Chapter 5: The impact on the ADF and ADF members
Overall assessment of the proposed new scheme
Benefit levels and impact on ADF members
Impact on recruitment and retention
Flexibility for future adjustments
This chapter provides a high level assessment of the proposed new scheme, and sets out the impact on ADF members and on the ADF as a whole, particularly with regard to recruitment and retention. The impact on some specific groups is discussed in more detail.
Overall assessment of the proposed new scheme
Table 5–1 summarises the Review Team’s assessment of the proposed new scheme against the Guiding Principles set out at the end of Chapter 2, and compares this with the assessment of the current open scheme, the MSBS.
Table 5–1: Assessment of MSBS and proposed scheme against the Guiding Principles
|
Guiding Principle |
MSBS |
Proposed Scheme |
Flexibility
|
In small part Yes |
Yes Yes |
Simplicity |
No |
Yes, but disability benefits remain complex |
Adequacy
|
In part Yes |
Yes, but with member risk Yes, but with member risk |
Tailored
|
Yes Yes |
Yes, with enhanced rehabilitation Yes, for members with 15 years service |
|
Visibly attractive
|
Limited Limited In part |
Yes Yes Yes |
|
Financially sustainable |
No |
Yes |
The following comments expand on this assessment:
Flexibility. ADF members will have the full range of member contribution options available to members of other Australian superannuation schemes. They will also have access to fund choice and full portability of the employee and employer-financed benefits on resignation. On retirement, ADF members will have a full range of benefit options including lump sums, account-based pensions and, for those with 15 or more years of service, indexed pensions with a choice of indexes. A range of investment options will also be available during both the pre-retirement and post-retirement periods.
Simplicity. The proposed defined contribution structure is in line with the vast majority of superannuation schemes in Australia. ADF members will have full transparency of their employer contributions and their value. The contemporary funded and taxed nature of the proposed scheme means that administration is relatively simple and can be provided by a broad range of commercial providers. The removal of complex employer benefit formulae significantly lessens the likelihood of the systemic errors that were evident in both the DFRDB and MSBS. The relationship between superannuation death and disability pensions and military compensation will be clarified and overlapping assessments removed.
Adequacy. The minimum employer contribution of 16% of salary ensures that Defence more than meets its obligation as an employer to contribute towards an adequate income in retirement for members with shorter periods of service. For these members, despite the risks involved, the resulting retirement benefits are likely to be higher than under the MSBS, and for all such members the benefits are higher than under contemporary civilian schemes including for the Australian Public Service. For longer periods of service the employer contribution is particularly generous compared to contemporary Australian schemes, although there is risk of lower benefits than under the MSBS. To an extent, the final outcome in terms of adequacy is in the hands of members who choose the level of investment risk that they are prepared to take to achieve a desired long term outcome. More details on likely retirement benefit levels are set out below.
Tailored. The unique nature of military service is primarily addressed through the death and disability arrangements. The arrangements have been tailored for the ADF through compulsory membership of this element of the scheme, and through being employer-financed rather than funded by employee insurance contributions, as is typical in contemporary schemes. The defined benefit nature of the benefits with reversionary benefits for dependants and the inclusion of prospective service in the benefit calculation ensure that current generous death and disability payments are preserved and, if anything, enhanced, but with a stronger focus on rehabilitation. The benefit design also ensures access for longer serving members to indexed pensions from age 55.
Visibly Attractive. The proposed scheme clearly has all the beneficial features of contemporary Australian superannuation schemes. Accumulated benefits would be clearly visible to members on a daily basis through the internet. Future benefits can also be projected under a range of scenarios through a web-based calculator and taken into account in future financial planning and lifestyle decisions. The level of generosity of the employer contribution is clearly visible to the ADF member and can be quantified as a financial element of the remuneration package for recruitment and retention purposes. This is likely to be particularly important for mature age recruitment and re-enlistment, and for retention purposes, as detailed below.
Financially Sustainable. While costing about the same as the current schemes, the new scheme will cap unfunded liabilities which would otherwise continue to grow under the MSBS; indeed, liabilities will decline substantially over the next 40 years (see Chapter 10). In addition, the scheme will sharply reduce the risks to Defence and the Government of future changes in life expectancy and inflation.
Benefit levels and impact on ADF members
Retirement Benefits
Figures 5–1 and 5–2 show the employer-financed benefit
payable at age 55 under both the MSBS and the proposed new scheme for a typical
member separating from the ADF at various ages. Figure 5–1 is based on an
‘other ranks’ member joining at age 18 and Figure
5–2 is based on an officer member joining at age 21 using the most common
patterns of career advancement. The illustrative investment returns in the
following graphs have been selected because investment modelling suggests a 70%
chance of the long term return being between 6% and 8.5% per year, and more
than 80% chance of the long term return being between 5.5% and 9% per year.
Figure 5–1: Comparison of employer-financed benefit for an ‘other rank’ member
Figure 5–2: Comparison of employer-financed benefit for an officer
PLEASE NOTE: Figures 5-1 and 5-2
may appear illegible on some browsers. Both Figures may be viewed in
PDF version [42KB].
The graphs demonstrate:
- the likelihood of gains in employer financed benefits (after tax) for members separating with under 20 years of service;
- the broad comparability of expected benefits (after tax) at age 55 for longer serving members; and
- the risks borne by members under the proposed scheme associated with uncertain investment returns. In particular, there is a risk of lower benefits for long serving members when compared to MSBS members who choose to receive their benefit as an indexed pension (there is also the probability of higher benefits than under the MSBS for all other ranks and most officers).
The apparent inconsistency of many ‘winners’ and few ‘losers’ but with the same long-term cost to Government is explained by the transfer of risks from Government to members. As a result, members will have the potential to achieve greater returns from the market (but with the risk of a similar or lower return).
The benefit levels under the proposed scheme, and comparisons with benefits under the MSBS, depend not only on investment returns and the risks associated but also depend upon personal circumstances, such as particular career paths and entry and exit points.
Table 5–2 draws on some common career paths and identifies likely benefit levels at age 55 under the new scheme and under the MSBS, based on entry into the ADF in 2007.
These cameos confirm the broad picture illustrated in the earlier graphs, but also reveal some other impacts of the proposed new scheme.
Even with modest investment returns, members of the ADF who join at an early age are likely to receive higher benefits under the new scheme than under the MSBS. This reflects, in large part, having more years prior to retirement during which the employer contributions are receiving investment earnings and not Consumer Price Index (CPI) indexation. This gain is less marked amongst those who, having joined at a young age, stay on until retirement age; this is the group that is most advantaged by the MSBS (and also by the DFRDB).
Those who enlist at a later age may not receive higher benefits under the new scheme as they have fewer years during which the employer contributions receive investment earnings. The MSBS is most likely to be more generous than the new scheme for those who then stay to age 55, as their MSBS benefits are not constrained by the MSBS preservation arrangements that only allow CPI adjustments rather than investment returns. Nonetheless, the new scheme remains a highly generous scheme for all these members compared to any contemporary civilian scheme, including the contemporary Australian Public Service scheme (the Public Sector Superannuation accumulation plan). Moreover, most such members should already have accumulated retirement benefits from earlier periods of employment.
Those who re-enlist at an older age will gain both from the compound interest on their employer contributions received during their first period of service, and from quickly gaining access to high levels of employer contributions when their total years of service reach six completed years or 15 completed years. They are likely to do better under the new scheme than the MSBS.
Table 5–2: Value of employer-financed benefit at age 55 in today's dollars (after tax)
Note Value in 2007 prices, assuming 2.5% inflation rate and 4% per annum movement in ADF pay rates
Disability benefits
Table 5–3 compares the employer-financed disability income benefits for the medically discharged under the MSBS and the proposed scheme (based on modest assumptions of investment returns and on accessing indexed pensions). The table shows income at the point of discharge, at age 59 (just prior to retirement) and at age 60 (after retirement).
Table 5–3 demonstrates:
- the unchanged disability benefits for compensable injuries during the years before age 60;
- the improved disability benefit for non-compensable injuries particularly through improved indexation arrangements; and
- the likelihood of improved benefits at age 60, with access to a substantial accumulated lump sum that can be converted into an indexed pension at least as generous as current MSBS arrangements, particularly after the new tax rules are taken into account.
Receipt of a disability income benefit would also count towards the 15 years service required to purchase an indexed pension from between age 55 and 65.
These disability income benefits would be reduced, of course, if the individual is successfully rehabilitated into employment and is therefore able to attract new superannuation contributions from a new employer. The table focuses on those who are fully disabled and unable to work. The rehabilitation focus may mean that some who under the MSBS might retain access to a Class B pension for partial disability would receive a lower benefit under the new scheme if they are successfully rehabilitated.
Table 5–3: Comparison of Class A disability income benefits in today’s dollars
Notes A modest investment return of 6.5% has been assumed for the proposed plan. A higher return would increase the benefits under this plan. There is, of course, a risk of a lower return. Prices are assumed to increase at 2.5% per year.
The disability income currently provided under compensation ceases at age 65. This effect is shown in Table 5–3 at age 60 for comparison purposes.
Figures assume salary growth of 4% per year.
Death benefits
Table 5–4 shows the employer-financed death benefit (not including the additional Military Rehabilitation and Compensation Act payments in the case of compensable death) at different ages as a lump sum or indexed pension, based on modest assumptions of investment returns. The table demonstrates the likelihood of more generous death benefits than under the MSBS.
Table 5–4: Comparison of death benefits in today's dollars
Notes A modest investment return of 6.5% has been assumed for the proposed plan. A higher return would increase the benefits under this plan. There is, of course, a risk of a lower return. Prices are assumed to increase at 2.5% per year.
Figures assume salary growth of 4% per year.
Impact on recruitment and retention
Retention
The Review Team considers that the new scheme will have a positive impact on retention, in particular, by making very transparent the value of the employer contribution as a component of the remuneration package, demonstrating its generosity compared to the level of employer superannuation contributions elsewhere. In so doing, it should take pressure off demands for increases in ADF pay and hence give better value for money to Defence from its total remuneration package.
This retention advantage is particularly relevant to the more skilled and experienced ADF members who, under the new scheme, will generally receive employer contributions at the 23% and 28% levels, not just 16%.
Discussions with the three Services highlighted the importance of retaining skilled and experienced staff beyond six years and preferably beyond 10 years. In designing the proposed new scheme, the Review Team took these concerns into account while noting recent decisions to use other levers to encourage retention. It considers that the proposed parameters of the new scheme fit well with those other incentives providing a series of ‘hooks’ to encourage continued service beyond the six year point. This is illustrated in Figure 5–3.
Figure 5–3: ADF retention initiatives by years of service
Recruitment
While superannuation does not have a major impact on recruitment of young people, the increased transparency of the value of the employer-financed benefit under the new scheme, and its enhancement of the remuneration package, should have a positive effect. There is likely to be a more significant advantage for attracting older and more experienced recruits. Effective marketing will enhance these positive effects.
Recruitment of Ex-ADF members. Ex members who re-enlist into the ADF currently become contributing members of the DFRDB or MSBS with complex provisions for prior service determined by legislation. The process is complex, often results in administrative errors and disputes and in some cases acts as a disincentive to re-join. Under the proposed new scheme, members can join with a clear understanding of their current and future superannuation entitlements. The ADF will set the employer contribution rate for an individual at a level which recognises past service, as now, but consideration could also be given to include experience and skills gained outside the ADF and the need to attract specific trained personnel.
Recruitment of foreign military and mature age candidates. Currently, trained foreign military personnel join as members of the MSBS and are given a notional length of service for employer contribution purposes based on the total of their previous military service. This is a significant benefit which is certainly appreciated by those joining but the ‘one size fits all’ approach does not always represent value for money and precludes targeted attraction measures for specific employment groups. Under the proposed scheme, the simple notion of recognising past service in a foreign military would be replaced by the ADF setting the employer contribution rate for an individual at a level which recognises the level of skill and experience brought to the ADF and the relative importance of those skills for recruitment purposes. A similar approach would be taken to attract skilled professionals who bring a breadth of skills and knowledge to the ADF.
Benefits of transitional arrangements
These impacts on retention and recruitment would be reduced, or at least delayed, if current ADF members and current MSBS preservers were not offered the opportunity to transfer to the new scheme. It is particularly important to allow current ADF members to transfer, and to see the value of their employer contributions. But there is also advantage in offering preserved MSBS members the opportunity to transfer, both directly in terms of re-enlistment incentives and indirectly in terms of the influence of Ex-service Organisations and their public attitudes towards military superannuation. Moreover, as explained in Chapter 10, the transitional arrangements are not expected to add to the costs to Defence or the Government, and they would ensure an attractive total package.
Other effects
Implications from Better Super
The Government introduced significant changes to the taxation treatment of superannuation known as ‘Better Super’ from 1 July 2007. The proposed new scheme will take advantage of the improvements introduced. The members of the new scheme will be eligible for tax-free superannuation lump sums and income streams from age 60, in contrast to the more limited 10% taxation rebate applicable to superannuation benefits paid to DFRDB and MSBS pension recipients over age 60. Secondly, members of the new scheme will not be required to include these benefits in their annual income taxation returns so that any additional income will be taxed at lower rates. This contrasts to DFRDB/MSBS members whose additional income will be taxed at the member’s marginal tax rate.
New scheme members will be subject to the new indexed contribution limits of $50,000 pa for concessional contributions and $150,000 pa for non concessional contributions. MSBS members have a $1m cap on the employer-financed benefit which would not apply to members of the new scheme.
Impact on Senior Officers
The generous nature of the new scheme’s employer contribution rates after 15 years of service (28% of salary) would see some senior officers reaching the concessional contribution limit. At 1 July 2007, affected officers would include 4-Star, 3-Star and the small number of 2‑Star officers on pay band five or six.
The superannuation taxation treatment of these officers would be no different to that applying to other Australian employees receiving this level of remuneration. Excess contributions above the concessional $50,000 limit (indexed) would be treated by the ATO as non-concessional contributions and taxed, in total, at the top marginal tax rate (currently 46.5%). That is, there would be an additional 31.5% tax payable on the excess (i.e. in addition to the 15% contributions tax). This tax is the same as if this excess were received as income.
Impact on the Gap Year Scheme
On 15 October 2006 the Minister for Defence, announced the Military Gap Year Scheme (MGYS) to enable young Australians to experience ADF training and the Service lifestyle. The scheme will be implemented from early 2008 and will provide up to a thousand positions across the ADF to school-leavers for 12 months paid military 'work experience'.
Since MGYS personnel will be part of the permanent ADF, under current arrangements they will be required to contribute to the MSBS. The military salary for MGYS personnel is expected to be in the range of $30,000 to $35,000 pa, with no Service Allowance payable. The preserved MSBS employer benefit after one year’s service would be around $5,400 to $6,300, with the funded productivity component comprising about $900 on average. Currently therefore, if a 19 year old MGYS member leaves the ADF after the 12 month initial period of enlistment, the (largely unfunded) MSBS employer benefit will have to be preserved for at least another 36 years (to the age 55 pension point) with the majority of the benefit indexed to CPI. The real value of the benefit at this point will not have changed in 36 years providing a poor reflection of military superannuation.
The features of the proposed scheme around choice, portability and preservation will provide more appropriate superannuation arrangements for MGYS participants who join the ADF after implementation of the scheme and who serve for short periods. The capacity to transfer from the MSBS to the proposed scheme will ameliorate issues for those who join prior to the introduction of the scheme as will portability of any preserved MSBS benefits for former MGYS members. The benefits of the proposed scheme can be used as an incentive to take up the option of joining the Services at the end of their MGYS period.
Impact on Reservists
As set out in Chapter 4, the Review Team does not recommend that Reservists, other than those on continuous full-time service, be eligible for employer-financed contributions to the new scheme. It believes more careful consideration of the role and nature of Reservists is required, and that this should flow through to consideration of the appropriate remuneration package including the applicability and level of superannuation.
The Review Team received submissions from Reservists and consulted with Reserve Policy Staff and the Defence Reserves Support Council, where proposals were made to extend employer-financed superannuation to Reservists.
In assessing these suggestions, the Review Team considered two fundamental issues. Firstly, is the nature of ADF Reserve service a form of part-time ADF employment or a unique form of service – or perhaps elements of both? Reserve service has changed from the traditional Citizen Military Force concept to include elements such as High Readiness and Specialist Reserves which clearly provide significant levels of capability on a daily basis. Arguably, if Reserve service is determined to be a form of part-time ADF employment, it would be appropriate to provide full-time ADF conditions of service on a fair pro-rata basis, including superannuation. However, if Reserve service is determined to be uniquely different to full-time ADF service, it may well be appropriate to apply unique conditions of service. The Review Team did not receive sufficient input to form an opinion on this issue and believes that it is a matter for Defence to determine. Once the nature of modern Reserve service is determined, the appropriate remuneration and conditions of service package can be determined.
The second issue is the connection between superannuation, taxation and the current tax-free remuneration arrangement. It was put to the Review Team on a number of occasions that there is no connection between the tax-free status of Reserve remuneration and superannuation. The Review Team believes otherwise. Superannuation is an element of the remuneration package paid by the employer which is taxed at a lower rate than other income because of restricted access to that income by employees. In the case of Reservists, however, their pay is exempt from taxation, so that were superannuation included in the remuneration package it would be taxed at a higher rate than the other income. The Superannuation Guarantee (Administration) Act 1992 (section 29) recognises the connection between superannuation and the tax-free status of Reservists' pay by stating that income exempt from income tax is not taken into account in determining whether the ADF meets its obligation to pay a minimum of 9% of salary for its employees.
The situation is stark in a practical sense. If Reserves were provided with an increase in remuneration of, say, 9% through a salary increase, they would get the full 9% available to use now or to put into superannuation as a non-concessional contribution (with a $150,000 annual limit) without any taxes. If the additional 9% remuneration were paid as an employer contribution, it would be reduced by the 15% contribution tax, preserved and further taxed if accessed before age 60. It would also impact on the Reservists concessional contribution threshold of $50,000 per annum and, in some cases, their status as ‘self-employed’ for superannuation deductions against other income.
Overall, the solution to the vexed problem of superannuation for the Reserves is to firstly determine the nature of modern Reserve service or its components, determine the total remuneration that should be paid for each component and then determine the applicability of and level of superannuation that should form part of the package.
Flexibility for future adjustments
When the DFRDB was introduced in 1972 and the MSBS in 1991, both schemes were significant improvements over their predecessors and reflected prevailing superannuation policies. As explained elsewhere in this report, the defined benefit nature of the schemes no longer reflects best practice either for members or for Defence and the Government. The nature of the schemes has also constrained incremental adjustments over time to meet the changing superannuation environment. For example, the DFRDB could not easily be adjusted to the superannuation taxation arrangements introduced in 1983 or the introduction of the Superannuation Guarantee legislation. The MSBS could not be adjusted for recent contemporary superannuation initiatives such as choice of fund and the beneficial ‘Better Super’ benefits introduced from 1 July 2007. Where changes were made, such as incorporating the 3% Productivity Benefit into the DFRDB, the result was a complex and poorly understood arrangement that invited administrative errors.
Experience has shown that there will be continuing changes to superannuation legislation and practice with the likely emphasis on more options and flexibility. The proposed scheme should allow the benefits of such changes to flow to the ADF without increasing complexity. Some examples of future changes that could be easily adopted are:
- allowing more flexibility within the remuneration package including, for example, an option to take the additional employer contribution levels above 16% as salary;
- introducing additional benefit options such as the recent Government provision to allow for transition to retirement income streams; and
- adjusting employer contribution rates or changing the contribution step points either universally or for specific employment groups to aid recruitment and retention.
In addition, the new scheme will now have a defined contribution framework that will be similar to most Australian superannuation schemes. This will mean that it will be much easier to respond to future legislative changes.