Messing with market linked pensioners

3 Apr 2017

Meg Heffron

Managing Director

It’s not popular to voice support for the very wealthy, particularly retirees with very large super balances. But they have just been shafted big time in the latest round of super changes.

Anyone with more than $1.6m in superannuation pension phase is currently preparing for a new world from 1 July 2017 when they will have to move part of their pension back to accumulation phase (or remove it from super entirely). In the conversations I’ve had with many people affected by these changes there has been little criticism of the overall direction taken by the Government. There seems to be widespread acceptance that something was likely to change when it came to superannuation tax concessions in retirement phase and capping the amount transferred into pension phase is a reasonable way to do it. For those already in the system, having to wind back their pension exposure to $1.6m at 30 June 2017 (rather than permanently grandfathering higher pensions) is generally also seen as reasonable.

What is iniquitous, however, is the treatment of those who have market linked and certain defined benefit pensions (called “complying” pensions).

These are people who generally retired more than 10 years ago after a lifetime of excellent superannuation concessions. It was back in the days when people paid tax on their super pensions and the rate of tax depended on the size of your pension balance. People with very large balances generally took market linked or complying defined benefit pensions as part of a trade off with the Government – locking up a lot of super up in one of these pensions allowed them to enjoy the best possible tax concessions on more of their pension balance.

The downside was that they really were “locked in” to that pension.

Once a market linked or complying defined benefit pension started, they were stuck with rigid rules around pension payments, couldn’t take any extra amounts if they wanted to and couldn’t change their mind and switch to an account-based pension. This remained the case even after 2007 when the rules changed for everyone and no-one paid tax on their super pensions any more.

At the time, I didn’t hear any howls of complaint. This group accepted that they’d chosen to be tied up in return for great tax concessions in the lead up to 2007. So even when the rules changed and new retirees got superannuation nirvana (no tax on pension payments no matter how large) this group with restrictive legacy pensions didn’t generally complain.

From 1 July 2017, however, the rules will change again. When the new $1.6m limit on pensions takes effect, this group can’t respond like everyone else and just roll back the excess over $1.6m to accumulation phase. They are stuck with their pensions. So naturally the Government has to do something to ensure that they don’t get a free ride (allowed to have a lot more than $1.6m in pension phase).

The Government’s approach has been to impose tax on the pension payments themselves – just for these old legacy pensions. Sounds OK so far.

But the tax is marginal rates (no offsets, no rebates), on half the pension payment over a $100,000 threshold regardless of its tax components. Someone who is receiving $500,000 in pension payments will therefore pay tax on $200,000 at their marginal rate (so the new tax bill could be up to $94,000). That’s like wiping 20% off the value of that part of their retirement savings immediately. It is likely to be far higher than the tax they would pay if a large part of their fund balance just moved back to accumulation phase and earnings in the fund were subject to 15%.

How can that be reasonable? Or fair?

The most frustrating thing is that there is a simple solution and the Government almost got there. Draft regulations issued before December added the power to roll back market linked and complying defined benefit pensions to accumulation phase in order to deal with an excess over the $1.6m cap. This would put recipients of these pensions in the same position as the rest of us. But those regulations don’t appear in the latest round presented to Parliament. That means people with large restrictive pensions have no option but to leave them in place and pay the extra tax.

Yes – no-one will die. The people receiving these pensions will not starve. They are by definition very wealthy. They would probably be the first to acknowledge that. But in what world is it reasonable policy to just hit a very small group of people with massive tax costs in a way that seems out of proportion to the way in which everyone else is dealt with?