Who needs employer contributions other than (if you do not need current income) as a way of lowering your marginal tax rate. For many especially after Peter Costello introduced his poorly conceived and designed contribution surcharge on higher income taxpayers the only way to go was undeducted personal contributions to your fund. As an aside the main reason I forced my brother Mal Dixon (Dixon Homes) to divert $10,000 to his fund was my concern that as a self-employed person, he had no super and even no death and disability cover. <\/p>\n\n\n\n
Please note with all the pressure forcing workers to divert money to compulsory super, governments have never been concerned about the welfare of this important sector of our economy. Many years later, there is still no requirement or pressure on self-employed people to have any super. In my brother\u2019s time, the tax legislation even discouraged the self-employed by offering minute limited tax concessions. At least today the tax rules are fair and encourage the brilliant for them ownership of own business premises in a self-managed fund (SMSF). <\/p>\n\n\n\n
Back to an interesting bit of history. The Dixon Homes fund was one of the first SMSFs ever audited by the ATO. Why? I religiously filed annual tax returns though the ATO gave low priority to at that time tax-free super income accounts because of no or little revenue. The ATO similarly paid little attention to compliance issues other than strict maximum benefit limits. The only contribution was $10,000 (quite a bit in 1970s) deposited as an undeducted contribution and invested in quality shares such as Santos, Woodside, and BHP, with the largest holding in Santos (at 2 cents a share- more about this later). The minimal outgoings were fees and life\/disability insurance (no tax in those days).<\/p>\n\n\n\n
A bright spark in the ATO who went on up to the upper ranks quickly, chanced upon the annual returns. How could the fund after about 6 years have made so much money? How could the balance be $1.3 million was the first audit question? Me. I always invest with the best possible research in undervalued companies. Following Bob Wilson\u2019s fundamental strategies, I was prudently helping my brother.<\/p>\n\n\n\n
A later short Chapter on the history of Santos will explain more. The takeaway point here is that Treasury and other policy makers do not really understand what can and does happen in the real world. Too many are macroeconomic theoreticians not switched on or unfamiliar with complex investment strategies that help maximise the benefits of tax shelters. Our super funds still offer successful investors low tax rates, unlimited tax-free payouts. The Dixon Homes 1970s super strategy is still open to everyone today. Fortunately for other taxpayers, only a privileged few hit the bullseye. <\/p>\n\n\n\n
Enough on this topic. To start this Chapter, some simple but very realistic calculations illustrate precisely how the compulsory super legislation penalises young and middle-aged people struggling to achieve or keep home ownership. Given how easy it now is (unlike in the past) to save tax and accumulate assets by voluntary super contributions, exploring the advantages and drawbacks of compulsory super contributions is long overdue.<\/p>\n\n\n\n
Consider first those worse affected. People paying no or little tax on their wagelose access to 12% of their earnings at once, pay tax at 15% on the money then tied up until age 60. Even if some tax is payable, it will be less than 15% in this income range. Assume there is an existing mortgage, reducing the mortgage provides an immediate after-tax return of at least 5%. This is a far safer and more certain return than paying more tax in super.<\/p>\n\n\n\n
Amongst other things, heaven knows what the super pay-out rules will be at age 60. More importantly the Australian banks know how to protect their own interests. Unlike in the USA where long-term fixed rate loans are the standard ones on offer, Australia has concentrated on long term variable interest rate loans to borrowers. They offer fixed rate loans but only for shorter periods and usually at higher rates than the variable rate option. The banks are not charities. They ensure that the impact of inflation flows quickly into higher variable rates i.e. they shift the burden fully on to borrowers.<\/p>\n\n\n\n
Has inflation ever been or likely to be a major problem in Australia? You know the answer. The dices all fall hurting borrowers and poorer sectors of the community. Given our large public debt and continuing deficits heaven help borrowers if the commodity prices propping up our economy fall sharply.<\/p>\n\n\n\n
Wake up Inflation is here to stay. How else can our economy work with governments relying so heavily on stealth taxation and inflation helping to reduce the debt burden.<\/p>\n\n\n\n
Who does inflation hurt hardest? Automatic indexation and variable interest rates on loans cushion the blow for retired public servants, welfare recipients (other than the much worse off unemployed) and the bank shareholders. These built in protections shift the maximum possible strain on to personal income taxpayers especially who are forced to put money into super while facing increased rents or higher mortgage servicing costs. <\/p>\n\n\n\n
Have you ever heard any of our politicians focus on the distortions created by our super arrangements and the built-in inflation protection in the system? A later Chapter will reveal just how strongly our Treasury and politicians have dipped in to the public purse. Let us consider here how much extra taxpayers on the 32% marginal tax rate (up to around $130,00 annually) gain from super compared with paying off a house mortgage.<\/p>\n\n\n\n
Assume we can only hope, a 5% annual interest rate. Using a CPI indexed annual salary of $60,000 simplifies the presentation. just double the figures to see how a $120,000 annual earner or a couple jointly earning that amount fare from money diverted out of the family purse.<\/p>\n\n\n\n
Also assume a 7 per cent after-tax super fund return and the 5% after no tax return from reducing the mortgage. Owning a home also provides a return via value increases but I ignore it here to avoid being accused of bias. An average 7% super return (between 4 and 5 in real terms) over longer terms is realistic for even good super funds. (As a later Chapter will highlight how Australian super options open many traps for the unwary or only plain unlucky.)<\/p>\n\n\n\n
Twelve percent of $60,000 reduces take-home pay by $4,896 a year. After 11 years the compulsory super balance is only about $30,000 or 41% ahead. After 21 years, super provides around 60% more while the advantage after 31 years is 84% ahead. This book does not focus on super strategies, nevertheless these calculations prove the benefits of getting money into super early when the tax on earnings is far lower than that on other investment options except for paying off non-deductible interest costs.<\/p>\n\n\n\n
Please note I have not focused on the much higher penalty that compulsory super places on unfortunately the growing numbers of taxpayers with personal (including large gambling and credit card) debts with 20% and even higher interest rates.<\/p>\n\n\n\n
The question crucial to achieving meaningful tax reform has not even bothered any of our strategic planners. Given the large and growing cost to revenue raising why can\u2019t we revert to allowing people to contribute to super when they want to up within tightly controlled limits on the tax subsidy.<\/p>\n\n\n\n
At the age of 84 with more money in super than you can poke a stick at, an employer needing some strategies offers me $100,000 as an annual salary for 2 hours work a week. The legislation compels the employer to pay an additional $12,000 into a fund of my choice. Another example. A judge or the PM retires with an annual indexed pension approaching $300,000 a year. In their new job, compulsory super is required as for me in the example above.<\/p>\n\n\n\n
Even worse and more ridiculous. Someone struggling to pay their rent manages to find part time work. The employer must contribute 12% compulsory super with costs and no or very little tax advantage with the money tied up till age 60. A further ridiculous piece of law are the provisions after age 65. Everyone can withdraw their super at any time tax-free. This provides the opportunity for two brilliant strategies for the hard pressed. <\/p>\n\n\n\n
First for people needing this strategy, the tax payable on the new super is 15% giving an immediate tax saving of 17% and the ability to withdraw the full amount of the new super tax-free. Second the maximum annual deductible super contribution is now $30,000 and $35,000 shortly. By using money already in super to make the contribution or by salary sacrificing the tax saving can be ranked up.<\/p>\n\n\n\n
These obvious examples show just how much the super tax concessions can be manipulated and\/or utilised by the well informed and further encouraged and made more rewarding by higher marginal rates of tax than those used in the above examples. <\/p>\n\n\n\n
Superannuation has changed dramatically over the years. Initially a tightly controlled instrument it has become a massive tax shelter and, in some cases after the 2007 changes a bottomless pity. The federal government\u2019s policy management of its unfunded superannuation liability (analysed in detail in a later Chapter) has been-self-serving and in many ways a disgraceful burden on taxpayers.<\/p>\n\n\n\n
<\/p>\n\n\n\n <\/p>\n\n\n\n Table 2 highlights the amount of pressure funding compulsory super places on personal income taxpayers. Look at the difference in returns applying the same 15% tax to super contributions, but increasing the super earnings tax rate to 30%, the company tax rate.<\/p>\n\n\n\n The 30% earnings tax reduces the super benefit and cost to government especially over the longer 31-year period. Instead of being 84% ahead as in Table 1 super is still 53% ahead. Super is still attractive for compulsory super and voluntary deductible contributions but less so for the Dixon Homes strategy.<\/p>\n\n\n\n <\/p>\n\n\n\n While the ATO and government may not be focussing on its original aim of providing retirement incomes, there is a long history (of not very sensible changes in several cases) of the development of the current superannuation tax shelter. While the motivation for the current mandatory 12 per cent superannuation employer superannuation (setting up and boosting the fortunes of the industry funds) is clear, how the government has concluded that the resulting large and increasing loss in revenue can be justified is not. .<\/p>\n\n\n\n The Fraser government assigned SWPS to help Ralph Hunt, the then Health Minister to deal with the first approach of the Storeman and Packers Union represented by Greg Sword and Gary Weaven seeking Endorsement of the Union\u2019s attempt to substitute productivity superannuation contributions to the newly established SPU fund for wage increases. The formal meeting included Messrs Weaven and Sword and several retail company corporate executives including one of the Coles founders. The union executives concentrated on having the added money paid only as contributions to their fund. Little action followed until the change of government. From then on, the industry super funds succeeded both in increasing super fund returns, outwitting the private sector funds, and increasing the compulsory contribution to the current 12%. <\/p>\n\n\n\n A later chapter covers a very serious government stuff-up by highlighting the feedback on my 1992 book 68 SUPER STRATEGIES (largely because of advice on how to find out whether you have been robbed as unfortunately many people had been) and a subsequent 4 CORNERS program revealing the huge commissions agents were making using government advertisements about super tax benefits to sell bum policies.<\/p>\n\n\n\n The industry fund initiative has been of great benefit to many Australians outperforming the private sector and many company funds. They are here to stay and exceptionally large, so that in some cases sending a large part of their assets offshore is their only workable investment option. Importantly they no longer need compulsory super legislation to ensure their survival. For even with major policy shifts for example to return to voluntary super legislation they are attractive investment vehicles.<\/p>\n\n\n\n What I can’t understand as a person always paying his bills on time, why with so much compulsory super contributions (at huge cost to income tax collections) a sensible prudent government could not change the super and pension fund earnings tax rates to more realistic levels (compared with the much higher personal tax rates) and still provide substantial benefits. All that this would require is to retain incentives for voluntary super contributions or HA HA force everyone with income in the right age groups to contribute to super. Despite their huge spending on advisers etc has any recent government even considered the pros and cons of Table 2? As far as lowering imputation costs and helping retain the imputation system (my greatest concern after the unfair treatment of many younger people), this option is far superior than an earlier Labor attempt to reduce imputation costs.<\/p>\n\n\n\n <\/p>\n\n\n\n Focusing now only on funded superannuation benefits, what we have is an inequitable and irrational system that is difficult to assess using traditional models.<\/p>\n\n\n\n For example, many countries opt to exempt superannuation contributions and earnings from tax when they are accumulating (accumulation funds) and tax the benefits when distributed as income, in most cases as income streams. Very few allow tax-free access to the benefits and most limit the maximum size of the fund and the ability to make lump sum withdrawals.<\/p>\n\n\n\n Furthermore many systems exist only to provide retirement income streams that reduce\/avoid the need for further direct income support to eligible residents. Our system provides no such direction or even guidance. Tax advantages encourage running down the accumulated balances as annual pension payments, but eligible people qualified as retired after age 60 and all those aged over 65 can withdraw all their benefits in whole or part as a lump sum free of any tax.<\/p>\n\n\n\n The 2007 changes opened up huge tax bonuses by removing all restrictions on fund account size and allowing tax-free withdrawals. The total proceeds can be gifted to related parties, used to purchase an owner-occupied house or invested outside super or spent. Gaining the benefits of the superannuation tax concessions in no way guarantees a reduction in age pension benefits or other aged care outlays..<\/p>\n\n\n\n <\/p>\n\n\n\n To conclude this summary of the Treasurer Costello generosity consider the superannuation surcharge stuff-up. By targeting the contributions of highest income taxpayers with a 15% surcharge and leaving the undeducted super contributions rules unchanged, the government focused attention on the largely till then ignored undeducted contributed strategy. Till the $1 million limit was brought in, the legislation did not limit contribution size. The largest I saw was $10 million but more importantly even with the still too high $1 million limit, a great way for the better-off to help children and grandchildren was to deposit my advice usually $50,000 as an undeducted super contribution for them. (Today of course the priority for many is helping the family achieve home ownership) That option is\/was a great way to help family members later in life and avoided the gift being spent on $10 ($20 today) cocktails or in other ways. To save tax, many highest rate taxpayers switched strategies, reducing their taxable super contributions and instead pumping taxable income into fully subsidized negatively (in many cases fully) geared investments. .<\/p>\n\n\n\n To conclude let’s look at just how much money is involved with the super tax concessions, Excel simplified calculations demonstrate the extent of the drain on revenues is. The assumptions are simple: 12 % compulsory super, two wage levels $60,000 and $120,000 annually in real terms for a maximum of 45 years (i.e. joining the workforce at 22 and retiring at 67, the age pension eligibility age).<\/p>\n\n\n\n This is of course not the history of many workers, if only it could be. The assumptions are unchanged real salary, 15% tax on super contributions and income and 32% personal tax if income earned in personal names. For higher income taxpayers, the tax savings are even larger, and those calculations would only show much larger revenue costs than those presented here. The accumulated costs assume a 4% interest rate because of the costs of government debt. <\/p>\n\n\n\n <\/p>\n\n\n\n <\/p>\n\n\n\n <\/p>\n\n\n\n These ball-park figures demonstrate just how large the tax expenditures incurred via compulsory super are. One further example highlights that even with modest real earnings rate of 4% p.a. how costly the concessional tax rate on fund earnings is. $100,000 invested e.g. via a parental gift in a 22 year old\u2019s account tied up to age 67 (45 years) would grow to $1,271,869 in real terms attracting $484,522 in tax subsidies.<\/p>\n\n\n\n More precise actuarial calculations may alter these calculations slightly. All I can conclude is that there must be real doubts about for how long the open ended superannuation tax concessions can continue .Even doing the sums assuming a 32 per cent average personal marginal tax rate (the rate applying between $45 and $135 thousand a year) the annual cost is 17 per cent of the annual employer and tax-deductible personal contributions of around $ X billion and the same percentage of annual total fund earnings (of around $X billion).<\/p>\n\n\n\n As total fund assets grow, these costs rise annually very much influenced by fund rate of returns. Successive governments have over many years whittled away the safeguards of the public purse. They have removed the tight limits on maximum fund size (called Reasonable Benefit Limits) and the taxation of benefits received. Australian Taxation Office (ATO) supervision of the sole purpose test has been patchy at best allowing multiple breaches of the original Sole Purpose Test (put simply super is to provide a retirement income and not be used for running businesses or trading activities).<\/p>\n\n\n\n In other countries, common practice is not to tax income as it accrues in super funds, but tax it as it comes out. Here after multiple changes income is taxed at a 15 per cent (10 per cent for some capital gains) with a new provision soon to be applied applying an additional 15 per cent or more when accumulated balances exceed $3 million (indexed). Above $10 million (indexed) they add another 10% but the top rate is still below the top 47 per cent marginal tax rate.<\/p>\n\n\n\n Some of the people affected by the latest changes are crying foul. The reality is that even the latest changes leave super as a honey pot for a privileged, lucky or smart few. After age 60 (in some cases 65 at the latest) funded super scheme members (except for some in defined benefit funds paying pensions) have absolute flexibility to either stay or run with their money elsewhere. Apart from the costs (possibly) of liquidating fund assets, there are no tax obstacles. All those large amounts in super can be withdrawn and even shipped overseas or blown once eligibility to withdraw is available.<\/p>\n\n\n\n The recent budget proposals to change trust and capital gains tax rules if enacted will focus much greater attention on the superannuation arrangements. For a variety of reasons, especially the age 60 access barrier and complexity has focused the attention of many elsewhere. If there is any lesson to be learned by the furor (a lot of it self-serving criticism), it is the urgent need for a sensible practical review of all the tax shelters and tax concessions to minimize distortions to rational decision making through piece meal changes.<\/p>\n\n\n\n A later Chapter will explain why the attack on trusts should never have happened. All the Treasury had to do was remember that the double taxation of dividends was the reason why the ATO convinced Bill Hayden not to introduce legislation to reverse the Barwick Court decision to allow trusts to distribute to companies. What part of your family is your company beneficiary? More easily created ($1,000 maximum) than live family members, it only blossomed when Treasury did not look at their files and blew billions of tax dollars by greatly increasing the trust tax shelter benefits by allowing assets to be built up in companies and only distributed when the recipients had lower tax rates and even better eligible for franking credit refunds.<\/p>\n\n\n\n Bill’s Blind Freddy sees how screwed up our current super arrangements. Compulsory is aggravating the financial situations of many less well off workers while the top end of town has received a gift from heaven. Consider the case of a property mogul I recently chatted to. Me. Given your love of property, you wouldn\u2019t have shares in your superannuation fund? Reply. Only $20 million currently. Years ago, I put $1 million in a friend\u2019s highly successful LIC (Listed Investment Company) to shut him up. Yet the government forces him and me to receive compulsory super on directors’ fees or wage income, in my case over 80.<\/p>\n\n\n\n Other reasons why compulsory 12 per cent employer rules are extremely silly and costly. Why do the rules include short term fruit pickers here for only a very small time under strict visa controls? And for many, such as lower aged groups deferring super contributions to later in life makes much more sense and would help pay rents and\/or facilitate achieving homeownership. For older people with not long to go to reach age 60, the tax concessions are much more beneficial even when there are mortgages and reasonably priced debt to repay, Enough about super now.<\/p>\n\n\n\nEnd Year<\/th> Salary<\/th> Super<\/th> Not Super<\/th><\/tr><\/thead> <\/td> $60,000<\/td> $6,120 p.a.<\/td> $4,896 p.a.<\/td><\/tr> 1<\/td> <\/td> $6,548\u200b<\/td> $5,141<\/td><\/tr> 11<\/td> <\/td> $103,357\u200b<\/td> $73,034<\/td><\/tr> 21<\/td> <\/td> $293,795\u200b<\/td> $183,625<\/td><\/tr> 31<\/td> <\/td> $668,415\u200b<\/td> $363,767<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n Table 2 \u2013 15% Contributions and 30% Earnings Tax Rates – Age 30 Start<\/h4>\n\n\n\n
End Year<\/th> Salary<\/th> Super<\/th> Not Super<\/th><\/tr><\/thead> <\/td> $60,000<\/td> $6,120 p.a.<\/td> $4,896 p.a.<\/td><\/tr> 1<\/td> <\/td> $6,583<\/td> $5,141<\/td><\/tr> 11<\/td> <\/td> $96,823\u200b<\/td> $73,034<\/td><\/tr> 21<\/td> <\/td> $257,845\u200b<\/td> $183,625<\/td><\/tr> 31<\/td> <\/td> $555,843<\/td> 363,767<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n Table 3 – Salary $60,000 in Real Terms<\/h4>\n\n\n\n
Year<\/strong><\/th> 12%
Super<\/strong><\/th>Earnings
Total<\/strong><\/th>After-Tax
Fund Balance<\/strong><\/th>Revenue
Loss<\/strong><\/th>Assuming 4%
Real Annual Interest Cost
of Accruing Total Loss
of Revenue Because
of Increased Deficit<\/strong><\/th><\/tr><\/thead>1<\/td> $7,200<\/td> $428<\/td> $6,486<\/td> $1,297<\/td> $1,349<\/td><\/tr> 15<\/td> $7,200<\/td> $9,933<\/td> $150,351<\/td> $2,749<\/td> $40,026<\/td><\/tr> 30<\/td> $7,200<\/td> $33,572<\/td> $508,135<\/td> $9,253<\/td> $167,334<\/td><\/tr> 45<\/td> $7,200<\/td> $89,823<\/td> $1,359,359<\/td> $15,567<\/td> $528,028<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n Table 4 – Salary $120,000 in Real Terms<\/h4>\n\n\n\n
Year<\/strong><\/th> 12%
Super<\/strong><\/th>Earnings
Total<\/strong><\/th>After-Tax
Fund Balance<\/strong><\/strong><\/th>Revenue
Loss<\/strong><\/th>Assuming 4%
Real Annual Interest Cost
of Accruing Total Loss
of Revenue Because
of Increased Deficit<\/strong><\/th><\/tr><\/thead>1<\/td> $14,400<\/td> $857<\/td> $12,968<\/td> $2,593<\/td> $2,697<\/td><\/tr> 15<\/td> $14,400<\/td> $7,200<\/td> $283,815<\/td> $5,825<\/td> $80,052<\/td><\/tr> 30<\/td> $14,400<\/td> $33,572<\/td> $1,028,510<\/td> $13,862<\/td> $334,638<\/td><\/tr> 45<\/td> $14,400 <\/td> $179,646<\/td> $2,566,378<\/td> $32,987 <\/td> $1,056,036<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n
\n\n\n