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Tax Change of the Treatment of Earnings on #Superannuation Assets Supporting Income Streams

Apr 05, 2013

Joint media release by Federal Treasuer Hon Wayne Swan and the Hon Bill Shorten MP Minister for Employment and Workplace Relations & Minister for Financial Services and Superannuation

The Government will better target the tax exemption for earnings on superannuation assets supporting income streams by capping it to the first $100,000 of future earnings for each individual.

In just four years, 20 per cent of Australia's population will be over 65.

Australians are living longer and in this context the superannuation system needs to be fair and it needs to be sustainable. This change will help restore a number of the original intentions of the superannuation system, to keep the system fair and sustainable.

Under current arrangements, all earnings on assets supporting income streams (superannuation pensions and annuities) are tax-free, in contrast to earnings in the accumulation phase of superannuation, which are taxed at 15 per cent.

From 1 July 2014, future earnings (such as dividends and interest) on assets supporting income streams will be tax free up to $100,000 a year. Earnings above $100,000 will be taxed at the same concessional rate of 15 per cent that applies to earnings in the accumulation phase.

The $100,000 threshold will be indexed to the Consumer Price Index (CPI), and will increase in $10,000 increments. Assuming a conservative estimated rate of return of 5 per cent, earnings of $100,000 would be derived from individuals with around $2 million in superannuation.

Special arrangements will apply for capital gains on assets purchased before 1 July 2014:

  • For assets that were purchased before 5 April 2013, the reform will only apply to capital gains that accrue after 1 July 2024;
  • For assets that are purchased from 5 April 2013 to 30 June 2014, individuals will have the choice of applying the reform to the entire capital gain, or only that part that accrues after 1 July 2014; and
  • For assets that are purchased from 1 July 2014, the reform will apply to the entire capital gain.

These generous transitional arrangements will ensure that people who have already purchased superannuation assets will have ten years to decide whether they want to restructure their superannuation holdings, before their capital gains start to be affected.

This reform will not affect the tax treatment of withdrawals. Withdrawals will continue to remain tax-free for those aged 60 and over, and face the existing tax rates for those aged under 60.

Former Treasurer Paul Keating introduced taxation arrangements for superannuation in 1988 which taxed contributions and earnings in the accumulation phase at a rate of 15 per cent. The 15 per cent tax rate did not apply to earnings on assets supporting income streams, because the payments from income streams were taxed at personal marginal tax rates in the hands of the individual, less a 15 per cent tax rebate.

Former Treasurer Peter Costello made payments from income streams tax-free for those aged 60 and over, however he did not change the tax treatment of the earnings on these assets. This has allowed retirees with millions of dollars in superannuation to receive more government support through tax concessions than Australia's poorest Age Pensioners.

For example, the maximum rate of the single Age Pension is currently $21,076 per year. In comparison, tax-exempt earnings of $100,000 receive a minimum tax concession of $26,447 each year. That means that an individual with around $2 million in superannuation (assuming a 5 per cent rate of return) currently receives more government assistance than someone on the maximum rate of the single Age Pension.

A retiree with $20 million in superannuation with typical returns would receive more than 20 times the government support provided to someone on the full Age Pension (over $438,000 compared to $21,076 a year).

This arrangement isn't fair and it isn't sustainable. This was never the intention of the superannuation system left in place by the Labor Government in 1996. That system included 'Reasonable Benefit Limits' that were specifically designed to place a limit on the amount of tax concessions that an individual could receive, by taxing withdrawals above that threshold at full marginal tax rates.

These Reasonable Benefit Limits were abolished by the previous Liberal Government. Had they not been abolished, the Reasonable Benefit Limit applying to a person who takes more than half of their superannuation as an income stream would today be set at around $1.8 million in superannuation assets.

For superannuation assets earning a rate of return of 5 per cent, this reform will only affect individuals with more than $2 million in superannuation assets supporting income streams.

Treasury estimates that around 16,000 individuals will be affected by this measure in 2014-15, which represents around 0.4 per cent of Australia's projected 4.1 million retirees in that year.

This reform will save around $350 million over the forward estimates period.

Applying the same treatment to defined benefit funds

The Government will ensure that members of defined benefit funds, including federal politicians, are impacted by this new reform in the same way as members of defined contribution funds (i.e. that there will be a corresponding decrease in concessions in the retirement phase).

This will be achieved by calculating the notional earnings each year for defined benefit members in receipt of a concessionally-taxed superannuation pension. These calculations will be based on actuarial calculations, and will depend both on the size of the person's superannuation pension and their age. The amount of notional earnings each year will fall as a person grows older, in the same way that yearly earnings for people in defined contribution schemes fall over time as they draw down their capital.

Where a person's notional yearly earnings exceed the $100,000 threshold, the amount in excess of $100,000 will be subject to tax at a rate of 15 per cent.

This reform will save $6 million over the forward estimates period.

Mr Taxman's comment:

Timid was the first word that came to my mind.  I think this is a fairly tame change on the taxation of superannuation and was expecting something that was going to affect a greater majority of Australians.  

Hardly anyone will be deriving an income from their super of more than $100,000 and to be honest I don't think they would be too upset to have to pay a mere 15% tax on the excess.  Taxing a potential 16,000 retirees out of a population of 22 million really isn't that much of an issue, particularly as they clearly aren't on Struggle Street.  If you earnt the same amount outside of the super environment, you would be paying 38.5% ... so when put in perspective 15% is really generous.  The rich families will be drawing $200,000 ($100,000 for both husband & wife) tax-free, so if they complain about paying a small amount of tax then they would probably complain about anything. 

Now there will be some that will be grumpy about the tax change & will everything in their power to get around it.  So what strategies could be deployed to get around this new tax rate?  First of all there is almost 15 months to get your ship in order as the changes are not effective before 1 July 2014.  Secondly, well I need to look at the detail of the proposed legislation alot closer before stringly advising this, but I suspect that an investment strategy which incorporates the receipt of fully franked dividends will be quite a popular way to reduce any potential tax as the receipt of 30% franking credits will more than cover the proposed extra tax.

Will there be future changes on the taxation of superannuation in Australia?  of course there will be - regardless of the Government in power.  From starting with a base close to nil in 1992 (when the compulsory 3% super guarantee levy was mandated), the superannuation industry has grown to one of Australia's largest with more than $1.4Trillion in total assets.  It's size is approximately 105% of Australia's GDP. That is some growth in 21 years ... imagine what it will look like in 21 years from now??

What would I change about super?  There are three things that I would change.  Firstly, I would introduce a deemed disposal of any capital appreciating assets prior to transferring a super fund from accumulation to pension phase.  I shudder to think how many capital gains on shares & property that we have missed out on & continue to miss out - and before everyone gets to upset the CGT rate for super funds is only 10%.  Secondly, a bit like what we saw today, I would introduce a marginal tax rate for those super funds in accumulation phase. This may mean a rate lower than 15% for the first step which would obvioulsy benefit the majority.  Thirdly, I would scrap the concessional cap limits as a result - or at the very least increase them substantially than their current levels. If you want to put extra into super then by all means do it but be aware that if you put in too much, the marginal tax rate system proposed in step two might not make it effective in putting all your eggs into super, particularly when you factor in the time cost of money (between putting it in now & accessing it in retirement).    

Tags: RetirementSMSFSuper

Author: Wayne Swan & Bill Shorten

Comments

"Dear Adrian, When I began my career in the super industry in 1975 it was in corporate S23F and S79 fund consulting. In 1978 my interest turned to SMSF which has been where it has remained dealing with small businesses. At that time the only tax on super was levied on receipt of 5% of the benefit received at the individual’s marginal rate. This mostly equated to tax due of less than 2.5%. Hawke had a Gillard moment when he announced that he would not increase taxes on super. The rest is history, he and Keating introduced new taxes on contributions and on super income. Later john Howard brought in the superannuation surcharge levy but later repealed it, Now all the taxes on super are Labor “REFORMS” while Ms Gillard and her top ten ministers will share around $50 Million in super mostly paid for by taxpayers who also bear the full cost of market risks and in effect pay all the taxes levied on the benefits. It is past time this rort is fixed not more tax levied on small business people who have actually worked in the real world unlike the political glitterati ratbags in Canberra who produce nothing but do create impediments to the rest of the real worker population. So please Adrian do not encourage them to steal more from us by justifying their theft. Earlier this year we did some admin work for a small fund which had two members and $4.5M in assets, now in their late 60’s their fund is averaging $270,000 in member pension benefits, if the new tax becomes law they will be slugged with a $10,500 tax bill. This is after working for 45 years+ and paying taxes on all their accumulated super fund assets. No I do not think the regular ratcheting of existing or news super taxes is fair is for the retirees when their capital is subject to market risk and collapsing interest returns. "

By: Anthony Willcocks on Jun 18, 2013 9:04PM

"Fair comments Anthony - as you clearly know your stuff, do you mind sharing with everyone, how much income tax this couple would have to pay each year if the $4.5M in savings was not in super & just part of their normal wealth - base calculations of $270k income. I think you will find it is a lot more than $10,500 (or 3.8%) which you are screaming about. Any how much tax did they save (or rather you saved for them) by shifting this money into super over the years in the first place? Australia is a very generous place for the rich in retirement & when the super fund industry lobbyists kept quiet after these changes, then they probably agree they were timid too. I agree that work needs to be done about the generous super that politicians get."

By: Mr Taxman on Jun 19, 2013 1:55AM

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