Australian Government, A Plan to Simplify Superannuation

A Plan to Simplify and Streamline Superannuation

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Appendix A: Examples of how the proposed changes would increase retirement incomes

Key points

  • Under the proposal, there would be significant reductions in tax on retirement benefits for those aged 60 and over.
  • The gains from the simplified tax treatment would grow substantially for Australians over time as changes in superannuation take full effect.
  • The gains would be substantially increased if people choose to contribute more towards their retirement benefits.
  • Generally, the greatest gains would be for people who take their superannuation benefit as a superannuation pension, although there would also be substantial reductions in tax on lump sums.
  • The rewards for continuing to participate in the workforce after age 60 would be increased. Working part-time, and supplementing income from retirement savings, would potentially be more attractive to people.

A.1 An explanation of the modelling approach

The tables in this appendix provide estimates of the overall impact on average weekly retirement expenditure for a variety of individuals arising from the Government’s proposed superannuation arrangements. The benefits outlined in this section would be in addition to benefits that may be achieved through reduced complexity of the superannuation system or other impacts of improved incentives to save and work.

Estimates are presented for individuals and couples accessing their superannuation through either a lump sum payment (ETP) or pension. The estimates vary according to age, retirement balances, annual incomes, type of superannuation arrangement, and whether there are contributions in addition to the standard SG. Estimates are also presented for individuals aged between 60 and 65 who continue to work part-time while accessing some of their superannuation to top up their income.

The following provides the estimated results, including an explanation of some factors underlying these results. Section A.6 details the assumptions used in the modelling, including current superannuation balances and level of member contributions.

A.2 Lump sum benefits

The top section of Table A1 shows the distributional impact of the proposed scheme on lump sum benefits for those retiring shortly (age 65 in table) and for younger Australians (ages 25 and 45) that contribute only their SG payments. There would be significant reductions in tax for people aged 60 or over currently paying tax on their lump sum retirement benefits. These benefits reflect the cut in tax rate from 15 per cent to 0 per cent for lump sums between $129,751 and the lump sum RBL of $648,946, and from 38 per cent to 0 per cent for amounts over the RBL. The range of percentage increases in the after-tax lump sum payment reflects the existing tax free lump sum entitlement (so that someone with a $100,000 lump sum benefit already pays no tax, and therefore a further tax cut is not possible) and the proposed removal of the RBL. The reduction in the age pension assets test taper rate would also provide benefits to some retirees.

Table A1 also shows that the gains to individuals from the proposed simplification of the superannuation system would grow over time. As Australia’s superannuation arrangements fully mature, most workers would benefit significantly from the proposed reforms. For example, under a fully mature SG system, a person on $1,000 per week (about average income) is projected to have accumulated superannuation benefits of approximately $466,000 over a working life of 40 years through the SG arrangements alone. Under the proposed plan, tax of around $37,000 payable when the benefit is paid would be abolished. This average worker would thus gain around $37,000 in retirement, an increase of approximately 9 per cent if they take a lump sum.

For those on higher incomes, retirement benefits are also estimated to be significantly improved. For example, under a fully mature system, an individual earning $2,000 per week would have around $116,000 more in retirement benefits as a result of the removal of the benefits tax and lump sum RBL, an overall increase of 14 per cent.

The bottom section of Table A1 shows the potential benefits for an individual who increased their superannuation with the best mix of either member contributions added to by the Government co-contribution, and additional tax deductible contributions of 5 per cent of their salary (lifting them from 9 per cent to 14 per cent). For a person on $1,000 per week (about average earnings) who increases their superannuation contributions by an additional 5 per cent of their salary over a working life of 40 years, their projected retirement benefit would total around $706,000, an increase of around $240,000 from the $466,000 estimated above. The tax benefit from these changes for this person, putting in some extra superannuation contributions, would be almost $77,000, a gain of around 12 per cent. Importantly, as illustrated in the next section, this person would generally gain even more from these changes if they took their retirement benefits as a superannuation pension. The benefits for couples taking their retirement benefits as a lump sum would be determined by summing the gains for individuals.

Table A1: Individual — Lump sum payment

Table A1: Individual — Lump sum payment

(a) See section A.6 for assumptions, including assumed current superannuation balances and level of member contributions.

(b) Incomes above the maximum level shown could be expected to generate a lump sum benefit in excess of the lump sum RBL. Consequently, under current policy, an individual in this position is unlikely to take a benefit solely as a lump sum as excessive benefits tax would be incurred. Instead the individual could be expected to take a benefit as a part pension (Table A2) in order to qualify for the pension RBL.

(c) People on these income levels would continue to pay no tax.

A.3 Superannuation pensions

A.3.1 Individual — SG only

The proposed arrangements provide significant benefits for those who choose to take their superannuation benefit as a pension in retirement. In particular, pension payments from a taxed fund will be tax free for individuals aged 60 and over. In addition, the reduced age pension assets test taper rate provides further benefits.

The top of Table A2 shows the distribution of superannuation pension benefits for those retiring shortly (age 65 in Table A2) and for younger Australians (ages 25 and 45) that contribute only their SG payments. The extent of gains projected from these changes for those retiring shortly depends critically on their level of accumulated superannuation savings. People currently entering retirement with superannuation balances in the order of $100,000 to $150,000 are paying little or no tax under the current arrangements as a result of tax concessions previously introduced by the Government such as the Senior Australians Tax Offset. They are already usually receiving the full age pension (assuming they do not have any other major asset holdings such as a share portfolio outside of superannuation — if they had such holdings, their gains would be greater than shown in Table A2). As there is little or no tax currently payable, there would be limited gains from further concessional tax treatment.

People entering retirement with higher current superannuation balances would receive a significant gain through reduced benefits tax and the reduction in the age pension assets test taper rate. For example, a person with a superannuation balance of $400,000 would have an estimated increase in average retirement expenditure of around $94 per week or around 17 per cent.

As with the lump sum scenarios, the benefits from the proposed system would increase as Australia’s superannuation system matures, because people would have significantly greater superannuation balances. Under a fully mature system (age 25 in Table A2), a person on $1,000 (about average earnings) over a working life of 40 years, is projected to have accumulated retirement benefits of around $466,000. If they choose to take the entire retirement benefit as a pension, they are projected to have on average around $136 per week in additional retirement expenditure as a result of the Government’s proposed changes. This would be an increase in average retirement expenditure of around 17 per cent. This gain would be greater than the 9 per cent gain they would achieve if they took the benefit purely as a lump sum payment.

Table A2: Individual — Superannuation pension

Table A2: Individual — Superannuation pension

(a) See section A.6 for assumptions, including the assumed current superannuation balances and level of member contributions.

(b) People on this income level would continue to pay no tax.

A.3.2 Individual — SG topped up with member contributions

The bottom of Table A2 shows the benefits for a person who increases their superannuation contributions with member contributions matched by the Government co-contribution, or additional tax-deductible contributions of 5 per cent of their salary. The results show the gains from the proposed system would increase significantly where people choose to contribute more towards their retirement.

For a person on average earnings who increases their contributions by an additional 5 per cent of their salary, their retirement benefit would increase for two reasons. First, as a result of the additional contributions, their total retirement benefit would increase from $466,000 to $706,000, a gain of $240,000. By itself, this leads to a significant increase in average retirement expenditure. Secondly, these changes produce significant gains for someone with $706,000 in retirement benefits. As indicated in Table A2, this part of the gain for this person would be on average $192 per week, a gain in retirement expenditure of around 22 per cent.

The combined impact of these two effects is illustrated in Chart A1. A person on average earnings and aged 45, who contributes an extra 5 per cent of salary into superannuation for 20 years, currently gets an 8 per cent increase in retirement expenditure. The combined impact of the additional contributions and the proposed changes would be an increase of 27 per cent in average retirement expenditure. For someone aged 25, the gains in average retirement expenditure would increase from 11 per cent under existing policy to 35 per cent under the proposed scheme.

Chart A1: Impact of additional contributions and new policy
for person earning $1,000 a week

Chart A1: Impact of additional contributions and new policy for person earning $1,000 a week

Additional contributions of 5 per cent of salary

A.3.3 Individual — working part-time

The proposed changes would provide incentives for those who have reached age 60 to remain in the workforce. All superannuation benefits paid from a taxed fund and received at age 60 or over would be exempt from tax and also excluded from a person’s assessable income. These arrangements would result in a significant reduction in tax for most individuals aged between 60 and 65 who continue to work while accessing their superannuation.

In addition to the increases in average expenditure for a person aged between 60 and 65, their retirement benefits continue to grow (see the first two columns of Table A3). This is because the drawdowns would be less than their SG contributions and the earnings on the accumulating benefits and pension. The higher retirement benefit also provides increased average retirement expenditure once the person retires.

Table A3: Part-time work implications for individuals aged 60 to 64(a)

Table A3: Part-time work implications for individuals aged 60 to 64(a)

(a) Estimates are presented in nominal terms.

(b) Part-time income is 60 per cent of previous full-time income (that is, working three days per week).

(c) Assumes accessing 75 per cent of their benefit at age 60 as a pension.

Table A3 illustrates the projected impacts of these changes in real terms for a male earning $1,000 per week when working full-time, who decides to work part-time (three days a week) from age 60 to 65 and top up his salary with a superannuation pension based on accessing 75 per cent of their retirement savings at age 60 (the superannuation pension would be $211 per week). At age 65 he retires. The proposed changes provide him with an extra $67 a week in retirement (more than 10 per cent) due to the removal of benefits tax.

A.3.4 Couples

Table A4 shows that couples who take their retirement benefits as pensions would generally receive even greater benefits than singles as a result of the proposed changes. For these examples, we assume that one person has two-thirds of the retirement benefit or income, and the spouse has the remaining one-third.

The gains from the proposed changes for couples generally would be higher than the combined gains for two individuals with the same retirement balances, because the asset threshold for the age pension for couples is lower than the asset threshold for two individuals.

For instance, the gain for a couple currently entering retirement with a combined superannuation balance of $600,000, ($400,000 and $200,000 respectively) would be around $130 per week. The combined benefit for two individuals with equivalent balances (Table A2) would be $105 per week, while the benefit for a single individual with a balance of $600,000 is around $102 per week.

The extent of gains from these changes would increase if additional superannuation contributions are made.

Table A4: Couple — Superannuation pension

Table A4: Couple — Superannuation pension

(a) See section A.6 for assumptions including assumed current superannuation balances and level of member contributions.

A.4 Self-employed

The proposed arrangements provide significant benefits to the self-employed, whether they take their benefits as a lump sum or a pension in retirement. This arises from a combination of increased deductibility of contributions, the Government co-contribution, no tax on benefits and the reduced age pension assets test taper rate, as these are applicable to individual circumstances.

Table A5 illustrates how these factors interact for some individuals. It shows that the gain is considerable for someone aged 25 with 40 more years in the workforce such that where a person has an income of $28,000 per annum, the proposed system would deliver an increased benefit of 34 per cent or over $88,000. Where the time remaining in the workforce is less, for instance 20 years, the benefit for a high income earner is still considerable with an increased benefit of over $83,000 or 16 per cent.

Table A5 also shows the improvement from taking a benefit as a superannuation pension is considerable at both income levels. The table shows an improvement in average retirement expenditure of between approximately 8 and 27 per cent.

Table A5: Self-employed

Table A5: Self-employed

It is assumed that individuals would adjust their contribution behaviour to ensure they maintain the same level of take home income.

A.5 Untaxed superannuation schemes

Table A6 illustrates the improvement under the proposed changes for a person receiving a pension from an untaxed superannuation scheme, generally former public servants. This reflects the introduction of a 10 per cent offset for recipients of these pensions. As the age pension assets test does not apply to pensions paid from an untaxed superannuation scheme, the reduction in the assets test taper rate generally would not affect these people.

People over age pension age (or veteran/war widower/widow pension age) on lower superannuation pensions may already be eligible for the Senior Australians Tax Offset. As a result, the tax savings from the 10 per cent offset for a person with a $400 per week superannuation pension may be lower — 4.7 per cent rather than 8.8 per cent — than for a person on a similar superannuation pension aged 60 to 64 years.

Table A6: Untaxed superannuation funds

Table A6: Untaxed superannuation funds

(a) People on this income level would continue to pay no tax.

A.6 Assumptions

The estimates were generated by Treasury, generally using RIMHYPO3. For those individuals continuing to work (Table A3), estimates were generated using a spreadsheet model based on RIMHYPO. This section outlines the assumptions underpinning the analysis presented in this appendix.

The results presented are generally based on real average weekly retirement expenditure.4 Average annual retirement expenditure is calculated as average annual superannuation drawdowns and age pension benefits less average annual tax payable over an individual’s retirement. For most of the examples, the retirement period varies between 20 years for males and 25 years for females, depending on life expectancy. Over this retirement period, the pattern of drawdowns is based on an allocated pension with minimum drawdowns (the most common existing pattern). Although the new arrangements would provide much greater flexibility in determining the pattern of drawdowns, all examples are based on this assumption for comparative purposes.

As the drawdown amounts vary over each year of retirement, there would also be variations in items such as age pensions. These are averaged over the period of retirement to give a single number (see Chart A2 for an example of the type of pattern of retirement income). This average annual amount is divided by 52 for average weekly retirement expenditure.

Chart A2: Average weekly retirement expenditure
Age 65 to 84

Chart A2: Average weekly retirement expenditure Age 65 to 84

A.6.1 General assumptions

Base

All estimates (except Table A3) are in 2007-08 dollars deflated by the Consumer Price Index (CPI) and are for a homeowner with no other income or assets.

Individual examples are based on a male retiring at age 65.

Couple examples are based on both partners retiring at age 65 with one partner having two-thirds of the retirement benefit or income, and the other partner having the remaining one-third.

SG is 9 per cent per annum capped at the maximum contribution base of $134,880 per annum.

Financial

The modelling assumes an investment return of 7 per cent per annum after fees and charges; wage growth of 4 per cent per annum; and CPI of 2½ per cent per annum.

Current superannuation balances

For individuals under a mature system (aged 25), their current superannuation balance was assumed to be zero. For individuals currently in the workforce (aged 45), an assumed current superannuation balance was required to reflect the compulsory superannuation arrangements in place since 1992. The assumed current balances for those aged 45 are outlined below.

Individual — SG

Current balances were assumed to be $20,000 for the $400 per week case, $30,000 for the $600 per week case, $40,000 for the $800 per week case, $50,000 for the $1,000 per week case, $75,000 for the $1,500 per week case and $100,000 for the $2,000 per week case.

These are approximately the balances likely for someone that has been in the compulsory superannuation arrangements since 1992. If balances are larger than this due to additional superannuation contributions, then the overall gains would be greater than shown.

Individual — SG and member contributions

Current balances were assumed to be $40,000 for the $400 per week case, $60,000 for the $600 per week case, $80,000 for the $800 per week case, $100,000 for the $1,000 per week case, $150,000 for the $1,500 per week case, and $200,000 for the $2,000 per week case. These greater balances reflect an assumed history of making member contributions beyond the SG level.

Couples — SG

Current balances were assumed to be $30,000 for the $600 per week case, $50,000 for the $900 per week case, $60,000 for the $1,200 per week case, $90,000 for the $1,800 per week case, and $120,000 for the $2,400 per week case.

All current balances are assumed to be split one-third, two-thirds between each partner. For example, for the $600 per week case, balances are assumed to be split $20,000 and $10,000.

Member contributions

Individual

Member contributions were assumed to be 5 per cent of gross salary. This is achieved through the optimal use of the Government co-contribution, where available, and salary sacrifice arrangements.

Couples

Member contributions were assumed to be 5 per cent of salary for both partners. Where one or both partners are eligible for the Government co-contribution, the amount contributed is optimised to achieve the maximum benefit and the remainder of 5 per cent of salary is sacrificed equally by both partners. As a consequence, the total level of saving is typically greater than 5 per cent for the low income partner, such that the overall saving level for the couple is 5 per cent of their combined salaries.

Tax and age pension

Superannuation benefits from deductible contributions are assumed to be 100 per cent post-June 1983 (taxed element) contributions; tax scales are based on the 2007-08 tax scales announced in the 2006-07 Budget indexed to CPI; age pension is indexed to wage growth; age pension income and asset test thresholds are indexed to CPI.

3 RIMHYPO is an individual hypothetical model of the interaction of superannuation accumulations with the tax and social security systems, applied over the lifetimes of hypothetical individuals and couples. The model has been developed by Treasury’s Retirement and Income Modelling Unit. Further information about RIMHYPO can be found at www.rim.treasury.gov.au.

4 For lump sums and individuals working part-time, the after tax lump sum and average weekly expenditure for ages 60 to 65 are presented respectively.

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Miscellaneous