How we dodged a super bullet

The proposed super reforms were fiercely debated in Cabinet … and luckily, we have dodged a bullet.

Summary: The proposed superannuation changes, announced a week ago, were fiercely debated behind the closed doors of the Cabinet room. Treasury had sought a lower tax-free threshold for income earned on superannuation assets in pension mode, but the reforms announced are based on a higher cap. As such, the superannuation system has dodged a serious and dangerous bullet.
Key take-out: Proposed changes in the capital gains tax area suggest that holders of equity style assets should be very careful of selling assets held before the April 5 announcement date.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Today I am going to take you through what I think happened in the Cabinet room when superannuation was debated, and then look at important new investment strategies that will be required, assuming the proposed changes become law before the election. And that is not certain.

The controversy over superannuation in Australia runs deep. And so, perhaps not surprisingly, I received criticism for suggesting in the lead-up to last week’s Government announcement that a tax-free amount based on a 5% return on $2 million in superannuation was a fair thing. And, as we now know, the Treasury figures before the Cabinet were inaccurate, and so the Government was forced to rely in part on my estimates.

My critics say I should have advocated staying with the current situation, which is far better for retirees. I recognise the point of view but disagree. In looking at what is likely to have taken place in the Cabinet, I must emphasise that I was not there. However, as I understand it, some of the superannuation issues were discussed with some heat.

The Treasury campaign against the current superannuation structure was both vigorous and relentless. As we all know, it used mathematically incorrect figures to justify its stance. It forgot the government benefits that come when superannuation savings reduces the age pension, and it used inflated long-term investment returns. It was all aimed to try and convince the politicians that the subsidy to superannuation was enormous and was concentrated on the rich.

The real fact was that the subsidy was nothing like what Treasury had suggested, it was attacking people who were not rich, and issues were far more complex than it canvassed. But, in the Cabinet, there were a number of ministers who used those Treasury arguments to suggest that a low tax-free concession level be established and that, thereafter, all benefits should be taxed at the top marginal income tax rate of 46 cents in the dollar. There were a series of triggers suggested for the 46 cents in the dollar tax rate, including having more than $800,000 or $1 million invested in superannuation. For those who understood that $1 million buys a low retirement income, it was horrific to have these ideas advanced with some passion in the Cabinet room. But given the backing of the Treasury people, this was an incredibly dangerous situation for superannuation. Had the anti ‘superannuation for retirement’ forces won, vast sums would have been shifted out of superannuation into negative gearing and other tax havens.

Taking on Treasury

My guess – and it is purely a guess – is that the odd resignation or two may have been threatened because of the damage such a proposal would have done to the nation and the retirement of its people. In my view the superannuation movement in Australia, including the self-managed fund area, which controls 50% of “pension mode” superannuation, has dodged a serious and dangerous bullet. And one of the reasons that bullet was dodged was that there was a credible alternative option on the table. I do not apologise for helping that option get legs.

From what I can tell, Wayne Swan has had such a terrible time with incorrect Treasury figures in the mining tax area that he may well have supported debunking the Treasury idea logs. But again, I can’t be certain.

There is no doubt that the idea of instituting a body to try and bring some rationality to superannuation changes came out of the Superannuation Minister Bill Shorten, but this appears to have been supported by Swan.

I am always frightened by bodies that are appointed by governments because they tend to reflect the views of the government of the day. But we certainly need much greater stability in our superannuation movement so that public servants can’t suddenly trump up incorrect figures to justify what they think is in the national interest.

It is possible that the proposed changes will get through the Parliament before the September election, but it will be tight. Even if they do get passed, they will not apply until the year starting July 1, 2014 (apart from the exception set out below). If the measures don’t get through before the election then they will have to be introduced and passed by the new government . The Coalition is currently saying that it does not want to change. My belief is that the Australian budget is in a serious mess, and the incoming government (assuming there is a change at the election) will need all the tax revenue it can get. Nevertheless, you can’t assume that the changes proposed on April 5 will in fact be enacted. However, it is certainly worth thinking of how you organise your strategies to adjust to the proposed new environment.

Organising your strategies

The first feature of the changes is that they will cut across funds. In other words, an individual will be allowed $100,000 in tax-free income from superannuation but, if that individual has investments in more than one fund, those funds will be pooled and the pooling will be achieved via a personal tax questionnaire. Accordingly, I assume that your spouse will also have a $100,000 tax-free entitlement, but I have not been able to check that. The whole situation will be made very difficult for large funds because each person will be different. It is going to be much easier to operate this scheme via self- managed funds. And the pro self-managed fund view is underlined by what is proposed in the capital gains area. If you own equity style assets on April 5, then those assets will be capital gains tax-free for 10 years. That means be very careful of selling these assets. Accordingly, I want to put this in bold type: DO NOT sell shares or property or other capital assets that you acquired before April 5 that are likely to rise in value.

Capital assets acquired after April 5 will be akin to income in the sense that if they rise in value then that rise will be taxed at 15%. In essence, capital gains will be treated as income on assets bought after April 5. It is not clear whether the tax will apply on a market basis or the gain is only triggered when there has been a sale. There is a small qualification in that for assets acquired between April 5 and June 30 – you can decide whether to use April 5 as the base date or to take capital gains after July 1. In other words, if you buy an asset after April 5 and it goes down in value you will want use the higher April 5 value as the base for capital gains.

This means that, in terms of capital assets acquired after April 5, superannuation will not have as big an advantage as it previously held. If you hold capital assets in your own name, then the capital gains tax is half the income tax rate. If you are in a retirement situation, your superannuation income doesn’t count. So you may have a very small income, which is taxed at a low rate, in which case your personal name capital gains may accrue a tax rate of less than 15%. Of course, if the personal capital gains are large then very quickly the personal tax liability will rise beyond the 15% mark. Nevertheless, it represents a new element to future planning. When it comes to income, there is no doubt that a 15% tax rate is very favourable if you are working or have investments in your own name. Put another way, a tax-free status is allowed on a total of $118,200 of income when a superannuation fund is in retirement mode--- $100,000 in the super fund and $18,200 in personal income from investments or work. If all your money is in superannuation, then you will need ways to try to create personal income to take advantage of the $18,200 personal tax-free threshold.

In terms of superannuation contributions, the government is proposing that people aged over 60 can contribute $35,000 and get a tax advantage compared to the current level of $25,000. There is also $150,000 you can contribute annually from tax-paid earnings. If you are likely to have a low income in retirement years you may consider investing that $150,000 outside of superannuation. Clearly superannuation is not as good as it was, but for the vast majority of people it will represent the best way of organising retirement savings.