Superannuation rort for the wealthy remains despite unfairness

It only takes a few people to disrupt things for everyone else and that appears to be happening at the moment with superannuation.

The “rort”, which at this stage is entirely legal, is to build up superannuation funds to well in excess of what is required for actual retirement and then use the tax-sheltered environment as an investment account to be withdrawn at some stage after reaching the retirement age.

More than 11,000 people now have super balances above $5 million, which many super experts have said is far in excess of what could be required in retirement.

The rort appears to be growing too, with more than 370 Australians younger than 30 now having superannuation balances exceeding $2 million, which is fairly convincing proof that super is being used by some as a tax planning vehicle.

All told, there are about 80,000 uber-wealthy self-managed super funds that are way above what is required to achieve a very comfortable standard of living in retirement.

Big benefits to having excess super

While the maximum that can be rolled over into a super pension at retirement is currently $1.7 million, there are benefits to amassing a much higher amount in super during the accumulation stage because the maximum tax on contributions and earnings is 15%.

That is much lower than the tax payable to someone earnings the top marginal tax rate, which is where the advantage for the wealthy cuts in.

The government’s retirement income review found a person with a superannuation balance of $5 million could achieve annual earnings tax concessions of about $70,000.

Mercer calls for $5 million super cap

Retail funds management company Mercer said the answer to the problem of inequality in the super system should be to limit the amount that can be saved within super to $5 million.

Mercer senior partner David Knox said super balances of more than $5 million were “clearly in excess of the amount required for the vast majority of Australians to maintain their standard of living during retirement”.

Other organisations to push for a cap on balances of $5 million include the Australian Institute of Superannuation Trustees and Super Consumers Australia.

The SMSF Association has said that the government should act to force people with excessively large super balances to withdraw some of their money or face higher tax rates but has not proposed a cap.

Problem of wealthy tax concessions is growing

It has long been known that the lion’s share of superannuation tax concessions goes to high income earners and the wealthy but the rapid build-up of excessive balances shows that the problem is worsening and could make the interaction between the super and taxation systems even more unfair.

Under the Mercer proposal, the 11,000 individuals with excessive super balances would be compelled to reduce their balance to $5 million by the age of 70 or 75. There would be a transition period to avoid forced disposal of assets such as property.

“What we’re really saying here is that the taxation support for super is there to enable Australians to maintain their living standards in retirement up to a reasonable level,’’ said Dr Knox.

“We’re not there to support flamboyant lifestyles or estate planning.”

One big super fund earns 3.1 pensions a year in tax concessions

That claim is borne out by Mercer research that showed the tax concessions enjoyed by a single $10 million self-managed super fund could fully fund 3.1 full aged pensions.

That is not a fantasy figure either – there are 27 SMSFs that hold more than $100 million each in concessionally taxed savings in the 2018-19 financial year, including one mega-SMSF that had accumulated $544 million.

Those numbers are likely to have increased since then.

Mercer also proposed that people with superannuation balances above the transfer balance cap of $1.7 million should be forced to draw down at least some of their retirement savings.

At the moment, retirees with more than $1.7 million in super can leave their excess funds in an accumulation account and continue to get a generous concessional tax rate of 15% even as they live on a very comfortable and tax-free pension.

Shock extension of 50% minimum drawdown cut won’t help

The issue of fairness within superannuation has not been helped by the unexpected announcement by the Federal Government that the minimum drawdown rule for account-based pensions will be halved for a third financial year due to the COVID-19 pandemic.

That pre-budget announcement is presumably designed to allow for retirees to avoid the need to sell assets for a lower-than-expected price due to depressed share markets due to the pandemic.

There may have been a case for that in the first year of the pandemic when share prices plunged but the following two years have so far not suffered from depressed prices so the logic for the 50% cut does not seem to hold.

While the promise to cut minimum drawdown amount by half doesn’t really cost the government anything initially, the 1.8 million people who rely on other income or eat into their savings to keep their super balances higher will get now further years of tax-free income out of their account-based pensions – assuming they live that long.

The change means that someone under 65 on a super pension must only withdraw 2% rather than 4% a year progressing all of the way up to a 95-year-old who must withdraw only 7% rather than 14%.