Earlier Chapters have already highlighted the burgeoning costs and major inequities in our superannuation system that will continue to increase personal income burdens and squeeze the living standards of renters and heavily geared home buyers. Particularly concerning are the recent budget changes to negative gearing and capital gains tax which will further increase superannuation’s attraction as a tax shelter.
With no upper limit on super account balances and a 15% tax rate applying till balances reach $3 million and only 30% up to $10 million, the tax benefits on offer are stupendous compared with normal income tax rates. Successive governments have provided a huge bonus by removing all maximum benefit limits and withdrawal taxes after age 60. Even with estates, the maximum withdrawal tax rate is 17%.
Without mechanisms to ensure age pension savings by requiring withdrawals as retirement income streams, revenue costs are rising and for many better off investors superannuation is now a highly tax effective wealth creation machine. Unfortunately for more people the compulsory super system is reducing their cash flow and reducing their living standards.
Chapter 18 presented options to reduce the financial burden of compulsory super on lower income wage earners and other taxpayers including renters and struggling home purchasers. By offering these options, the government would keep the basic integrity of the 12% compulsory super system allowing selected categories of taxpayers to boost their current after-tax wage income by 8.2% in most cases.
Instead of forcing people to put away money untouchable to 60, allowing access to the money now would both improve their housing options and current living standards. A lucky few earning less than $45,000 a year would pay less tax than if the wage income goes into more superannuation. For the others, the immediate income tax burden would be 17% or even higher, but especially for those paying off personal or housing debt the longer-term benefits would still be large.
Apart from these suggested changes to reduce the adverse impact of compulsory super on living standards, other more fundamental structural changes would improve both the equity and affordability of the superannuation tax concessions. For far too long, successive governments enraptured with their own and their senior advisers privileged superannuation system have ignored the growing budgetary costs of the tax concessions.
Double dipping, having both employer and separate private super accounts have resulted in extremely generous legislation opening with the help of the imputation credit system a massive retirement tax shelter. There currently is no upper limit on the maximum size of the unfunded lifetime indexed pensions payable to former politicians and bureaucrats or on their access to further compulsory and private super benefits in retirement.
Amongst other things, this helps explain why in the mid-2000s the legislation removed the earlier strict maximum benefits limits. Reintroducing these or similar limits is essential to both achieving equity and reducing the attractions of super as a tax shelter.
Unfortunately, once you break an egg, restoring it is a challenging task. The maximum benefit limits were effective in controlling or limiting new contributions to super (except for high income recipients of unfunded employer pensions). But they were not equally effective in limiting the tax advantages and cost to revenue of funds achieving remarkably high compound rates of return.
Consistently high compound rates of return (for example with several of our successful resource companies and more recently in key tech companies) can result in exceptionally large account balances. Over the years, extremely high returns in personal and small company super funds included situations such as $100,000 becoming $17 million over a 7-year period. Limiting the amount deposited into super does not lower the cost to revenue of the 10% capital gains tax rate applicable to such transactions.
After considering the alternatives, reintroducing maximum benefit limits would not be a workable solution given the difficulty of forcing people to withdraw assets from superannuation especially before age 60. A workable alternative would be legislation banning all new superannuation contributions (both deducted and undeducted) when the account balance exceeds the maximum indexed $2.1 million amount that retirees can convert into a tax-free pension.
This cap on new contributions would work by requiring employers to pay new compulsory super contributions as taxable wages and prevent new personal contributions. Special provisions would be needed for the declining but still considerable number of active defined benefit fund members with large benefits. These could focus on the tax concessions available when they draw their benefits.
Apart from limiting new contributions, changed taxation arrangements for account balances above the indexed $2.1 million cap would both improve equity and reduce the budgetary cost. Increasing the basic tax rate to 30% for all income including capital gains and removing the tax-free status of withdrawals may be sufficient to remove the current massive subsidy to large account balances.
The goal would be to provide a strong incentive for the voluntary withdrawal of large balances under existing tax-free arrangements. The proposed 30% tax rate on the income of large super accounts above $2.1 million would be consistent with the standard personal income tax rate and the new CGT and trust arrangements. Importantly also it would reduce the costs of imputation credits for large funds.
More importantly, given that the proposed 30% tax rate when balances exceed $2.1 million is still a concessional rate, levying an exit tax on withdrawals not taken as a pension warrants consideration. For all benefits more than the indexed $2.1 million cap, an exit tax applied using a non-refundable franking credit proposal would apply added tax to higher income earners and their beneficiaries.
For example, including the withdrawals in assessable income with an attached non-refundable franking credit at a 30% rate would reduce the benefits for higher income taxpayers of keeping large amounts in super after retirement. This proposal in effect applies a modified version of the company tax system to large account balances.
Compared with the current Division 296 tax on large account balances, this proposal is a much more effective mechanism to remove the benefits of keeping large amounts in super later in life. Even when the added 10% income tax rate applies to balances above $10 million, the applicable tax rate of 40% is still below the personal marginal tax rate of many large account holders. The attraction of keeping the assets in super comes from the current exemption from tax of super fund withdrawals after age 60.
Even for withdrawals after death, the maximum tax rate applicable is 17% for benefits paid to non-dependents. Applying the proposed changes to all account balances above the $2.1 million indexed cap would go a long way to removing the tax advantages currently available to a small number of taxpayers with large balances.
Two other issues call for serious attention. The first provides a massive unjustified benefit to retirees drawing tax-free or subsidised pensions. The tax-free status of the first $125,000 of annual funded pensions is already extremely generous compared to $18,200 tax-free threshold for all other taxpayers. Yet incredibly Treasury and successive governments have over many years also allowed these fortunate retirees access to the standard tax-free area and other aged and low-income tax benefits.
This raises the annual tax-free income of pension recipients with other taxable income to around $150,000 or more annually. When the private taxable income also includes franking credits, the annual tax-free income can even be larger. Ironically and to further benefit retirees, the government indexed the tax-free pension income periodically from the original $100,000 to the current $125,000 even in periods when they did not index the tax threshold for ordinary taxpayers.
Providing only one tax-free area to retirees would reduce the budgetary costs of the superannuation tax concessions and improve equity of the system. Similarly, reforms allowing access to accrued benefits in specified approved personal situations such as periods of extended unemployment or helping the achievement of home ownership.
Allowing access to superannuation benefits to help achieve home ownership runs the risk of rash decisions and upward pressure on house prices. But when taxpayers are already home-purchasers with large mortgages and/or with negative equity in their home, withdrawals from super to reduce mortgages to say 70% of the current market value would minimise these risks. By levying tax at 15% on the money withdrawn, the effective tax rate on the money withdrawn would be approximately 30%, the same as the basic 30% tax rate.
Given the $4.8 trillion already invested in super and the large annual new contributions via the 12% compulsory super payments, the cash management problems of super funds would be minimal. Requiring potential withdrawers to provide their funds with one month’s notice by moving the required amounts into a cash investment choice at that time would deal with all cash flow problems for super funds.