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Lessons to heed from Down Under

Australia's superannuation system — non-government funds held up for 30 years as a model to be emulated — has been found to have serious flaws that should serve as a warning to other government entities designing retirement systems.

The Australian system requires employers to contribute 9.5% of an employee's wages to a superannuation scheme of the employee's choice. Employees have approximately 500 funds from which to choose and those funds manage A$2.6 trillion ($1.96 trillion) in assets. The employer contribution is scheduled to increase to 12% by 2025. There are no mandatory employee contributions, although employees may make voluntary contributions.

The mandatory nature of the system means all working Australians have some form of employer-provided retirement savings plan. The system was designed to take the strain off the equivalent of Social Security, which is means-tested and funded from general tax revenues.

There are several different kinds of superannuation funds with more than half of the assets being in two — retail funds and self-managed funds. Retail funds are multiemployer funds run by financial institutions for groups of individuals. Industry funds are run by unions, and many are small. Retail master trusts are funds run by institutions for individuals. Self-managed funds are funds established by four or fewer individuals. They are regulated by the Australian Tax Office.

Employees generally can select in which fund to have their employers' contributions invested and can switch from one fund to another to seek better performance, to lower fees, or to cut costs.

But a two-year review of the system by the Australian Productivity Commission found major problems that were costing employees A$2.6 billion a year, what one newspaper called the "great superannuation rip-off." One of the major problems is the default funds into which contributions are directed when employees do not make a choice. Many of those funds are underperforming.

Another significant problem is that employees who change jobs eventually wind up with multiple small funds and paying high fees. The commission found that a typical worker with two accounts would be more than $38,000 worse off at retirement than a worker with only one.

It also found many fund directors did not have the right skills for the responsibilities, and that fund mergers that might have reduced costs and improved performance had been blocked by directors who feared losing their jobs in the mergers.

The Productivity Commission has proposed capping management fees for small accounts, and establishing an expert group to select a shortlist of the best performing funds into which the workers who do not choose a fund would be defaulted. This would drive out of business the poor performing funds.

The basic problem is that the initial structure of the system failed to assure the interests of the fund providers were aligned with those of the participants. That is: If the participants prospered, so did the fund providers. If not, the fund providers went out of business.

While the Australian system has significant differences from the U.S. defined contribution system, officials in states and cities attempting to establish programs to cover the estimated 55 million private-sector workers in the U.S. who do not now have retirement plans can nevertheless learn from it.

If the officials succeed in establishing plans to cover those workers, they must ensure that the systems align the interests of those servicing the targeted employees with the interests of the workers.

They also must ensure that the executives overseeing the systems have the necessary expertise to be effective overseers.

In the private sector, the Employee Retirement Income Security Act — especially its fiduciary standards — and the courts ensure that the interests of the participants come first, and take action to halt any divergence. The proposed publicly established plans do not have that protection.

In other words, states and cities planning defined contribution plans for private-sector workers must plan carefully, draw on all available expertise, and learn from mistakes others have made, for example, in Australia.