Mercer busts a wealth bias myth

PORTFOLIO POINT: It’s a myth that the wealthy get the bulk of the benefits in the funding of retirement incomes, according to new research from wealth manager Mercer.

Higher-income earners can be forgiven for thinking that, under this Labor government, their hard work or success is not something to be proud of.

Policies such as the halving of concessional contribution limits and reintroduction of widespread means testing for various government benefits has seen the screws tightened on many who would not necessarily see themselves as what Kevin Rudd considers “wealthy Australians”.

Many now suspect that they are being softened up for changes on a much bigger scale, with an eye to what the upcoming Henry tax review has in store for superannuation.

One leak suggested that Treasury secretary Ken Henry thinks that it’s unfair that higher-earning Australians get a “bigger” tax break from contributing to super (for more on this click here). The claim is that the taxpayer unevenly contributes to the post-retirement incomes of higher-earning Australians.

The argument is that someone earning $200,000 a year gets a benefit of 31.5% for contributing to super – the difference between the marginal tax rate of 46.5% and the super contributions rate of 15% – while someone earning around $25,000 doesn’t get any benefit because their marginal tax rate is also 15%.

Wealth manager Mercer decided to test this assertion, and the numbers it has crunched have dispelled a few myths on this. And what Mercer concluded was that if you give people incentives to put money into super, you will considerably reduce their likely future reliance on the age pension.

Mercer’s figures show that the overall cost to the public purse of paying an age pension versus the tax concessions for contributing to superannuation aren’t actually that different, even over a range of incomes.

The assertion that the tax breaks for super contributions “cost” governments more is plain wrong, Mercer argues.

The numbers are complex – the assumptions seem to take up more space than the findings – but Mercer tackled the issue on the assumption that the cost of the tax benefits of contributing to super is only one side of the costs story of governments providing for, or helping citizens’ build their own, retirement incomes.

The other side of the equation is the cost of providing the government age pension itself.

Mercer arrived at its figures by adding together the net present values of the contribution tax costs (the cost to government of the difference between the marginal tax rate and the 15% contributions tax) and the cost of providing the age pension.

The research takes into account the cost of super contribution tax concessions for single males and couples on various incomes over a working life of 40 years, then the cost of providing an age pension until death, based on current life expectancy tables.

So, what is the cost to the government of these tax breaks?

In today’s dollars, about $379,000 to $385,000 for a single male earning $40,000, with an income rising over time at various rates.

The interesting point is how that’s made up.

For the employee starting on a lower wage who is only getting cost-of-living increases (4%) over his working life, the total cost to the government is $385,182. This is made up of $53,737 in tax concessions for super contributions and $331,445 in pension payments.

For an employee getting bigger salary increases through to retirement, in the order of 8% per annum, the total cost of $379,555 but the benefit split is $131,721 in super concessions and $247,834 as a reduced age pension benefit.

Mercer then runs through a scenario of a salaried employee starting on a higher income of $62,500 a year and uses the same annual salary increases of 4% and 8% per annum.

The worker gaining only CPI increases to his income will cost the taxpayer $377,384 – or a super contributions benefit of $83,964, while they will pick up a pension worth $293,419.

For the worker starting on the same amount but having quite substantial income gains over the course of his working life, the cost to the taxpayer will be $375,798 – or super concessions of $249,455 with an age pension benefit of $126,343.

In both scenarios the overall difference in the benefits in today’s dollars is less than $2000.

Mercer went further and compared the cost to taxpayers of raising the level of contributions under the Superannuation Guarantee from 9% to 12%. Without grinding further into the numbers, the findings were similar.

Mercer says that what shines through in their research is that:

• High income earners get higher ongoing tax deductions, but will rely less on the age pension.
• Those who earn higher salaries through their working lives will get a higher tax concession, but will rely even less on the pension.
• If the concessional contributions are lifted from 9% to 12%, the cost to governments of the future will drop sharply.
• When the process is run substituting couples for singles the results are broadly the same.

Mercer concludes that higher income earners do not gain any greater overall direct benefit, when the twin components of age pension and super tax concessions are combined.

“The total government support for retirement savings represented by the current arrangements '¦ is remarkably equal across a range of lifetime income levels,” Mercer said.

“It is likely the Henry tax review will recommend incentives to encourage non-superannuation savings. Such a change is to be welcomed in terms of an incentive to encourage savings.

“However, it must be recognised the current arrangements to save for retirement income are not overly generous and any additional incentive to save outside superannuation is likely to lead to lower levels of superannuation saving and a greater reliance on the age pension in the future.”

I couldn’t have put it better myself.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.