Super reform measures

Strategies

David Barrett
Wednesday 30 March 2016

There are several reforms to the existing superannuation system currently being debated in various forums around the industry. Although it is unlikely that all of the debated reforms will make the ultimate transition into law, nonetheless it is worthwhile for financial services professionals to be aware of the proposals and the issues that surround them. This article provides explanation and commentary on a number of the mooted reforms.

The Government’s focus on superannuation is multi-faceted. Firstly, its need to increase revenue and reduce expenditure is driving review of a number of areas, including the superannuation system, which now comprises more than two trillion dollars of Australian individuals’ savings. Secondly, expenditure on the ageing population through the age pension and health care costs is still a major concern for the Government, especially when projecting demographics and costings forward into the late 2020s and 2030s.

Thirdly, the integrity of the superannuation system may be improved by better targeting public expenditure on superannuation tax concessions. Directing tax concessions towards encouraging low and middle income earnings to accumulate superannuation assets, and away from high income earners, is a driver of some of the proposed reforms.

1. Progressive taxation of concessional super contributions

Progressive taxation of concessional superannuation contributions, rather than the current flat rate taxation at 15 per cent, first gained widespread exposure with the release of Australia’s future tax system, Report to the Treasurer (the ‘Henry Tax Review’) in May 2010.

The Henry Tax Review’s recommendation involved including concessional contributions (CCs) as personal income subject to tax at marginal tax rates, with a rebate applying to ensure that the majority of taxpayers do not pay more than 15 per cent tax on their CCs. Table 1 below illustrates the impact of varying the rebate level on the effective level of CC tax for different marginal tax rates.

Table 1: Progressive taxation of concessional superannuation contributions

Taxable incomeMarginal tax rate on personal incomeEffective CC tax rate (assuming Medicare levy does not apply)
15% rebate17.5% rebate20% rebate
     
Up to $18,200 Nil - - -
$18,201-$37,000 19% 4% 1.5% -
$37,001 - $80,000 32.5% 17.5% 15% 12.5%
$80,001-$180,000 37% 22% 19.5% 17%
$180,001+ 47% 32% 29.5% 27%

The Henry Tax Review recommendation indicated that the superannuation contribution would be received by the relevant superannuation fund pre-tax, and the individual would be responsible for the payment of tax. This would result in reduced take home wages, but an effective increase in net superannuation contributions. For a more in-depth analysis of the Henry Tax Review recommendation refer to the MAStech article The graduation of super contributions tax.

The reduction in take home wages has led to Government consideration of alternative mechanisms for collecting the progressive tax, including directly from the superannuation contributor (typically the employer) and the superannuation fund.

To a limited extent CCs are already subject to progressive taxation. The low income superannuation contribution (LISC) reduces the effective tax rate on SG contributions to zero for those with adjusted taxable income of up to $37,000. This is achieved by a Government contribution of up to $500 directly to the taxpayer’s superannuation fund. At the other end of the income spectrum, those with income in excess of $300,000 pay an extra 15 per cent tax on their concessional contributions. Commonly referred to as Div 293 tax, this additional tax is collected by the ATO from either the taxpayer or the taxpayer’s superannuation fund, at the taxpayer’s discretion.

The tax collection/payment features of the LISC and Div 293 mechanisms are possibly a basis for broader application to progressive taxation proposal. For example, a flat ‘withholding tax’ type deduction may be made by employers as they pay contributions to the employee’s respective superannuation funds. Later, a further deduction (similar to Div 293 tax) or credit (similar to the LISC) would be made directly from or to the superannuation fund by the Australian Taxation Office (ATO) after the taxpayer’s personal income tax return has been finalised.

Whichever mechanism is used, it is likely that a progressive tax system will cause significant additional administration for the ATO and/or the receiving superannuation funds. But the measure would address the equity issue of the current 15 per cent flat rate system, where high marginal tax rate payers receive greater tax benefits than those subject to lower marginal tax rates. The revenue impact for the Government will be dependent on the level of rebate chosen.

2. Lower contributions caps and the SG rate

Lowering the annual concessional contributions cap will have a positive impact on Government revenue. Currently the CC cap is $30,000, or $35,000 for those age 49 years and over on 30 June 2015.

We have seen the CC cap reduce significantly since July 2007 when it was $100,000 for the over 50s. One ultimate outcome may be a convergence of the CC cap with the maximum SG contribution amount. The maximum SG amount will be based on $51,620 per quarter, (or $206,480 per annum) in 2016/17 – 9.5 per cent of the annual amount is $19,616, but that figure would rise to $24,778 if the SG rate is increased to 12 per cent, as currently legislated.

Some discussion of lowering the CC cap to $25,000 has occurred, with a more drastic reduction to $11,000 being suggested by one industry commentator, the Grattan Institute.

Readers may recall that the Henry Tax Review recommended a permanent CC cap of $50,000 for those over age 50, a measure which was not accepted by the Government in its response document.

The Henry Tax Review also recommended maintaining the SG rate at nine per cent, albeit levied on pre-tax income and therefore an effective contribution rate that is higher than under current tax settings. The Henry Tax Review also recommended lowering the earnings tax rate to 7.5 per cent, from the current 15 per cent, to ensure a higher rate of compounding growth over time.

Nonetheless the Government legislated a progressive increase in the SG rate to 12 per cent by 1 July 2019, but scaled back the progression such that 12 per cent will not be reached until 1 July 2025.

Current discussion surrounds potential removal of future increases in the current SG rate of 9.5 per cent. The measure will not have a positive impact on Government revenue until 2021/22, when the SG rate is scheduled to increase to 10 per cent.

Another possible lever for the Government to raise revenue is reduction of the non-concessional contributions (NCC) cap. The current annual NCC cap of $180,000 means that up to $540,000 of after tax funds can be contributed to superannuation if the two year bring forward threshold is triggered.

Reducing the NCC cap may also help improve the integrity perception, as it is generally wealthy individuals who fully utilise the NCC cap. But reducing the NCC cap is unlikely to have as much revenue impact for the Government as a reduction in the CC cap, especially in the short term.

3. Superannuation ‘opt out’

During February 2016 a number of press articles emerged suggesting that those who earn less than $37,000 could be allowed to opt out of the compulsory superannuation system – that is, opting out of their employer making superannuation guarantee (SG) payments, and instead receiving those funds as increased wages.

The proposal would result in an immediate net take-home pay increase, which understandably may be popular for low income earners, but will cause a reduction in retirement benefits in later life.

The justification for the proposal is the minimal immediate taxation benefit of SG contributions applicable to those earning less than $37,000 receive. That is, SG contributions are taxed at 15% whereas personal income is taxed at marginal tax rates, which are low (nil and 19 per cent) below $37,000 of taxable income. If implemented, the proposal would impact on the level of population coverage of the Australian superannuation system.

Closer scrutiny of ‘effective marginal tax rates’ reveals an accurate picture of the tax implications of SG contributions. We define ‘effective marginal tax rate’ (EMTR) as the amount of taxes and levies paid on a hypothetical additional dollar of earnings at a specific level of taxable income. The example in Table 2 may help to understand the concept.

Table 2: Impact of earning an extra $1.00

Base caseAdd $1 of incomeDifference
    
Taxable income 33,000.00 33,001.00 1.00
Income tax 2,812.00 2,812.19 0.19
Low income tax offset 445.00 445.00 -
Medicare 660.00 660.02 0.02
Net income 29,973.00 29,973.79 0.79
Effective marginal tax rate on $1.00 extra of income 21.0%

So the EMTR at $33,000 of taxable income is 21 per cent, comprised of 19 per cent income tax and two per cent Medicare. If the extra one dollar was paid into superannuation as a concessional contribution (ie an employer SG payment), the tax rate would be 15 percent, six per cent less than the individual’s EMTR.

We have calculated the EMTR for taxable incomes from zero to $250,000, which are represented in Chart 1 below.

Chart 1: Effective marginal tax rates

Chart 1 illustrates that below $20,542 of taxable income, re-directing one dollar of extra income to superannuation as a concessional contribution taxed at 15 per cent creates a greater tax liability than receiving that one dollar of income personally. Above this figure, the tax benefit ranges from 14 per cent ($20,897 to $26,120) to six per cent ($26,120 to $37,000).

The value (or cost) of the two options is dependent on the size of the SG payment, which we assume is 9.5 per cent of taxable income in Chart 2 below. Chart 2 shows the actual dollar cost or saving based on the level of taxable income. It demonstrates that there is a positive tax benefit from SG contributions for those with taxable incomes of approximately $20,000 or more. Note that the calculations do not include the impact of the low income super contribution (LISC) which will be removed effective from 1 July 2017.

In general those with taxable income of less than $37,000 receive a relatively low tax benefit from SG contributions, compared to those taxed at the higher marginal tax rates that apply beyond $37,000. However, the administration issues that opt out may present are not insignificant, especially if employers are required to administer the impact of the opt out. And, as mentioned, the proposal would appear to reduce superannuation coverage, potentially disadvantaging those who would benefit most from the SG system at retirement.

Chart 2: Tax benefit of 9.5% SG contribution compared to receiving equivalent personal income

4. Accessing superannuation

Deferring access to superannuation funds will help reduce public expenditure in the future. Two measures in particular have been discussed in the media that limit access to superannuation funds.

Firstly, increasing the superannuation preservation age to age 65 will limit early draw down of superannuation funds, and provide more time for funds to accumulate. The Henry Tax Review recommended aligning the preservation age with the age pension age, a measure ruled out by the Government back in 2010.

The current preservation age is age 56, and is legislated to increase progressively until it ultimately reaches age 60 for those born on or after 1 July 1964. Raising the preservation age to age 65 is likely to be a further progression over time, perhaps ultimately reaching age 65 for those born on or after 1 July 1969.

The age pension age is already scheduled to increase to age 67. Those born on or after 1 July 1952 but prior to 1 January 1954 cannot access the age pension until age 65½. The qualifying age will increase progressively until it reaches age 67 from 1 January 2024. So the preservation age and age pension age will remain unaligned even if the preservation age is raised to age 65.

The second measure discussed has been the removal or limitation of the transition to retirement (TTR) condition of release. The difficulty with the removal of TTRs is there are members who have a genuine need to access funds prior to age 60 or 65. Introducing a more involved health or activity assessment criteria for early access to superannuation funds will place a burden and cost on superannuation funds.

5. Lifetime superannuation balance cap

This idea is straightforward: set a benchmark above which superannuation balances do not attract concessional tax treatment. The measure addresses the concerns that the wealthy may use superannuation as a tax planning vehicle to shelter returns on assets from tax.

The practical implications however are less than straightforward. Should this type of restriction be a fund-by-fund limit, which is relatively easy to administer? The weakness of that proposal is the more informed members, and those who receive financial advice, will be likely to restructure their superannuation assets to avoid breaching the threshold, either by using more than one fund, or by making withdrawals and re-contributing.

A threshold that accurately reflects the amount a couple needs to save for a comfortable retirement over 20-30 years would be reasonably large, with some stakeholders proposing $2.5 million. A threshold of this magnitude would be inconsistent with the policy objective of preventing excessive saving through superannuation, however a lower threshold would potentially undermine the capacity for Australians to self-fund their own retirements.

Alternatively a central reporting and monitoring system could be developed, akin to the former reasonable benefits limit (RBL) system. Those who recall the pre-July 2007 RBL system, including the ATO, will be reluctant to return there.

So it’s unclear how this measure could be introduced in a manner that addresses both fairness and cost efficiency issues.

6. Other measures

Other superannuation system amendments have been discussed, which may have a positive impact on the Government’s revenue position. These include the removal of:

  • anti-detriment payment tax benefits associated with lump sum death benefit payments to dependants (including adult children)
  • spouse contribution tax offsets
  • pre-1 July 1988 funding credits (impacts State Government unfunded superannuation schemes).

Revenue gains for the Government from removal of these benefit is considered to be modest.

Summary

The Government has consulted with various industry groups on many of the above-mentioned issues, and received feedback. The forthcoming Federal Budget, now scheduled for Tuesday 3 May 2016, may present an opportunity for the Government to announce some measures, if any, that it considers appropriate after the consultation and further consideration.

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