Just as the nation strives for gender equality, it should seek equality of benefit outcomes under proposed changes to superannuation. Whatever superannuation policy the government ultimately chooses to implement it should treat all superannuants equally, no matter their accumulations, age, current or post employer and employment history.
Although the government appears committed to increase the fairness of the system with its proposed legislative amendments (such as proposing catch up contributions, allowing self-employed workers to claim tax deductions for super contributions and introducing the superannuation tax offset for low income workers) there are still potential inequalities in the proposed changes.
Some areas of potential unfairness that have received focus in the media recently include the difficulty of a 50-year-old reaching $1.6 million in superannuation given the $500,000 non-concessional cap if they have focussed on family costs and mortgage and not superannuation to this point, as well as the sudden change in the transition to retirement arrangements.
Another area where there are potential inequalities remaining (despite efforts to introduce fairness) would be recipients of defined benefit pensions, on which we focus this article.
A proportion of Australians currently retired or planning to retire would have joined the workforce during an era when a defined benefit superannuation plan was common, although such plans have since mainly been phased out, with entitlements grandfathered.
We understand the government are attempting to ensure superannuation taxation for all schemes both in the public and private sectors will be equivalent and there will be equality of treatment in relation to retirees or those planning for retirement.
For example, it announced that from 1 July 2017 it would include notional and actual employer contributions in the concessional contributions cap for members of unfunded defined benefit schemes and constitutionally protected funds. Previously, members of these schemes could receive their annual entitlement to the defined benefit pension but also sacrifice salary and invest in a conventional accumulation fund, which could be considered “double dipping”. The proposed change will bring the treatment of these individuals in line with those working in the private sector.
The government reportedly estimates about 150 retired politicians, 170 ex-federal judges and about 1000 retired public servants will be affected initially, with workers in defined benefit superannuation funds earning about $150,000 a year no longer able to avail themselves of the annual salary-sacrifice cap for any complementary accumulation accounts they might have.
The government also stated that it had decided to ensure equivalence to the $1.6 million tax free super cap by legislating for 50% of defined benefit payments over $100,000 from unfunded schemes to be taxed at the individuals’ marginal rate. For funded schemes, the 10% of the defined benefit that is tax free will be capped at $10,000.
The $250,000 threshold above which Division 93 tax is levied would also apply to defined benefit scheme members, as would the $500,000 lifetime non-concessional cap.
However, there are still elements of difference between the treatment of super funds of most Australians and those with defined benefit funds.
For example, individuals classed as state higher level office holders who have super contributions made on their behalf into a constitutionally protected fund are exempt from the 15% higher tax on their superannuation even if they earn over $250,000. This includes state ministers and their staff, state governors and their staff, state MPs and heads of Department, judges, justices or magistrates of state courts. The same applies to justices of the High Court or a Court created by parliament.
Certain individuals who were members of a defined benefit fund in 2009 also have special arrangements that ensure they cannot exceed their concessional cap, even if their notional contributions exceed the $25,000, grandfathering previous arrangements. These members will not have to use their non concessional caps for the overflow of concessional caps.
As can be seen in the table below, using data from the Public Sector Remuneration Report, in some cases the benefit of such an arrangement may be considerable for senior executive employees. Approximately 90% of these executives are part of defined benefit schemes.
For those without grandfathered benefits, additional contributions become non-concessional contributions. If the $500,000 cap has been exceeded in a defined benefit account, employees can remove equivalent amounts from an accumulation account to rectify breaching the cap.
Another element of the superannuation proposals that could cause inequality is that the basis for asserting the equivalence of the $1.6 million cap and the taxation of defined benefit payments over $100,000 is unclear. Ian Hosking, financial adviser with Fiducian Financial Services told the Australian that this was one of the most worrying aspects of the budget night announcements.
Echoing this concern, former Professor of Econometrics at the UNSW Ron Bewley (himself a defined benefit pension recipient) completed an analysis of the expected income from $1.6 million tax free in super and a $100,000 a year tax free defined benefit and found that there was “serious doubt that there is any reasonable comparability”.
He highlights that for indexed defined benefit pensions, not only does the government foot the bill for the longevity risk, but the inflation risk as well, which can be expensive to insure against. A superannuation member incurs these risks themselves as well as market risk. He also notes that after the death of the defined benefit recipient, younger spouses can receive a reduced pension for the rest of their life.
Bewley disputed the government’s statement in the budget papers that a “balance of $1.6 million could support an income stream in retirement of around four times the level of the single Age Pension”. He examined this level of drawdown and found that the median life of the fund was likely to be around 20 years, there was a 10% chance that funds would be exhausted after only 16 years, and a 1% chance that they would be exhausted after only 14 years.
“I disagree in the strongest terms that a $1.6 million super fund is in any way equivalent to a pension of four times the Aged Pension. Obviously, drawing down, the defined-benefits assumption of $100,000 per annum would run out quicker than the lesser $90,884 pa – and that does not even allow for the possibility of a surviving spouse!”
Bewley’s next paper will reportedly show that capital of $3 million or more is required to receive a $100,000 per annum income stream. The Australian Shareholders Association notes that with current pricing, purchasing an annuity with the $1.6 million secures an income of $60,000.
If the government is not in a position to legislate to ensure equality of treatment of every constituent, it would be our assessment that until it is in such a position it should not set about changing the arrangements of retirees who have been planning and provisioning in many cases over a period of up to 50 years in the workforce.
We acknowledge the difficulty, however, of achieving equality. Government-employed defined benefit recipients may have sacrificed future reward arrangements in the private sector to join the public service with the expectation that they will receive a defined retirement allowance. In the cases of judges, by way of example, they may have left a successful law practice. Others may well have made significant personal sacrifices to build adequate resources within a retirement fund to equally provide benefits which would enable them to be comfortable in retirement.
The government’s commitment to the universality of treatment arising from the superannuation changes is unclear. One example of a potential complication is the case of justices of the high court, who cannot have their remuneration reduced during their period in office – the reason they are exempt from Division 293 tax.
The recent changes to the inclusion of funded defined benefits payments as income for the calculation of pension entitlements have demonstrated how irate members can become if previous arrangements alter. The protest has been particularly heated given some defined benefit schemes, including those for the military, are exempted. A sign that those affected by the superannuation changes may be similarly vocal has come this month as it surfaces that a Melbourne QC has started a lobby group to protest the government’s proposals.
Egan Associates acknowledges that government need the resources to meet their varied obligations but equally are of the view that any policy change should lead to equivalent fairness of treatment and impost on every citizen who has planned for retirement and made sacrifices of varying proportions to secure an income beyond their employed years.