Superannuation – the New Elephant in the Room

This year is the twentieth anniversary of Australia’s superannuation guarantee system and, as such, it’s unsurprising that the scheme is the subject of continuing debate.

Its billions of dollars in tax concessions are also an ever more promising target in times when the government is desperately trying to achieve the promised surplus amidst disappointing income flows.

In the budget this year, the government announced an additional 15% tax (on top of the existing 15% flat rate) on concessional superannuation contributions from 1 July 2012 for individuals whose income exceeds $300,000. It also delayed the start of a higher $50,000 annual cap for concessional contributions of individuals over fifty by two years to 1 July 2014. The current concessional cap (above which contributions to superannuation attract excess contributions tax) is $25,000.

Speculation has been rife that there might be more changes to the system to help achieve a surplus, although any changes seem unlikely to be announced until the 2014 budget. According to an Australian Financial Review report last month, capital gains tax breaks for self-managed superannuation funds are the most clear cut target. Self-managed superannuation funds are entitled to a capital gains tax discount of one-third, if the asset in question is owned for at least 12 months.

A recent study by CPA Australia on household savings has now thrown more fuel onto the fire, coming to the conclusion that despite the sacrifice of around $30 billion in tax revenue annually to fund the superannuation system, individuals are still falling back on the old age pension.

The report found that although Australians’ superannuation balances, property holdings and other assets had grown between 2002 and 2010, so had their debt. Non-retired households aged 50 to 54 years had a debt to superannuation ratio of 91% and even those close to pension eligibility had a ratio of 42%. Women, on average, accumulate $149,000 in superannuation by age 60 to 64 if they do not retire early and men $266,000.

This debt has led to an expectation of a higher standard of living than had been the case when the superannuation scheme was put into place. The 9% superannuation scheme was meant to fund a retirement wage that was 40% of the pre-retirement wage. This was not going to meet most people’s expectations, which led to the new proposed compulsory adjustment to 12% superannuation contributions. The superannuation rate is being increased gradually with increments of 0.25 percentage points on 1 July 2013 and on 1 July 2014. Further increments of 0.5 percentage points will apply annually up to 2019/2020, when the superannuation rate will be set at 12%.

The debt has also unfortunately led to lower non-superannuation savings coming into retirement. Each dollar contributed as superannuation is offset by a 30 cent reduction in other savings, CPA Australia stated.

“The wealth of Australian households increased by 38% in real terms between 2002 and 2010 and the growth in wealth of those households aged 50 to 64 years was slightly less at 35%. It could have been expected that this age group would outperform the overall average as they are motivated by their close proximity to retirement. So what went wrong?” the report asked.

CPA Australia’s theory was that because households knew the superannuation funds were coming, they were not as careful with how they spent their money as they would have been if they had not had those funds coming. They used the equity in the family home to travel, retire early or help their children participate in the property market. Lump sum superannuation payouts were then being treated as a “windfall” to pay off debt or spend on the lifestyle the family had become accustomed to, rather than considered as income for retirement.

Although most people had the family home to fall back on if superannuation ran out, it was not often that people were willing to downsize to release funds for retirement, according to CPA Australia, which said they were discouraged by the fact that the family home is exempt from the means testing of the age pension.

When these households start to draw on the pension, it will have a serious impact on Australia’s budget bottom line, CPA Australia warned.

“The government is effectively funding a $30 billion per annum tax concession that will do little if anything to relieve pressure on the cost of providing the age pension to retirees and the impact on the public purse,” it concluded.

It urged the government to consider limiting the amount of superannuation that can be taken as a lump sum, instead encouraging an income stream in retirement. Superannuation Minister Bill Shorten has agreed that there “does need to be a national conversation about the best policy settings for the final third of people’s lives”.

Egan Associates believes superannuation is looming as a significant issue affecting multiple stakeholders that will need to be tackled with care. Some of the issues were addressed by Jeremy Cooper’s report into superannuation, which has led to government focus on governance within the superannuation and related funds management sector.

Employees will want a consistent scheme that will be a safety net for their retirement and on which they can base their financial planning. Employers will want to manage their costs, adding the incremental superannuation increases onto the Fair Work Australia determined minimum wage rises, keeping the broader economy, productivity and consumer price index levels at front of mind. The government has the most important role: establishing the policy setting. It will want to increase the number of people who are drawing on their own funded pension, while containing the amount it needs to spend to fund these schemes.

In order for the government to stop people spending everything at once then going onto a government pension, it will have to decide whether to allow pension funds to be partially or fully converted to a lump sum, what tax, if any, would apply to such a conversion, or whether there should be a mandatory requirement for all accumulated retirement plan funds to be retained for the purpose of an annual pension. We believe it may be best to increase concessional contribution limits while reducing the lump sum conversion to a percentage of the superannuation balance and prohibiting it altogether if the superannuation balance is below a certain amount.

On the government’s deliberations as to whether it should change superannuation tax concessions, it is important to consider the needs of the employee for a consistent scheme that provides certainty and doesn’t change regularly as the need for unplanned government funding arises. It’s also important to keep in mind that the aim of the scheme is to have Australians save for their retirement. Given that contributions are inaccessible until the preservation age, the government should either consider removing or substantially increasing the limit on non-concessional contributions that can be paid into the super fund, while taxing lump sum withdrawals at the marginal tax rate.

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