With the Federal Election run and won, and Parliament set to resume, attention will once again focus on tax reform, and, in particular, what will happen in relation to the proposed superannuation tax changes as announced on Budget night.
Since Budget night, there has been much debate about the merit, or otherwise, of many of the proposed changes, in particular, the reduction in the concessional cap to $25,000 a year, the non-concessional lifetime cap of $500,000 and the transfer balance concept of $1.6M (i.e. the concept that when a member moves from the “accumulation phase” to the “pension phase” there is a limit on the amount of funds that may be moved into this phase).
Much of the debate has focused on the equity of the distribution of tax concessions, winners and losers, whether measures are retrospective or not, the adequacy of retirement balances, practical limitations with implementation of many of the initiatives and the complexity of many of these changes within a Defined Benefit setting. To say nothing of the cost of compliance for administrators, custodians and superannuation funds.
Whilst there has rightly been due attention to the purpose of superannuation as a way of analysing any reforms, the choice for how Australia chooses to tax our superannuation system needs to also be understood. It is this policy setting that informs how a Government can respond to the growing cost of the tax concessions as more members move into pension phase.
Not all pension systems are the same
Most pension systems around the world are taxed very differently to the Australian superannuation system. Most pension systems have what is referred to as an “E – E – T” taxation regime. That is, contributions to the pension system are tax deductible (and hence not subject to tax), earnings are exempt from tax, with benefits subject to tax (at varying rates). Some of the arguments for this type of taxation regime is that it encourages contributions to the system, it prevents tax being a drag on investment returns so as to improve the benefits of compounding, and, through the use of either compulsory drawdowns or annuities, it takes the funds back out of the system and appropriately taxes benefits based on capacity to pay.
It is important to acknowledge that the Australian system is structurally different, in that there is a high degree of compulsion, with the Superannuation Guarantee. Additionally though, there is a growing pool of voluntary savings within superannuation (and, it must be said, a blurring of the second and third pillar of Australia’s retirement incomes strategy).
The taxation regime for Australian superannuation funds is quite different.
In Australia, we have a “t-t-E system” (with the “t” being lower case on the basis of concessional tax as contrasted to tax at full rates). That is, contributions are concessionally taxed, earnings throughout the accumulation phase are concessionally taxed, with benefits (largely) tax free.
In effect, what this type of system does is that it brings forward the taxing point to the contributions and earnings phase. However, in doing so, there is limited capacity in pension and benefits phase to further tax (excessive) benefits based on capacity to pay.
Accordingly, the levers our current system provide are to restrict the amount of money that comes into the system (either via concessional or non-concessional contributions) or to limit the amount of funds that can be held in pension phase (the transfer balance concept). As an aside, alternative models may require funds be withdrawn from the system, taxing income in pension phase or taxing benefits.
How we view superannuation matters
As the debate around the appropriateness of the tax concessions in superannuation intensifies over the coming week, it is worth looking at these issues through the following lens:
- What is the objective of our system?
- What does a comfortable (rather than an adequate) income in retirement look like?
- To what extent are we prepared to provide tax concessions to assist in meeting these retirement income objectives?
- Once we understand the extent to which we are prepared to provide tax concessions to assist Australians reach their retirement incomes objectives, have we got the current tax policy settings correct?
Important considerations for how we tax superannuation
- Should the current Division 293 additional 15 percent tax, start at $250k, $200k or even $180k?
- Assuming that there is an annual limit on concessional contributions, where should this limit be and should there be the opportunity to catch-up? If so, noting that the current system is still only 20+ years young, what is the appropriate mechanism to allow catch-ups?
- Assuming that there will be a lifetime cap on non-concessional contributions, what should this cap be (understanding that not all Australians have the opportunity to make concessional contributions) and what contributions should already be counted towards the cap (if any)?
- Is the transfer balance concept the most appropriate mechanism in comparison to other mechanisms to limit the amount of FUM in pension phase? If so, what should this limit be?
- Should we have a legacy taxation system for the Defined Benefit plans separate from the Defined Contribution system (rather than trying to draft one set of rules to address two very different systems)?
May the debate continue.