Taxation of superannuation

Observation

In reviewing the taxation of contributions and investment earnings in superannuation, the Tax White Paper should consider:

  • Aligning the earnings tax rate across the accumulation and retirement phases.
  • Options to better target superannuation tax concessions to the objectives of the superannuation system.

Objectives

  • Remove tax barriers to enable a more seamless transition to retirement.
  • Better target superannuation tax concessions to achieve the objectives of the superannuation system discussed earlier in this chapter and, in doing so, reduce the cost of the superannuation system to Government, reduce distortions to the allocation of funding in the economy, and improve long-term confidence and policy stability in the superannuation system.

Discussion

Problem the observation seeks to address

As acknowledged in submissions, superannuation is seen as an attractive savings and wealth management vehicle for middle- and higher-income earners due to the highly concessional tax treatment of contributions and earnings (Chart 6: Share of total superannuation tax concessions by income decile). According to Rice Warner, “It is self-evident that the tax concessions for superannuation are tilted towards those Australians who have the most income and wealth, and who have the highest personal marginal tax rates”.101

Superannuation tax concessions are not well targeted at the objectives of the superannuation system discussed earlier in this chapter. As illustrated in Figure 4.3 of the Interim Report, a small minority of members hold a high proportion of superannuation assets.102 Individuals with very large superannuation balances are able to benefit from tax concessions on funds that are likely to be used for purposes other than providing retirement income, such as tax-effective wealth management and estate planning.103 The AIST supports “… a focus on promoting and delivering greater equity in the system to build retirement incomes over the course of every person’s working life, as opposed to making superannuation a tax effective wealth creation vehicle and estate planning tool, for the few”.104

As a result, the majority of tax concessions accrue to the top 20 per cent of income earners (Chart 6). These tax concessions are unlikely to reduce future Age Pension expenditure significantly.105

Chart 6: Share of total superannuation tax concessions by income decile

This chart shows the proportion of superannuation tax concessions accrued to different deciles of income earners, based on 2011-12 ATO data. Higher income earners receive greater tax concessions, with more than half tax concessions accruing to the top 20 per cent of income earners.

Source: Treasury, based on an analysis of 2011–12 Australian Taxation Office data.106

Poorly targeted tax concessions increase the cost of the superannuation system to Government. In turn, this increases the fiscal pressures on Government from an ageing population. Giving high-income individuals larger concessions than are required to achieve the objectives of the system also increases the inefficiencies that arise from higher taxation elsewhere in the economy, including differences in the tax treatment of savings (refer to the Appendix 2: Tax summary).

In addition, tax concessions contribute significantly to policy instability and undermine long-term confidence in the superannuation system. Around half of the announced policy changes over the past 10 years appear to have been aimed at addressing concerns related to the targeting and equity of tax concessions.107 Despite this, concerns remain and continue to undermine public confidence in the fairness and sustainability of policy settings.

The differential tax rates on earnings between the accumulation phase (taxed at 15 per cent) and the retirement phase (tax-free) of superannuation have adverse effects as they:

  • Create a tax boundary that limits pension product innovation and acts as a barrier to funds offering whole-of-life superannuation products. This increases costs in the superannuation system by requiring multiple, separate accounts between the accumulation and retirement phases.108
  • Can contribute to sub-optimal investment strategies in the years approaching members’ retirement by focusing attention on investing until the point of retirement (the end of the accumulation phase), rather than investing over the long term beyond the point of retirement.
  • Provide an opportunity for tax arbitrage in superannuation between the accumulation and retirement phases. Capturing these benefits by allocating specific assets to individuals can result in a shift away from investment pooling and diversification in superannuation and reduce the efficiency of the system. It can also provide non-neutral outcomes between different types of funds, as mentioned in the Interim Report.

Options considered

Align the earnings tax rate between the accumulation and retirement phases

As noted in some submissions, aligning the earnings tax rate between the accumulation and retirement phases would result in significant simplification benefits. This was also recommended by Australia’s Future Tax System Review (AFTS).109

Aligning the earnings tax rate could be revenue-neutral for Government, would reduce costs for funds, would help to foster innovation in whole-of-life superannuation products, would facilitate a seamless transition to retirement and would reduce opportunities for tax arbitrage. However, a positive tax rate in retirement could reduce equity for some lower-income individuals taking income streams.

Better target tax concessions

The Inquiry considered two options to better target superannuation tax concessions at achieving the objectives of the system. Both options would limit tax concessions for individuals with large superannuation balances.

1. Reduce the non-concessional contribution cap and better target superannuation contribution tax concessions

Some submissions suggest applying a more neutral tax treatment of superannuation across taxpayers. This could be done by implementing the AFTS recommendation to tax superannuation contributions at marginal rates less a flat-rate rebate.

Tightening the non-concessional contribution cap — currently $540,000 over three years — would help to target the tax concessions for superannuation contributions better by reducing the extent to which individuals could accrue very large balances in the system in the future. The administrative and compliance costs would be relatively low. However, it would reduce individuals’ flexibility to save for their retirement at different times of their life and could adversely affect individuals with broken work patterns.

2. Levy additional earnings tax on superannuation account balances above a certain limit

This option imposes a higher rate of earnings tax on individuals with superannuation balances in excess of a certain limit. It would target superannuation tax concessions to achieve the objectives of the system and reduce costs to taxpayers. It would also facilitate the removal of the non-concessional contribution cap.

The Inquiry is aware that similar policy proposals in the past have not succeeded due to their complexity and the high costs of implementation.110 Industry express a strong view that imposing a different rate of earnings tax inside a pooled superannuation trust based on members’ individual incomes would impose high compliance costs and complexity on funds. Submissions also stress the need to avoid options that impose large compliance costs on funds.111

To avoid these large compliance costs, stakeholders raise alternative implementation options to which the Inquiry is attracted. One approach is to apply the higher rate of earnings tax to affected individuals outside the superannuation system, with the option of paying the tax liability out of superannuation benefits — similar to the mechanism for applying the tax on excess contributions. To reduce complexity further, the tax could be calculated on a simplified tax base.112 This option would increase Government revenue.113

Conclusion

Superannuation taxation arrangements should be reformed to place policy settings on a more sustainable footing over the long term. Superannuation tax arrangements should be targeted to achieve the objectives of the superannuation system, reduce the cost of the retirement income system to Government, better position Australia to meet the fiscal challenges of an ageing population and reduce funding distortions in the economy.

The choice between options to better target superannuation tax concessions rests partly on the treatment of very large superannuation balances already in the system, which are likely to be used for purposes other than providing retirement incomes. Tighter contribution limits could reduce the future prevalence of very large superannuation balances. On the other hand, account balance limits would address the disproportionate allocation of tax concessions to individuals with very large balances now and in the future, and reduce the costs of these concessions.

The Inquiry has not recommended a specific option because a range of relevant considerations fall outside its scope — in particular, interactions and alignment with the broader taxation system.

Implementation considerations

Prior to implementation, Government should consult with industry to avoid unintended consequences for industry and fund members.

Individuals have made superannuation contributions and decisions based on the existing rules and tax arrangements. If Government introduces a higher rate of earnings tax for account balances above a certain limit, transitional arrangements should be considered. For example, individuals with account balances above the limit could be given the opportunity to transfer assets out of the superannuation system without detriment.


101 Rice Warner 2014, Second round submission to the Financial System Inquiry, page 24.

102 Commonwealth of Australia 2014, Financial System Inquiry Interim Report, Canberra, page 2-121.

103 Commonwealth of Australia 2014, Financial System Inquiry Interim Report, Canberra, page 2-126.

104 Australian Institute of Superannuation Trustees 2014, Second round submission to the Financial System Inquiry, page 5.

105 As noted in the Interim Report, “… the large number of accounts with assets in excess of $5 million could each receive annual tax concessions more than five times larger than the single Age Pension”. Commonwealth of Australia 2014, Financial System Inquiry Interim Report, Canberra, page 2-120.

106 Treasury 2014, Data provided to the Financial System Inquiry, 29 October 2014.

107 Financial System Inquiry analysis of Government policy announcements in annual Budget documents, Mid-Year Economic and Fiscal Outlook statements, Pre-Election Fiscal Outlooks and Economic Statements.

108 For example, if a retiree has commenced a pension and later decides to make a contribution to superannuation, the retiree will need to open a new accumulation account and a new pension superannuation account. This results in some members having multiple pension accounts in retirement.

109 AFTS made a number of recommendations regarding the taxation of savings and superannuation. AFTS recommended taxing long-term savings (including superannuation) at a lower rate to avoid discriminating against individuals who choose to defer consumption and save. It also recommended implementing a more neutral tax treatment of superannuation contributions across taxpayers. This Inquiry endorses these recommendations. Commonwealth of Australia 2010, Australia’s future tax system: Report to the Treasurer, Canberra.

110 The previous Government proposed capping earnings tax concessions in retirement at $100,000 before a higher rate of tax would apply. The proposal was not implemented. In addition, the high costs of administration resulted in the abolition of reasonable benefit limits in 2007.

111 For example, see Mercer 2014, Second round submission to the Financial System Inquiry, page 32; Association of Superannuation Funds of Australia 2014, Second round submission to the Financial System Inquiry, page 57.

112 For example, the Australian Taxation Office could calculate superannuation earnings net of taxes and fees using existing account balance and contribution data, without the need for additional reporting. A less attractive alternative is to deem a rate of earnings on account balances based on industry-wide average returns, or based on long-run average returns. This could be justified on the basis of being a penalty rate of tax that seeks to discourage higher balances. The account balance limit could only apply in the retirement phase, if that further reduced implementation costs.

113 The increase in Government revenue in the short term would be reduced by implementation costs for the Australian Taxation Office.