Budget Takes Away, Too

Is the federal budget really a plan to simplify and streamline superannuation? It embodies a long-awaited desire to get rid of the current complex tax rules and restrictions that apply to people’s superannuation benefits. Limits on how much money you can put into super '” reasonable benefit limits (RBLs) and some taxes on superannuation lump sums have been abolished. Treasurer Peter Costello's objective has been to lift retirement incomes and encourage people to stay longer in the workforce.

On the face of it the changes sound like a super bonanza, but is this really the case?

This is a shrewdly engineered tax and superannuation policy, whereby Australians who are saving for retirement appear to have been given benefits that are too good to be true. The Government is using tax cuts as a carrot to coerce people into working longer '” at least to the age of 60.

But while these positive changes filter through the system, the Government has excluded a lot more investors from any residual access to the state pension. This budget reduces the ability for people to increase their entitlement to get an age pension by removing the 50% assets test exemption on complying income streams such as term allocated pensions. This tightening of the assets test has been an ongoing pursuit of the Howard Government. In 2004, it reduced the full assets test exemption on new complying income streams to 50%.

So, while the Government appears to be giving a bonanza of superannuation benefits, the overall effect of this budget will be to reduce reliance on social welfare. This change will greatly affect many existing transition-to-retirement plans that depend on using private funds and government pensions.

Specifically, the budget plays havoc with retirement planning that is heavily based on additional undeducted contributions (contributions to super using after-tax savings) as well as concessionally taxed contributions.

Some of the more optimistic projections offered in the budget papers are based on a working life of 40 years. This is unrealistic for many people and the annual restriction on concessionally taxed contributions and undeducted contributions do not take into account fluctuating income and ability to make consistent superannuation contributions, let alone consider the effects on superannuation funds of market fluctuations and/or poor performance.

Moreover, the budget offers no concessions for people who have inadequate retirement savings and those who have struggled to pay a mortgage on an investment property with the objective of selling it just before retirement and using the proceeds to boost their superannuation.

Separately, the shock introduction of a $50,000 limit for annual superannuation contributions, if implemented as announced, will create a host of new problems. First, it assumes a consistency of available funds, and people raising children, who can’t afford to put much into superannuation while they are paying school fees and large mortgages, will never get a chance to “catch up” in a similar fashion to the current retirees, who had no time-based restrictions on their contribution.

In addition, it is particularly discriminatory against women, migrants and others with broken work patterns, who need the ability to boost superannuation when they are able to.

So, let’s look at the proposed changes to superannuation and how and when they apply.

From May 9, 2006:

• If the package is implemented as announced, undeducted contributions will be limited to $150,000 annually from the time of the announcement. There appears to be no intention to index this threshold.

Warning: Advisers and trustees of self-managed superannuation funds need to be aware that this restriction is proposed to apply from the time it was announced. Prior to the budget announcement, there was no restriction on the amount of undeducted contributions that could be made. This immediate change is a severe blow for fee-for-service advisers who have been assisting people who are planning their retirement in the near future.

People in the middle of a re-contribution strategy can’t make their planned re-contribution of undeducted contributions if they exceed $150,000. In the same way, people who are realising assets, such as selling property held in their own name and who planned to contribute the proceeds to their superannuation fund, have been left in limbo.

It is unacceptable for the Government to say it will “consider” whether this cap should be averaged over three years to allow one-off payments when this restriction applies immediately.

From July 1, 2007:

• People aged 60 or over will receive lump sums tax-free if they are paid from a taxed superannuation fund, which includes a self-managed superannuation fund. Lump sums will not need to be reported in the individual’s tax return, thus reducing taxable income. Pensions will also be tax-free, including those that commenced before July 1, 2007. Trustees will not need to report benefit payments for RBL purposes, thus removing some of the compliance burden. This looks too good to be true, so here’s the catch: under current rules rebateable pensions receive a 15% rebate on each dollar of taxable income, and any unused rebate can be offset against other tax payable, but from July 1, 2007, where the income is tax free, there will be no excess rebate.

• Age-based limits relating to tax-deductible superannuation contributions will be abolished, and employers and self-employed individuals will be able to claim a full deduction for superannuation contributions they make until the recipient reaches the age of 75.

Warning: The removal of limits on tax-deductible claims sounds brilliant '¦ but the Treasurer’s speech failed to highlight the restriction on the amount of concessionally tax super in the fund in the next point.

• Here’s the sting: Regardless of the person’s age, an annual limit of $50,000 per person will be placed on the amount of deductible contributions that are eligible to be taxed in the fund at the 15% tax rate, with any contributions above this limit (as identified by the tax office) taxed at the top marginal tax rate of 45%. There is no proposal to index this threshold.

It is worth noting that currently there is no restriction on the amount of taxable contributions that can be taxed at 15%. Whereas in the past employers have borne the cost of contributing over a person’s age based limit, this responsibility will now be in the hands of fund members, and so trustees of self-managed superannuation funds will need to monitor the amount of contributions they accept if they are want to avoid this tax impost. The only relief offered is that a transitional period is proposed to apply for people aged 50 or over to allow those planning to retire soon to have contributions of up to a maximum of $100,000 taxed at 15% each year from 2007-08 to 2011-12.

• Reasonable benefit limits (RBLs) will be abolished.

• People will no longer be forced to take their superannuation benefits at a particular age '” such as at 75, or at 65 if they do not meet a work test '” thus giving them greater flexibility as to how and when to draw down their superannuation in retirement. This will enable people to take benefits in the form of an income stream, lump sum or to just draw benefits out of the fund as they want to.

• The rules that apply to the amount of pension payments per year and type of allowable pension products will be simplified, with simpler new minimum standards and basic restrictions applying including a minimum amount of payment to be made at least annually. No maximum will apply and therefore the whole amount can be taken except in the case of pensions commenced under the transition to retirement rules. Provided that a pension meets the new minimum standards, earnings on assets supporting that pension will be exempt from income tax.

• Self-employed individuals can be eligible for the Government co-contribution scheme for their personal post-tax contributions on the basis of an adjusted income test.

• Employer lump sums (eligible termination payments or ETPs) will be capped and will not be able to be rolled over into superannuation. The post-June 1983 component will be taxed at 15% on amounts up to $140,000 for people aged 55 and over and at 30% for those aged under 55. Amounts over $140,000 will be taxed at the top marginal tax rate.

• Benefits paid before age 60 will be taxed in a similar way to current arrangements and will still be required to report details of lump sums (ETPs) and pensions in their tax return. However, the number of components will be reduced to two:
  1. an exempt component comprising the pre-July 1983 component (which will be calculated at a particular date and become a fixed component in the future and form part of the undeducted purchase price of a pension that commences on or after July 1, 2007), CGT exempt component, post-June 1994 component, concessional component and undeducted contributions; and
  2. a taxed component comprising the post-June 1983 component, which will be taxed in the same way as currently, applies depending on whether the person is aged 55 to 59 or under age 55; and non-qualifying component.

The removal of the RBL means that people who are overfunded are the big winners, but there are also losers, because the Government is giving with one hand and taking away with the other. It has failed to take into account long-term plans that individuals have already put in place, such as building equity in a property outside of superannuation with the intention of selling it and making a large undeducted contribution just before retirement. This is due to the instant imposition of an annual limit of $150,000 now placed on undeducted contributions.

The biggest losers are the baby boomers approaching retirement because it fails to address the inadequacy of many baby boomers’ superannuation savings and removes their ability to make “catch up” undeducted or deductible contributions.

In addition it does not address the problem of employees who are not permitted personal deductible contributions from investment income and whose employers do not permit salary sacrifice.