Thursday, 29 August 2013

Who would pay 7% real interest rates?

Superannuation policy is a political mess in NZ and many would agree that something needs to be done. In steps Peter Dunne with a something: choose your own retirement age.

Economists often argue that more choice is better than less. Discarding unwanted options is costless, so what could be wrong with having more of them? Well, choosing does take effort which is a cost that some prefer to avoid. Also, foregoing good options could make you less happy.

But rather than quibble, lets check out Mr Dunne's idea. Basically he'd require you to choose between a smaller annual superannuation payment starting earlier, or nothing for a few years and then a larger annual sum. Here is the example he presents...
“...on current superannuation levels, a couple who get $522 a week today when they turn 65 could choose to wait to 70 and get $840 a week. Equally if they instead chose to wait just two years and get super at 67, they would get $630 a week.
Here's how it works out. If you expect to live to age 85, taking the money early is effectively borrowing at around 7%. Superannuation is inflation indexed, so that's a real borrowing rate. Add another 2% or so for inflation and compare the result with mortgage rates of around 5%.

Conclusion 1: picking the early option would only make sense if you are cash constrained (i.e. poor) or don't expect to live to 85.

Conclusion 2: this would effectively raise the superannuation age while arguably sticking to the letter of one's election promise.

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