In this post I take a look at the Super plan that the ALP has proposed to be implemented should they be elected into government. This analysis is especially timely as the 2016 Australian Federal election is approximately one month away, and significant changes to the Super system were recently announced by the LNP government as part of the 2016 Federal Budget. These LNP changes are unlikely to be become law if the ALP wins the Federal election.
What is the ALP Super Plan?
Information on the ALP Super plan may be found here.
The first section of this site describes a policy that taxes Superannuation returns in Pension mode in excess of $75,000 at 15%. The information on the ALP site is actually quite confusing (perhaps deliberately so) because it first states:
“The proposed measure would reduce the tax-free concession available to people with annual superannuation incomes from earnings of more than $75,000. From 1 July 2017, future earnings on assets supporting income streams will be tax‑free up to $75,000 a year for each individual. Earnings above the $75,000 threshold will attract the same concessional rate of 15 per cent that applies to earnings in the accumulation phase.”
and then states:
“This measure will affect approximately 60,000 superannuation account holders with superannuation balances in excess of $1.5 million”
These statements are inconsistent because you may very well have significantly less than $1.5M in superannuation assets but still have more than $75,000 in superannuation income for a particular year. In fact this is quite likely because the average Super fund typically returns in excess of the 5% assumed by the ALP (e.g. the Australian Super balanced fund has averaged 8.69% per year since 2004, and this includes the GFC).
The $75,000 threshold appears not to be indexed to inflation. Most commentators (e.g. here, here and here) have concluded that the $75,000 is not proposed to be indexed, although some have speculated otherwise (e.g. here). To quote from the second commentary:
LABOR’S proposed superannuation tax on wealthy retirees could eventually hit more older Australians because it will not be automatically indexed to inflation.
…
Opposition treasury spokesman Chris Bowen yesterday said a future Labor Government would consider lifting the $75,000 threshold when necessary but dismissed automatic indexation.
“I would expect any government of the day would monitor the thresholds to ensure that the original policy intent was being met and would respond accordingly,’’ Mr Bowen told the National Press Club.
For the purposes of this post, I have assumed it is not indexed. Should authoritative information become available which contradicts this assumption, I will update the post.
The second part of the site describes a plan to reduce the Higher Income Superannuation Charge (HISC) threshold from $300,000 to $250,000. I won’t look into this second part as it will not impact many Australians (and a similar policy is already part of the LNP Plan).
Who will be impacted by the ALP Plan?
The ALP plan looks fairly benign (after all, not many people have over $1.5M in super), but we will investigate to see if this is actually the case. The policy can and will impact many people with considerably lower balances than $1.5M because:
- Super returns are, on average, higher than 5%.
- Super returns are not the same every year, but actually have a fairly high variation. During the years that Super returns are high, the government of the day will collect a high tax from Super members, while when the returns are negative, the retiree will suffer the losses with no compensation. An example I provided earlier may be found here.
- The $75,000 limit is not indexed. So, the $1.5M limit (which will actually be smaller in any case if the average return is used) will diminish overtime. The process will be accelerated when we move away from the present historically very low inflation rates.
How to mitigate against the effects of the policy
The obvious mitigation to this policy for a couple is to split Super between individuals. That way each individual essentially receives half of the returns, and there will be less likelihood of being subject to the tax. This kind of splitting is likely to be less easy under the new LNP rules regarding non-concessional limits (should they become law).
Another mitigation is to move some of your funds outside the Super system. In 2016, income below $18,200 per year is tax free. Furthermore if you are above retirement age, SAPTO allows, in 2016, a tax rebate of up to $57,948 for a couple. If you have funds in the super system and believe that you may be subject to the tax, then you could place some of your funds in, for example, a combination of cash and index trackers such as this one.
As an example, say you are below retirement age but over 60, have $2M in super, the Super rate of return for the year under analysis is 10%, and the Index funds/Cash combination you invest in also returns at this rate:
Tax without Super Splitting, No index fund: $18,750
Tax with Super splitting, No index fund: $7,500
Tax with Super Splitting, $500,000 in Index fund: $2,584
Tax with Super Splitting, $364,000 in Index fund: $2,040
Note that the latter is the optimal (retrospective) solution for a 10% return. By making assumptions about the distributions of returns from Super and the Index fund, it would be possible to provide a recommended optimal mix between the Super fund and the Index fund. If the ALP form a government in 2016, I may do this in a later post.
Further mitigation strategies would include postponing selling your (tax exempt) PPOR until existing Super assets are reduced.
See here for more information on mitigation.
An Analysis of our Situation
As usual, I will look at how this policy will impact on us.
I will look at the impact of the tax through three models, increasing in order of sophistication and realism, and also compute power!
Model 1 – Assumes a constant Super return each year with no variation, and a constant spend. This is the model used by the ALP when determining the impact of the tax.
Model 2 – Assumes a constant spend and variable Super return.
Model 3 – Assumes a variable Super return and a spend that is calculated at the end of each year that would result in Super being zero at 90 under the assumption of standard inflation and Super returns for remaining years.
Model 1 – Constant Super Return with no variation
In this section I will assume a constant Super return of 5.5% in the accumulation phase and 6% in the pension phase, as per the analysis described in the Tweaks and Mathematical Diversions post. At 6%, we would need more than $1.25M in the Super pension phase account to be subject to the tax.
Here is the spending plan prior to the tax, this time showing, for the purposes of comparison, the tax in accumulation mode.
Super Returns are always the same, no Super splitting
If I deduct 15% of any earnings above $75,000, as per the ALP Super tax without Super splitting, it appears that the policy is fairly benign. Here is the spending plan with the ALP tax policy in operation:
As you can see, there is not really too much difference (about $700 per year). Total ALP Super tax is approx $25.6K in 2015 dollars and to get back to our original spend, we would need an additional approx $30.5K.
Super Returns are always the same, Super splitting
OK, what if we split Super between accounts? Well, in this case there is no impact because Super is always below $2.5M, the amount that would be required to cause tax to be levied, assuming a 6% return.
Super Returns are always the same, Effect of Inflation
Unlike most other policies, the ALP Super Plan is impacted by higher inflation, so let’s see what happens when the rate of inflation increases. We can expect a higher tax as the $75K is not indexed. In addition, Super returns will be higher, so we can expect higher taxes.
Here is the diagram with no Super splitting, and assuming an additional 3% inflation becomes the norm, for a total of inflation rate of 5.73%. Total ALP Super tax is now $145K in 2015 dollars. As you can see, this is quite significant when compared to the accumulation tax.
And here is the same diagram, but now assuming we split Super. Total ALP Super tax is now approx $77K in 2015 dollars.
The diagram below shows the effects of various inflation rates. For reference, and as a sanity check, the spend with zero tax is also shown. As expected, spend does not change much with increasing inflation without the tax.
And here is information on the historic inflation rates in Australia (from the ABS site). You can see that inflation has been pretty stable since about 2001.
Note the region between the two horizontal bars is the RBA target range for inflation.
Model 2 – Constant Spend and Variable Super Return
Now lets take a look to see what happens when we have variable returns. We can expect higher tax and lower spend when we take into account variable returns, because the Super member will get hit for higher taxes in the good years, and will not be compensated in the bad years.
Luckily an analysis of the impact on retirement of variable returns has already been completed in the More on Risk post. In this post we looked at, amongst others, the impact of variable super returns on the length of time that Super would last assuming a constant spend.
Here is the graph showing the distribution of ages at which funds run out, assuming there is no tax as described in More on Risk. I have used, for the moment, the Age pension rules prior to the 2015 budget changes as described in this post. Note that the spend levels here are the spend levels which cause Super at 90 to be zero assuming no Super return variation (which is an average spend level of $90,463, as described here):
Note that the average age is 90.36. I have colour coded showing the 60% of results that are less than 20% percentile and higher than the 80% percentile as green , and the 80% of results which are less than the 10% percentile and higher than the 90% percentile as green and blue.
The diagram below provides summary data for a number of scenarios using the colour coding above:
And here is similar information for the amount of tax:
Constant Spend, Super Returns are variable, Sensitivity to Volatility
As Super returns become more volatile, we can expect the average age funds will last to be reduced. This is indeed the case.
Here is how the Age at which funds run out varies as we increase volatility, assuming this time we split super, and spend at the rate where we solve for super being zero prior to the 2015 budget changes and any taxes:
You can see that the average age to which funds last declines as volatility increases, but not significantly so.
And here is the average total ALP Super tax (in 2015 dollars) by volatility:
Note that the volatility of the Australian Super Balanced fund returns over the last 17 years is about 7.5%, and the volatility of the Vanguard ASX Index fund over the last 10 years is about 21%.
Finally, here is the Age funds last until by Volatility without the Tax:
You can see that the average does not vary much, but total variation increases quite a bit.
Constant Spend, Super Returns are variable, Tax by Age
The diagram below provides details of the average ALP Super tax by Age when assuming variable returns, and also assuming we do not split Super. The spend levels are those which make Super at 90 equal to zero for the standard fixed returns of 6.0% and the ALP Super tax without splitting. For comparison, I have included the taxes for the fixed returns. Total ALP Super tax for variable returns is about $75.5K, while total tax for fixed returns is about $25.6K. I have assumed post 2015 Budget pension rates.
Here is the distribution of the amount of tax by age. Note that I have not included the zero tax possibility in the diagram as this would tower over the other probabilities (in most years zero tax is paid after 64):
Model 3 – Variable Super return and a spend that is calculated at the end of each year to make Super zero at 90.
OK, before we start modelling the ALP Super Tax increases with model 3, let’s look at the results of this model with the updated pension rates (the More on Risk post had the old pension rates). I will also present the results of this model in some different ways:
Here is the spend per year for this model using the new pension rates:
Here is a graph showing the spend in more detail, this time including the full distribution for each year:
The result is not so smooth as only 4000 runs were done.
OK, let’s take a look at the results for the ALP Super tax. The graph below shows the average spend for the spend prior to the 2015 pension changes, after the changes, the ALP super tax with splitting, without splitting, and without splitting and 5% inflation:
And there are the taxes for the last three policies:
Why I dislike the ALP Super Tax!
The ALP has given two reasons to support the introduction of their Super Tax:
- The majority of the Super Tax concessions go to the top income earners, and these concessions are unlikely to reduce future Age Pension expenditure significantly.
- The cost to the Tax payer for the Super Tax concessions in the form of forgone revenue is large and growing and is not sustainable.
The ALP Super Tax will indeed have the effect of reducing Super tax income concessions in Pension mode to top income earners, and this is a good thing. However, it will not impact the Super accounts of these same people when in accumulation phase (unlike the LNP policy, which restricts the amount that can be contributed).
The Tax will also have the effect of gradually affecting more and more people as the $75K limit is eroded by inflation, eventually affecting everyone. In addition, significant chunks of people’s life savings will be eroded in the event of high inflation or high market volatility, both of which are outside the control of the retiree. The government will gather more tax, and more people will be find themselves on the Age Pension sooner. The tax is a disincentive to getting ahead, not only for high income earners, but also for average person.
Conclusion
When I started this post, I suspected that the ALP super plan would have a significant impact on people like me, mainly because of the high taxes in high return years. I gave an example to show how this would work. In order to better understand the impact of the tax on us, I have used three models:
- In the first model, I assumed that Super returns are always the same, and solved for Super being zero at 90. I looked at splitting and not splitting super funds between individuals in a couple, and also looked at the impact of an increase in inflation.
- In the second model, I assumed that Super returns are normally distributed and the spend per year (adjusted for inflation) is static. I worked out how the age at which Super funds run out is impacted, and how much additional tax is due. I looked at splitting and not splitting super funds between individuals in a couple, and also looked at the impact of the Super return volatility.
- In the third model, I assumed that Super returns are normally distributed and the spend to be used for each year is worked out in advance as the value that makes Super at 90 zero, assuming a constant spend and standard rates for Super and inflation for remaining years. I looked at splitting and not splitting super funds between individuals in a couple, and also looked at the impact of 5.7% inflation.
These models showed that in our situation:
- If we do not split Super between accounts, the ALP super plan will result in an additional tax of $25.6K (model 1), $66K (model 2) or $68K (model 3).
- Super splitting can significantly reduce tax ($25.6K to zero in model 1, $66K to $27.8K in model 2 and $68K to $25K in model 3).
- Tax to be paid and average spend is very sensitive to increases in inflation. The higher the inflation, the more real tax to be paid and the less to spend. Tax goes up quickly with inflation increases.
- Tax to be paid is also sensitive to Super return volatility, although quite a bit less sensitivity than to inflation. The more volatility, the higher tax to be paid.
Given the sensitivity to inflation, and the inability of the retiree to influence it, it would make sense to index the $75K threshold to inflation.
Retiring early for Australians 