Tax concessions for retirees
Policymakers and commentators would do well to keep in mind that superannuation is only one of a wide range of investment options open to retirees. Indeed, for retirees with SMSFs in particular, their superannuation is often only a part of their investment portfolio.
The tax exemption on earnings on assets supporting pensions is often put forward as a compelling reason to keep money invested in super in retirement. However, tax concessions such as the Seniors and Pensioners Tax Offset mean that many retirees would not pay income tax even if they held their savings outside the super environment. Any changes to the taxation of superannuation should be mindful of this.
Proposals for a tax on pensions
In its submission to Treasury ahead of the 2014/15 Budget in May, another actuarial firm proposed a tax on earnings on assets in the pension phase. It was suggested that the Government could circumvent its promise not to make any detrimental changes to superannuation by simultaneously reducing the rate of tax on earnings on accumulation assets and setting both rates at a level such that the current tax take is not increased. They estimated that setting a tax on all super earnings at 10.5% would raise the same revenue as the current 15% tax on accumulation earnings.
The kicker is that over the longer term, with our ageing population, the proportion of assets in pension phase will increase therefore increasing the tax take overall. On the face of it, this sounds fairly sensible. It would simplify the administration of super and increase the tax take in the longer term by taking money from wealthier retirees to help pay for the ever-expanding age pension bill.
However, our analysis suggests that such a measure alone would most likely have completely the opposite effect; it would drastically reduce the total amount of superannuation savings in Australia and the tax accrued from those savings.
Simply put, if retirees behave rationally in response to this policy, then most would remove much or all of their superannuation in favour of better tax sheltered investments. In fact, if the tax rate in the accumulation phase is reduced, the ATO should expect to see a significant reduction in the total tax take from superannuation and at the same time we may see a reduction in Australians’ retirement incomes.
To consider this further, let’s look at how this proposed policy might impact someone who is about to retire and deciding how to manage their retirement savings.
A fairly typical couple retiring at age 65, who own their own home and have $400,000 in superannuation savings between them as well as limited other savings, need to decide where to invest their savings to provide an income in retirement.
Under the current regime, if they choose to keep their savings in the super environment and commence account-based pensions, then earnings on those assets are exempt from tax. They have a wide range of tax efficient investments to choose from, as they would outside super, but mainly for reasons of familiarity and consistency they leave their superannuation within the same system that has looked after their savings for their working life.
Introduce a tax on earnings in the pension phase and our couple must think twice about leaving their savings in super. If they withdraw their savings and invest them outside super then the income earned would form part of their assessable income for tax purposes.
A reasonably balanced investment strategy in retirement might yield around 5% p.a. on average over the long term – say $20,000 in income on their current $400,000 in savings. When we allow for the Seniors and Pensioners Tax Offset this is below the threshold at which they would start paying income tax, even taking into account their age pension entitlements. From a tax perspective they would be better off investing their money outside super.
In fact, we estimate that our couple would need retirement savings of over $1.5 million between them, well beyond the average Australian, in order for it to be tax efficient to leave their savings in a taxed super fund compared to outside. This is again based on achieving a 5% p.a. return both inside and outside super.
Clearly, this is going to have an impact on the amount of money retirees choose to keep invested in super funds. The proposed policy assumes retirees keep pumping their retirement savings into super pensions at the current rates despite the fact they will be worse off tax-wise. We don’t believe that this is likely, particularly for well advised SMSF trustees, and therefore that the proposed policy will not raise the expected levels of tax. Given that the proposal also reduces the tax rate on super assets in accumulation, we would anticipate that this policy would actually reduce the overall tax-take from earnings on super assets.
We would go further and suggest that incentivising people to take their savings out of the super environment may also be detrimental to their retirement outcomes. For the less financially literate, choosing your own investments outside the regulated super environment may lead to less appropriate investment, perhaps resulting in too much money sitting in cash rather than being invested. Also, removing the self-imposed discipline of setting up a pension to provide a regular income could lead to retirees spending their savings more quickly and falling back on the age pension sooner.
The information in this document is provided by Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, tax advice or legal advice and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. Tax is only one consideration when making a financial decision. We recommend that you seek appropriate professional advice before making any financial decisions.