Experts propose controversial super tax overhaul

Here in Australia, we tend to be quite proud of our superannuation system and with some justification.

With a combination of regulatory carrot and stick, we have managed to build a $4 trillion nest egg that is one of the largest in the world and will guarantee a dignified retirement for a large slice of the population.

Of course, the carrot is the nest egg itself which is designed to use a combination of compound earnings and low tax over time to produce an amount of money that would otherwise not have been available.

The stick is obviously the fact that an increasing part of your salary – soon to rise to 12% – is quarantined from immediate consumption and stored away for a very long time until retirement age.

If there is a weakness in Australia’s retirement system, it is the lack of a clear system to produce retirement income.

We’re still not up to the retirement leaders

That weakness has prevented Australia from overtaking some of the global leaders such as the Netherlands, Iceland and Denmark, all of which provide a solid system of providing income through retirement.

Fortunately for us, some of those involved in the super system have suggested some alternatives that should be considered – although changing a live system is always difficult if it produces some winners and losers.

Mercer recently produced a report which suggested some changes and earlier the Actuaries Institute produced a paper which proposed some more far reaching and challenging changes.

Most of the Mercer recommendations are around simplifying the super system, which in itself is a worthwhile goal given the lack of engagement by many Australians and the complexity of super, which can lead to some costly mistakes and anxiety around retirement.

Income products for those between 65 and 75

Mercer recommended that superannuation trustees be allowed to offer members aged between 65 and 75 the option to transfer their accumulated benefit into an eligible retirement income product – which would also need to be deemed suitable for the relevant member cohort – provided by their super fund.

Importantly, these so called ‘soft default’ products would generally be fully portable, allowing individuals to transfer their full balance to another retirement product within the same super fund or to a different fund.

Individuals would also be provided with additional information or limited financial advice by the trustee and the products would specify a level of drawdown or regular payment, and a projected income.

Automatic income products from 75 years old

Under the Mercer suggestion, from the age of 75, the opt-in basis would no longer apply, and income would be automatically provided from pension products – mirroring the requirement in the US, where required minimum distributions to start at age 73.

Mercer also recommended that the government introduce legislation to simplify and strengthen the transition from accumulation to the retirement phase and so provide better outcomes for older Australians.

Interestingly, the report also suggested a slight variation to this recommendation, proposing that no minimum drawdown would be required for balances below $30,000.

This is based on the super company’s real-life observation that many older Australians want to maintain a capital buffer or “rainy day” fund to cover unexpected expenses, even when they are on the full age pension.

Actuaries want to share tax burden across generations

The ideas put forward by the Actuaries Institute would be a lot more controversial because they would require increasing the tax burden on already retired Australians – something that any Government might find a “courageous” decision.

The idea is that rather than paying a 15% tax on super tax earnings in the accumulation phase and no tax at all in the retirement phase, a blanket tax of 10% on earnings throughout your life.

The aim of this proposal is to rebalance the pension system in favour of younger people – something that might get a receptive response from struggling millennials at a time when Baby Boomers are at the top of the consumer spending pile.

However, it would be a very difficult “sell” to the cohort of already retired or about to retire Australians who are accustomed to the idea that they don’t pay any tax on their retirement savings once they start drawing them down.

Just one account needed

One of the benefits of the Actuaries Institute idea is that there would only be a single account needed whether you were in accumulation or decumulation mode – indeed, you could probably switch back and forth without any change to the tax treatment of your super.

The report also recommends closing the loophole to tax super in the hands of non-dependents once the superannuant has died.

At the moment there are a couple of ways around paying this tax – the most bizarre being the system of “laundering” taxable super payments by withdrawing them from the system and then recontributing them again.

It can also be “dodged” by withdrawing funds from super before death – a fairly uncertain method should someone get a sudden illness.

One way or another, it would certainly be good policy to treat all super benefits equally when they are inherited by non-dependents without needing to resort to strange tactics that are arguably more available to those who can afford financial planning help.

A new way to tax the wealthy

Another interesting wrinkle in the Actuaries Institute report provides a new and potentially much better way to prevent super being used as a tax dodge for the very wealthy.

At the moment the Federal Government’s proposal to add a 15% earnings tax to any personal super account greater than $3 million (called the Division 296 plan) is in limbo, not having passed the Senate.

Already income stream products are limited to $1.9 million per person but under the Actuaries Institute plan, wealthier retirees would be hit with more tax on the income side of the equation, with anyone earning more than $150,000 a year in super hit with an extra tax above the proposed 10% earnings tax.

That would effectively maintain the current threshold for wealth taxes in super.

The report’s authors acknowledge the difficulty of taxing retirees who are currently tax exempt but says: “the dollar value (of the tax) would be low for those with low- to medium-sized balances and compensation could be provided by, for example, adjusting the age pension.”

Another controversial recommendation is imposing a penalty on any lump sum withdrawals above $250,000 a year, which would hit those who try to pay down a large mortgage quickly once retired.

The report does have the advantage of being cost-neutral in trying to level the taxation playing field across retirees and super savers.

All of which would make the plan to tax super income for the wealthy potentially appealing to the Albanese Government, should it be re-elected but find itself still unable to pass the current $3 million super tax bill.