Heffron | When super policy becomes a crazy game

When super policy becomes a crazy game

Sometimes the lunacy of politicians (both sides) amazes me when it comes to superannuation policy.  Although perhaps that fact in itself is amazing since I have been working in superannuation for nearly 30 years and should have learnt better by now.

The Opposition Treasury Spokesman recently re-iterated some of Labor’s superannuation policies which were reported here but the full explanation is readily available on their website here.  These reports don’t specifically cover their earlier announcements about changes to franking credits to make them non refundable but this is also clearly part of the mix.

Essentially the problem for any politician today is that superannuation in retirement phase looks like a very juicy pot of potential tax revenue that is currently largely untouched.

There are two ways of changing that:

  • Tax the payments (benefits) people receive from their superannuation funds, or
  • Tax the income received by the fund itself so that it has less money with which to pay benefits. 

The first approach - taxing the benefits paid out of super directly - would unwind the very generous treatment introduced by the Coalition back in 2007.  From 1 July 2007, anyone over 60 has been able to receive any amount from a conventional superannuation fund and pay no tax.  (I say “conventional” because there is a small number of funds that don’t pay tax while their members are building up their superannuation entitlements but do pay tax when the money comes back out again.  Most of us are not in these funds.)

I would be prepared to bet that no politician has the courage to adopt this approach.

So both the major parties are currently taking the easier second option of focussing on taxing investment income (dividends, rent, interest etc) received by the funds that are paying pensions. 

Winding back tax concessions funds paying pensions

Historically, once a superannuation fund member started taking a pension the fund stopped paying income tax on the earnings it received from the assets supporting that pension.  Paying less tax meant more money built up in the superannuation funds and therefore higher benefit payments to members.

Years ago, the ALP proposed to change this by introducing a policy to say:

  • Fundamentally it’s OK that superannuation funds pay no tax on their earnings if their assets are being used to pay out pensions to retirees; but
  • Only up to a point.

The ALP proposed to achieve this by placing a limit of $75,000 on the amount of tax free income a fund could receive for each pensioner each year.  A fund with two members receiving pensions, therefore, could receive up to $150,000 of its dividends, rent, interest etc tax free.  If the fund earned more, this would be taxed at the usual superannuation fund tax rate of 15%.  Before this policy could be legislated, the ALP lost power.

The Coalition approached the same problem slightly differently.  Their approach was that instead of directly capping the amount of tax free investment income a fund could earn, they would cap the amount that could go into the sorts of pensions that created this income in the first place.  They did this by making two changes from 1 July 2017:

  • Firstly, only pensions being paid to people who had actually retired would be entitled to give rise to this tax free income in their superannuation fund (this is why transition to retirement pensions were specifically excluded from the definition of “retirement phase” pensions and only retirement phase pensions create tax free investment income);
  • Secondly, the amount that could be put into a retirement phase pension was capped at $1.6m.

This second change was really designed to achieve something very similar to the ALP policy in allowing tax free income to be generated in superannuation funds for retirees but “only up to a point”.

In fact, the two policies also give very similar outcomes under a number of scenarios.

Imagine a fund generates around 5% income on its assets.  Capping the amount that can be put into a retirement phase pension at $1.6m means that the tax free income generated in the fund thanks to that pension will be around $80,000 (5% of $1.6m) which is quite similar to Labor’s $75,000 limit.

Over time, if the $1.6m pension account grows because its investment returns are higher than the pension payments withdrawn, the tax free income might be higher.  But all pension balances eventually start to reduce courtesy of the compulsory draw down rates.  At that point, the current rules are entirely likely to result in much less tax free income than Labor’s $75,000 (particularly if the Labor policy involved some indexation of the $75,000 threshold).

Where the two policies really deviate would be in their treatment of capital gains.  Selling assets and realising capital gains might well result in a far more than $75,000 of taxable income in a single year, even for funds that traditionally fall well within the $75,000 per person threshold.  For this reason, Labor previously floated some complex workarounds to spread capital gains over a number of years – although I notice that these are not discussed on their website.  Perhaps because it would be even more obvious that it involves yet more complexity.

So conceptually the two approaches look like variations on a theme – designed to achieve more or less the same thing but in different ways.  And in both cases, designed to continue the practice of tax free investment earnings for pension funds but only up to a point.

This is why the recent comments from Chris Bowen on ALP policies are completely bewildering to me.  He has indicated that if elected, the ALP would do both – they would keep the existing $1.6m pension cap introduced by the Coalition and overlay their $75,000 per person limit.

To me this is taking a simple policy that achieves 90% of what you’re after and then adding three times as much complexity to achieve the final 10%.

I refuse to believe that the $75,000 per person limit will actually add much to the Government’s coffers over and above what is already being achieved by the new rules.  There are some large savings mentioned on Labor’s website but this is presumably relative to the position before 1 July 2017 when the $1.6m pension limit did not apply.

Labor will no doubt argue that this is a “belt and braces” approach that will allow them to be really really sure that they are constraining the tax concession they are targeting. I’d argue it’s actually just a belt plus another belt - which would look stupid on any set of pants.