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2016 Federal Budget

Federal Budget 2016: superannuation reform proposals

The policies that the both the Government and Opposition took to the recent election were substantially about measures to move the federal budget back towards surplus. These policies included proposals for reform of superannuation arrangements that are designed to redirect tax concessions away from high income people who, it is claimed, are getting a disproportionately large share of the advantage that the concessions provide.

As well as proposals for changes to particular aspects of superannuation, such as caps on contributions, there is a proposal to enshrine in legislation a core purpose for the superannuation system. The Government has stated this core purpose as: 

‘To provide income in retirement to substitute or supplement the Age Pension’.

Referring to this core purpose, and its proposed reforms, the Government has further stated:

‘The superannuation changes will improve the integrity of the superannuation system by reducing the extent to which it is used for tax minimisation and estate planning.

The introduction of tighter caps are key elements in improving confidence that the system is being used for its core purpose.’

In assessing the impact of the reform proposals the Association gave most of its attention to whether or not a proposal would act similarly on recipients of untaxed-source defined benefit pensions, such as our Super SA pensions, as on recipients of other forms of retirement income (taxed-source defined benefit pensions and allocated pensions). Our assessment was that this would be the case and we will not, at this stage, be attempting to argue against any of the proposals.

Changes proposed for accumulation schemes and/or account based pensions

Pre-retirement

1. The maximum annual amount of concessional (pre-tax) contributions, currently set at $30,000 for people under 50 years of age and $35,000 for older people will be reduced to $25,000 for everyone from 1 July 2017. 

2. The current arrangement, allowing non-concessional (post-tax) contributions of up to $180,000 pa or $540,000 every three years, is to be replaced, from 1 July 2017, by a lifetime limit of $500,000 with all such contributions made since 2007 contributing towards this limit.

Transition to Retirement

The current arrangement allowing people to open a ‘Transition to retirement income stream’ while still working part-time or full time sees the earnings of the account balance driving the income stream exempt from tax. From 1 July 2017 these earnings will be subject to tax at a rate up to 15%. This is the only proposed change that has the potential to adversely affect people with relatively small superannuation holdings.  See below for more detail.

Full retirement

1. The current arrangement allowing people to have an account-based (allocated) pension where the earnings of the account balance, no matter how large that balance is, are exempt from tax is to be replaced by an arrangement which sets a maximum of $1.6 million on the account balance for which earnings will be tax-free. For example, where there is an account balance of $2.0 million the person will have to transfer $400,000 to an accumulation account where the earnings will be taxed at a rate up to 15%. If this $400,000 earns (say) 5% ($20,000) the tax payable will be up to $3,000.

2. Abolition of the work test for people aged up to 75 years. See below for more detail. On 15/9/2016 the Treasurer announced that this would not proceed as a consequence of the Government being forced by its back-bench members to abandon the lifetime cap of $500,000 on after-tax contributions. The savings that would have been made by this measure will now be made by maintaining the work test.  

Changes proposed for defined benefit pensions

For defined benefit pensions the budget papers (Budget paper No 2, p26) state that

‘Commensurate treatment for members of defined benefit schemes will be achieved through changes to the tax arrangements for pension amounts over $100,000 from 1 July 2017’. This ‘commensurate’ treatment will be as follows.

For Super SA, and other untaxed-source pensions above $100,000 pa, the 10% tax offset available at age 60 will not be able to be claimed on the amount in excess of $100,000. This would see a person with a pension of $120,000 being able to claim a tax offset of $10,000 rather than the $12,000 that can be claimed now.

For taxed-source defined benefit pensions such as those paid by other state governments the amount of pension up to $100,000 will be tax – free with any additional amount being halved, added to taxable income and then taxed at the marginal rate for the person’s resulting taxable income. For a pension of $120,000 this will see the person assigned additional taxable income of $10,000. The threshold above which tax becomes payable is $18,200 and so a person with a taxed source pension of $120,000 will only pay extra tax if they already have  other taxable income of more than $8,200. If there is no other taxable income taxed-source defined benefit pensions will continue to be tax-free up to $136,400 p.a.

Transition to retirement income streams

Consider the case of a person in full-time employment with an annual salary in the range $60,000 - $80,000 p.a. and who has $200,000 in a superannuation accumulation account. If this person has reached his/her superannuation preservation age (55 years for people born before 1 July 1960 and up to 60 years for those born later) he/she is entitled to use some or all of the $200,000 to commence a transition to retirement income stream (TRIS) which is a form of allocated pension. This pension can have an annual amount between 4%  and 10%  of the account balance ($8,000 to $20,000). If the person is aged over 60 years the income from the TRIS is tax-free and does not attract the medicare levy. A person for which all this applies may currently arrange his/her affairs as follows.  

1. They may salary sacrifice $30,000 p.a. into a separate superannuation account from that which holds the $200,000 they have already accumulated. A 15% ($3,000) contribution tax will be payable and the net amount added to the new account will be $27,000.

2. Of the $30,000 that was salary-sacrificed into super 34.5% ($10,350) would have been payable as tax (32.5%) and medicare levy (2%) if it had been retained as normal salary. So the reduction in net income due to the salary sacrifice is $19,650.

3. The person can use the $200,000 already accumulated to commence a TRIS pension with an annual amount of $19,650 (on which no tax or medicare levy will be payable) thereby keeping his/her net income the same.

4. The result of all this is that the person is working full-time, maintaining his/her net income and has contributed $27,000 to his/her super which is $7,350 more than the $19,650 withdrawn in the form of a TRIS pension.

An additional advantage of this salary sacrifice arrangement is that the earnings of the $200,000 backing the TRIS pension are not taxed as they would be if the TRIS had not commenced. At an earning rate of 5% the earnings would be $10,000 and the tax payable would be an amount up to 15%  ($1,500). The reduction in tax payable as a result of these arrangements would be $7,350 + $1,500 = $8,850 p.a. For a salary of $80,000 p.a. or less this is more than the superannuation guarantee (S.G.) which is currently 9.5% of salary. For higher salaries TRIS pensions are even more effective at reducing tax on employment income.

The Government is not proposing to stop the use of TRIS pensions, only that the investment earnings of the money backing a TRIS pension will be taxed at a rate up to 15% from 1 July 2017. Another measure that will affect TRIS pensions if it is implemented is the lowering of the cap on concessional contributions to $25,000. These measures will make TRIS pensions less effective at minimising tax on employment income than is the case now but they will still be very effective for this purpose.

People still in full-time work, who are members of the State Pension Scheme, can use the above arrangements if they have a separate accumulation account e.g. an account in the Southern State Superannuation (SSS) scheme. The State Pension Scheme itself can also be used for transition to retirement but this will require the person to go part-time or to a lower paid position. By itself, the State Pension Scheme does not permit full maintenance of net income, reduction in tax paid and increased superannuation. 

Abolition of the work test  

As stated above the Government does not intend to proceed with this measure. What is written below will let a reader know what would have been possible if the work test did not apply for people aged 65-74 years.  

Currently a person who has reached age 65 years cannot contribute to a superannuation fund unless they satisfy a work test by working 40 hours in any 30-day period in the financial year in which the contributions are made. They must be paid for the work.

The Government’s proposals made on budget night  included removal of the work test for people aged up to 75 years. The Government has changed its mind about this now but If the original budget proposal was implemented a person who is fully retired, and has taxable income, would have been  able to reduce their net tax as follows.

They could have made a contribution to super up to the concessional contribution cap (proposed to be $25,000 p.a. from 1 July 2017) and pay 15%  tax on the contribution. They would then be able to claim a tax deduction against their taxable income. For example a person who is paying tax at a marginal rate of 32.5% and the 2% medicare levy could have made a super contribution of $1,000, paid the contributions tax of $150, then claimed a tax deduction of $1,000 thereby reducing their income tax payable by $325 and medicare levy by $20  to end up in front by $195 for every $1,000 contributed to super. Where this was done as a tax minimisation strategy there would be no point making contributions larger than those needed to reduce tax payable on personal income to zero. If the amount of $25,000 is contributed then the tax saving is 25 x 195 = $4,875.

Untaxed-source pensions, including Super SA pensions, continue to be taxable income and so where such a pension is large enough to see the recipient still being a net tax payer this reform, if it had been implemented, would have opened up an avenue for tax currently being paid to be reduced. But this is not going to happen now.