Professor John Piggott | CEPAR

Australia is lauded throughout the world for its retirement income structure. Although it is largely unappreciated at home, we are in an enviable position when compared to the implicit pension debt being racked up among our OECD counterparts. As a paradigm, it has everything going for it – income protection for the less well-off, cost containment, and mandatory minimal levels of mandatory self provision for those who can afford it.

But successive governments put the whole structure at risk by tinkering with super taxes.  No country has borne more capricious changes to the taxation of its private pensions than Australia.

It’s worth taking a step back from the current controversy to reflect on three questions. First, what should a pension tax system look like? Second, why should Australia’s pension tax system be subject to so many more changes than its counterparts elsewhere? And finally, why does it matter if Canberra fiddles?

Almost all countries offer tax concessions for pension saving. The implicit deal is, preserve your savings until you retire, and get a tax break.  The most common break is exempting the investment earnings of the pension fund. Then either contributions are deductible under the personal income tax, or benefits are tax-free.

On the whole, taxing benefits is the better way to go. This avoids complexities around employer deductions for pension contributions, and bad investment outcomes are cushioned through lower taxes, while investment outcomes above the norm pay some extra tax. The government shares the risk. The timing of tax collections is better too – tax revenues will increase when an expanding older population cohort is driving public expenditure up.

But whether contributions or benefits are taxed, as long as investment earnings are exempted, economic efficiency is well served. You have a system that closely aligns the tax treatment of super with the tax treatment meted out to the other major life-cycle asset – owner-occupied housing. This is a critically important aspect of the policy design.  In their roles as retirement saving vehicles, these two retirement assets should be treated similarly under the tax system. And by exempting earnings, the price distortion between consumption during working life and consumption during retirement is largely eliminated.

Australia’s super tax departs from both these standard paradigms. Instead, it separates superannuation taxes from personal income tax altogether. Contributions are income tax exempt, but taxable at a flat rate in the pension fund; earnings on those contributions are also taxed. And benefits used to be taxed as well, until the 2007 Better Super reforms exempted benefits paid to those over 60. The result is that there is no link with the progressivity inherent in the personal income tax.

Separating superannuation taxes from the personal income tax makes tinkering with pension taxes tempting for governments. Changes can be made without their showing up in a pay packet the next week.

This has happened several times since the Superannuation Guarantee was introduced, and it looks like it’s about to happen again. What is proposed may be a small step in the direction taken by the Henry Review on this issue, which accepted contributions taxes were here to stay, but recommended that the rebate be linked to the personal rate schedule. It also recommended a reduced earnings tax to help the power of compound interest generate more accumulations.

If that’s the direction of change, then it would be better to take the proposal in its entirety, rather than just apply it to the top 1%, as news reports suggest is likely. And this should be well thought out, converging to something stable, with discussion and consultation, not a last minute cash grab.

Not that the top 1% is taxed especially harshly in Australia. A somewhat higher marginal tax rate for the top 1%, say 49% above $250,000, maybe on a temporary basis, would be a better response.

So, why does the tinkering matter? Two important reasons. First, this is a whole-of-life issue, and long-term planning is part of it. Although some rules are bound to change with time, surprises are bad and should be avoided whenever possible. Once you get to a point where arbitrary policy surprises are expected, credibility in the system evaporates. The top 1% today, the top 5% tomorrow, who knows the day after?

People will likely reduce their non-mandatory contributions, saving will fall, eventual reliance on the age pension will be higher than it would otherwise have been, and most importantly, many people will have a less satisfying retirement.

Second, change increases administrative costs and charges. More records have to be kept, checked, and transferred when the worker changes funds. Australia’s pension costs are already on the high side. Through a full career, increasing charges by just a half percentage point can reduce the eventual accumulation by more than 10%. That impacts on everyone’s super outcomes, not just the top 1%.

Professor John Piggott is director of the ARC Centre of Excellence in Population Ageing Research at the University of NSW.

This article first appeared in the Australian Financial Review 30 April 2012.

Michael Sherris

Australia needs new infrastructure. We need to fund it. And there are substantial assets in superannuation funds. Why don’t we combine the two?

Former Treasury secretary Ken Henry says that Australia’s infrastructure projects should be reformed in a way that will make them more attractive to superannuation funds that fear taking on too much risk.

There are vast assets in superannuation funds that can do a lot of good for Australia. These are a potential source of funding to finance the infrastructure that Australia badly needs.

These superannuation funds will increasingly be seeking assets that will allow them to provide retirement income streams to their members either directly or through retail products such as indexed life annuities.

Among the potential reforms suggested by Ken Henry is one that would see the Federal Government assume greater risk, with less pressure on the private sector, to reassure funds and their investors that infrastructure projects are safe investments, such as the latest proposals for the fast rail network on the east coast of Australia.

Super funds could pay for these proposals now. If these funds are to finance major infrastructure assets they should be seeking long term inflation linked annuity bonds to fill the limited market in indexed linked and long term securities in Australia. This would provide opportunities for the funds to offer income streams to members and have matching long term assets.

I would like to see this taken further. Ken Henry’s Tax Review proposed that the government should issue more long-term inflation linked longevity bonds, to support the development of a longevity insurance market. Now, if we were to be really innovative we may even be able to develop a longevity bond with payments linked to population survival rates to allow the funds to manage mortality risk, which would naturally compensate for the population living longer. This mortality risk is driving the growth of longevity swaps for defined benefit pension funds in the UK and Europe as well as attracting interest in the US.

Australia is one of many countries that has a rapidly ageing population. However there are few products that provide longevity insurance, which is protection against the risk of individuals living too long, running out of cash and then relying on the state. Using these longevity bonds, we could also fund key infrastructure projects in Australia, which are currently suffering from a lack of cash from risk-wary superannuation funds which have seen large losses on projects such as the Clem Jones tunnel in Brisbane.

Michael Sherris is a Professor of Actuarial Studies at the Australian School of Business.

Associate Professor Anthony Asher

Higher “superannuation guarantee” contributions are an assault on the poor and the young.  They only seem a good idea to those who can afford to save, or who do not understand the pressures on the young, or perhaps will benefit from the additional fees flowing into the financial services industry.

Australians in the lowest income brackets already have more money after they retire than before. If super contributions go up, they will receive even less in their pay-packets now.

Increases to super contributions hit hardest at working mothers, who are spending a large chuck of their energy and finances on their children. They already work harder than any other group in society:  research suggests that an average of 80 hours a week including domestic work is the norm. Those most exposed are single mothers and mothers repaying mortgages, who are probably worse off.

The higher contributions do not just hit the poor. One reason for misunderstanding is that many older – middle class – people bought their houses when average prices were 3 times average wages, and it cost a month’s wage to send a child to a good private school. These people seem to have difficulty seeing that needs have changed significantly when house prices are 6 times average wage and it costs six months’ wages to pay private school fees for 3 children.  Taken together, these additional costs can take 15% of a lifetime’s earnings and so should also lower retirement income.

If government and the superannuation industry were serious about improving people’s retirement income, they would focus more energy on facilitating proper lifetime pensions. Properly designed, these can increase spending power in retirement by almost 20%. This would also stop the situation where men spend their superannuation proceeds and leave their widows to live off the pension.

Anthony Asher is an Associate Professor of Actuarial Studies at the Australian School of Business, University of New South Wales.

Gordon Mackenzie

When planning for one’s own death, it isn’t wise to depend on handing over superannuation funds to beneficiaries.

Spouses and children face the prospect of significant tax bills upon the death of a parent or partner following a ruling by the Australian Taxation Office.

The ATO ruling clarifies the manner in which pension assets will be treated following a death, and mean that private pensions are no longer tax-free upon the death of a pensioner and that any beneficiaries will have to pay capital gains and income tax on the assets.

What we are seeing with this ruling is the view that super funds should not be used for estate planning purposes.

If a death benefit is paid to someone other than a spouse or dependent child, the taxes in the fund and when the benefit is paid reverse the tax concessions that the deceased got for using a super fund in the first place.

What that means is that benefits paid to non-dependant adult children, say, will be taxed at an effective tax rate of 31.5%, (or 16.5% on capital gains). That rate is, broadly, the tax rate that most Australians would have paid had they not used a super fund on that account balance. So, in that way the tax concessions for using a super fund are recaptured.

Gordon Mackenzie is a Senior Lecturer and Program Convenor at the Australian School of Taxation and Business Law at the Australian School of Business. Gordon Mackenzie has given submissions to Henry Tax Review Panel on Resolving the Tax Inefficiency of Losses, and the Cooper Review on Tax Governance of Superannuation Funds, into the structure and operation of Australia’s superannuation system.