The following article has been written for National Seniors by Michael Rice AO as part of our ongoing series on reforming the retirement income system. Michael is an Executive Director and founder of actuarial group Rice Warner. He has a keen interest in the integration of social security and superannuation, as well as measuring the adequacy of retirement incomes. In 2020, Michael was awarded an Officer of the Order of Australia, “for distinguished service to business and economics, particularly to the actuarial profession, and through advisory roles”.
Last September, the government set up a review into the retirement income system, in response to a recommendation made by the Productivity Commission. It will cover the progress of the system after 25 years of mandatory contributions (known as SG) deducted from wages, and how the system is expected to perform in the future as Australians live longer and the population ages.
The Retirement Income Review will also consider the incentives for people to self-fund their retirement, the fiscal sustainability of the system, the role of the three pillars of the retirement income system, and the level of support provided to different cohorts across time.
The report is now due to be completed at the end of July. As it will not be making any specific recommendations, we can expect the government to make the document public shortly thereafter. We expect the report will dig deep into our complex retirement system and be the basis for resetting government policy.
The economic dislocation caused by COVID-19 might even lead to more significant changes than governments would normally take, though the political climate in relation to superannuation is likely to make some changes unpopular and difficult to introduce.
Mandatory employer contributions
There are two key issues on which we can expect an early resolution against the background of our large government debt. Can we afford the legislated increase in the SG from today’s 9.5% to 12% over the next 5 years and will superannuation keep its preferential tax treatment on contributions, fund earnings and member benefit payments?
Currently, SG contributions cost the government money as they are taxed in the fund at 15% rather than the marginal personal tax rate that would have applied if they were paid as wages. Of course, this “cost” is inflated by the high levels of personal income marginal tax rates, and the SG is a positive incentive aimed at better retirement living which will save the government money later through lower Age Pension costs.
There have already been steps taken to reduce these costs. Over the last decade, the concessional contribution caps have been reduced from a high of $100,000 a year (2008-09FY) to the current level of $25,000. Further, those people whose salary and contributions together exceed $250,000 pay an extra 15% on the contributions.
More importantly, will the newly impoverished working population want to divert more into superannuation contributions, or would they prefer to clear debts and get back into a sound financial position first? The extent to which superannuation contributions reduce wages, especially for different wage cohorts, is still the subject of much academic debate. Some within the industry now speculate that the SG might be rounded to 10% (which starts from July 2021) and then be deferred until times are better for us all.
Superannuation pension benefits
Since 2007, all governments (and the Opposition at the time) have promised to allow all superannuation payments to be tax-free. This is likely to continue, though it would be simple to pick a number (say $100,000 a year) and deem all annual withdrawals above this to be included in taxable income. Alternatively, withdrawals from accumulation accounts (held by those with more than the $1.6m pension transfer balance) could be taxed at (say) 15%.
One easier alternative might be to tax fund earnings at a higher rate as this is less visible than personal taxes. The obvious way to collect more taxes would be to tax each fund’s earnings in the pension phase at the same rate as the accumulation phase, namely 15%. That would increase taxes from the super funds collectively by close to 50%, as well as simplifying the system – you would no longer need a Pension Transfer Balance.
Finally, will franking credit refunds to pensioners paying no tax still be sacrosanct? This was a major political issue at the last election.
Remember, we now have a huge debt and the government will be looking to pay it off over a decade or so, so superannuation will no longer be as sacred as it was in the past.
While our elephantine system works well in aggregate, it is administratively painful for many Australians, particularly retirees. A lot could be done to improve retirement income products.
Unless you are lucky enough to have a defined benefit pension, run your own SMSF or have your retirement benefit on a retail investment platform using a financial adviser, you are likely to have a simple Account-based Pension. These accounts are not linked to your partner’s super, so it is more difficult to manage your retirement finances. Further, if you work part-time in retirement, your SG (and any other contributions you make) will go into a separate accumulation account. You can roll it into your pension account at the end of each year, but it is an administrative nightmare for most people.
It is worse if you end up in a non-performing fund and want to move it. You will need to commute your pension, roll over your accumulation benefit to the new fund, and then convert it back into a pension. The process is so painful, that it is anti-competitive!
It would be possible to simplify the administration of pension accounts to allow contributions to be made directly into them (say above age 65) and to transfer them directly from one fund to another. Of course, if accumulation and pension earnings were both taxed at the same rate, you would only ever need to hold one account.
Before the government does make a tax-grab, it should look at the existing inequities in the system. The top 100 SMSF’s collectively hold about $8.7 billion. Many appear to be run as businesses – according to the ATO, one even has a loan of $168 million against property holdings! Taxing the wealthy first always makes good political sense.
Means testing arrangements
Another area of ongoing pain is the deeming system used in the means-tests of the Age Pension. National Seniors have been fighting for years to make this fairer and some progress has been made. It would be simpler if we had a single test for the Age Pension based either on assets or on income to simplify it; reviewing Deeming should be part of this.
Finally, it is often punitive to work part-time in retirement with very high effective rates of taxation. It doesn’t make sense to stop people contributing to the economy and improving their retirement lifestyle.
To conclude, it is likely that we will all need to pay our share of taxes to help repay our bloated national debt. Superannuation is a relatively soft target. It should pay its share, but let’s hope any changes are well targeted, don’t make the system even more complicated, and still allow the system to do its job, which is to provide better retirement outcomes.
You can also listen to an interview with Michael Rice on this topic in the latest installment of our new podcast.
Read our related article on the idea for a universal pension here.