Category: Letters To Save Our Super

Superannuation restructure tips to stay under $1.6m pension cap

Australian Financial Review

16 November 2016

by Sam HendersonMake the most of opportunities before June 30 to balance out super sums between partners, writes Sam Henderson who answers your questions on super.

Q: To comply with the proposed $1.6 million tax-free pension limit, our SMSF will require restructuring. What I am contemplating is withdrawing a significant amount as a pension from my member pension account and making a non-concessional contribution into my wife’s pension member account – which happens to be well below the $1.6 million limit. As the trustee, I need to choose the withdrawal type – ie, lump sum or pension. Both withdrawal types count towards the minimum withdrawal requirement of our pension and are not taxed in my personal tax return. Will such a withdrawal, dependent on whether it is nominated as a pension or a lump sum, compromise the grandfathered status of the pension account when considering eligibility of the Commonwealth Seniors Health Card? I retain a right to exclude the non-assessable pension under the grandfathered rules at January 1, 2015. Are there other ramifications dependent on the type of withdrawal that is made? What are the differences between a lump sum and a pension withdrawal? David

A: Put simply, a commutation means that your pension account will need to stop and restart, therefore affecting the grandfathered Commonwealth Seniors Card (or, more widely than your case, those on the grandfathered age pension deeming rates with lower balances). Since there are no upper limits (there is a minimum only) of pension payments, it’s best to make your withdrawal in the form of pension payment to ensure existing grandfathered scenarios remain unaffected.

As a general rule, I typically make lump sum withdrawals for clients as pension payments for the sake of simplicity and to maintain any grandfathered provisions.

With respect to making a non-concessional contribution in your wife’s name, you may be able to contribute up to $540,000 into her super fund by June 30 if she hasn’t triggered the bring-forward rule. If she’s over 65, though, she will be limited to $180,000 a year and only if she meets the work test of working 40 hours in 30 consecutive days in the financial year in which the contribution occurs. Next year, of course, all these amounts will be markedly reduced so the next half of this financial year will be a big one for super funds to maximise their opportunities.

Q: Sam, if I have more than $1.6 million in my self-managed superannuation fund (SMSF), can I still make non-concessional (after-tax) contributions in 2017-18? Peter

A: Peter, my understanding is that after July 1, 2017, if your balance exceeds $1.6 million then you will not be permitted to make further non-concessional contributions. People with less than $1.6 million in their fund will be able to make non-concessional contributions up to their $1.6 million cap of $100,000 per annum or up to $300,000 using the bring-forward rule. If you do make further non-concessional contributions, you will be issued with a direction from the ATO to remove the money from your superannuation fund.

For this reason, it may make sense to make arrangements to contribute up to $540,000 for each member in this financial year using the existing bring-forward rules to potentially max out a contribution between a couple of up to $1,080,000

Q: I am 67 and fully retired, therefore I cannot open a superannuation account as I would fail the work test. If my pension exceeds $1.6 million (say $2 million), where could I put the extra $400,000? Frank

A: Frank, the government plans to make this one easy for you by compelling you to comply with the apportionment rule. If you have an existing retirement pension (account-based pension), then you will not be given any other alternative other than using an apportionment process to calculate your $400,000 over and above the proposed $1.6 million cap.

That said, you will be able to cash the funds out of the superannuation environment and for some people, this may be a viable alternative. Just remember, though, outside of the super entity, you will need to pay the regular individual marginal tax rates and potentially capital gains tax. It’s the latter that concerns me.

I mentioned last week that I am curious as to how the government will be able to apply the rules to those with multiple superannuation funds and if the apportionment rule can practically be applied given potentially two different trustees (such as when a person has an SMSF and an industry fund). For example, if we rolled your $400,000 excess amount into an industry fund and invested it into direct shares with franking credits, we could potentially eliminate the income tax by segregating the accounts which won’t be possible if all the funds are in one account. So too, we may see an emergence for higher-net-worth clients having two SMSFs for this reason, ignoring any potential impact on the Commonwealth Senior Health Card or any other grandfathered provisions under Centrelink.

You see, you don’t need to meet a work test to do a rollover into another fund and you can do partial rollovers (potentially in-specie) depending on where you’re rolling your fund to or from although, as mentioned, you’d want to check the grandfathering if you have a health card. Advice is definitely recommended to those in this situation.

Senate Inquiry into Government’s superannuation package

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Senate Economics Legislation Committee

11 November 2016

Mr Jack Hammond QC

Save Our Super

By email:

 

Dear Mr Hammond

Inquiry into Superannuation (Excess Transfer Balance Tax) Imposition Bill 2016 [Provisions] and

Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 [Provisions]

On 10 November 2016 the Senate referred the provisions of the Superannuation (Excess Transfer Balance Tax) Imposition Bill 2016 and the Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 to the Senate Economics Legislation Committee for inquiry and report.

I am writing to invite you to make a submission to this inquiry.  The Committee is due to report to the Senate by 23 November 2016. Given the short time frame for inquiry and report, the Committee would like to receive submissions by 17 November 2016.

The Committee is seeking written submissions from interested individuals and organisations preferably in electronic form submitted online or sent by email to economics.sen@aph.gov.au as an attached Adobe PDF or MS Word format document. The email must include full postal address and contact details.

Alternatively, written submissions may be sent to:

Committee Secretary

Senate Economics Legislation Committee

PO Box 6100

Parliament House

Canberra   ACT   2600

 

E-mailed submissions should include your name, phone number and postal address (in the email, not the submission) so that we can verify them and/or contact you.

Submissions are confidential until the Committee releases them. You must not release your submission until the Committee advises that it has accepted and released it. Submissions that are accepted are protected by parliamentary privilege but the unauthorised release of them is not.

The Committee will normally make submissions public unless there is a request for confidentiality. If you would like a submission or part of it to be kept confidential please say so clearly in the submission.

The Committee will sympathetically consider requests for confidentiality, but cannot make promises in advance. If you have concerns about confidentiality I encourage you to call me to discuss this before lodging the submission. Notes on making submissions are available from the website. The Committee secretariat can also help: phone (02) 6277 3540 or email economics.sen@aph.gov.au. More information about this Committee is available at www.aph.gov.au/senate_economics.

Written submissions can address one or both bills in whole or in part.

Superannuation (Excess Transfer Balance Tax) Imposition Bill 2016 [Provisions]

The Superannuation (Excess Transfer Balance Tax) Imposition Bill 2016 proposes to impose a tax on the notional earnings of capital moved into a retirement phase superannuation account that is in excess of the $1.6 million transfer balance cap. From 1 July 2017, any notional earning of the excess capital would be taxed at a rate of 15 per cent.

Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 [Provisions]

There are 10 measures proposed in the Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 (TLA Bill). The measures are:

Transfer balance cap

Schedule 1 to the TLA Bill imposes a $1.6 million cap (the transfer balance cap) on the amount of capital that can be transferred to the tax free earnings retirement phase of superannuation.

Concessional superannuation contributions

Schedule 2 to the TLA Bill reduces:

  • the annual concessional contributions cap to $25,000 (from $30,000 for those aged under 49 at the end of the previous financial year and $35,000 otherwise); and
  • the threshold at which high‑income earners pay Division 293 tax on their concessionally taxed contributions to superannuation, to $250,000 (from $300,000).

Non-concessional contributions cap

Schedule 3 to the TLA Bill reduces the annual non‑concessional contributions cap from $180,000 to $100,000 (or $300,000 every three years).

Low income superannuation tax offset

Schedule 4 to the TLA Bill amends the Superannuation (Government Co‑contribution for Low Income Earners) Act 2003 to enable eligible low income (less than $37,000) earners to receive the low income superannuation tax offset.

Deducting personal contributions

Schedule 5 to the TLA Bill removes the requirement in the income tax law that an individual must earn less than 10 per cent of their income from their employment related activities to be able to deduct a personal contribution to superannuation and make it a concessional contribution.

Unused concessional cap carry forward

Schedule 6 to the TLA Bill introduces provisions to allow catch‑up concessional contributions.  This will allow individuals with a total superannuation balance of less than $500,000 to make additional concessional superannuation contributions in a financial year by utilising unused concessional contribution cap amounts from up to five previous financial years.

Tax offsets for spouse contributions

Schedule 7 to the TLA Bill amends the tax law to encourage individuals to make superannuation contributions for their low income spouses.  This is achieved by increasing the amount of income an individual’s spouse can earn before the individual ceases to be entitled to a tax offset for making superannuation contributions on behalf of their spouse.

Innovative income streams and integrity

Schedule 8 to the TLA Bill will extend the tax exemption on earnings in the retirement phase to products such as deferred lifetime annuities and group self-annuitisation products.

Anti-detriment provisions

Schedule 9 to the TLA Bill removes the income tax deduction which allows superannuation funds to claim a tax deduction for a portion of the death benefits paid to eligible dependants.

Administration and consequential amendments

Schedule 10 to the TLA Bill is designed to streamline some of the administrative processes of the Australian Taxation Office. In particular:

  • Part 1 of Schedule 10 to the TLA Bill 2016 amends the tax law to simplify and consolidate the range of existing processes for the release of amounts from individuals’ superannuation using a release authority.
  • Part 2 of Schedule 10 to the TLA Bill 2016 simplifies the taxation law to assist in streamlining the administration of the Division 293 tax regime. The amendments reduce compliance costs for superannuation providers and individuals where superannuation benefits become payable from defined benefit interests by removing the requirements in the taxation law relating to superannuation interests for which a Division 293 tax debt account is being kept for:
    • superannuation providers to notify the Commissioner of Taxation (Commissioner) of the amount of end benefit caps for their members in some circumstances; and
    • individuals to notify the Commissioner in any circumstance when their superannuation benefits from such interests first become payable.
  • Part 3 of Schedule 10 to the TLA Bill 2016 clarifies that the Commissioner can provide a single notice that includes two or more separate notices that are required to be provided.
  • Part 4 of Schedule 10 to the TLA Bill makes consequential amendments to the Superannuation Act 1976 that sets out the rules that govern the Commonwealth Superannuation Scheme (CSS) in relation to release authorities issued by the Commissioner.  The amendments take account of changes made by other parts of the Superannuation Reform Package.

We look forward to receiving your views on this important issue.

Yours sincerely

Mr Mark Fitt
Committee Secretary

PO Box 6100, Parliament House, Canberra  ACT  2600 | Tel: (02) 6277 3540 | Fax: (02) 6277 5719
Email:  economics.sen@aph.gov.au | Internet: www.aph.gov.au/senate_economics

The $1.6 million transfer balance cap explained

By William Fettes (wfettes@dbalawyers.com.au), Lawyer, DBA Lawyers, Bryce Figot (bfigot@dbalawyers.com.au), Director, DBA Lawyers and Daniel Butler, Director, DBA Lawyers (dbutler@dbalawyers.com.au)

Introduction

The Department of Treasury on 27 September 2016 released the second tranche of exposure draft legislation and explanatory material in relation to the Federal Government’s proposed superannuation reforms.

These materials provide long-awaited detail on the workings of the $1.6 million transfer balance cap measure. This article explains some key take-away points about this measure.

The transfer balance cap and transfer balance account

Broadly, the $1.6 million balance cap measure is a limit imposed on the total amount that a member can transfer into a tax-free pension phase account from 1 July 2017.

The general transfer balance cap is $1.6 million for the 2017-18 financial year subject to indexation (see below for further information on the indexation rules).

An individual’s personal transfer balance cap is linked to the general transfer balance cap. All fund members who are in receipt of a pension on 1 July 2017 will have a personal balance cap of $1.6 million established at that time. Otherwise, a fund member’s personal balance cap comes into existence when they first become entitled to a pension. An individual’s personal transfer balance cap is equal to the general balance cap for the relevant financial year in which their personal balance cap commenced.

Usage of personal cap space will be determined by the total value of superannuation assets supporting existing pension liabilities for a member on 1 July 2017, as well as the capital value of any pensions commenced or received by a member from 1 July 2017 onwards.

A member’s available cap capacity over time is subject to a system of debits and credits recorded in a ‘transfer balance account’, which is a kind of ledger whereby amounts transferred into pension phase are credited to the account and amounts commuted or rolled-over are debited from the account.

Earnings and capital growth on assets supporting pension liabilities are ignored when applying the personal transfer balance cap. Thus, a member’s personal balance cap may grow beyond the $1.6 million cap due to earnings and growth without resulting in an excess. As such, a taxpayer who allocates growth or higher yielding assets to their balance cap will generally be better off if their pension assets appreciate in value. However, note the limitations with regards to the segregation method discussed below.

Any amounts in excess of a member’s personal transfer balance cap can continue to be maintained in their accumulation account in the superannuation system. Thus, members with superannuation account balances greater than $1.6 million can maintain up to $1.6 million in pension phase and retain any additional balance in accumulation phase.

What counts as a credit?

The following items count as a credit towards an individual’s transfer balance account and thereby their personal transfer balance cap:

  • the value of all assets supporting pension liabilities in respect of a member on 30 June 2017;
  • the capital value of new pensions commenced from 1 July 2017;
  • the capital value of reversionary pensions at the time the individual becomes entitled to them (subject to modified balance cap rules for reversionary pensions to children); and
  • notional earnings that accrue on excess transfer balance amounts.

As can be seen from the above list, death benefit pensions count towards to the recipient’s personal transfer balance cap.

The inclusion of death benefit pensions as part of the reversionary beneficiary’s transfer balance cap is in accordance with DBA Lawyers’ prediction in our 1 August 2016 newsfeed article. This aspect will have a significant impact on the succession plans of all fund members who collectively with their spouse have more than $1.6 million in superannuation.

Fortunately, there is an important concession. An excess will only occur as a result of a death benefit pension six months from the date that the reversionary beneficiary becomes entitled to receive the pension. This means there is a grace period for reversionary beneficiaries to commute their pension interest(s) to stay within their personal transfer balance cap without triggering any excess. The exposure draft explanatory memorandum (‘EM’) explains the six month period as follows:

This gives the new beneficiary sufficient time to adjust their affairs following the death of a relative before any consequences – for example, a breach of their transfer balance cap – arise.

Typically, a surviving spouse suffers years of grieving following the loss of a spouse but only has a six month period to make a decision on a reversionary pension if that results in an excess of their personal transfer balance cap.

What counts as a debit?

A member’s transfer balance account is debited when they commute (partially or fully) the capital of a pension. When a commutation occurs, the debit entry to the transfer balance account is equal to the amount commuted. Accordingly, it is possible for an individual’s transfer balance account to have a negative balance if their debits exceed their credits. For example, a full commutation of a pension where the assets supporting that pension have grown from $1.6 million to $1.7 million will result in a transfer balance account of negative $100,000.

Ordinary pension payments do not count as debit entries for the purposes of the transfer balance account. Proposed legislative amendments will ensure that partial commutations do not count towards prescribed minimum pension payments. This proposal may also impact a member with an account-based pension electing to convert an amount to a lump sum for claiming their low rate cap.

In addition to the above recognised debits, relief will be available in relation to certain events where an individual loses some or all of the value of assets that are held in pension phase. The proposed relief concerns family law payment splits, fraud and void transactions under the Bankruptcy Act 1966 (Cth). In these circumstances, an individual will be able to apply to the ATO for relief so that their transfer balance account can be debited to restore their personal transfer balance cap, eg, if a member is defrauded of their super savings and the perpetrator is convicted, then a debit (or restoration) can be made to their transfer balance account.

At this stage, there is no relief proposed in relation to a major economic downturn eroding the value of fund assets held in pension phase. Therefore, if another global financial crisis were to occur, any adverse economic effects on the assets supporting pensions could substantially impair a member’s personal transfer balance cap.

Excess personal transfer balance cap

Individuals who exceed their personal transfer balance cap will have their superannuation income streams commuted (in full or in part) back into accumulation phase and notional earnings (see below) on the excess will be subject to an excess transfer balance tax.

Notional earnings accrue on excess transfer balances based on the general interest charge. Notional earnings accrue daily until the breach is rectified and are generally credited towards an individual’s transfer balance account (subject to a transfer balance determination being made by the Commissioner).

The draft EM provides the following example of an excess transfer balance (refer to example 1.14):

On 1 July 2017, Rebecca commences a superannuation income stream of $1 million from the superannuation fund her employer contributed to (Master Superannuation Fund). On 1 October 2017, Rebecca also commences a $1 million superannuation income stream in her SMSF, Bec’s Super Fund.

On 1 July 2017, Rebecca’s transfer balance account is $1 million. On 1 October 2017, Rebecca’s transfer balance is credited with a further $1 million bringing her transfer balance account to $2 million. This means that Rebecca has an excess transfer balance of $400,000.

On 15 October 2017, the Commissioner issues an excess transfer balance determination to Rebecca setting out a crystallised reduction amount of $401,414 (excess of $400,000 plus 14 days of notional earnings). Included with the determination is a default commutation authority which lets Rebecca know that if she does not make an election within 60 days of the determination date the Commissioner will issue a commutation authority to Bec’s Super Fund requiring the trustee to commute her $1 million superannuation income stream by $401,414.

As can be seen from the above example, there is some flexibility built into the system for proactive rectification where an excess transfer balance occurs.

An excess transfer balance tax is payable on the accrued notional earnings of the excess amount to neutralise any benefit received from having excess capital in the tax-free retirement phase. The excess transfer balance tax is assessed for the financial year in which a member breaches their transfer balance cap. The excess transfer balance tax is 15% on notional earnings for the first breach and 30% for second and subsequent breaches.

Indexation of the balance cap

The transfer balance cap is indexed in increments of $100,000 on an annual basis in line with the Consumer Price Index.

A person’s eligibility to receive indexation increases in relation to their personal transfer balance cap is subject to a proportioning formula based on the highest balance of the member’s transfer balance account compared to the member’s personal balance cap.

The proportioning formula as applied to an example increase of $100,000 is as follows:

(Personal transfer balance cap – highest transfer balance) x $100,000
Personal transfer balance cap

 

An example of how the proportioning formula applies in practice is set out below.

Example

John commences a pension with an account balance of $800,000 in FY2017-18. At that time, he has used 50% of his $1.6 million personal transfer balance cap.

If the general transfer balance cap is indexed to $1.7 million in 2019-20, John’s personal transfer balance cap is increased by $50,000 because he is only eligible to take 50% of the $100,000 increase. Accordingly, John can now commence a pension with capital of $850,000 without breaching his personal transfer balance cap.

The above answer does not change if John partially commutes his pension prior to the indexation increase, as the formula is based on John’s highest transfer balance (ie, $800,000).

A member who has exhausted or exceeded their personal transfer balance cap will not be eligible for any cap indexation.

CGT relief

The draft legislation also provides CGT relief which broadly enables the cost base of assets reallocated from pension to accumulation phase to be refreshed to comply with the transfer balance cap or the new transition to retirement income stream arrangements. The draft EM states:

Complying superannuation funds will now be able to reset the cost base of assets that are reallocated from the retirement phase to the accumulation phase prior to 1 July 2017.

Where these assets are already partially supporting accounts in the accumulation phase, tax will be paid on this proportion of the capital gain made to 1 July 2017. This tax may be deferred until the asset is sold, for up to 10 years.

Segregated assets

Broadly, an SMSF trustee can elect to obtain CGT relief to reset the cost base of a segregated asset to its market value provided the asset ceases to be a segregated asset prior to 1 July 2017. The market value is determined ‘just before’ the time the asset ceased being a segregated current pension asset.

Typically, an asset would cease to be segregated by being transferred from pension to accumulation phase. However, it appears that an asset could also cease being segregated by being treated as an unsegregated asset (with an associated actuarial report).

It is important to note, however, that the segregation method will not be available to SMSFs and small APRA funds, with at least one member in pension mode who has a total superannuation fund balance of over $1.6 million (in all funds). This limits planning opportunities that may otherwise be available to SMSFs under the segregation method.

Unsegregated or proportionate assets

Broadly, where an asset is supporting a pension liability using the unsegregated or proportionate method, an SMSF trustee can elect to obtain CGT relief to reset the cost base of an asset to its market value on 1 July 2017 subject to the following requirements:

  • the fund must calculate a notional gain on the proportion of the asset that is effectively attributable to the accumulation phase as at 30 June 2017;
  • if not deferred, the fund must add this notional gain to its net capital gain (or loss) for FY2017 which effectively crystallises the tax liability that would have arisen if that asset had been sold in FY2017;
  • however, an SMSF trustee can elect to defer the notional gain for up to 10 years (ie, up to 1 July 2027) unless a realisation event occurs earlier than 1 July 2027; and
  • if a realisation event does not occur by 1 July 2027, the cost base of the relevant asset will revert to its original cost base.

If the relevant asset is sold before 1 July 2027, the deferred notional gain is added to any further net capital gain (or adjusted against any net capital loss) made on a realisation event such as the ultimate sale of that asset. This further notional gain is calculated based on the higher cost base determined as at 30 June 2017 (being the market value of that asset at 30 June 2017 with any further adjustments to that asset’s cost base since 30 June 2017).

Thus, an SMSF trustee may elect to reset the cost base of an asset. This election may be applied on an asset by asset basis as some may prefer not to reset the cost base of all eligible assets to market value, eg, a particular asset’s market value may be lower than its cost base and a cost base reset in that context could result in a greater future capital gain. Further, this election can be made in the SMSF’s FY2017 annual return and does not need to be made prior to 1 July 2017 (as is the case for a CGT reset for a segregated asset as discussed above).

The net capital gain attributable to the accumulation interest that is not exempt under the exempt current pension income provisions is taxed at 15% subject to the 1/3 CGT discount available for assets held for more than 12 months. Refer to examples 1.45, 1.46 and 1.47 in the draft EM.

Although the prospect of resetting the cost base of current pension assets may be attractive in the lead up to 1 July 2017, paragraph 1.226 of the draft EM reminds SMSF trustees not to overlook the general anti-avoidance provisions in part IVA of the Income Tax Assessment Act 1936 (Cth). This paragraph of the EM states:

The CGT relief arrangements are only intended to support movements of assets and balances necessary to support the transfer balance cap and changes to the TRIS. It would be otherwise inappropriate for a fund to wash assets to obtain CGT relief or to use the relief to reduce the income tax payable on existing assets supporting the accumulation phase. Schemes designed to maximise an entity’s CGT relief or to minimise the CGT gains of existing assets in accumulation phase may be subject to the general anti-avoidance rules in Part IVA …

Naturally, the impact of the CGT reset provisions will need to be carefully considered as there are numerous strategies that will unfold under the draft proposals.

Conclusions

The proposed $1.6 million transfer balance cap measure involves substantial changes to Australia’s superannuation system, especially the tracking of each member’s personal balance cap. The balance cap proposal will reduce the tax effectiveness of pensions due to the new cap and have a major impact on succession planning strategies giving rise to substantially more tax payable overall in respect of death.

In particular, many couples will not like the fact that their deceased spouse’s reversionary pension gets ‘retested’ to a surviving spouse where the surviving spouse is subject to only their own $1.6 million personal balance cap. The Government has seen that raising extra tax revenue is preferred rather than allowing a deceased spouse’s pension that would have already been tested within their personal transfer balance cap to revert to a surviving spouse. We see this as a major issue that is likely to arise in submissions.

Note that the above commentary is a general summary only based on exposure draft legislation and explanatory material that is subject to change. For full details, see https://consult.treasury.gov.au/retirement-income-policy-division/super-reform-package-tranche-2

Related articles

http://www.dbalawyers.com.au/pensions/automatically-reversionary-pensions-super-reform/

http://www.dbalawyers.com.au/announcements/proposed-superannuation-reforms-july-2016/

http://www.dbalawyers.com.au/announcements/1-6m-balance-cap-examined-tax-death-benefits/

*           *           *

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

DBA LAWYERS

4 October 2016

Email to all Coalition Senators and MHRs from Terrence O’Brien – dated 19 September 2016

Dear Prime Minister, Treasurer, Ministers, Government Senators and Government MHRs

I wrote today to Messrs Gee and Buchholz in their roles as leaders of the Coalition Backbench Committee on Economics and Finance to convey  a copy of my submission of 16 September to Treasury on the first tranche of Government superannuation measures.

You will see I am critical of the process of consultation, the apparent separation of the new super tax expenditure measures from the tax increases on super, the Government’s proposed objective for its superannuation policy, and the content of some of the new expenditure measures.

My criticisms draw on the four articles by the Centre for Independent Studies which I forwarded with my earlier correspondence with you.

Yours sincerely

Terrence O’Brien

(Address and contact number supplied)

Email to Andrew Gee, MP and Scott Bucholz, MP from Terrence O’Brien – dated 19 September 2016

Mr Andrew Gee, M.P., Chairman
Mr Scott Buchholz, M.P., Secretary

Coalition Backbench Committee on Economics and Finance 
Parliament House, Canberra, ACT

Dear Sirs

Further to my e-mail of 8 September to you in your capacities as leaders of the Coalition Backbench Committee on Economics and Finance, I attach a copy of my submission of 16 September to Treasury on the first tranche of Government measures.

You will see I am critical of the process of consultation, the apparent separation of the new tax expenditure measures from the tax increases on superannuation, the Government’s proposed objective for its superannuation policy, and the content of some of the new expenditure measures.

My criticisms draw on the four articles by the Centre for Independent Studies which I drew on in my earlier correspondence with you.

Kind regards

Terrence O’Brien

(Address and contact number supplied)

Terrence O’Brien’s submission to Treasury – lodged 16 September 2016

16 September 2016

SUBMISSION ON FIRST TRANCHE OF SUPERANNUATION EXPOSURE DRAFTS – Terrence O’Brien, (Address and contact number supplied)

1.     Inadequate time for public comment

Providing only 7 working days for public input on the first tranche of complex super measures shows contempt for public consultation.[i]

An interested citizen may wonder: what is the reason for such a rushed consultation process for the subset of new super measures that are revenue ‘give-aways’, when all the closely related Bills to raise taxes on self-funded retirees and reduce the super savings opportunities of those nearing retirement are still weeks, if not months away?

To illustrate how far Australian super lawmaking  processes have degenerated to the cost of confidence in super, contrast the current exercise with the planning for and consultation around the last major change of strategic direction in Australian super law, the Costello Super Simplification exercise of 2006 and 2007.[ii]  A substantial discussion paper was issued with  the May 2006 Budget announcement of the measures, with an extended consultation over four months until September 2006.[iii] There was keen interest to comment: more than 1,500 written submissions and more than 3,500 phone calls from across the community. Modest revisions to the original ideas were incorporated into revised costing for the forward estimates period and incorporated into legislation introduced by end 2006, with effect from 1 July 2007.

2.     Inappropriate separation of legislative packages

It is wrong to separate consultation on the Budget super measures into a first tranche of $2.8 billion in revenue give-aways over the forward estimate period and a later tranche of yet-to-be-finalised tax increases of some $6 billion.  Both sets of measures are built on similar, highly contested assertions about the purpose, fairness, cost and effectiveness of super concessions. Logically, they ought be considered together, in both consultation and Parliamentary processes.

It would be economically irresponsible if the Government were to seek to legislate sequentially a first tranche of give-aways followed by a second tranche of tax increases.  If, for example, some of the $2.8 billion in new concessions proved on examination to be poor quality and unlikely to meet its stated objectives, that should affect the consideration of the $6 billion in super tax increases that in part pay for the new concessions.

One possible outcome of separate tranches is that the give-aways might be passed with populist cross-bench support despite Labor’s announced rejection of most of them[iv], and the tax increases postponed or rejected, further damaging the budget.  Alternatively, the tax increases could also be passed at a second stage (or further increased as Labor proposes[v]) with Labor and Green support.  The only clear message to super savers from these uncertainties is that superannuation law making has become chaotic and untrustworthy.

The Government should guarantee that all the Bills implementing the Budget’s super measures will be introduced to Parliament simultaneously as a package.

Not only should the new concessions and the increased taxes be considered together, they should all be subject to public examination by Parliamentary Committee, with the Committee calling on submissions and evidence from the public.  This would help overcome weaknesses in the derisively short consultation processes concluding today.

3.     Damaging mis-statement of objective(s) for superannuation

The Superannuation (Objective) Bill’s proposed primary objective for Government policies toward superannuation wrongly states that super merely “substitutes or supplements the age pension”.  This is as if the government stated the objective for  labour market law was that paid employment should ‘substitute or supplement government income support such as the Newstart Allowance’.[vi]  The Government’s intended super objective loses all sight of the fundamental economic and moral cases in an increasingly rich society for:

  • reducing systemic income tax and age-pension disincentives to long-term saving;
  • supporting thrift; and
  • increasing self-provision for retirement.

With this maladroit statement, the Government has turned its back on insights that have been clear since at least 1942[vii], and were applied through 30 years of super reforms during the Hawke-Keating[viii] and Howard-Costello years[ix].

The Explanatory material to Superannuation (Objective) Bill 2016 and Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016 adds five subsidiary objectives (most rather abstract) to the primary objective in the Superannuation (Objective) Bill, with all six to be subject to unspecified, case-by-case ‘balancing’. This destroys any coherent guidance for policy, so again the message to super savers is that anything could happen to the taxation of their life savings.

 

The Treasurer nonetheless asserts that the primary objective has “guided the development of the Government’s reforms”.[x]  But as if to prove the uselessness of the government’s proposed ‘primary plus five other’ objectives, it is striking that the two draft Bills and the two draft Regulations in the first tranche do not themselves include illustrative statements showing the compatibility of their measures with the primary objective of the legislation (or any of the other five, for that matter) as would become compulsory if the Superannuation (Objective) Bill became law.  If the Government believes its stated objectives have any meaning, it should use them to provide clear and quantified illustrations of the estimated effects of its legislative proposals on self-sufficiency in retirement and numbers on the age pension.

4.      A better objective

An objective that better captures the reality of superannuation’s purpose is recommended by John Roskam: “The objective of the superannuation system is to ensure that as many Australians as possible take personal responsibility to save for their own retirement. The age pension provides a safety net for those who are unable to provide for themselves in retirement.”[xi]

5.      New tax expenditures on super

Critics of existing super concessions currently dominate public debate with false claims that the costs of present incentives are excessive, unsustainable and unfair. (Robert Carling’s paper for the Centre of Independent Studies explains why these claims are overblown, with many of the estimates “unfit for purpose”.)[xii] Against the backdrop of these criticisms, any proposals to create additional incentives costing $2.8 billion over the forward estimates must clear a high hurdle by demonstrating their cost effectiveness measured against any stated objective of government policy.

All measures in the first tranche fail that cost-effectiveness test. All seek to induce additional voluntary contributions into super by subsidy or concessions which are both complex and modest from the individual’s perspective, albeit costly to the revenue in aggregate.  The broader budget package destroys confidence in super through what Scott Morrison accurately called ‘effective retrospectivity’ [xiii], making complex new incentives less credible to savers than if confidence had been maintained.[xiv]

For an example of complexity defeating any intended beneficial impact, the Low Income Superannuation Tax Offset offers a non-refundable tax offset of up to $500 to the super fund of a low income saver with adjusted taxable income less than $37,000 and who has had a concessional super contribution made on their behalf. To the practically-minded, this $1.6 billion give-away poses three questions: how much, if anything, can someone earning under $40,000 a year afford to lock away in superannuation? How many of us could say what our ‘adjusted taxable income’ was, in terms of superannuation law? And what incentive to the low paid to save from very modest income for up to 40 years before they can access it is offered by a non-refundable tax offset to their super fund of up to $500?

Another illustration in Explanatory Statement to Exposure Draft: Treasury Laws Amendment (Fair and Sustainable Superannuation) Regulation 2016 also highlights both the trust problem and the witlessness of those who write these illustrations.  “Ed is aged 67 and retired in July 2017.” He has $250,000 in his superannuation fund, and after downsizing to a smaller home, has $150,000 to invest.  Under one of the Government’s new give-aways costing $130 million, he is said to add the $150,000 to his super fund.  (The treatments of super balances under the income and assets tests for the age pension are complex, but it may well be that the main effect of downsizing his house and adding $150,000 to Ed’s super balance would be to greatly reduce the part aged pension he may be eligible for.)  After watching the super policy circus of the last 18 months in which three political parties competed to re-write the superannuation rule book to the disadvantage of self-funded retirees, why would Ed decrease investment in his principal residence and increase his exposure to super rule changes? Ed needs a good financial adviser.

Some measures seek to induce additional super contributions from those on low incomes, or into the super accounts of low income spouses.

Possible beneficiaries from these measures fall into three categories:  those who will have low income over their lifetimes; those who are lower income earners in high income households; and those who are low income at the start of their careers, but who will be richer later.

The first group will mostly not accumulate sufficient super balances to lift them above the means and income test thresholds for age pension eligibility at any plausible subsidy, and they will rightly retire on the age pension. That’s what it’s for. So for them, what was the point of the Government’s measure?   At best it might induce minor lifetime savings over their working life at the cost of suppressing their modest living standards while they worked.  As Simon Cowan has pointed out, exacting saving from people whose greater need was to spend the money merely boosts the demand for other forms of government income support.  For example, “A family of four with a single income earner on $75,000 a year pays $7,125 a year into superannuation but receives around $7,500 a year in family tax benefits alone.”[xv]

Lower income earners in high income households may indeed pocket taxpayer subsidies to achieve super splitting strategies with their partners. But they might well use those strategies anyway without subsidy. (Such strategies reduce the damage to lifetime savings from further retrospective rule changes by tomorrow’s governments to attack high super balances.) Or they may persist with family financial planning to pool their super funds in retirement.  (While ‘a man is not a financial plan’, couples are emboldened in this super pooling by trust in each other, common sense, common practice and family law, which treats superannuation entitlements as joint assets in a relationship.)

It is obvious why super funds, surely one of Australia’s worst examples of crony capitalism, want to use bogus ‘feminist’ arguments to harness taxpayers’ funds multiply the number of super accounts with low balances and high fees.  It is not clear why the Government should legislate to implement the social engineering implicit in such attempted equalization of spouses’ super balances.

Finally, for those who are temporarily low income at the start of their careers, there is no case for the Government trying to front-load their lifetime savings profile away from the savers’ own preferences.  Better the Government facilitate those preferences by not excessively restricting higher super savings later in life through miserly restrictions on concessional and non-concessional contributions.  This is another example of the interconnection between the first tranche measures and the super tax increases of the second tranche which necessitates their joint consideration.

6.      A better path forward

There are much better ways than the first tranche measures to improve the lifetime welfare and savings of lower income earners, such as illustrated in papers for the CIS by Simon Cowan (cited above) and Michael Potter[xvi]. A sensible selection from and development of those ideas would improve self-sufficiency and thrift, improve superannuation outcomes, improve retirement living standards, and improve budget outcomes. The Government should go back to the drawing board on its Budget measures.

 

 

[i] The following discussion refers to the first tranche package of revenue give-aways for which Treasury originally provided exposure drafts on 7 September 2016:

  • Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016
  • Superannuation (Objective) Bill 2016
  • Explanatory material to Superannuation (Objective) Bill 2016 and Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill 2016
  • Treasury Laws Amendment (Fair and Sustainable Superannuation) Regulation 2016
  • Explanatory Statement to Treasury Laws Amendment (Fair and Sustainable Superannuation) Regulation 2016

To these were added, at some time during the short consultation period, two more exposure drafts:

  • Treasury Laws Amendment (Fair and Sustainable Superannuation) Regulation 2016 – Low Income Superannuation Tax Offset
  • Explanatory Statement to Treasury Laws Amendment (Fair and Sustainable Superannuation) Regulation 2016 – Low Income Superannuation Tax Offset

There was no extension of the consultation period to allow for the later provision of this last pair of drafts.

 

[ii] Peter Costello, A Plan to Simplify and Streamline Superannuation: Detailed Outline, Canberra, May 2006

 

[iii] Peter Costello, Simplified Superannuation – Final Decisions, Press Release 093 , 5 September 2006

 

[iv] Bill Shorten, Address to the National Press Club – Canberra – Wednesday, 24 August 2016:

“In a time of budget pressures, the Government should be closing unsustainably generous high-income loopholes in superannuation; not opening new ones.

This is why Labor will oppose the Government’s plans to:

–          Allow catch-up concessional superannuation contributions

–          Harmonise contribution rules for those aged 65 to 74

–          Allow tax deductions for personal superannuation contributions.

Despite the merit of some of those propositions, this new spending cannot be a priority, especially when it will set the Budget back $1.5 billion over the forward estimates and $14.7 billion over the next ten years.” http://www.billshorten.com.au/address_to_the_national_press_club_canberra_wednesday_24_august_2016

 

[v] Bill Shorten Address above, “We will not tie the $500,000 lifetime contribution cap back to 2007.

Instead, our changes will apply from Budget night.

This means Australians who have invested for their retirement in good faith based on clear rules, no matter how generous, will not be punished after the fact.

….

At the same time, I am proposing we lower the threshold for high-income super contributions from $250,000 to $200,000.”

[vi] I owe this analogy to John Roskam (cited below) and Rebecca Weiser and Henry Ergas, Strangling the goose with the golden egg:  why we need to cut superannuation taxes on Middle Australia , September 2016, IPA Research Essay, http://ipa.org.au/publications/2545/strangling-the-goose-with-the-golden-egg .

While 80% of age-eligible people receive some age pension, and only about 20% of those of workforce age receive government income support, the analogy still holds:  no one thinks a citizen should be indifferent between being  unemployed and receiving welfare.

[vii]  Robert Menzies, The Forgotten People, 22 May 1942 http://www.liberals.net/theforgottenpeople.htm

“The great vice of democracy – a vice which is exacting a bitter retribution from it at this moment – is that for a generation we have been busy getting ourselves on to the list of beneficiaries and removing ourselves from the list of contributors, as if somewhere there was somebody else’s wealth and somebody else’s effort on which we could thrive. ….

“Now, have we realised and recognised these things, or is most of our policy designed to discourage or penalise thrift, to encourage dependence on the State, to bring about a dull equality on a fantastic idea that all men are equal in mind and needs and deserts: to level down by taking the mountains out of the landscape, to weigh men according to their political organisations and power – as votes and not as human beings?  …..

We have talked of income from savings as if it possessed a somewhat discreditable character. We have taxed it more and more heavily. We have spoken slightingly of the earning of interest at the very moment when we have advocated new pensions and social schemes. I have myself heard a minister of power and influence declare that no deprivation is suffered by a man if he still has the means to fill his stomach, clothe his body and keep a roof over his head. And yet the truth is, as I have endeavoured to show, that frugal people who strive for and obtain the margin above these materially necessary things are the whole foundation of a really active and developing national life.”

[viii] Paul Keating, The Story of Modern Superannuation , Australian Pensions and Investment Summit, Sanctuary Cove, Queensland, 31 October 2007

[ix] Peter Costello, Address to the Investment and Financial Services Association, Tuesday, 13 June 2006,  http://www.petercostello.com.au/speeches/2006/2105-address-to-the-investment-and-financial-services-association-canberra

[x] Scott Morrison, Superannuation reforms: first tranche of Exposure Drafts, Media Release 7 September 2016. http://sjm.ministers.treasury.gov.au/media-release/094-2016/

[xi] John Roskam, The Turnbull Government Backs An Unprincipled Purpose Of Super, 9 September 2016, http://ipa.org.au/news/3555/the-turnbull-government-backs-an-unprincipled-purpose-of-super

[xii] Robert Carling, How should super be taxed?, Centre for Independent Studies, Policy,  Vol. 32 No. 3 (Spring, 2016), pp13-18, https://www.cis.org.au/commentary/policy-magazine

[xiii] Scott Morrison, Address to the SMSF 2016 National Conference, Adelaide, http://sjm.ministers.treasury.gov.au/speech/001-2016/ :  “Our opponents stated policy is to tax superannuation earnings in the retirement phase. I just want to make a reference less about our opponents on this I suppose but more to highlight the Government’s own view, about our great sensitivity to changing arrangements in the retirement phase. One of our key drivers when contemplating potential superannuation reforms is stability and certainty, especially in the retirement phase. That is good for people who are looking 30 years down the track and saying is superannuation a good idea for me? If they are going to change the rules at the other end when you are going to be living off it then it is understandable that they might get spooked out of that as an appropriate channel for their investment. That is why I fear that the approach of taxing in that retirement phase penalises Australians who have put money into superannuation under the current rules – under the deal that they thought was there. It may not be technical retrospectivity but it certainly feels that way. It is effective retrospectivity, the tax technicians and superannuation tax technicians may say differently. But when you just look at it that is the great risk.”

[xiv] On the damage to trust in super caused by ungrandfathered tax increases, see Terrence O’Brien, Grandfathering super tax increases, Centre for Independent Studies, Policy, Vol. 32 No. 3 (Spring, 2016), pp3-12. https://www.cis.org.au/commentary/policy-magazine

[xv] Simon Cowan,  Building a better super system, Centre for Independent Studies, Policy,  Vol. 32 No. 3 (Spring, 2016), p 20. https://www.cis.org.au/commentary/policy-magazine

[xvi] Michael Potter,  Don’t increase the super guarantee, Centre for Independent Studies, Policy,  Vol. 32 No. 3 (Spring, 2016), pp27-36, https://www.cis.org.au/commentary/policy-magazine

Email to all Coalition Senators and MHRs from Terrence O’Brien – dated 9 September 2016

Dear Prime Minister, Treasurer, Ministers, Government Senators and Government MHRs

I wrote yesterday to Messrs Gee and Buchholz in their roles as leaders of the Coalition Backbench Committee on Economics and Finance to convey four recent studies on superannuation and retirement income policy to be published by the Centre for Independent Studies  in the forthcoming edition of its magazine, Policy.  I hope the studies will be helpful to consideration of the Budget superannuation measures.

I also conveyed my impressions of some important developments since the four studies were finalised. I undertook to circulate the studies and my letter to other Government members, and do so today as attachments to this letter.

Yours sincerely

Terrence O’Brien

(Address and contact number supplied)

Attachments to the email dated 9 September 2016:

Letter to Mr Andrew Gee, M.P., Chairman and Mr Scott Buchholz, M.P., Secretary from Terrence O’Brien – dated 7 September 2016

https://www.cis.org.au/app/uploads/2016/08/32-3-obrien-terrence.pdf

https://www.cis.org.au/app/uploads/2016/08/32-3-carling-robert.pdf

https://www.cis.org.au/app/uploads/2016/08/32-3-cowan-simon.pdf

https://www.cis.org.au/app/uploads/2016/08/32-3-potter-michael.pdf

Letter from Kelly O’Dwyer, MP to Jack Hammond QC – dated 16 September 2016

kodwyerDear Jack,

As someone who has contacted me in relation to the Government’s superannuation reforms, I thought you may be interested in an announcement that the Treasurer and I made this week regarding modifications to the superannuation reform package to make it fairer, more flexible and sustainable.

First, can I thank you for your feedback on the policy. It has been very helpful to receive constructive input from local members of my community.

The revised package will provide greater support for Australians investing in their superannuation with the primary objective of providing an income in their retirement.

Kelly O’Dwyer – Minister for Revenue and Financial Services

Specifically, the $500,000 lifetime non-concessional cap will be replaced by a new measure to reduce the existing annual non-concessional contributions cap from $180,000 per year to $100,000 per year from 1 July 2017. Individuals will continue to be able to ‘bring forward’ three years’ worth of non-concessional contributions.

Individuals with a superannuation balance of more than $1.6 million will no longer be eligible to make non-concessional (after tax) contributions from 1 July 2017.

By limiting eligibility to make non-concessional contributions to those with less than $1.6 million in superannuation, it targets tax concessions at those who have an aspiration to maximise their superannuation balance and reach the transfer balance cap of $1.6 million.

Eligible small business owners will continue to be able to access an additional CGT cap of up to $1.415 million.

In order to fully offset the cost of reverting to a reduced annual non-concessional cap, the Government will not proceed with a change to contribution rules for those aged 65 to 74. The Government will instead keep the current arrangements that allow people to contribute to their superannuation up 75 years if they are working. This will encourage individuals to remain engaged in the workforce, which will benefit the economy more generally. While the Government remains supportive of the increased flexibility this measure, it can no longer be supported as part of this package, given the changes to non-concessional contributions.

From 1 July 2018 flexibility will be improved by allowing the ‘catch up’ of unused portions of concessional contributions on a rolling five year basis for individuals with balances under $500,000. This will help people with broken work patterns.

For further information I attach a copy of the Media Release, Press Conference and Fact Sheets on the Government’s superannuation changes.

Again, I very much appreciate the feedback that you provided on the Government’s policy and look forward to staying in touch.

 

Kind regards,

Kelly

The Hon Kelly O’Dwyer MP

Federal Member for Higgins

Minister for Revenue and Financial Services

 

A   Suite 1, 1343 Malvern Rd, Malvern VIC 3144

P   03 9822 4422    F  03 9822 0319

E   kelly.odwyer.mp@aph.gov.au

W  www.kellyodwyer.com.au

 

 

….

 

Letter to Mr Andrew Gee, M.P., Chairman and Mr Scott Buchholz, M.P., Secretary from Terrence O’Brien – dated 7 September 2016

7 September 2016

Mr Andrew Gee, M.P., Chairman

Mr Scott Buchholz, M.P., Secretary

Coalition Backbench Committee on Economics and Finance

Parliament House, Canberra, ACT

Dear Sirs

Examination of proposed superannuation changes

I am writing to you in your capacities as leaders of the Coalition Backbench Committee on Economics and Finance, tasked (according to recent media reports) with reviewing the Government’s Budget proposals to change the taxation treatment of various aspects of superannuation. 

To assist your Committee in its work, I wish to draw your attention to four recent studies bearing on the superannuation changes and the broader challenge of retirement income policy reform.  The studies are to form part of the forthcoming edition of the Centre for Independent Studies’ quarterly magazine, Policy.  They are attached to this letter for your convenience, and have been released electronically on the Centre’s website (https://www.cis.org.au/commentary/articles/four-solutions-to-the-big-problems-with-superannuation-policy ).

I am the author of the first of the four studies, which I hope might clarify from the last 40 years of history why so many super savers feel betrayed by the Government’s Budget measures; unconvinced by the alleged need for them; and unpersuaded by the Prime Minister’s and Treasurer’s attempted defence of them.  Moreover, they fear that if retrospective measures are approved, more will follow in the unprincipled political competition to raise revenue from super savers that was revealed over the election campaign.

Previous significant increases in super tax have been designed to gradually raise revenue over time, but were grandfathered to avoid reducing the living standards of those already retired and living on lifetime savings legally amassed under the previous rules.  Similarly, those near retirement (usually, those over 50 years of age, as a rule of thumb) have traditionally been spared the adverse impact on their lifetime savings of tax increases that they were too close to retirement age to adjust to. These traditional practices conform to the grandfathering principles codified in 1975 by the Asprey review of taxation, and successfully applied to tax increases in the 40 years since.

In contrast, the Turnbull/Morrison measures take the opposite approach, instantly penalizing those who trusted in, and acted on, the deliberate, well-researched incentives of the previous law.

The four studies and their main messages for your Committee are:

Grandfathering super tax increases – Terrence O’Brien:  The Government’s tax increases would do less damage to trust in super if they were grandfathered, as has been done over at least the last 40 years for other changes adverse to those already retired or near retirement.

How should super be taxed? – Robert Carling:  The common claims that super tax concessions are very expensive are wrong, and claims that their cost is unfairly distributed are based on an indefensibly narrow, one-dimensional conception of fairness.

Building a better super system – Simon Cowan:  The main problem with the super tax concessions is that they are not reducing reliance on the age pension as much as they could do if better designed.

Don’t increase the super guarantee – Michael Potter:  Scheduled increases in the SG from 9.5% to 12% would worsen the budget outcome for many years (because they move income from relatively highly taxed to lower taxed forms); bear inequitably on women and the low-paid; expose households more to the risk of adverse regulatory change; and reduce pre-retirement welfare of the less-well off without much improving their post-retirement income or reducing their dependence on the age pension.

On my reading of the studies, an implicit message emerging across all four is that reforming Australia’s retirement income system will require future well-researched, well-explained, gradual changes that can only be successful if governments retain the trust of the retired and those near retirement.

In my view, the largest cost of the Budget measures to raise tax on super is that, for want of grandfathering, they have destroyed trust in superannuation law-making in a way that will severely damage future prospects of better-considered retirement income reforms to superannuation, the age pension and their important interactions. To be clear: the Budget measures are not about stopping egregious tax avoidance (such as was done through retrospective measures deployed in the 1970s against contrived ‘bottom of the harbour’ schemes); rather, they attack law abiding savers who responded as previous governments wished to the intended purpose of well-deliberated incentives passed into law.  They have merely lawfully saved enough money to retire on, after properly paying tax on it in the contributions and accumulation phase.  This hardly warrants an attack on their living standards near or after retirement.

Reported Coalition reflection on the measures

I was concerned to read media reports that the Coalition’s focus in reviewing the measures is mainly on the proposed $500,000 lifetime cap on non-concessional contributions to super. Protest against that measure rightly focusses on its retrospectivity, narrowly defined. But as I argue in the first study above, all the Government Budget measures are “effectively retrospective”, in the useful phrase coined by Treasurer Morrison in his  address of 18 February 2016.  The measures all serve to invalidate retirement decisions and late-career savings plans for self-funded retirement by imposing disadvantageous new rules or tax rates where irrevocable decisions and plans have been induced by, and legally based on, previous rules.

Equally worrying, the reported adjustments being considered to the $500,000 cap are mainly increases to the cap, which misses the central problem: retrospectivity itself, rather the amount to which the retrospective cap is applied.  A higher cap backdated the same way is still retrospective and still destroys everybody’s confidence in law-making for super saving.

Recent developments

The four CIS studies were completed shortly after the election. Two subsequent developments should be very worrying to the Coalition, and to all concerned to maintain confidence in superannuation, limit growth in reliance on the age pension, and improve or at least maintain the efficiency with which scarce capital is allocated in the Australian economy.

Firstly, APRA quarterly superannuation performance statistics for the June quarter 2016 are showing marked declines in personal contributions (e.g.the concessional and non-concessional contributions to be further restricted under the Budget measures) as shown in the following table.  (Since personal contributions are by far the largest source of overall member contributions, the latter have also declined by about the same percentages as shown in the table.)

Such a dramatic decline after normal growth in previous quarters is easily understood: the Greens and Labor have been promising significantly to increase tax on super since March and April 2015, respectively.   The Liberals proposed in effect tripling the Labor tax increases in the 3 May 2016 Budget, providing cover for Labor to triple its original tax grab.  So super savers and self-funded retirees knew by May that their retirement living standards from super savings were sure to decline whatever the election result in early July, and through chaotic policy processes likely to lead to further tax raids in future.  So they commenced rebalancing their lifetime savings away from super in the June quarter 2016. I suspect the current quarter’s data, capturing a full three months of savers’ reaction to the new super landscape and the election outcome, will confirm and extend the adjustment apparent in the last quarter.

Source: APRA Quarterly superannuation performance,  June 2016  http://www.apra.gov.au/super/publications/pages/quarterly-superannuation-performance.aspx 

Second, the super policy decision-making process continues to degenerate. The election result confirmed that the attack on lifetime savings would be compounded by protracted political and legislative uncertainty and unpredictable horse trading — a new low in bad policy processes in the area demanding the highest standards of clarity and predictability. In late August, Labor made its third super tax policy iteration in less than 18 months. (Remarkably, Labor still claims to support removing super rule changes from the election cycle and budget night surprises by the creation of a superannuation charter and a new, objective analytical process for evaluating proposed policy change.)

Labor’s first policy announcement in April 2015 was promised to be its last.  Its second policy change in June 2016 (tripling its tax grab) was promised to be its last for five years.  Labor’s third but doubtless not final change of 24 August 2016 proposes both higher taxes on contributions to super, plus the desirable elimination of the government’s $3 billion in new but largely forgotten and unloved increases in tax expenditures on super.  Essentially, this bargaining approach promises Labor’s support to the Coalition, conditional on the Coalition eliminating all ‘winners’ from its Budget measures, and further increasing the tax burden on those aspiring to be self-funded retirees.

I anticipate there will be a further late twist to Labor’s support for the Coalition’s tax increases on self-funded retirement.  After Labor has ensured all ‘winners’ from new tax expenditures have been eliminated and all losers multiplied to maximize the damage to Coalition support, its emphasis will turn to its historical championing of grandfathering (such as in the Keating-Hawke reforms of 1983 and 1988 described in my study).  It will support the Coalition’s tax increases, but only conditional on the Government accepting Labor’s ideas on grandfathering.  This will deny the Coalition the revenue from the tax increases in the forward estimates period that encompasses the life of the current Parliament. 

It is easy to script this next stage in the rout of the Government’s super measures:  Labor will claim it has been ‘both fair and fiscally responsible’, by ‘securing increased tax on super through sound structural reforms’ for it to spend in its own future terms of government, but ‘only prospectively and not to the disadvantage of two generations of savers who have built their plans on the current rules’.  (Those two generations are the current self-funded retirees (say the 60-80 year olds); and those in mid-to-late career savings efforts to become self-funded (say the 40-60 year olds).) 

The economic consequences

Why might the trends and possible resolutions above matter (apart from permanently destroying big swathes of voter support among super savers of the 40-60 and 60-80 generations)? 

Funds not contributed into super will be used somewhere else:  spent, or saved or invested in other ways.  Looking to the absolute numbers behind the percentage declines shown in the table above, nearly $1 billion that was flowing into super funds in the June quarter 2015 was flowing somewhere else in the June quarter 2016. Treasury assumes in its revenue estimates for the Budget measures that those alternative destinations will be more highly taxed than superannuation, but that seems unrealistic to me. 

More likely, the long-term savings previously destined for super will now mostly flow to the only other forms of long-term saving not heavily penalised by the progressive taxation of nominal income: negatively-geared rental property, and the principal residence. The latter option has the considerable additional advantage of being outside the age pension means test.  For those formerly planning to be self-funded in retirement, rearranging their affairs to preserve access to the pension offers three advantages that super-funded retirement lacks: it removes longevity risk (the risk that savers will outlive their savings); it is safe from current and prospective very high market risk of zero or low returns (because pensions are indexed); and it is safer than super (for the moment) from regulation risk – for example, that tomorrow’s governments might restrict negative gearing, or reduce capital gains or pension asset test protection for the principal residence.

For the Australian economy, the costs of these likely reallocations of long-term savings from super into one form or another of property investment ought be obvious: instead of super savings being allocated through reasonably efficient capital markets to finance diversified productive assets such as infrastructure investment, equities, or corporate or government bonds, they will instead increase the demand for property. The supply of property is restricted and prices are inflated by restrictions on land release and other obstructive regulations.  Much of any revenue from increased demand for real estate will accrue to State and Territory governments. Real estate may not be able to be confiscated by the Commonwealth in the way lifetime superannuation savings can be, but the potential of such property investments to support increased future national living standards is much lower than from the mix of productive investments financed through superannuation.

The corollary of the adjustments hypothesized above is of course increased future reliance on the aged pension – a real fiscal sustainability threat, unlike the bogus sustainability threat often asserted to arise from the well-researched and carefully implemented Costello Simplified Super reforms of 2006-2007.  In effect, every dollar the Government’s measures discourage from going into super will morph to some degree into an increase in the future cost of the age pension.

The budget consequences

Compared to the seriously adverse consequences of the Budget measures for the economy and for confidence in super, the fiscal impact is small and easily made good. As noted in my study, grandfathering will of course delay the buildup of revenue from tax increases, because (depending on details of design) the increases would only apply to those some distance from retirement, and with time to adjust their savings strategies to the new tax regime. That is a fair adjustment of tax parameters that change lifetime savings strategies, in the tradition of previous tax increases on super savings in retirement, such as those implemented in 1983 by the Hawke-Keating government.

For reasons noted above, I doubt the Budget measures would raise anything like the revenue forecast.  But let’s accept for argument’s sake that $6 billion over the period to 2019-2020 is the notional target for the urgent priority of fiscal consolidation.  I need hardly argue to Coalition members that  a better strategy to sustainably improve the budget with improvement to the efficiency with which resources are used is to reduce government spending.  Based on a calculation by Mikayla Novak, the required expenditure reduction to make good the revenue forgone by grandfathering the superannuation tax increases would  be a cut in the expenditure of each government department of about two-fifths of one percent. (Departments usually live with efficiency dividends of 1-2%, and sometimes as high as 4%.) Can it seriously be argued that any voter would even notice the difference in government services from a 0.4% loading on the efficiency dividend?

In conclusion, I suggest the Coalition should go back to the drawing board on its super tax increases.  If it feels it must persist with them, it should comprehensively grandfather them, as was done by the Hawke-Keating Government with its super tax increases of the 1980s. Better that the course of good superannuation policy rule-making be embraced by the Coalition than that it be forced on it by Labor.

Should it be helpful to you or your Committee, I am of course happy to speak with you on the themes of this note.

I am unaware of the membership of your Committee, and so have copied this letter to all Government members.

Yours sincerely

Terrence O’Brien

Declaration of interest: I am a retired public servant who worked for some 40 years in the Commonwealth Treasury, the Office of National Assessments, the Productivity Commission, and at the OECD and the World Bank.  I receive a superannuation pension from a fund I joined at age 19. My pension would be more heavily taxed by one of the changes proposed by both Liberal and Labor.

(Address and contact number supplied)

The new death tax – automatically reversionary pensions?

dbalawyers-logo

By: Daniel Butler, Director (dbutler@dbalawyers.com.au) and

William Fettes (wfettes@dbalawyers.com.au), DBA Lawyers

Introduction

The $1.6 million balance cap proposal adds another layer of complexity to understanding whether an automatically reversionary pension (‘ARP’) is still an appropriate SMSF succession planning strategy.

What is an ARP?

We refer to the term ARP and deliberately avoid the term ‘reversionary pension’ as a reversionary pension is generally a mere wish in relation to paying the pension to a nominated beneficiary. Under most SMSF deeds and pension documents, trustees retain a discretion to make a pension reversionary even though a member has nominated a reversionary beneficiary. Broadly, this has worked well over many years where a member separates with his or her spouse, as the last thing many deceased members would like happening is for their superannuation benefit to be paid to their former spouse.

In contrast, an ARP is a pension that must be paid to the nominated beneficiary without any exercise of discretion by the fund trustee. Special wording in an SMSF deed and pension documentation is required to ensure a pension is an ARP as discussed below. This is to abide by the ATO’s view in TR 2013/5 where the Commissioner states at [29]):

Death of a member

  1. A superannuation income stream ceases as soon as a member in receipt of the superannuation income stream dies, unless a dependant beneficiary of the deceased member is automatically entitled, under the governing rules of the superannuation fund or the rules of the superannuation income stream, to receive an income stream on the death of the member. If a dependant beneficiary of the deceased member is automatically entitled to receive the income stream upon the member’s death, the superannuation income stream continues.22

Moreover, the ATO elaborates on what constitutes ‘automatic’ for tax law purposes in TR 2013/5 at [126]:

  1. A superannuation income stream automatically transfers to a dependant beneficiary on the death of a member if the governing rules of the superannuation fund, or other rules governing the superannuation income stream, specify that this will occur. The rules must specify both the person to whom the benefit will become payable and that it will be paid in the form of a superannuation income stream. The rules may also specify a class of person (for example, spouse) to whom the benefit will become payable. It is not sufficient that a superannuation income stream becomes payable to a beneficiary of a deceased member only because of a discretion (or power) granted to the trustee by the governing rules of the superannuation fund. The discretion (or power) may relate to determining either who will receive the deceased member’s benefits, or the form in which the benefits will be payable.

Accordingly, if there is any discretion afforded to the fund trustee under the governing rules of the fund or the pension documentation in regard to paying a particular superannuation dependant or the payment method, the ATO will consider the pension ceases on death for tax law purposes. This can have important consequences for SMSF succession planning, including insurance payouts and the retention of other valuable concessions.

We turn now to consider some key areas where having an ARP in place can provide some advantages.

Insurance

For those SMSF members who do hold a life insurance policy in their SMSF, an ARP may be worthwhile if the following conditions are satisfied:

  • the SMSF member is likely to receive a sizeable insurance payout upon their death or permanent incapacity;
  • the relevant insurance policy premium is paid from the member’s pension account; and
  • the relevant pension account that serviced the insurance premiums is comprised of a high proportion of tax-free component.

Broadly, in these circumstances, when a life insurance payment is allocated to a member’s pension account, the payment will broadly take on the same proportion of the underlying taxable and tax-free components as the member’s pension.

Example:

If a deceased member commenced a pension entirely comprising tax-free component, and the insurance premiums were deducted from that member’s pension account, then the $1 million insurance proceeds paid to the SMSF on that member’s death and allocated to the deceased member’s pension account would constitute a 100% tax-free component. This could fund a tax free reversionary pension.

In contrast, if a deceased member’s pension ceased on death, any insurance proceeds that are subsequently paid into the fund would form part of member’s accumulation account and comprise a 100% taxable component.

Grandfathering of favourable income testing

Another area where ARPs may prove important is for the retention of concessions that relate to income testing.

For instance, the eligibility testing for the age pension provided by Centrelink or the Department of Veteran Affairs (‘DVA’) includes a more favourable income test for account-based pensions (‘ABP’) in place prior to 1 January 2015.

For ABPs that commenced prior to 1 January 2015, only the amount of pension withdrawn less a deductible amount (broadly, the deductible amount is the amount of the member’s pension account divided by their life expectancy) counts towards the income test. However, for ABPs commenced from 1 January 2015, the amount of the member’s pension account for an ABP is deemed to earn income at prescribed rates for the purposes of the income test (even though the member’s account balance has suffered a loss).

Where an ARP was in place prior to 1 January 2015, and thus the pension continues on the member’s death, the more favourable income testing regime for ABPs commenced is grandfathered for the reversionary pensioner.

Eligibility for the Commonwealth Seniors Health Card (‘CSHC’), which allows access to cheaper prescriptions via the pharmaceutical benefits scheme and provides certain other government funded medical services, may also be affected.

Prior to 1 January 2015, ABPs were not assessed for CSHC eligibility. However, since 1 January 2015, earnings on the assets supporting ABPs are assessed under the adjusted taxable income test. The income from the ABP will also be taken to have a deemed rate of return.

Having an ARP in place enables a reversionary pensioner to preserve the potentially favourable ‘grandfathered’ status for Centrelink, DVA and CSHC income testing in respect of ABPs that commenced prior to 1 January 2015. This allows, for instance, a surviving spouse to continue to be paid a pension following the death of their spouse, and therefore, continue the favourable income treatment of a pre-2015 ABP.

$1.6m balance cap

The $1.6 million balance cap proposal included in the May 2016 Federal Budget will limit the amount that a member can hold in retirement or pension phase from 1 July 2017. This will limit or cap the amount that obtains the exempt current pension income (‘ECPI’) exemption from tax in a fund. Broadly, from 1 July 2017 only earnings on assets capped at $1.6 million that support the fund’s liability to pay a pension will be tax-free. The balance cap proposal also allows earnings on the $1.6 million to obtain the ECPI exemption as there are no restrictions proposed to be placed on subsequent earnings on the $1.6 million balance cap amount, which will be allowed to be maintained in the fund.

While the draft legislation for the balance cap proposal has yet to be released (there may also be a chance that the start date of 1 July 2017 gets deferred for the systems to be implemented to cater for the wide spread changes relating to this measure), it does appear that this proposal will significantly impact SMSF succession planning.

This is because a death benefit pension (ie, an ARP on the death of a spouse) paid to a surviving spouse who has already utilised their $1.6 balance cap will likely result in additional tax payable. Additional tax is likely to arise through a requirement that the death benefit be paid as a lump sum on the spouse’s death as the surviving spouse already has used up their balance cap.

Alternatively, assuming the pension can revert under the proposal, then since the surviving spouse has already used up their balance cap, any further amount added to their member balance in superannuation could be subject to substantial tax. The $1.6 million balance cap has an excess balance transfer tax that applies when someone seeks to transfer an amount in excess of their balance cap to their retirement account. This tax is equivalent to 49% of the excess amount. If an ARP locks in a reversion, subject to what the finalised law provides, and an excess pension phase transfer occurs above the balance cap then the excess will be subject to penalty tax of 49%. Naturally, this would have a severe impact on SMSF succession planning for many couples.

If, however, there is no flexibility provided under the proposed legislation in reverting to a spouse who has already used up their balance cap, then this may result in a compulsory cashing event for the deceased spouse requiring a lump sum payment to be made. Since the ECPI will only cover tax on assets up to a maximum of $1.6 million (plus earnings thereon as indexed), then the other assets that need to be liquidated or disposed of may give rise to taxable gains on which tax is payable. Over time, considerable extra revenue is likely to be raised through this measure by the ATO.

Accordingly, members in retirement phase with pension account balances exceeding $1.6 million can no longer rely on ECPI applying to any death benefit pensions paid to them as a surviving spouse or eligible beneficiary. There is likely to be detailed discussion and, hopefully some meaningful consultation, in relation to these concerns before the legislation is finalised.

Accordingly, the $1.6 million balance cap represents a new hidden death tax and it poses a challenge for ARPs as a tax effective SMSF succession planning tool.

However, many people will still probably want to position themselves with an ARP until the uncertainty of how the $1.6 balance cap measure is resolved. If the ARP results in the surviving spouse’s balance cap being exceeded further planning at or before that time may be needed.

Reduced flexibility in relation to in specie transfers

There can also be disadvantages in having an ARP. Having an ARP in place may, for instance, reduce the flexibility in relation to an in specie payment of superannuation death benefits.

The extension of the pension exemption on death for non-ARPs under sub-regs 995‑1.01(3) and (4) of the Income Tax Assessment Regulations 1997 (Cth) provides greater flexibility in relation to payment of assets supporting a pension to a fund member. Broadly, these provisions enable a lump sum death benefit to be paid by way of an in specie transfer of assets and be treated as an income stream payment covered by ECPI subject to the balance cap limit from 1 July 2017.

Note that these regulations do not apply to an ARP. To pay a lump sum by way of an in specie transfer of an asset in the context of an ARP, the ARP must be partially commuted, which can create complications for claiming ECPI (subject also to the balance cap proposal).

SMSF and pension documentation

The above strategies depend on quality SMSF, pension and other documentation. Many SMSF deeds and pension documents may not provide an adequate foundation to implement an ARP consistent with the ATO’s view in TR 2013/5.

Accordingly, advisers should ensure that their clients have appropriate documentation in place to implement their clients’ SMSF succession plans, including a strategic SMSF deed supported also by appropriate pension and BDBN documentation.

Naturally, DBA Lawyers’ SMSF deed and related documents provide for and support smooth and tax-effective SMSF succession planning outcomes.

Conclusion

As can be seen from the above, ARPs are not a ‘one-size-fits-all’ solution for every situation, but they do have a strategic role to play in tax-effective SMSF succession planning.

Advisers should be aware of the benefits and challenges of utilising ARPs, including in the context of insurance, government concessions, and the proposed $1.6 million balance cap.

For more information on ARPs, refer to:

http://www.dbalawyers.com.au/pensions/what-wins-out-an-automatically-reversionary-pension-arp-or-a-binding-death-benefit-nomination-bdbn/

For more information on the $1.6 million balance cap, refer to: http://www.dbalawyers.com.au/announcements/1-6m-balance-cap-examined-tax-death-benefits/

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Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

20 August 2016

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