On Friday, the government announced a number of significant changes to superannuation. The purpose of this strategy note is not to list them, but now that the dust has settled, to discuss the implications of the proposed reforms and what it means for those in the accumulation and pension phases of super.
The principal characters in this dramatic turn of events (brought forward from the May 14 Budget due to frenzied media speculation) are Wayne Swan, Julia Gillard and Tony Abbott. The intriguing question is this: who is Tuco, who is Blondie and who is Angel Eyes?
When Peter Costello made pension income streams tax free in 2007, super balances in excess of $5 million were extremely rare (except perhaps for retired politicians like, err, Peter Costello). Such a balance generates annual income and capital growth in excess of $300,000. Is it right and fair (apologies for using such a truly awful word) that this sum should be entirely exempt from tax? Will the imposition of a 15% tax cause the wealthy to abandon super? Will this put more pressure on the age pension? No, no and no. We see no philosophical argument with introducing a tax on the dividends and capital gains of assets in pension phase, and we rather like the $100,000 per person tax-free threshold (which effectively exempts a husband and wife SMSF balance of $4 million). Whilst Tony Abbott and the business media have worked themselves into a frenzy, it really is more a case of move along, nothing to see here.
Where we do have issues and concerns are focused on the following:
- Firstly, the new 15% tax should not apply to those who have already retired. These folk planned their retirement on the basis of a tax free pension. Those of us with plenty of working years left can simply adjust our retirement plans accordingly; however, those who are no longer in the workforce have fewer options. This seems unfair.
- Second, we are surprised that Julia Gillard has put her name to a tax on pension assets having made the following statement on Feb 6th, ‘the government reaffirms that it will never remove tax-free superannuation payments for the over-60s’. Technically her statement still holds, as the proposed tax is on income earned not pensions withdrawn. But whilst the letter of the law remains intact, the spirit most certainly isn’t.
- Thirdly, every small tinkering with the super system weakens it further. Why, oh why, can’t governments grasp this simple fact?
- Fourth, the 15% tax will raise almost no additional tax revenue (just $90 million a year). Hence, it really is an ideological tax. The reaction from nearly all sides of the political spectrum has been negative. Why go through so much pain for so little gain? It just doesn’t make sense.
- Fifth, it has made the super system massively more complicated. This really is a gift horse to the financial advice industry from the government. Great news for us and your accountant – not so good for you!
- Sixth, it has failed to address the single greatest weakness of Australia’s super system – the ability to withdraw the entire lump sum tax-free once a condition of release has been triggered.
The Good
The good news is that it could have been a whole lot worse. Perhaps this was Labor’s strategy all along. Leak a whole series of tax grabbing, bash-the-rich, destroy self managed super fund measures, and then announce a relatively mild and [whisper it] pragmatic series of reforms.
Tony Abbott is wrong to announce that he is against all the proposed reforms as there’s quite a bit to like, namely:
- The increase in the concessional contribution to $35,000 for those aged over 50 (from Jul 14).
- A very sensible proposal to stop the egregious practice currently in place that penalises those who make tiny excess contributions to their super fund.
- Tax concessions for deferred annuities.
- Politicians defined benefit pensions (nirvana, in our opinion) will also face the new 15% tax. It must be an election year!
- Transition-to-retirement pensions are to be left alone despite being in the firing line. In fact, this type of pension strategy will now be even more valuable given the new higher concessional contribution limits.
The Bad
- The proposed abolition of capital gains tax relief sounds innocuous (after all CGT will only be 10% for assets held for more than a year) but the application of CGT to pensions is nightmarishly complicated.
- Advice and accounting fees are likely to rise due to the significant increase in complexity. How will the ATO police multiple super funds? How will the new rules apply to SMSFs with two member balances?
- The establishment of a new Council of Superannuation Custodians to ensure that any future changes are consistent with an agreed Charter of Superannuation Adequacy & Sustainability. Whichever political party is in power, this looks like a recipe for the ‘great and the good’ of the Australian Establishment to meddle, tinker and generally screw things up.
And The Surprising
We are (mostly pleasantly) surprised at the following:
- There was no mention of the government’s earlier proposal to double the tax rate to 30% on concessional contributions for those earning over $300,000. Maybe they forgot?
- No proposals to tax large lump sum withdrawals.
- No change to the ability to buy property and then gear it up – a practice that is unfortunately attracting the ‘white shoe’ brigade to SMSF advice.
- No removal of the ability to refund franking credits. * No further kicks in the guts to self managed super funds.
Future Super Strategies
Like all changes made with good intentions, there are plenty of unintended consequences that will lead to new strategies being pursued. Here’s a few for starters:
- Given that accumulation and pension balances over $2 million will face similar rates of tax, there are no longer any obvious benefits to converting all super assets into a pension. It may make more sense for those with very large balances to commute their pensions back into accumulation phase, and leave the balance to the kids. They will like this strategy.
- Capital Gains Tax will apply to existing assets from July 2014. Hence next financial year will be the last opportunity to sell assets with large capital gains to reset the cost base.
- Strategies will now focus on finding assets whose returns are expected to come more from capital growth than income. Not only are capital gains taxed at a lower rate (10% versus 15%), but by pursuing a buy-and-hold strategy, CGT can be deferred indefinitely and ultimately paid by the children. They will not like this strategy.
- Super splitting is back in vogue. As much money as possible will need to be transferred to the lowest earner.
- Super balances for those with large balances should be as similar in size as possible. It may make sense to withdraw money from the larger account balance and re-contribute (provided you are under 65) to the smaller balance.
- The tax free component will need to be maximised.
- A retired couple can hold almost $1.4m in assets outside super and pay no tax. This will now become a central part of financial planning for those with super balances in excess of $2 million.
- We expect Super to become a more marginal investment strategy for the very wealthy. The tax benefits are no longer as compelling, and there remains the fear that the tinkering will continue and lead to something far more draconian such as forced annuities or compulsory investments in certain favoured government sectors, such as infrastructure.
With sincerest apologies to Sergio Leone.
