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An opt-in universal pension could boost income

A universal pension – which National Seniors is campaigning for – could be easily rolled out in Australia through an opt-in model says leading economist, Kevin Davis.

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Key Points

  • Adopting a universal pension system in Australia could make retirement simpler.
  • Emeritus Professor Kevin Davis suggests an opt-in model is one way to achieve it.
  • National Seniors’ campaign calls for an independent review of the costs and benefits as a first step.

National Seniors Australia is calling on the federal government to commission an independent analysis of the costs and benefits of adopting a universal pension as part of our Fairness in Retirement Income campaign.

This analysis should explore how this might be practically implemented.

Kevin Davis, Emeritus Professor of Finance at The University of Melbourne shared with online financial news publisher Firstlinks one way this could be achieved: an opt-in universal pension.

Read an excerpt from the Firstlinks article with Kevin Davis below.

Opt-in universal pension

Allowing all retirees to opt-in to receive a non-means-tested Age Pension, which would trigger the application of a different tax schedule for wealthier retirees (let’s call it the retiree tax schedule [RTS]) could solve several current problems with our existing super system without breaking the government budget.

What problems could it solve?

  1. There is an enormous waste of resources in the financial planning industry aimed at enabling individuals to structure their financial affairs so as to access the means-tested Age Pension.
  2. Managing a means-tested pension system involves considerable government resources and burdens individuals with excessive ‘red-tape’ and administration.
  3. Superannuation tax concessions in retirement create an unlevel playing field favouring superannuation funds, and reducing external competitive forces, in the market for the management of retiree wealth.
  4. The Howard Government’s introduction of a zero-tax rate for superannuation earnings in retirement was a major policy mistake which is politically infeasible to reverse – unless combined with some offset such as the opt-in universal pension to make it palatable to voters.

How would such a system work?

At retirement (or later if the option has not yet been exercised), individuals would be able to elect to receive the non-means-tested pension (which is set at the same level as the means-tested pension). However, in doing so, the retiree agrees to be subject to a different tax schedule (the RTS) which has two main features:

  1. Superannuation account earnings would be included in the retiree’s taxable income and subject to personal income tax at the rate specified in the RTS.
  2. The RTS would be no different to the normal tax schedule up to some income level, such as that which enables a retiree to currently receive (for example) a 25% part-pension. Above that income level the RTS would involve a higher marginal tax rate than the normal tax schedule, designed to offset the additional income to be received by wealthier retirees from the universal pension.

For those currently on full or significant part-pensions, opting into the universal pension can leave their after-tax position no worse off, and avoids the costs of tax-driven financial advice and the hurdles of means-testing. For the wealthier, the decision to opt-in requires some analysis, but no more than could be readily available from web-based calculators.

The information required would include:

  • Superannuation balances and their expected annual return
  • Other financial assets outside of super and expected earnings therefrom
  • Other (part-time employment) income
  • The RTS and normal tax schedules.

How this would work

A simple example (obviously ignoring many complications, such as uncertainty of returns) may be useful.

Take a retiree with $500,000 in super which generates a pre-tax return of $30,000 p.a. (untaxed). The retiree has $400,000 in other assets generating a pre-tax return of $25,000. Under the current system (with super earnings tax-exempt), no pension is received and tax of $1,292 is levied (at 19% marginal rate on income over $18,200). After-tax income is thus $30,000 + $23,708 = $53,708.

Under the opt-in alternative, the full $55,000 of earnings (inside and outside super) plus the universal pension amount of $25,000 (approximately) would be taxable, giving taxable income of $80,000.

To leave the retiree equally well-off from opting in, the RTS would involve levying $17,292 of tax on that income to leave $53,708 after tax.

The current (non-RTS) tax schedule would levy $16,467 on that income, indicating that the RTS needs to be set above the normal tax schedule to leave such an individual indifferent.

The exact specification of the RTS would reflect government objectives regarding budgetary considerations and possibly weaning retirees off super-subsidy.

Once set and fixed for all time at specified margins above the normal tax schedule, retirees could make a decision to opt-in or not depending on their individual circumstances.

Political feasibility

Could it be sold politically? Yes, individuals are given a choice to stay with the status quo or opt into an alternative system, rather than simply having a tax-break taken away from them.

Would it be difficult to implement? No.

Would it be difficult for retirees to understand and make sensible decisions? Not with the aid of web-based calculators.

Would the super industry and financial advice industry support it? No, because it goes against their self-interest, even though it has social merits.

What are the scheme's social merits?

National Seniors Fairness in Retirement Income campaign

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  • Less resources spent on financial advice aimed at maximising pension income.
  • Less public sector resources spent on means-testing (and less hassles for individuals subject to means testing) and other activities associated with implementing a means-based pension scheme.
  • A level playing field for the management of post-retirement wealth by removing the tax concession only applied to superannuation earnings in retirement. Unless super funds can provide higher pre-tax returns (or design better retirement products) than other funds, they will be subject to loss of funds under management via the competitive process.

A politically-feasible method of watering down the zero-tax subsidisation of retirement earnings, which primarily benefits the wealthier members of society, and which would also reduce the tax incentive for not running down superannuation balances in retirement due to bequest motives. It would be a major policy change and invoke howls of protest from vested interests in the financial sector. But one well worth considering.

Keith Davis is Emeritus Professor of Finance at The University of Melbourne.

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