A Plan to Simplify and Streamline Superannuation
The Government is committed to Australia’s three pillar approach to providing retirement incomes. The three pillars are:
- a taxpayer funded means-tested age pension for people who are unable to fully support themselves in retirement;
- a minimum level of compulsory employer superannuation contributions made in respect of employees; and
- voluntary private superannuation and other savings, supported by incentives to save for retirement and incentives to stay engaged with the workforce.
The policy objective is to assist and encourage people to achieve a higher standard of living in retirement than would be possible from the age pension alone. An example of the assistance provided by the Government towards this objective is the superannuation co-contribution for low to middle income employees. The Government also provides superannuation taxation concessions valued at $15.9 billion in 2005-06.1
The Government recognises that individual needs and circumstances vary. As such, the superannuation system should be flexible, adaptable and give individuals choice. Again, the Government has taken action in this area with measures such as the introduction of choice of fund. As staying engaged with the workforce past age 55 is one of the key factors in lifting retirement incomes, the Government has also introduced incentives for older workers such as the Mature Age Worker Tax Offset and allowing drawdowns of superannuation while still working.
The Government also recognises that for the superannuation system to be efficient, the associated taxation arrangements and other rules regulating superannuation must be understandable, send clear signals and provide appropriate incentives. Impediments, complexity and rigid rules should be minimised where possible.
To this end, the Government has a plan to reduce significantly the complexity of the tax arrangements and the restrictions on superannuation benefits that have built up over time, complicating the superannuation system.
The current system has different arrangements for tax on contributions, earnings and benefits. In 1988, the then Government brought forward part of the tax which was previously applied to end benefits. This dramatically exacerbated the complex tax treatment of superannuation in Australia.
The report of the Taskforce on Reducing Regulatory Burdens on Business, Rethinking Regulation, recommended that high priority be given to comprehensive simplification of the tax rules for superannuation benefits. The report highlighted that the greatest area of complexity is the taxation of end-benefits.
Superannuation benefits tax is by far the most complicated and is the tax that individuals must confront when entering or contemplating retirement. At present, it is difficult for anyone to understand how their superannuation benefits will be taxed.
A lump sum may include up to eight different parts taxed in seven different ways.
The complexity of the benefits tax arrangements not only affects retirees. It affects individual decisions concerning additional superannuation contributions. It also adds to the administration costs of superannuation funds.
Associated rules and regulations on superannuation
The associated rules regulating matters such as how benefits are to be taken and forced payment of benefits are complicated and limit individual choice.
The Government is inviting comments on a proposal to sweep away the current raft of complex tax arrangements and restrictions that apply to superannuation benefits. This would improve retirement incomes and increase incentives to work and save.
Under the proposed plan, from 1 July 2007:
- Superannuation benefits paid from a taxed fund either as a lump sum or as an income stream such as a pension, would be tax free for people aged 60 and over.
- Benefits paid from an untaxed scheme (mainly affecting public servants) would still be taxed, although at a lower rate than they are now for people aged 60 and over.
- RBLs would be abolished.
- Individuals would have greater flexibility as to how and when to draw down their superannuation in retirement. There would be no forced payment of superannuation benefits.
- The concessional tax treatment of superannuation contributions and earnings would remain. Age-based restrictions limiting tax deductible superannuation contributions would be replaced with a streamlined set of rules.
- The self-employed would be able to claim a full deduction for their superannuation contributions as well as being eligible for the Government co-contribution for their after-tax contributions.
- The ability to make deductible superannuation contributions would be extended up to age 75.
- It would be easier for people to find and transfer their superannuation between funds.
To increase further the incentives to save for retirement, it is proposed from 20 September 2007 to halve the pension assets test taper rate to $1.50 per fortnight for every $1,000 of assets above the assets test free area.
The superannuation preservation age would not change. The preservation age is already legislated to increase from 55 to 60 between the years 2015 and 2025. People would still be able to access superannuation benefits before the age of 60, although they would continue to be taxed on their benefits under new simplified rules.
As is the case under the current taxation system, the taxation treatment would vary depending upon whether contributions were made from income that had been subject to income tax. Similarly, separate arrangements would apply to benefits arising from an untaxed source.
A summary of the proposed concessional taxation arrangements is set out below.
Employer contributions, salary sacrifice contributions, or deductible contributions from the self-employed
These contributions are made from income that has not been subject to income tax. They would be subject to the following taxation treatment.
- Contributions up to an annual limit of $50,000 per annum per person would be taxed at a concessional rate of 15 per cent (for members of defined benefit schemes this would also include notional contributions). The ATO would identify any contributions above this limit. These contributions would be taxed at the top marginal tax rate.
- Earnings on these contributions would continue to be taxed at a concessional rate of 15 per cent (10 per cent on capital gains where the asset is held for 12 months or more). Tax payable on earnings would still be able to be reduced through the application of imputation and other credits.
- No tax would be paid when superannuation benefits were paid after age 60 (irrespective of whether the benefit was taken as a lump sum or pension).
Member contributions (paid from after tax income)
These are contributions made from income after the individual has already paid tax on that income. Member contributions would be subject to the following taxation treatment.
- No tax would be payable when the contributions are made (given income tax would have already been paid on the income). These contributions would be limited to $150,000 in an income year (three times the limit on concessionally taxed deductible contributions).
- Earnings on these contributions would continue to be taxed at a concessional rate of a maximum of 15 per cent (10 per cent on capital gains where the asset is held for 12 months). Tax payable on earnings would still be able to be reduced through the application of imputation and other credits.
- No tax would be paid on these contributions when they are paid to the individual as superannuation benefits (irrespective of whether the benefit is taken as a lump sum or pension).
- A Government co-contribution will continue to be paid for eligible persons (now including the eligible self-employed) on incomes up to the co-contribution upper threshold, and no tax is payable on the co-contribution.
Untaxed schemes (mainly for public servants)
In some superannuation schemes run by the Australian Government and the State and Territory governments, no employer contributions are made until a benefit becomes payable and no contributions or earnings tax is paid. Only 10 per cent of all superannuation fund members are members of such schemes and they are nearly all public servants. The majority of such schemes are now closed to new members.
As no contributions or earnings tax is paid there should be a higher level of tax when benefits are paid to fund members. This ensures equity with other superannuation funds where contributions and earnings tax would have been paid. Reflecting this, these types of benefits are already subject to a higher level of tax than other benefits and this distinction would continue. However, consistent with the proposed new concession to remove benefits tax for those aged 60 or over in a taxed fund, the tax on benefits received by members aged 60 or over from an untaxed source would be reduced.
Lump sum benefits paid from an untaxed source to those aged 60 or over would be taxed at 15 per cent on lump sums up to a total of $700,000. Amounts above this threshold would be taxed at the top marginal tax rate. Pensions paid to those aged 60 or over would be taxed at marginal tax rates but receive a 10 per cent offset. For example, a person who received a pension of $50,000 per annum would receive a reduction in their tax of about $5,000.
There are significant simplicity benefits for retirees. Under the proposed plan, the 100,000 Australians who turn 60 each year and choose to retire would have a much simpler system to face when deciding how to draw on their superannuation. They would no longer need to pay for expensive financial advice on the tax treatment of their superannuation benefits. Independent evidence given to the House Standing Committee on Economics, Finance and Public Administration inquiry into improving superannuation savings of people under age 40, stated that this advice can cost in the order of $3,000 to $10,000 depending on the complexity.
The plan would also have a significant impact on a person’s retirement income. An average income earner would have an additional lump sum of around $37,000 or an additional $136 per week if they take their benefit as a superannuation pension. There are greater benefits if a person chooses to make additional superannuation savings. See Appendix A for further details.
Withdrawals would be tax exempt, removing complexity for people aged 60 and over. There would be:
- no need to worry about the complying or non-complying status of income streams for tax purposes;
- no forced payment of superannuation benefits; and
- greater choice and flexibility for Australians planning their retirement.
As many superannuation benefits would no longer be included in assessable income, there would no longer be a disincentive for people to continue with some work while drawing on their superannuation. With no tax on their superannuation, they may pay less tax on any income from work.
Individuals would no longer be forced to draw down on their superannuation benefits after age 65. Subject to fund rules, superannuation could be paid out whenever and however a person wished. People could take as much or as little as they like and it would generally not have to be included in their tax return.
Individuals would have the flexibility to change their arrangements as their circumstances change. If people want to keep some money in their superannuation accounts for other contingencies, then that choice would be left to the individual.
The plan reduces the myriad of rules and red tape that superannuation funds must contend with when paying a benefit. This reduction in complexity could be expected to reduce the costs facing superannuation schemes in delivering their services and therefore contribute to lower fees and charges over the longer term.
Currently, there are different rules on the concessional treatment of contributions made by the unincorporated self-employed. The self-employed can claim a tax deduction for the first $5,000 of superannuation contributions and then 75 per cent of any contributions above this amount until they reach their age-based limit. An employer can claim a full deduction up to the age-based limits of their employees. The self-employed also do not qualify for the co-contribution.
Under the plan, contributions made by the self-employed would be treated in the same way as contributions made for the benefit of employees. This means that the self-employed would be eligible for a full deduction for their superannuation contributions. The self-employed may also be eligible for the Government co-contribution for any personal undeducted contributions. Currently the self-employed are not eligible for the Government co-contribution.
The plan would not reduce an age pensioner’s existing entitlements. Superannuation would still be included as part of the income and assets tests in determining a person’s eligibility for the age pension.
However, more generous pension assets test rules are proposed to increase incentives to save.
Currently, a person loses $3 of age pension per fortnight ($78 annually) for every $1,000 of assets above the assets test free area. This is very punitive as retirees must achieve a return of at least 7.8 per cent on their additional savings to overcome the effect of a reduction in their age pension. This acts as a large disincentive to save for retirement.
As superannuation savings increase, as well as the value of other assets such as investment houses and shares, the number of people affected by the assets test is projected to grow with more low to middle income earners having their age pension reduced by the assets test. The current assets test also prevents retirees with relatively modest assets but with low incomes from being able to access the age pension.
To make the assets test fairer, it is proposed to reduce the pension assets test taper rate to $1.50 per fortnight for every $1,000 of assets above the assets test free area from 20 September 2007. Based on the current age pension, a single retiree homeowner could have around an additional $165,000 of assets before losing the age pension, while a couple could have around $275,000 of additional assets.
The current 50 per cent assets test exemption for complying income streams would be removed from 20 September 2007 to coincide with the reduction in the assets test taper rate. Retaining the assets test exemption under the new arrangements would create scope for wealthier individuals to access the age pension and the associated concessions.
However, people would still be eligible for a 50 per cent assets test exemption for complying income streams purchased before 20 September 2007, and a 100 per cent exemption for those purchased before 20 September 2004.
The complexity that a retiree currently faces when accessing their superannuation benefits compared to the proposed system is illustrated in Diagram 1.
Diagram 1: Current arrangements
Proposed simplified system
1 See page 8 of the Tax Expenditure Statement 2005.