Is high Australian household wealth a source of support for consumers?
- Australia ranked as having one of the lowest rates of disposable income growth per capita amongst OECD countries in mid 2023.
- An increasing income tax burden and mortgage repayments have weighed on income growth, despite solid wages and salaries.
- But, household balance sheets in Australia look stronger compared to incomes. Household wealth increased in 2023, as home prices rose.
- However, growth in household wealth will decline in 2024 as home prices are expected to fall. Household incomes will also be under pressure as earnings growth slows from a softening labour market.
- As a result, high household wealth holdings will not be enough to offset a challenging environment for households in 2024, despite some easing in cost of living challenges.
Household income data from the OECD showed that Australia had one of the lowest rates of annual real household disposable income per person compared to its OECD peers (see the chart below).
Over the year to June 2023, Australia’s real per capita household disposable income was down by 5.1%, compared to a 2.6% rise across OECD countries.
Source: AMP, Macrobond
This occurred despite very healthy labour market conditions in Australia which saw employment growth running above 3.0% per annum all year, the unemployment rate remaining below 3.9% and underemployment continuing to be low, all of which boosted wages growth. Despite this positive earnings backdrop, the income tax burden increased in 2023 as households have been moving into higher income tax brackets (otherwise known as “bracket creep”), as well as the end of income tax concessions.
Mortgage interest repayments are also an increasing drag on incomes (see the chart below) as the cash rate has been increased by 425 basis points since May 2022. Australia’s very high population growth in 2023 (running at 2.4% over the year to June 2023) also masked a fall in household disposable income growth per person, relative to other OECD countries.
Source: ABS, AMP
Just looking at household income accounts does not show everything about the position of households. In a country like Australia where home ownership rates are high (66% of Australian households own their home, with or without a mortgage), looking at household wealth is also important.
Household wealth in Australia
The Australian Bureau of Statistics estimates the value of a household’s assets, liabilities and therefore wealth. Net worth or wealth is calculated as a household’s total assets minus its liabilities. Total wealth is close to 11 times the size of household disposable income (or 1083%) and net wealth is 896% of income.
The latest data for the year to June 2023 showed a slight fall in wealth as a share of income, after it reached a record high in 2022 – see the chart below. Non financial wealth is worth 647% of income, larger than financial wealth at 436% and well surpassing household debt, which is 187% of income.
Source: RBA, AMP
Around 70% of Australian household wealth is tied to the value of homes (which is made up of land and dwellings) and moves closely in line with home prices (see the chart below). Household wealth rose throughout 2023, in line with solid growth in home prices.
Source: ABS, AMP
Other components of household wealth are shown in the chart below. Assets include superannuation, shares and currency and deposits. Loans which are mostly for housing are the source of household liabilities.
Source: ABS, AMP
How does household wealth compare around the world?
Australian household wealth, as a share of household disposable income, is at the top end of its OECD peers (see the chart below).
Source: OECD, AMP
High holdings of wealth could be considered a source of support for households, especially against record levels of household debt in Australia. This is a concept known as the “wealth effect”. When household wealth increases, households feel more secure with their financial position and household savings tend to decrease which lifts consumer spending. When wealth decreases, households feel less secure which leads to an increase in savings and decline in spending. However, this relationship does not always work.
Most recently in the pandemic, household wealth rose in 2021/22 alongside the lift in home prices but the savings ratio also surged thanks to government driven stimulus cheques. Since then, the household savings ratio has been falling but growth in total consumer spending has been low. We expect that the household savings rate will continue to fall in 2024 as it normalises after the pandemic but growth in consumer spending will still be low.
Implications for investors
Households dealt with a cost of living challenge in 2023 because of high inflation and rising interest rates. Inflation is expected to slow in 2024 and we expect the RBA to start cutting interest rates by mid year which should ease the repayment burden for households with a mortgage, as mortgage interest repayments as a share of income are rising to a record high (see the chart below).
Source: ABS, AMP
So, while cost of living issues should improve for consumers, household wealth will come under pressure in 2024 as we expect home prices will decline by 3.0% to 5%. This is likely to occur alongside a slowing in household incomes as the labour market weakens and the unemployment rate increases. This environment is expected to be negative for consumer spending and GDP growth. We see GDP growth rising by 1.2% over the year to June 2024, below the RBA’s forecast of 1.8% and anticipate the unemployment rate to increase to 4.5% by mid year. This should see the RBA cutting interest rates by June and we expect a total of 3 rate cuts in 2024.
Wealth inequality between households is also an issue in Australia. The top 20% of households (by income quintile) owned 63% of total household wealth in 2019-20 but the bottom income quintile (the bottom 20%) owned less than 1.0% of all household wealth. In Australia, there is also increasing generational wealth gap, with wealth across older households increasing significantly over recent decades but this has not been the case for younger Australians. There are numerous government policies that could address these issues of wealth inequality, including improving the housing affordability issue (through lifting housing supply and/or looking at the favourable treatment of housing investment) and doing a tax review (looking at broadening the GST and examining the merits of a wealth or death tax), which could help the wealth inequality issue.
Many people continue, or even start, working once they’ve reached Age Pension age. This may be for social reasons, personal fulfilment or to maintain their standard of living. With the higher cost of living at the moment, even more pensioners are taking up work.
But what does this mean if you’re receiving the Age Pension? The government’s Work Bonus means you can earn a little more without it affecting your pension. The permanent increase to the Work Bonus means you may be able to continue this longer if you choose.
Consider this example, of Margaret, to show what this could mean for you.
Margaret has just reached her Age Pension age of 67 and owns a home with her husband (who has also just reached Age Pension age) and they have $440,000 in joint financial assets including super.
Like many others, Margaret was looking to do more in her retirement years. She missed the company of colleagues and doing something purposeful.
Through a friend, Margaret was offered an opportunity for some paid work for a charity that she was passionate about.
Margaret asked her friend about her work opportunity. Her well-meaning friend mentioned that even a small increase in Margaret’s income would reduce her Age Pension. Regretfully, Margaret turned down the opportunity as she hated losing some Age Pension. However, Margaret didn’t understand the full situation.
What is the Work Bonus?
The Work Bonus is a scheme offered by the government that increases what a person of Age Pension age can earn from work before it affects their pension amount. It’s essentially an offset for assessable employment income in the Age Pension income test. Assessable income is the amount of income you earn that is assessed under the income test which helps determine how much Age Pension you receive.
In simple terms, it means eligible pensioners can keep more of their Age Pension while working.
The government provides the Work Bonus as an incentive to keep pensioners, and their valuable skills, in the workforce.
How much is the Work Bonus for pensioners?
The Work Bonus is $300 per fortnight for eligible pensioners. This means the first $300 earned in a fortnight won’t affect how much Age Pension you receive.
If you earn less than $300 in a particular fortnight, the unused bonus amount is accrued as a Work Bonus balance that you can apply to future income. This means, when you earn over $300 in a fortnight, the Work Bonus offsets the first $300 of your earnings and then any Work Bonus balance you have can be used to reduce your remaining employment income. So, your income will have less of an effect on your pension amount.
If the Work Bonus applied to you before, then you may be aware the limit that could accrue in a person’s Work Bonus balance was previously $7,800.
Margaret was offered work that would pay $800 per fortnight (or $20,800 per year). Margaret went to see a financial adviser. After considering her full financial situation, her adviser determined that her and her husband’s combined Age Pension under the previous Work Bonus rules would have reduced by almost $5,768 per year. On the one hand, Margaret was pleasantly surprised she could still receive some Age Pension while working – but it cost her more than a quarter of her new income. She was eager to understand what the new rules mean for her pension.
What are the changes to the Work Bonus?
Prior to 1 December 2022, a new Age Pension applicant started with a Work Bonus balance of zero. Any unused Work Bonus each fortnight would accrue in their Work Bonus balance up to a maximum of $7,800.
From 1 December 2022, pensioners received a one off $4,000 boost to their Work Bonus balance, while the maximum balance that could be accrued increased to $11,800. These temporary changes were due to cease on 31 December 2023, and amounts in a pensioner’s Work Bonus balance over $7,800 would be forfeited.
However, this temporary increase will be permanent from 1 January 2024. This means those already on a pension will keep their Work Bonus balance which is subject to a maximum of $11,800. New pensions will have a starting Work Bonus balance of $4,000. So, you don’t have to build up a balance but have an amount you can start using straight away.
Margaret’s adviser explained how the new Work Bonus balance boost of $4,000 meant she could earn $800 per fortnight from working and her Age Pension would not be reduced until her Work Bonus balance is used which would take around eight fortnights. Margaret and her husband receive an extra $1,774 in Age Pension during this time due to the $4,000 boost. Margaret also learned that she could encourage her husband to get out there too as he could also earn up to $800 per fortnight for eight fortnights without their Age Pension being reduced during that time.
Margaret and her husband are now doing a mix of paid and unpaid work for the charity. They are loving being able to give back and afford a few more luxuries – not to mention a new social network.
They may need to reassess when their Work Bonus balances are used up, as any employment income from that point over $300 per fortnight each is likely to start affecting how much Age Pension they receive.
Does the Work Bonus balance reset each year?
The Work Bonus balance doesn’t reset. It carries forward without a time limit. However, you can’t grow your balance over the $11,800 cap.
Who is eligible for the Work Bonus?
To receive the Work Bonus you need to be:
- of Age Pension age or over, and
- receiving the Age Pension, Carer Payment, Disability Support Pension, or an eligible payment from the Department of Veterans’ Affairs.
The Work Bonus applies to reduce income earned from employment, as well as self employment income from doing gainful work (which is work that requires some effort).
Importantly, the Work Bonus applies automatically if you’re eligible. So, you don’t have to do anything to benefit from it.
Keep up to date on what you might be entitled to. Rules change often and you may find that you can receive additional benefits. You can check out your Age Pension eligibility using free Age Pension eligibility tools or you can speak to your financial adviser.
Source: Colonial First State
It’s a dilemma many of us face – are we better off directing extra money to our mortgage or super? As with most financial decisions, it’s not a one size fits all approach and here are some factors to consider in deciding what’s right for you.
- There may be tax advantages when you contribute to super, especially if you salary sacrifice or you’re eligible to claim a tax deduction for personal super contributions.
- The power of compounding returns could mean that even small contributions to your super over many years could make the world of difference.
- By making extra mortgage repayments, coupled with any potential increase in the value of your property, you will build equity in your property at a faster rate than if you were to make just the minimum repayments.
Building the case for super over mortgage
You might think your super is already being taken care of – after all, that’s what your employer’s compulsory Superannuation Guarantee contributions are all about. But these contributions alone often aren’t enough to ensure you achieve the retirement lifestyle you want to live.
Making extra contributions to your super is a great way to boost your retirement savings. As an investment vehicle, super is a very tax effective way to save for the future.
The power of compounding returns
Super is a long term investment, at least until you retire, and potentially much longer if you leave your money in super and draw a pension after you retire.
This long investment term, coupled with the rate of tax on your super investment (generally 15%), means your money can add up and generate further investment returns on those returns. This is known as compound returns, or compounding.
The expenses of daily life can be considerable. Thinking about directing money to super might not seem like a priority when we feel overwhelmed by the effort to save a deposit for a home, paying down debt, and the costs of raising a family.
However, the benefit of compounding returns means that even small, frequent contributions can make a big difference down the track. It’s about striking a balance that is right for you today and remember, nothing has to be forever. As your life changes, you can simply adjust your contributions strategy to suit your needs.
Building super early
To maximise your retirement savings while allowing compounding returns to do the heavy lifting, the best approach is to start early. The longer compounding continues, the bigger your savings could be. Entering retirement debt free is an attractive prospect. It can be easy to think that you need to repay your debt before you can start thinking about saving for retirement. However, it doesn’t have to be one or the other.
You can see the difference small, regular contributions could make to your final retirement income using the MoneySmart retirement planner calculator.
Tax benefits of super
From a tax point of view, super can be incredibly beneficial. Salary sacrificing some of your before-tax salary or making a voluntary after-tax contribution for which you can claim a tax deduction, can be effective ways to not only grow your retirement savings but also reduce your taxable income.
One great benefit of investing in super is that concessional (before tax) contributions are taxed at a maximum rate of 15%. This can be higher though if you earn over $250,000.
Mortgage repayments are usually made from your take home pay after you’ve paid tax at your marginal tax rate. Your marginal tax rate could be as high as 47%. So, depending on your circumstances, making a voluntary deductible contribution to super or salary sacrificing may result in an overall tax saving of up to 32%.
There is a limit on the amount you can contribute into super every year. These are referred to as contribution caps. Currently, the annual concessional contributions cap is $27,500. If you’re eligible to use the catch-up concessional contributions rules, you may be able to carry forward any unused concessional contributions for up to 5 years. If you exceed these caps, you may be liable to pay more tax.
Tax on super investment earnings
The initial tax savings are only part of the story. The tax on earnings within the super environment are also low.
The earnings generated by your super investments are taxed at a maximum rate of 15%, and eligible capital gains may be taxed as low as 10%. Once you retire and commence an income stream with your super savings, the investment earnings are exempt from tax, including capital gains.
Also, when it comes time to access your super in retirement, if you’re aged 60 or over, amounts that you access as a lump sum are generally tax free.
However, it’s important to remember that once contributions are made to your super, they become ‘preserved’. Generally, this means you can’t access these funds as a lump sum until you retire and reach your preservation age, between 55 and 60 depending on when you were born.
Before you start adding extra into your super, it’s a good idea to think about your broader financial goals and how much you can afford to put away because with limited exceptions, you generally won’t be able to access the money in super until you retire.
In contrast, many mortgages can be set up to allow you to redraw the extra payments you’ve made or access the amounts from an offset account.
Building the case for reducing your mortgage over super
For many people, paying off debt is the priority. Paying extra off your home loan now will reduce your monthly interest and help you pay off your loan sooner. If your home loan has a redraw or offset facility, you can still access the money if things get tight later.
Depending on your home loan’s size and term, interest paid over the term of the loan can be considerable – for example, interest on a $500,000 loan over a 25-year term, at a rate of 6% works out to be over $460,000. Paying off your mortgage early also frees up that future money for other uses.
Before you start making additional payments to your mortgage, it’s suggested that you should first consider what other non-deductible debt you may have, such as credit cards and personal loans. Generally, these products have higher interest rates attached to them so there is greater benefit in reducing this debt rather than your low interest rate mortgage.
Conclusion: mortgage or super
It’s one of those debates that rarely seems to have a clear-cut winner – should I pay off the mortgage or contribute extra to my super?
The answer, probably somewhat annoyingly, is that it depends on your personal circumstances.
There is no one size fits all solution when it comes to the best way to prepare for retirement. On the one hand, contributing more to your super may increase your final retirement income. On the other, making extra mortgage repayments can help you clear your debt sooner, increase your equity position and put you on the path to financial freedom.
When weighing up the pros and cons of each option, there are a few key points to keep in mind.
One of the key questions to consider is what is the likely balance you’ll need in your super? Work backwards starting with working through what retirement looks like for you, the type of lifestyle you’d like, and how much you need to live on each year.
From there, you can start to consider your sources of income in retirement. This is likely to include super but could also include a full or part Age Pension, or income from an investment property or other sources.
You can then start thinking about your current balance, contributions strategies and whether you’re on track to have enough saved to supplement your other retirement income sources.
The MoneySmart retirement planner calculator can help you to estimate how much super you may have in retirement and how long your super may last. You also need to think about how you plan to spend your money in retirement.
In most cases, there isn’t one set strategy that you should follow and it can quickly change as you grow older, start a family and reach retirement age. You should also consider whether you’ll need to access any additional funds you put aside before you reach retirement. If it’s in your super, it’s locked away. If it’s in your mortgage, there are generally options to redraw.
Home ownership and comfortable retirement are financial goals that many strive towards. If you reach a point where there’s some surplus cash flow to consider where to put your extra money, it’s a good dilemma to have.
Life is complex, so it pays to speak with a financial adviser before you make any big financial decisions when it comes to your super or mortgage.