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Four Ps: pass or fail? - Column

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The proposed changes to superannuation announced in the federal budget are aimed at simplifying superannuation planning and increasing the benefits to retirees.
The proposed changes to superannuation announced in the federal budget are aimed at simplifying superannuation planning and increasing the benefits to retirees. Taxes have been reduced to an extent, and in a manner, that was not anticipated. The changes will benefit some already in retirement, but more importantly are designed to encourage greater contributions to superannuation than under the current system.

Under the proposals, superannuation will offer clear and simple-to-understand tax concessions for the majority of those in a position to make voluntary contributions. All employees, including the self-employed, can make tax-deductible contributions up to the age of 75. The tax advantages are clear at the point of saving, while savings grow and at the point when benefits are taken.

1. When savings are made: So long as the member's marginal tax rate is above the 15 per cent contributions tax, the amount saved through super will exceed the amount saved outside super. That is, $1000 of pre-tax income will result in $850 savings in super and $1000*(1 - marginal income tax rate) outside super.

2. Savings accumulating pre-retirement: Superannuation savings are subject to an annual 15 per cent earnings tax rate, while non-super savings are taxed at the member's marginal tax rate. If the member's marginal tax rate is above the 15 per cent earnings tax, superannuation savings will accumulate faster than the same amount saved outside super.

3. Savings accumulating post-retirement: Post-retirement super savings are subject to zero tax. If a member's marginal tax rate is above zero, post-retirement super savings will accumulate faster than the same amount outside super.

4. When benefits are taken: Under the new rules, for people over 60, there are no further taxes when money is taken from either post-retirement superannuation or private savings.

At stage 1, taxpayers get to exchange their marginal tax rate for the contributions tax rate of 15 per cent on a maximum of $50,000 of income a year. Stages 2 and 3 provide taxpayers with tax-advantaged deferral.

Stage 4 ensures these tax advantages are not eliminated when benefits are taken. Non-deductible contributions, that is, contributions from after-tax income, benefit only from deferral at stages 2 and 3. With non-deductible contributions, there is no tax advantage between the amount contributed to super and the amount saved outside super. Non-deductible contributions are limited to $150,000 a year.

These tax incentives make it highly likely the level of voluntary contributions, both tax-deductible and non-deductible contributions, will increase. Furthermore, with annual contribution limits, financial planning must occur over a period of time and not just at the point of retirement. However, one risk, particularly for those many years away from retirement, is whether the rules will change again in the future in a manner that will disadvantage those that have acted as the current legislation intends.

All tax systems face a trade-off between equity and efficiency. Equity is designed to give benefits where they are most needed. When equity is the overriding objective, the system can become overly complex, raising the costs of compliance, increasing the need for specialist advice and reducing the benefits since many participants will not understand how the system works. Efficiency is improved through simplification, which lowers the cost of compliance, makes the benefits understandable to a wider group of people and typically promotes confidence and better planning. The trade-off is that the benefits are not as carefully distributed across taxpayers, requiring rules, such as limits on annual contributions, to prevent abuse.

If the major political parties value equity and efficiency differently, Australians planning for retirement might assume the rules will change with a change in government. When tax concessions are given at the start of the planning horizon and not the end, it is harder for any future government to take these concessions away in a manner that penalises those that have already saved. The danger when significant tax concessions lie at the end of the planning horizon, as they do when taxes on benefits are eliminated, is that a decision to reintroduce taxes on benefits will penalise those who have already made contributions.

Despite this tax rule uncertainty, the proposals provide a significant improvement to the existing system, which has become so complex that tax advice around retirement has been essential and few investors have understood the advantages of making voluntary contributions. The advantages are larger and much clearer than with the current system. Finally, even for those with equity concerns, it is possible to limit any taxpayer's access to benefits without changing the underlying simplicity of the proposed system, through measures like further restricting the level of annual contributions.

 

 

Four Ps: pass or fail? - Column
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