Thanks to my late colleague and great friend renowned Editor and Journalist Max Walsh\u2019s insistence that I should always pay a close attention to history in advising on policy, I feel compelled to provide a quick summary of the reasons why our still bottomless super subsidy pit needs urgent attention. From the tightly controlled limit on maximum superannuation private sector benefits when Trevor Swan and I were ensconced in the Tax Commissioner\u2019s headquarters in the 1970s, we now read in the press about superannuation balances totaling up to $100 million.<\/p>\n\n\n\n
Even more concerning is the fact that there has never been rigorous scrutiny of the extent to which the private sector tax concessions should also be available to public sector employees usually receiving CPI or other indexed pensions in retirement. As mentioned in Chapter 1, the Keating government\u2019s decision to abolish the Policy Coordination Unit I was heading and gifting me a redundancy in 1986 has added enormously to our unfunded superannuation liability.<\/p>\n\n\n\n
At the same time, it opened massive opportunities to help already well superannuated taxpayers double dip into the benefits set up to help fund the retirement of private sector superannuation members. How could this happen when there has always been pressure on successive governments to fund their commitments responsibly?<\/p>\n\n\n\n
Was it self interest on the part of key bureaucrats and government decision makers profiting from the wide-open double dipping opportunities? My experience aiding the Tax Commissioner and Gang of Three in 1974 and 1975 suggested otherwise. The more likely explanation was senior Treasury, and other key policy makers never focused on proper budgetary management, concentrating instead on the sexier and equally challenging issues such as interest and exchange rates, tariff, and other macro-economic issues.<\/p>\n\n\n\n
But let us return to the real action. Where there are opportunities to reduce tax liabilities or gain subsidies, there will be many well informed or advised people willing to give it a go. Some, most notably the tax schemes ranging from cattle embryos, pine trees, to wildflowers etc. ended up especially when geared to multiply the tax advantage in disaster for many. But most probably from lack of bureaucratic interest, superannuation, especially double dipping provided then and even now a very productive shelter.<\/p>\n\n\n\n
You are fortunate if you were not around when the RBA cash interest rate was 18% and the 10-year bond rate reached 15%. Safe second superannuation funds owning assets like these were the only way to go for public servants and others able to salary sacrifice up to 50% of their wage to a second fund. Of course, the highest paid were more able to afford this than lower income struggling employees (which is precisely why we need tax reform).<\/p>\n\n\n\n
Up until 2007 (the Costello changes) there were various controls limiting the benefits of pumping money super mainly via a high rate of tax on large pay-outs, peaking at the top marginal tax rate. Even then, switched on taxpayers already paying top rates on their income recognized the tax advantages of paying 15% tax in the fund, building assets up in super and delaying paying the top tax rate by not drawing benefits.<\/p>\n\n\n\n
You may even remember when the Howard government limited the largest annual undeducted contribution to glory be $1 million. Before then there was no limit. Treasury or whoever were designing the policy were relying on the top marginal rate tax on large withdrawals to deter use of this opportunity. What they neglected in doing so was that by using the withdrawals to fund negative gearing, deductible tax losses could help negate the tax penalty.<\/p>\n\n\n\n
My advisory calculations at that time included a strategy to show healthy federal politicians not needing more income that taking the full parliamentary pension was far superior to taking an inadequate lump sum option (only justifiable actuarially if they had no spouse and a certain expected short life span because of a terminal illness). Take the full pension and receive an indexed pre-tax yield of over 10% based on the available after-tax lump sum alternative, borrow to buy safe investments and use the pension and any other spare income to service and reduce the loan. With the loan fixed in nominal terms, the pension increasing every year for most calculations the strategy and the tax refunds paid off the loan within 10 years. <\/p>\n\n\n\n
In that way the government contributed twice to enhance the pension recipient\u2019s retirement. If you are old enough you may also remember when the government introduced a $100,000 annual limit on tax-deductible superannuation contributions. That did not last for long, after the latest change it is now set at a much lower limit of $35,000. Unlike when it was so large, the limit now applies to all recipients of employer contributions to funded schemes. For years, however, the ATO did not administer even the $100,000 limit fairly.<\/p>\n\n\n\n
When it was set up, they penalized people exceeding the statutory annual limit by denying the employer a tax deduction for contributions above the limit. Yes. You guessed it at once. If your employer was not a taxpayer there were no penalties. Over the years, highly paid government, universities, charity and other executives and employees could divert a large part of their pay to superannuation. These arrangements also helped non-tax paying schools attract retired teachers drawing pensions for their former government jobs. By offering to pay up to all their new pay as 15% tax rate superannuation, they successfully attracted highly sought after especially Mathematics teachers. <\/p>\n\n\n\n
Today as it always should have been the case, the ATO imposes the penalties on the taxpayer not the employer. This long overdue change was essential even when tax paying employers were involved. Can you believe it, the sloppy legislation allowed a $100,000 deduction per employer. That allowed directors of say 3 listed companies to legitimately receive $300,000 a year of employer super contributions.<\/p>\n\n\n\n
Knowledge of these slip-ups also allowed self-employed workers to avoid the harsh impact of the gross discrimination against them when strict limits (for a long time as little as $3,000) applied to their annual tax-deductible super contributions. By arranging for any or even all the firms or other entities using their services to pay them with superannuation, they were able to receive larger tax savings.<\/p>\n\n\n\n
An even more concerning equity issue has received little if any attention. Why should recipients of large heavily subsidized defined benefit pensions also be eligible to access the benefits available to the rest of the population to help their accumulation of retirement assets? With government action to phase out access to defined benefit pensions, this issue is now of less importance for future policy development except in one-key area.<\/p>\n\n\n\n
This is whether future tax reform should be limiting the total amount or value of assets available to attract concessional tax treatment. Limiting the value of the tax subsidy to (my preferred solution) the actuarial annual value of the age pension after age 67 (or even at an earlier age if at present there are no caps on the maximum eligible concessionally taxed account balances) would require ascribing actuarially calculated values to annual defined benefit pensions.<\/p>\n\n\n\n
For far too long, policy formulation has ignored the huge value to retirees and the resulting costs to taxpayers of unfunded government pension benefits, even when recognized putting it in the too difficult category in most cases. One exception is the inclusion of the valuation of pension payments in the $2.1 million limit stopping taxpayers from making any further undeducted contributions to their funds.<\/p>\n\n\n\n
Nevertheless, as highlighted in Chapter 4, the Compulsory Super legislation still requires employer contributions of 12% of salary (up to an annual salary of around $260,000) for all employees no matter how large their super balance is. Earlier legislation prohibited any further super contributions once the account balance exceeded a generous but realistic maximum benefit limit. Why we no longer have a maximum benefit limit is a question worth thoughtful consideration.<\/p>\n\n\n\n
One explanation is the huge actuarial value of the annual indexed pensions of higher income defined benefit fund members due to recent large increases in final salary and the outdated life expectancies figures used to calculate entitlements. That should not divert attention away from by far the best strategy to maximize superannuation account balances. This is of course achieving exceedingly high rates of return and allowing the magic of compound interest to come into operation.<\/p>\n\n\n\n
Over 60 years of investing, I have seen many instances of this way of accumulating large assets holdings both inside and out of super via capital appreciation. The public sale of both CSL and CBA at what has turned out to be ridiculously low prices is a perfect example of the large profits available from owning undervalued assets. <\/p>\n\n\n\n
Prior to the 1987 capital gains tax introduction, investing in super was far less attractive than it is today. Today the low 15% income tax rate in super enhanced by a 10% capital gains tax rate for assets owned for over 12 months is particularly attractive. With rare exceptions especially for older taxpayers, this tax rate is the lowest available and particularly attractive when fund assets are accessible.<\/p>\n\n\n\n
Compared with owning assets in personal names, owning them in super also provides maximum flexibility in timing realization of accrued gains with the maximum tax rate being 15%. In personal names, the tax rate depends on the other taxable income received in the year of sales and holding on till a more favorably taxed year increases the risks of achieving a lower sales price. Also, the proposed recent budget tax rate changes will trigger higher tax liabilities than payable investing via a super fund.The tax-free treatment of capital gains in funds in pension phase adds to the attractions of moving superannuation assets into pension phase when this option is available. The big takeaway point is of course the obvious one. The proposed budget changes will add to the advantages of owning assets almost certain to appreciate in superannuation and pension funds.<\/p>\n\n\n\n