Why we need to watch out for the 'wealth effect' and avoid debt

If you are feeling wealthier when you look at your rising superannuation balance, watch out you don't increase your spending and take on more debt.

A new report believes there is a correlation between pre-retirees feeling more financially secure because of their growing nest egg and then borrowing money to improve their current and future living standards.

"As the wealth of an individual grows, whether it be in home ownership, investment portfolios or their retirement savings, so too does their comfort with amassing debt," explains Dr David Knox, author of the Melbourne Mercer Global Pension Index for 2019 which studies 37 retirement systems around the world.

In fact for every $1 in retirement savings, there is evidence individuals take on around 50c worth of net household debt on a global basis, says Knox, senior partner and actuary at Mercer.

How does the Australian retirement system compare to the rest of the world?

Retirees around the world are facing intense pressure in the form of increasing longevity, rock bottom low interest rates, rising pressure on health systems and public infrastructure.

At the same time, individuals have responsibility for their own nest eggs and in Australia they can choose how to invest it.

Australians can take heart that the Australian retirement system is the third best in the world, according to the Melbourne Mercer Global Pension Index.

The panel of retirement experts from Monash University have given Australia a score of B+, pipped by Denmark and the Netherlands, both scoring an A rating.

But despite Australia's high ranking, Knox says that there needs to be better integration between superannuation and the age pension.

In particular it is important to moderate the asset test for the means tested age pension to increase the net replacement rate for average income earners.

This would involve reducing the taper rate, that was adjusted in 2017, and weakened the incentive for Australians to contribute more to superannuation.

Currently it is a harsh and steep taper rate for every $1000 in assets over the lowest threshold asset rate, a retiree loses $3 in the age pension.

"The overall system needs to provide clear additional benefits from making extra contributions," says Knox.

In addition, the report recommends the level of Australian household saving needs to be increased and household debt be cut to improve the quality of retirement savings.

Also it advises taking part of the retirement benefit as an income stream.

Another way to boost Australia's retirement income system is to allow more older people to work as life expectancies rise.

In addition, the report suggests the pension age is pushed out from the current age of 67.

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