrats, and their dependents do not live as long because the bulk of the indexed pension benefits promised are unfunded, i.e. payable out of current tax revenue or adding to the deficit. Even more concerning the government continues to still follow past practices. When employers such as Australia Post and Telstra contributed to the funding of the CSS on an accruals basis and even now when employees convert their accumulated contributions to a lifetime pension, Treasury promptly spent and continues to spend that money as soon as they receive it.
Put crudely, the standard policy has been and continues to be to ease pressure on the current budget by boosting unfunded super liabilities. Very responsible behaviour not! Concerned not to mislead you, I emailed Press Relations at Treasury (copy to my lawyer) to confirm this information is correct. I also sought confirmation that the (selfish) reason for this imprudence is that they and their political masters consider that the sole purpose of the Future Fund is to help service the unfunded liability (allowing them to ignore the long run costs of their super benefits).
Of course, no answer to my email. But fortunately, I will not need a lawyer to defend criticism of misleading readers. Google AI bless its soul reveals all the gory details confirming my long-held assessment that the estimate of the actual liability for future generations (currently officially estimated at over $300 billion) is grossly understated. Claiming the Future Fund has always been theirs to splurge, they calculate the unfunded liability assuming:
- No one else has claims to its assets. Excuse me. My Cambridge education provided a particularly important reason for not running up future debts. Not too long after the war and after strict rationing finally ending, Joan and other Tutors drew our attention to the key roles Keynes and James Meade (a then current lecturer) played in funding the huge added war and associated costs outlays. Money had to come from everywhere and the strategies involved in doing so including included the forced exchange of personal overseas investments for newly created long-term bonds.
- There is no guarantee that future decision makers will not find other uses for the Future Fund. If Australia faces a major similar event such as the depression that ended when the war started or a war event and needed quick access to foreign assets and cash the Future Fund is an obvious first port of call. For public servants and politicians to calculate our future commitments assuming that the Future Fund is there only to meet the cost of their profligacy is unlikely to pass any current or future smell test.
Why does the government not simply use realistic methodology and just report the estimated total of the outstanding and future new commitments to pay CPI (bureaucrats and defence personnel and surviving spouses) or salary indexed Judges and (politicians and surviving spouses) pensions for over 100 years ahead. The recruited actuaries estimate the outstanding liability but then only report discounted figures. Even then for many years the new discounted periodic revaluations have exceeded those reported in earlier years.
An excellent example of this is a 2006 Treasury research paper (discussed in detail later in this Chapter) which estimated the discounted 2023 outstanding liability at just over $150 billion compared with the current discounted estimate at that year over twice that amount. I confidently estimate a realistic estimate exceeds the $500 billion figure used in the introduction to this Book.
Google explains the current method clearly. By discounting using the bond rate, the following is the result. “When bond yields fall: The denominator shrinks. The mathematical result is a much larger present value (of the unfunded liability). On paper, the government’s liabilities skyrocket, even though the actual money promised to employees has not changed by a single cent. When bond yields rise: The denominator expands. The present value shrinks dramatically. The liability drops on paper, making the government’s balance sheet look far healthier overnight.”
What rot and pigs will fly. For one thing inflation and salaries can and do sometimes increase faster than the bond rate (ever heard of hyper inflation or looked at the 1973-75 data). The defined benefit fund commitment is CPI or salary adjustment of the retiring pension. Do they really think higher inflation and faster salary increases for those accruing benefits (many defence employees for the next thirty years) reduces the cost to taxpayers of all the promised indexed benefits. Even more worrying is that discounting gives a misleading costing of longer-term commitments more than the immediate ones.
Deliberately or not, this is Snake Oil merchant type understatement of the extent of past profligacy. The NSW Treasury helped its future taxpayers responsibly. The extent of the future taxpayer bills from past federal decisions or lack thereof will keep growing for many years to come.
Enough of this. Understanding why the unfunded liability is so large and still growing will help you appreciate the dimensions of the problem. The basic starting point was the 1922 scheme when very few people lived till and past 70. By designing an indexed pension benefit at 55 or later, the Commonwealth was able to construct a tax reduction/deferral scheme justifying lower current salaries compensated for by generous retirement pensions.
These pension benefits initially were affordable only because of high mortality rates and the rules providing only modest benefits to most workers exiting before retirement age. Over time the costs increased dramatically for several reasons especially after I and several others started highlighting strategies for the empire to fight back. Treasury continued to ignore the cost-blowouts because unlike NSW they were not even trying to fund super benefits as the liabilities accrued.
The situation in NSW was different. They followed private sector practice of funding super liabilities on an accruals basis. Would you want shares in a company that promises future benefits for employees and does not account for them as the liabilities mount up? Norman Oakes and his switched-on team in NSW Treasury (always keen to give me a day or two work should the need arise) understood the situation clearly. Despite their best efforts to fund their pension fund benefits on an accruals basis, Mr. Oakes convinced his government that the only realistic option was to close off their (1915 mortality factors more tightly designed schemes) in 1985 (bureaucrats) and 1988 (Police) to new members. Increased longevity and poor investment returns were putting too much pressure on his budget.
HELLO federal Treasury only started down this path 20 years later adding several hundreds of billions to the unfunded liability in the process.
Worse still, a meagre attempt in 1990 to change from the CSS to PSS (new employees and volunteers to switch) may have increased the unfunded liability because even 68 years after the original start date, they did not change mortality factors used to calculate the pension.
Two other factors have increased the unfunded liability by a large amount. The 1999 changes compelling people to preserve their super to retirement age stopped imprudent or desperate fund members from cashing out their contributions and thereby losing access to the more valuable pension. Second even though it does not appear to have changed the actuarial costings, the recent change granting same sex partners access to generous surviving spouse benefits (67% of pension defence and bureaucrats’ pensions, amazingly remarkably interesting story 83% for politicians) will increase costs especially because of more surviving spouses and considerably larger age difference in many same sex relationships.
I have written elsewhere about the strategies available to maximise benefits available from all the federal government schemes. The generous Judges Scheme (now restricted to new selected higher levels of judges) is still open to new members. Only 10 years’ service gives access to a non-contributory indexed pension of 60% of salary at or after age 60. When I last looked in the selective areas still eligible for the pension, the annual cost of pensions was about or exceeded that for current wages but at least in this case there is a justification for the outlays involved.
Scrapping the judges’ pension for new members would require major increases in judges’ salaries which would in turn increase the pensions of already retired judges under the indexation arrangements. Fortunately for all of us back in 2004 pressure from Mark Latham forced the Howard government to close off entry to our Parliamentary Pension Scheme which was even more generous. Latham can also claim credit for providing the impetus to close off the newer PSS to new members.
Even though now only relevant to a few remaining contributors, the Parliamentary Scheme will still cost taxpayers a large amount for many years yet. As designed it provided even more generous and costly benefits on an unfunded basis than the Judges’ Scheme. The rules required a 11% annual member contribution, but achieving only 3 terms in office triggered a pension of 50% of salary (indexed by future wage increases) at any age. After the Hawke election massacre of Coalition members, one well-off ex-member with 7.5 years (3 terms) service asked me privately was it true?
Yes. He had a winning Tattslotto ticket. His pension at age 29 (which he is still receiving) was 50% of final salary starting at once indexed for future MP salary increases. After 18 years in parliament the pay-out was 75% of final salary. Salaries used to calculate the pension were even higher for those holding higher office or designated parliamentary positions for up to a period of 10 years. To top it off, to encourage a former PM with a much younger partner to retire parliament made a major change. With the support of the Democrats, the government passed legislation to increase (as it has turned out with large added budgetary cost because of a remarriage benefit not available in almost no other fund) to increase the surviving spouse benefit from the original 67% of the pension (still applying for public servants) to 83%.
Back to the pack now. There was no way politicians would allow new bureaucrats access to an indexed pension fund when they had closed their fund to new members. Nevertheless, the top brass succeeded in increasing their unfunded liability by around $50 billion (an estimate provided privately by a person involved in the later decision in 2015 to close entry off) by convincing the Howard government not to close off their fund to new entrants. They succeeded by highlighting the greater difficulty of recruiting and higher risks for their personnel as well as the added budgetary costs of making cash contributions to the accumulation funds of new employees.
Instead of racking up future bills like the Commonwealth, NSW in sharp contrast always tried to fund the benefits promised by their pension funds as they accrued. As funding shortfalls increased, largely because of larger pay-outs than expected, their Treasury officers realised continuing with 1915 mortality assumptions providing indexed pensions was not financially workable. Unfortunately for all future federal taxpayers, their Treasury never even tried to fund their pension schemes on accruals basis. This allowed federal bureaucrats continued access to their increasingly costly funds for far longer. As mentioned above for the Defence funds, changing course added to the growing cost of paying pensions by having to contribute to the accumulation funds of new employees.
The Commonwealth’s unfunded liability also increased as pension fund members became better informed about the options available to them. For many years, departments and administrators reduced the long run costs by not providing relevant information to employees leaving or taking redundancies before the minimum retirement age of 55.
Outsiders may find it difficult to understand just how easy it was/is to increase the final CSS and PSS benefits received. My several books, weekly Sunday Canberra Times articles for 30 years and departmental seminars generated widespread interest and interstate invitations. Even though it was introduced in 1990 to save the government an estimated $7.5 billion (from Cabinet paper leaked to me and quickly shredded), the actual outcome was a much lower saving and it may actually have added to long run costs as knowledge spread about the most valuable PSS option, taking all the benefits as a pension and contributing 10% of salary instead of the standard 5%.
After 10 years, the government matched the added contribution and even when there was no matching the indexed pension was around 80 to 100% larger than ones sold in the private sector (especially for those with younger spouses).
I could give many examples of how (unlike the NSW scheme) there was considerable flexibility to maximize final benefits from both Commonwealth funds. One that stands out is when David Lamont, a switched-on TWU organiser arranged for me to present seminars about the newer PSS in their Action Bus lunchrooms.
Many of the attendees were wary about contributing to the fund (voluntary in their case) and even in some cases were still using fee riddled private sector or the better industry funds.Almost all were richly rewarded by receiving information about the benefits of contributing 10% of salary to the PSS. Their main concern was losing access to all or part of their age pension and the attached valuable fringe benefits.
Two things convinced many attendees to change course and join the fund or increase their contribution to 10%. First Centrelink rules assess indexed pensions much more generously than lump sums assessed under the assets test. Taking a pension reduces the assets counted under the assets test and the income test is more generous in assessing the annual income to qualify for a pension especially when there are also other assessable family assets. Equally importantly whilst employed was the much larger free death and disability cover available by contributing at 10%.
The NSW scheme closed to new members in 1985 provided sound but not overly generous benefits to people leaving before the minimum retirement age. The Commonwealth schemes were extremely (outsiders would say overly) generous. A keyway to boost the benefits of many CSS members was the treatment of members leaving before age 55 or receiving a redundancy. Depending on their career history especially having extended periods of modest salary increases could generate larger pensions for CSS members much larger pensions if they resigned or were made redundant before age 55 or even better were made redundant after 55 but before age 65.
After 30 years’ service the CSS provides a pension at age 65 of 50% of final salary and 75% of that pension at age 55 for the same period of service. However, if they knew about the rules, larger benefits were available for many members particularly for the vast bulk of the public service with only modest salary growth especially at the end of their career. Preserving their benefits available by resigning at least two days before age 55 or gaining a redundancy at any age before age 65, opened a Treasure Chest for many exiting employees.
My advising record included one client who received 92% of her final salary at age 55 by resigning just before age 55 and taking a deferred pension at age 55. She was then able to take another job and divert a large part of her salary to a new super fund via salary sacrifice arrangements. Even more costly for the unfunded superannuation liability resulted from the actions of a switched on union official.
Remember all the ADI defence ammunition factories in Footscray, Maribynong, Lithgow and St Mary’s (needed now) shut down by the Hawke government to sell off the land for housing generating massive redundancies of skilled workers, all members of the CSS. Their union organizer listened to Michael Shildberger on Melbourne ABC, and convinced his Union to demand that ADI hire me to be on site in several Canteens for four weeks to help employees understand their CSS options.
That union officer’s initiative helped hundreds of employees maximise their redundancy payments and added significantly to the unfunded superannuation liability. The skilled workers involved faced pressure by salespeople selling fee charging products from the available 3.5 times the member contribution taken as a lump sum. That option would have saved the Commonwealth substantial amounts in the long term and not boosted the unfunded liability.
My involvement explaining the options did precisely the opposite. Most of the redundant employees were skilled workers from a diverse range of countries used to arduous work for low pay. Already almost all had lined up new jobs, and the redundancy pay up to a year’s salary and accrued leave at concessional tax rates already met the cash needs of many, even of some of those with debts.
You could not ask for a better group of people to assist with technical advice about their superannuation options. Several higher level executives uninvited sat in the seminars and discussions because they had been given the option of joining a new structure. The CEO of that organisation was insisting (for very sound reasons) that the new structure not be forced to use the CSS as its super fund.
The topic clearly was options for redundant CSS members. Guess what. The biggest winner was the highly popular Canteen manager at one facility. At age 60, she could immediately draw a pension of 45% of her final salary plus receive all her contributions and earnings back as a tax-free lump sum. When she and all the other employees learnt that the redundancy triggered the second option of preserving accumulated benefits for at least two days (for the under 55s the minimum period was until age 55) thereby triggering an alternative pension calculation) -2.5 times the accumulated basic 5% contribution plus attached earnings converted into an indexed pension using the 1922 mortality factors.
In that case, the pension on offer was 87% of the final salary and allowing for the fact that no further 5% non-tax deductible contributions were required, the overall result was more income than available for staying in employment. For almost all of those aged less than 55, tying up their super till 55 and then receiving all their contributions and earnings back plus an indexed pension calculated using 2.5 times their contributions and accumulated earnings on a 5% contribution rate and then dividing the accumulated lump sum by 12 at age 55 was the deal on offer. Amongst other things, it allowed them not to bother about super in their new job unless they had surplus money to do so.
You can understand now when our politicians claim that they are saving money through redundancies this is in many cases snake oil PR. While there are still members in the defined benefit pension funds, redundancies can add substantially to our unfunded liabilities.
This is only one reason why I am sceptical about official estimates that the total unfunded liability was only estimated at $322 billion in late 2022. Way back in 2006 a Treasury Officer paper (Wilson Au-Yeng, Jason McDonald and Amanda Sayeh with disclaimers of course) waxed lyrical about the Future Fund helping to manage the Unfunded Liability with projections of an unfunded liability of $150 billion in 2022 and less than $200 billion in 2042.
These projections were made in a publication clearly designed to minimize concern about a Treasury and governments asleep at the wheel. Even minimal research using current outlays from the administrator (ComSuper as it used to be called) allows me to report total outlays i.e. cash payments of $13.5 billion in 2023-24 and $14.2 billion in 2024-25. Of more interest is that are still 100,000 members and pensioners of the CSS fund closed off to new entry in 1990, 214,000 members and pensioners of the PSS closed off in 2005, 182,000 Military Super members and pensioners (closed off in 2015) and 50,000 DFRDB pensioner members.
It will be an exceedingly long time before the total annual call on the budget falls in any major way. You may be interested also to know when selling off enterprises such as Telstra and Qantas, the federal government had no reservations closing off access to their defined benefit funds for future periods of service to maximize the revenue received from the sale.
You may also be wondering why I included this chapter in a book about tax reform. There are two reasons. First, it is essential reading about how past governments have been chalking up exceptionally large bills for future taxpayers to finance. Second and more importantly the superannuation taxation rules have allowed massive double dipping where by getting a second job or merely contributing cash as a deductible personal contribution recipients of costly (to taxpayers) defined benefit pensions can receive additional taxation benefits.
One interesting example illustrates the generosity of our policy makers to themselves and many others when they draw a defined benefit pension. A spy sought advice about what to do. He had a crucial job essential to national security, but his prickly nature led to a career with few promotions. The resign before 55 option gave him the option of receiving a pension at 55 of around 80% of his current salary and working past 55 would give a much lower percentage of his final salary.
With the pension indexed for inflation and not likely to be promoted, what should he do. Me. Do they need you? Him. Yes. Especially in dealing with the FBI, I am the expert. Me. Resign and draw your pension. They will come back and offer you work on an annual basis, and you can save tax by salary sacrificing 50% of your new salary to a private super fund. If they really need you, there are several instances where federal government employers will pay all your new salary into a new super fund, and you will only pay 15% tax on your new earnings.
Can you believe it. Until more recent changes, even though there was at one time a maximum $100,000 limit on tax-deductible annual super contributions, that limit only applied to employees of taxpaying entities. The rules then in force placed no restrictions on tax deductible contributions by governments, charities, and other tax exempt employers. How our tax policy experts could introduce such unfair arrangements defies rational explanation. More about sloppy administration in a later Chapter.