Australia’s tax system for superannuation is one of the most complex for pensions of anywhere in the world. It’s costly to administer, regularly being tinkered with, hard to understand, and a driver of wealth inequality.
Whoever forms government later this year must prioritise its reform to ensure a fairer and simpler system for all Australians.
While the Retirement Income Review did not make any recommendations about superannuation taxation, it found that the cost of the super tax concessions is projected to grow as a proportion of GDP and that improvements in targeting these concessions would improve the equity of the retirement income system. The big question is: How to do it?
Most occupational-based and personal pension systems worldwide receive some form of taxation concessions compared to the personal income tax system. The most common arrangement is that contributions (often up to a limit) and investment earnings are not taxed. In contrast, the benefits are taxed as personal income during retirement.
As income during retirement is normally lower than income during working years, the tax rate paid on retirement benefits under a progressive income tax system is normally lower than that which is paid during the pre-retirement years.
However, the Australian system sees tax paid on concessional contributions and investment earnings during the accumulation phase, with no tax generally payable on the benefits received after age 60 and, in most cases, on the investment earnings during the pension phase.
Tax concessions need fixing
There are good reasons to provide some superannuation taxation concessions. Superannuation is a long-term investment and this needs to be recognised within the tax system. Taxation incentives have also often been introduced to encourage certain behaviour, such as saving for retirement.
They are an important part of the system, but they need fixing.
Here’s what’s needed. Firstly, a concession of 15-20 per cent should be applied on all concessional contributions – subject to the current annual limits. Secondly, a tax rate of 15 per cent (10 per cent on realised capital gains) should be applied to all investment income received by superannuation funds. Thirdly, all accumulated benefits should be required to be gradually drawn down during retirement, providing tax-free income. And lastly, there should be a $4,200 government superannuation contribution to all primary carers following the birth of a child, thereby contributing to a reduction in the gender super gap.
It’s an ambitious, but not at all unrealistic, set of reforms.
The steps which need to be taken
Several steps need to be taken to provide a concession of 15-20 per cent on all concessional contributions.
The income limit to receive the Low-Income Super Tax Offset (LISTO) should be increased from $37,000 to $45,000 and the maximum LISTO payment should be raised from $500 to $710. This is equal to the tax paid on an employer superannuation contribution of 10.5% at an income of $45,000
The government should also introduce an additional LISTO payment equal to 15% of concessional contributions for individuals with taxable incomes less than $21,884 (i.e. the effective tax-free threshold) so that everybody receives some form of government support for their super.
To achieve this outcome in a cost-neutral way, a tax rate of 15 per cent (10 per cent on capital gains realised after 12 months) should be applied on all investment income received by superannuation funds. That is, the tax exemption on investment income from assets supporting pension payments, which provides greatest support to higher income earners, would be gradually removed.
Practical measures could also be taken to ensure accumulated benefits are gradually drawn down during retirement. This would include requiring all individuals with superannuation balances more than $5 million to withdraw assets above this limit and to apply the minimum drawdown rules to all superannuation assets from a particular age (say age 70 or 75).
These changes would enable the transfer balance cap to be abolished, as investments supporting pensions in payment would no longer attract special tax concessions. In addition, the tax paid on a member’s death in respect of their superannuation assets should be abolished as all accumulated benefits would be gradually withdrawn. These changes would make the system much simpler for retirees.
Lastly, and to further reduce the gender super gap, the government should make a superannuation contribution of $4,200 to all primary carers in the first year of a child’s life and increase the carry-forward period for unused concessional contributions from five years to at least ten years, providing additional flexibility.
These changes would re-balance superannuation tax concessions from higher-income earners (where men outnumber women) to lower-income earners (where women outnumber men) and help address the gender super gap in a cost-neutral manner, as well as simplifying the system.