Well, it seems that the Government of the day can’t resist tinkering with the Super and Pension system during each federal budget. In 2016 the LNP Government is no exception, and in fact, there have been some major changes in the 2016 Federal Budget. In this post I will describe how the most relevant changes will impact retirees, early retirees and, continuing with the theme of using us as a case study, our situation in particular.
I will also look at some interesting aspects of the changes, and also have a brief look at the ALP alternative.
Reasoning behind the Changes
The government has made clear that it believes that the purpose of the Super system is to:
- Assist retirees to obtain the assets required to enjoy a comfortable retirement
- Reduce the cost to the government of providing retiree support by providing incentives to people to contribute towards their own (no more than “comfortable”!) retirement.
According to the government, it is definitely not supposed to:
- Provide tax-free income on earnings in retirement where those earnings are in excess of the amount required for a retiree to achieve a “comfortable retirement”.
- Provide assistance to retirees to accumulate assets in excess of the amount required to achieve a “conformable retirement”
Of course, a “comfortable retirement” is a relative term, but the government has sought to define the amount of income required to achieve it via this legislation.
Note that it is perfectly possible for a person to enjoy a retirement with more funding than the funding required for the government defined “comfortable retirement”, it’s just that the retiree will not receive any tax benefits for the excess funding.
In view of the above, a raft of measures have been introduced in this budget aimed at reducing existing large (tax-free) pension-mode Super accounts and, moving forwards, making it difficult for individuals to transfer excessive amounts of funds into the Super system (including the low tax accumulation accounts).
To my mind, these measures are very sensible and long overdue. In Australia today there are some individuals with over $100M in their Super account. Why should the community be supporting the tax free returns generated by these extremely rich individuals?
What are the major changes that will impact early retirees
There are four major changes that will impact on early retirees. These are:
A Cap of $1.6M on the amount that can be transferred to retirement phase accounts
Retirement phase accounts are the so-called account based pensions. This measure is saying you can transfer no more than $1.6M from your accumulation account into your account based pension. Note that normally you are eligible to do this at 60, and most people will do this as soon as possible in order to reduce the accumulation mode tax (normally around 8%) to zero.
Although not stated in the budget papers (page 40 onwards), according to this web site, it seems that the $1.6M cap will be indexed “in $100,000 increments in line with the Consumer Price Index, similar to the treatment of the age pension assets threshold.”. It would be good to see a government site confirming this.
If you wish to make multiple transfers into your account based pension (e.g. if you sell your house, or receive an inheritance), you can do so.
According to the budget papers:
“The amount of cap space remaining for a member seeking to make more than one transfer into a retirement phase account will be determined by apportionment.”
This means that if you contribute, say 50% or $800K now, then you can contribute your remaining 50% of the cap limit at a later date (which may be higher, as the cap limit will increase along with inflation).
The other aspect of this policy is that if you have more than $1.6M in your account based pension now, you are considered to already have reached your Cap, and must move any excess out. You can move it into your accumulation account (and then presumably take it out as a lump sum at a later date). Note that you are typically taxed at about 8% in the accumulation account. Those few Australians that have over $100M in their Super accounts still get a good deal by having a very low tax rate on their savings. It has been speculated that the low tax in the accumulation account may not be low enough, and those with high super balances may move the excess into negative gearing, thus putting upward pressure on property markets.
Note also that, moving forwards, there is no limit to the amount you can have in your account based pension. Once you have transferred the $1.6M into your account based pension, if it grows to $3.2M that is fine and you wont suffer any penalty.
This measure comes into effect on the 1st July 2017. It will help the government reduce oversize Super accounts.
A lifetime Cap of $500K on non-concessional contributions
This measure is saying that you cannot contribute more than $500K in non-concessional contributions during your lifetime. Non-concessional contributions are the post tax contributions that you make direct to your super fund. The $500K will be “indexed to average weekly ordinary time earnings” and according to this web site, will be “indexed in $50,000 increments”.
According to the budget papers:
Basically if you have already made non-concessional contributions, then they will be counted in the lifetime limit if made after 2007 (which makes me feel better about not making additional non-concessional contributions prior to the budget!).
Given that the median house value in Sydney is around $1M, and many people will be downsizing in their retirement, this seems a bit restrictive, especially if you are single. However, at least for couples, when you look at the tax free limit on earnings (about $18K per individual), this may not be as restrictive as first thought.
It’s not clear at the moment if this new regulation will co-exist with the existing yearly limits on non-concessional contributions and the “bring-forwards” rule.
This measure has immediate effect (assuming it is passed into law) and again will help the government reduce the possibility of oversize Super accounts.
Lower Concessional Cap to $25K from July 2017
The concessional cap for all Australians will change to $25K (it is presently $30K if you are under 50, and $35K if you are over 50). Many retirees contribute excess amounts of concessional contributions when nearing retirement as it is at this time excess funds are often available (e.g. mortgage paid off, kids left home). The ability to contribution over $25K per annum will no longer be available after this measure comes into effect. Again, this will help the government reduce the possibility of oversize Super accounts.
Note that this concessional Cap has been changed so many times now, it is highly unlikely it won’t be changed again!
Harmonising contribution rules for those aged 65 to 74
Retirees can now contribute to Super up to the age of 74 (previously it was possible to contribute to Super after 65, but you had to satisfy the works test). In addition, it will be possible to claim tax deductions for Super contributions up to this age.
This is quite handy,as if you are planning to downsize your home and put the proceeds into Super, you no longer need to do this prior to 65.
What are the other Changes?
There are a number of other measures related to Super and retirement announced in the 2016 budget. In brief these are:
Catch up contributions – To support people with uneven work histories (e.g. women taking a break from employment), it will be possible to carry forwards concessional contribution caps on a 5 year rolling basis (however, only if you have less than $500K in super).
Extension of Low Income Super Contribution (LISC)
Now it will be called LISTO.
Lower the threshold for 30% concessional tax limit
Now $250K rather than $300K.
Tax offsets for spouse contributions
You can make a contribution to your low-income Spouse’s super account and receive tax benefits. The low-income threshold has increased from $10.8K to $37K.
Transition to retirement income streams
The assets supporting a TRIS will now be taxed at 15%. Previously assets were not taxed after 60 and a withdrawal rebate of 15% to income prior to 60. With this provision, TRISs become less attractive.
Tax exemptions on retirement products
Tax exemptions will be extended to some additional retirement products, e.g. Deferred annuities. Deferred annuities allow you to purchase an income stream that is applicable once you pass a certain age. It is kind of like insurance (i.e. in case you live longer than expected). It will be interesting to see if these products are competitive/useful.
How do these change affect us?
In accordance with the theme of this blog, I will take a quick look at how these changes impact on our plan.
Negatives
According to our original plan, we planned to move the funds in our accumulation accounts into pension mode accounts when I am 60 (in 2023) in order to immediately get the tax free benefits of the account based pension. The value of the accumulation account at this time is now estimated to be approximately $748K (in 2016 dollars).
When I am 64, in 2027, we planned to sell our house, and move the estimated proceeds of $1.13M (in 2016 dollars) into first accumulation accounts and then the pension mode account. The age of 64 was chosen because this was the last age at which funds could be transferred into Super without having to pass a works test.
In relation to the $1.6M cap, these amounts are not a concern because:
- We need to transfer approx $1.9M into account based pensions.
- Because there are two of us, we can split the transfers between each of our account based pension accounts (e.g. when we plan to sell our house we can make contributions to different accounts). Effectively we have a limit of $3.2M, and we will be well below this.
- Even if I continue to work for some time, it is unlikely we will breach this cap.
In relation to the non-concessional contribution limit the maximum we can move into our accumulation accounts is $1M, or $500K each. As we need to move $1.13M, this new measure will impact us. However, again, this is not of especial concern because:
- The income tax threshold of approx $18K will mean that we can invest outside Super and are likely to receive tax free returns.
- We can take advantage of SAPTO once we reach retirement age.
The change in concessional cap will limit our ability to boost Super contributions if I continue to work in Australia. As this is not presently in our plans, it shouldn’t have an impact.
Positives
We no longer need to sell our house at 64, and we can sell it up to an age of 74. This is quite handy as there is no longer an artificial constraint regarding when we can move.
In Summary
In summary, these measures are fairly benign to our situation. The greatest impacts are:
- If real-estate really takes off, due to the non-concessional limit, we may not be able to enjoy tax free returns on all the proceeds of the sale of our house.
- There is no longer a requirement for us to sell our house before 65. We now have more flexibility and can sell anytime up to 75.
- If I decided to work in AU, the amount of concessional contributions I can make is reduced. I wont be able to receive the same amount of tax benefits I would otherwise have received. As I am now 53 and paid off the mortgage, this is the time in my life that I do have excess funds to contribute to Super.
How do these changes interact with the proposed ALP Super Plan
One day the ALP will be back in power. If they introduce their Super policy, how will this interact with the LNP one?
The ALP intend to tax Super earnings above $75K at 15%. Note that:
- The government will experience windfall taxation in good Super return years, and low tax in poor super return years. The overall effect for the retiree is that they will be hit hard in good years, but when returns are negative or low, they will not receive a refund from the government.
- Effectively retirees with a balance of $1.5M + X will experience a higher tax than 15% on earnings on X. The amount can be determined by Monte-Carlo simulation (I might look at this later!). Refer to End Notes for an example.
- The $75K limit is not indexed. As time goes on more and more of your Super will be subject to the ALP Super tax.
Under the LNP plan, your pension-mode balance can exceed $1.6M, especially if you transfer the maximum amount from your accumulation fund at 60 into your pension account to get the benefits of compounding.
I think the ALP tax will be a hard sell, as, because the LNP policy already has the effect of restricting the amount of funds that can be placed in Super, the ALP policy will be seen as a Tax grab as its only real impact will be taxation and will not be associated with any incentives to members.
Limits to Super Contributions
Given the goal of most of the headline measures is to limit the amount that can be transferred into Super accounts, it is interesting to look at how much the average person can expect to have in Super given particular concessional contribution amounts.
The graph below illustrates the amount of Super at 65, given a yearly concessional contribution indicated on the x-axis, and an assumed Super real return of 2.77% in accumulation mode, and 3.25% in pension mode. It also assumes contributions start at Age 20.
You can see if you contribute near the maximum of $25K, the most you can expect is about $2.3M in your accumulation account. Of this amount, only $1.5M can be transferred into your pension-mode account. Also note that the graph is a rough estimate at this stage; most people will have a lower salary in their 20s, and will also be less likely to contribute large amounts of Super while paying a mortgage and raising children during their 30s and 40s.
Are these measures retrospective?
Bill Shorten is claiming that some of the new measures are retrospective.
There is some truth in this:
- If you have assets above $1.6M in Super now, then you may have to modify your plans to take into the account that your income in retirement may be lower than expected (although as mentioned earlier, the determined retiree may decide to use negative gearing).
- You may not have bothered to split Super assets within a couple prior to the budget coming into force. For example, you may have received an inheritance and put it into one Super account. Now, in an effort to get below the $1.6M threshold you can transfer some into your spouse’s account, but you have needlessly used up some of your own non-concessional limit.
- If you were planning to boost your Super with non-concessional contributions, then this option is now curtailed, especially if you have already made non-concessional contributions. Your income will be less than expected.
However, the government’s supporting argument is that the levels of assets permitted in Super are more than enough to support a very comfortable retirement, and tax payers should not be supporting other Australians to achieve tax free earnings on balances in excess of the amount to provide this level of retirement.
More complexity!
One disadvantage of these measures is that the Super system is now getting awfully complicated. A small army of otherwise productive people will be required to administer, advise, monitor and regulate the new policies. Unfortunately the cost of this army will be borne, one way or the other, from Super returns.
Changes, Changes, and more changes
The Super and Pension system seems to change radically each year. The system in ten years time may have little resemblance to the existing system. It makes it very difficult for pending retirees to plan.
Conclusions
- For most Australians the Super changes announced in the 2016 budget are fairly benign. You would need to have, or planning to have, a large Super balance to be impacted (which is exactly the intention of the measures).
- One of the attractive measures to retirees is the removal of the works test for contributions to Super up to the age of 75. If you are planning to sell your house and contribute the proceeds to Super, you can now delay this decision.
6. End Notes
ALP Super Tax example
I consider 3 years of super returns and two examples. In the first example, exactly 5% is returned every year. For simplicity, I assume there is no drawdown of funds, and taxes are paid from another source:
| Initial Super | $2,000,000 | |||||
| Super Return | 5.0% | 5.0% | 5.0% | Total Tax | Average return Per Year | 5.00% |
| Value of Super | $2,100,000 | $2,205,000 | $2,315,250 | Total Return (3 years) | 15.76% | |
| Tax | $3,750 | $4,500 | $5,288 | $13,537.50 |
Here is an example where the same effective return is achieved at the end of 3 years, except the returns are a lot lumpier:
| Initial Super | $2,000,000 | |||||
| Super Return | 20.00% | -20.00% | 20.59% | Average return Per Year | 5.00% | |
| Value of Super | $2,400,000 | $1,920,000 | $2,315,250 | Total Return (3 years) | 15.76% | |
| Tax | $48,750 | $0 | $48,038 | $96,788 |
You can see in the first example, the retiree pays approx $13K in Tax, while in the second example the retiree pays approx $97K, even though the total Super return over 3 years is the same.
Retiring early for Australians 