Reforms to the Aged Care Act last year looked to put aged care funding on a more sustainable footing by increasing the contribution made by people receiving care, at least those who have the means to pay. While this will slow growth in the cost of aged care to the taxpayer, funding aged care remains a rising burden on younger Australians.  

Instead, a system of compulsory aged care insurance for people once they reach pension age should be considered. This would shift the cost of aged care away from workers to the retired cohort. An insurance approach would also share the burden of funding aged care more broadly, away from just those unlucky enough to need care to the entire cohort who have a higher probability of needing aged care. 

The cost of aged care is rising – a burden falling on taxpayers 

Increasing longevity, the post-war baby boom and slowing population growth mean that demand for aged care will continue to rise strongly for at least the next 20 years. Not only will the number needing aged care rise substantially (140 per cent growth in the over 85 cohort from 2021 to 2041), the share of the population of working age will fall while the share over 65 rises (from 16.8 to 20.8 per cent in the same period). 

The costs of the current aged care system, like the health care system, are funded by a mix of user pays (out of pocket costs) and tax revenue. In 2022-23, the government funded 70.8 per cent of health expenditure and around 75 per cent of aged care expenditure. Recent reforms, coming into effect from 1 November 2025, will seek higher contributions for non-clinical care (e.g., showers and food preparation) from home care package recipients on a means tested basis. New rules for residential care recipients are also incoming. 

Numerous concerns have been raised about increasing the out of pocket costs. These include the financial burden on lower income households and pushing people into residential aged care or hospitals given that non-clinical care can be preventative. The savings are also modest. The changes to residential aged care funding are expected to reduce the share that government pays for aged care only from 76 to 73 per cent and at home care from 95 to 89 per cent.  

Most proposals for putting aged care onto a more sustainable footing involve increasing tax revenue. The Medicare levy is 2 per cent for most taxpayers, with a surcharge for higher income earners if they do not have private hospital insurance. However, the levy only covers around 17 per cent of the Australian Government’s funding for healthcare.  

An aged care levy would simply raise income taxes, meaning its burden would fall mostly on workers. This type of pay-as-you-go funding system works when there is a rising share of workers to dependents. However, Australia’s demography means that the share of working age population has peaked and will fall over the next 40 years. Relatively fewer workers will bear the rising costs of aged care (and health care as these costs also rise with age).  

A superannuation levy can shift the burden to older cohorts – but there are downsides

One proposed solution is to fund the aged care system with a levy on superannuation that would rise with age cohorts, with the main funding coming from the 40-65- and 65–80-year-old cohorts. There are three concerns with this approach. First, it is a wealth tax applied at an age when people are seeking to boost savings for their retirement. This could reduce the incentives to save using the superannuation system beyond compulsory contributions. Second, a substantial portion of most retirees’ wealth is held outside the superannuation system in their family homes, and so would not be included in the levy. And third, a levy on superannuation balances after a certain age would make it harder to reform the income tax system to treat all income – whether from investment or wages – the same.

One argued advantage of a super levy is that it would fall more on men than women, with the latter tending on average to have lower superannuation balances. However, it is total wealth rather than wealth in superannuation that determines capacity to pay.  

Could a compulsory insurance approach work?

The current aged care system is a lottery: not all people will need aged care, but some will need a lot. No one wants to need aged care, but we all want care to be available if we need it.  

The proposed superannuation levy described above takes the social insurance approach. Australia’s age pension, Medicare, National Disability Insurance and JobSeeker systems are all social insurance systems.  

Social insurance systems can be designed with taxes or levies that are directed to funding a set of services (a hypothecated tax), meaning they rise or fall as the cost of the service provision rises or falls. However, this is rarely the case. Rather, governments tend to set out the conditions for entitlements and then seek to control the cost of meeting the demand under this set of entitlements, including by introducing co-payments or reducing what is provided.  

An alternative to a social insurance system funded by taxes is a compulsory insurance system funded by premiums. Under such a system, government would:  

• Provide a basic insurance cover.  
• Set and police minimum standards for this basic cover. 
• Charge a premium for all people over retirement age on the basis of expected average cost of aged care at that age.  
• Provide subsidies for people who lack the means to pay the premium.  
• Manage the cash-flow problem for people who are asset rich but cash poor, through a reverse mortgage type system.  

People could be free to purchase private insurance, but if they switch to the public insurance system their premiums would be back dated and charged accordingly.  

There are several advantages to this approach. Principally, the risk of needing aged care would be pooled across the whole retirement cohort, rather than the cost falling on those who need care. The cost of aged care would also be shifted from the working age cohort to the retired cohort, who currently are lightly taxed and own a rising share of wealth.  

Moreover, all retired people would have an interest in ensuring that the insurance coverage balances cost with benefits, reducing the lobbying efforts that seek greater benefits while shifting the cost back onto taxpayers. They would also have an incentive to get value for money from the system as savings would be passed on to lower premiums. 

As with the current system, there could be a maximum payment over a person’s lifetime set, or a maximum payment could be capped as a share of a person’s estate value. To avoid partners or dependent children being required to sell the family home, the estate could be transferred to a family member with a lien to be paid on the sale of the property.  

Many details will need to be worked out, but an insurance approach can improve intergenerational equity while also providing a more secure and predictable funding approach to aged care. 

Dr Jenny Gordon is an Honorary Professor at POLIS: the Centre for Social Policy Research at the Australian National University and a non-resident fellow at the Lowy Institute. She was the Chief Economist at DFAT from 2019 to 2021, was previously Chief Economist at Nous Group, and spent 10 years as Principal Adviser (Research) at the Productivity Commission. She has a PhD in Economics from Harvard University. 

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