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An Act of Betrayal
Many of today’s retirees are feeling betrayed.
In 1992, Australians entered into an agreement. They agreed with a plan made by the politicians of the day that, in order to reduce the burden of the Age Pension on future generations of working taxpayers, everyone would save super for their own retirement.
In return for having their take-home pay reduced by super, which they would generally not be able to touch until they retired, reduced tax would be applied to their savings during their working life and no tax would be applied to most of their savings in retirement.
Reduced tax before retirement was necessary to ensure they were able to save enough by the time they retired. No tax after retirement (at least for most of their savings) was necessary to ensure that their savings, which they would now need to rely on for an income, would last for as long as possible.
This bargain has now been broken due to the inability of today’s politicians to stand by it. Politicians from both major parties have been unable to resist the temptation to increase taxes on super to the detriment of retirees.
Today’s retirees are now being told that they are no longer entitled to ask that the bargain be honoured by our politicians when they have honoured their side of the bargain.
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I think that most people, if they are honest, would say that a person who breaks a bargain, not the one who keeps it, should be the one who is demonised.
Let us look at how we got to this position.
In the Beginning
Retirement was largely paid for through the Age Pension up until the time that compulsory super was introduced. In turn, the Age Pension was largely paid for by income tax on working taxpayers and corporate tax on companies.
Paul Keating as Treasurer (and others) recognised that the burden of the Age Pension would increase in future as people were living longer after they retired.
The cost of funding this increased burden would have to come through increased personal income tax and/or increased corporate tax on companies unless another way could be found.
It was important that another way was found because making working taxpayers and companies bear this increased cost would depress the income of all people through reduced economic activity, which would lead to fewer jobs.
Another way was found in super. Super was designed to shift some of the burden from working taxpayers and companies to retirees. Retirees needed to fund at least part of their own retirement income by saving during their working lives.
From the introduction of the compulsory super regime in 1992 (note that the treatment of retirement savings prior to 1992 is not considered in this paper), the system provided concessional tax treatment for super savings both before and after retirement.
Reduced tax of 15% on earnings was imposed before retirement so that people could build up a meaningful amount of savings by the time they retired without having a sizeable portion of their wages deducted.
After retirement, those savings would largely have no tax imposed on earnings for people over a minimum age who used their super to provide themselves with an income in retirement through an allocated pension. The allocated pension imposed minimum withdrawal requirements to encourage people to use super for income rather than bequests.
Protection against the concessional tax treatment within the system being exploited by the rich was also provided by reasonable benefit limit (RBL) rules, which capped tax-free benefits that could be taken in retirement. Additional tax was imposed on benefits above the limit.
Ghost in the Machine
There were two major flaws with super as it was first set up.
The first flaw was in the way that the system attempted to ensure that richer people could not unduly exploit the tax concessions that it provided.
This came about because of the way tax-free benefit limits were indexed. The RBLs were indexed by inflation. Because super savings are tied to wages, which generally grow at a faster rate than inflation, over time more and more super in retirement would be subject to increased tax. Increased tax would mean that those savings would last for less time and people would be forced back onto the Age Pension sooner. This was opposite to the intent of the super system.
The second flaw was in the rate at which the Age Pension was removed the more that people saved in super. This meant that people who qualified for some Age Pension would have their Age Pension income reduced by more than the increased income they could generate if they saved more in super.
These flaws discouraged many people from saving extra super beyond the amount required by law.
Less savings in super would force people back onto the Age Pension sooner. This was opposite to the intent of the super system.
The flaws also punished people who invested wisely to generate a larger amount of super by retirement.
A Step Forward
By 2007 these flaws were identified and it was decided to improve super by removing them. Removing the flaws would mean that those who sought to put more into super than the bare minimum and those who had invested wisely and accumulated more super for their retirement would no longer be unduly punished.
Changes were made that lowered the rate at which the Age Pension was withdrawn because more super was held and all super investments in retirement were made tax free.
To replace the protection against exploitation of the tax concessions provided by the RBLs, restrictions on the amount that could be put into super were applied.
Limiting contributions achieves the same goal of limiting tax concessions as taxing savings in retirement. But limiting contributions doesn’t unduly punish those who make good investment decisions or put more into super. Also, it doesn’t make your savings run out sooner in retirement.
Taken together, these changes resulted in super being better able to achieve its aim of reducing the cost of the Age Pension.
The other advantage delivered by the 2007 changes was that it made a complex system at least partially simpler.
Two Steps Back
The changes made in 2007 have been partly and selectively unwound by the Liberal government, resulting in increased taxation on super in retirement and the removal of people’s incentives to save more.
First, in 2016 the Liberals reversed the reduction in the rate at which the Age Pension was withdrawn as a result of more super being held.
At the same time the amount of super that could be held before the Age Pension was reduced was also increased.
However, the re-establishment of the much higher rate at which the Age Pension was removed meant that many people, including middle income earners, once more faced losing more in Age Pension income than the increased income they could generate if they saved more in super, reinstating the disincentive to save more super.
Secondly, at the start of 2017 the Liberals reintroduced a limit on the amount that could be taken as benefits in retirement tax free, with increased tax of 15% being imposed on amounts above the limit.
To add insult to injury, the Liberals did not reverse the other part of the 2007 changes to the super rules, which put in place more stringent restrictions on the amount that could be put into super. In fact, rather than reversing this change, the Liberals imposed even more stringent restrictions on the amount that could be put into super.
Blaming The “Rich”
The truly insidious part of the changes made by the Liberals was to tell the public that they were justified because the increased tax would only be imposed on a few people who were rich and rorting the super system.
The fact is, while the increase in tax imposed by the Liberals might only apply to a few better off people now, over time it will apply to everyone’s super.
The Liberals have repeated a flaw in the indexation of the original RBLs. I believe the inclusion of this flaw was very deliberate and intended to allow the Liberals to claim that only the better off would be affected now while also allowing them to hide the fact that everyone would eventually be affected.
The reason I believe it was deliberate is because all the limits on the amount that could be put into super that they tightened rather than relaxed were indexed in line with wages, whereas the limit they imposed before increased tax applied was deliberately only indexed by inflation.
As noted earlier, the amount that people save in super is likely to increase at a faster rate than inflation, meaning that more and more of the super savings of more and more people will face increased tax in retirement. Eventually there will be an increase in tax on everyone’s super in retirement, including the least well off.
Most people do not understand that the difference in indexation will eventually lead to this outcome. This allows the Liberals to make their claim that only the “rich” will be affected without people understanding that eventually they will all be affected.
The Liberals have managed to unwind the two key improvements made in 2007; improvements that were made after extensive analysis and modelling of the effects on the retirement income system, the Age Pension and Budget.
No meaningful analysis or modelling seems to have been undertaken before the Liberals made their 2016/2017 changes or, if it was undertaken, the Liberals have yet to release it. Maybe in fear of what it would reveal.
In doing so, the Liberals have made changes that once again punish people who save more in super and invest more wisely. They have made it even harder to save more super. They have also reimposed increased tax on super in retirement that will eventually apply to all people with super, which is pretty much most of us.
Coup De Grace
Not willing to be outdone by the Liberals, we now have Labor seeking to go even further by increasing tax on super in retirement to 30%.
The truly insidious thing about Labor’s proposal is not just that it seeks to impose a higher rate of tax, but it will only apply higher tax to certain investments and certain people.
The tax will be applied to investments in Australian shares that are made by people with little or no tax liability because they will no longer be able to claim refunds of tax that has already been paid.
Which people fit that description? Mainly people who are retired and invest through self-managed superannuation funds, which provide competition to retail funds as well as industry funds controlled by unions.
You could argue that super in retirement should be taxed more. However, regardless of the outcome of that argument, it makes no sense to argue that only some people should have their super in retirement taxed more.
The people who invest through self-managed superannuation funds must find another way to invest if they are to avoid the increased tax, or find another similar investment that will not face the increased tax.
The alternative ways to invest in Australian shares are to invest in retail funds (mostly run by banks savaged by the Royal Commission), or to invest in industry funds. Industry funds, of course, are run by and benefit many of the unions who support Labor.
When you realise this, you begin to see that the real purpose of the proposal is not just to increase tax on super at the expense of some retirees but to benefit the supporters of the party making the proposed change.
A Sting in the Tail
There is a further downside to this policy. If investors using self-managed superannuation funds want to avoid investing through retail funds or industry funds but still invest in shares to benefit from higher returns in the long term, they will need to invest in overseas shares instead of Australian shares.
Total assets held by self-managed superannuation funds as at March 2018 were $682 billion, of which the biggest category was invested in Australian shares at $208 billion (overseas shares only comprised $5 billion).
Labor’s policy, if it becomes law, has the potential to reduce the flow of investment to Australian companies. This will reduce investment in the Australian economy, which will ultimately reduce jobs.
Labor’s policy will hurt the companies and the working taxpayers that the super system was meant to protect.
It is argued by both parties that the tax concessions from super need to be capped so that the “rich” do not exploit the super system.
The fact is that the concessions have always been capped before these changes were made (Liberals) or proposed (Labor), initially through increased tax on super above limits and then by restricting what could be put into super.
This latter change was made in 2007, along with the removal of tax on earnings in retirement and a lessening of the punitive reductions in Age Pension entitlement. These changes aimed to strengthen the super system and encourage rather than punish people who put more into super and/or who invested wisely.
We’ve now regressed to a system that combines the worst aspects of previous super systems.
The main features of our current system are
- a punitive reduction in Age Pension entitlement the more is saved in super;
- punitive restrictions on what can be put into super;
- increased tax in retirement if you end up with more than a limit set so that it will shift over time to eventually apply increased tax to everyone.
We also face the prospect of a significant part of our super system, which is used by people who wish to retake control of their own retirement investments from retail and industry funds, being punished by the imposition of a 30% tax on their major investment choice. This will force many of them to invest in retail and industry funds or invest in overseas shares rather than Australian shares.
These made or proposed changes are driven by nothing more than a desire to extract more and more tax from Australia’s retirees at a time when the amount invested in super has become too large for politicians of both parties to resist doing so.
There has been no consideration of what damage these changes will make to the viability of the superannuation system. The only consideration that seems to have been undertaken relates to what level of obfuscation, half-truths and outright lies is required so that the public pick up their pitch forks and run after the “rich”.
This has been done to disguise the real intent of the changes. This is to extract more tax from everyone, including ordinary and poorer people, to pay for the increasingly expensive bribes that our politicians feel are necessary for them to be allowed by us to continue in office.
If you listen to our politicians only “rich” retirees will pay for these changes. But in the end we will all pay.
Acknowledgements: I would like to gratefully acknowledge the assistance provided to me in preparing this piece by Terrence O’Brien, Jim Bonham and Jack Hammond.