PORTFOLIO POINT: With superannuation becoming increasingly less attractive from a tax point of view, many investors may want to consider negative gearing in the next year or two.
This week, I spoke to a large number of middle-aged, middle-income people who were very angry about the impact of the federal budget on their savings plans. As a result of those conversations, I realised that superannuation in Australia as a means of self-funded retirement is, step by step, becoming the province of the very wealthy.
This is a very sad and disturbing change in our society and one many Eureka Report readers will need to come to grips with.
When I was in my 40s, 50s, and even 60s, I was able to contribute very large sums to superannuation and pay only 15% tax on the contribution. Combine that with a rising sharemarket and by the time I reached 65, I was in a position to comfortably self-fund my retirement (as it turned out I kept working – but that’s another subject).
Some of the people I was talking to this week were in their late 40s. They have been working hard at reducing their mortgages and putting money into superannuation, but they are way behind where they expected to be because the sharemarket has not delivered the sort of returns they’d been hoping for.
They need to step up their superannuation contributions to recover the gap. And then they discovered that in the budget, even if they had less than $500,000 in super, they could only contribute $25,000 next financial year at the 15% concessional tax rate. It was going to be $50,000.
At $25,000 a year, it is virtually impossible to gain the $1 million to $2 million that is needed in superannuation to achieve self-funded retirement.
The only way to get that sort of money into your fund if you are in your 40s and 50s is to make voluntary contributions with tax-paid dollars. But it is not easy for people with families and mortgages to find $150,000 a year (or part thereof) in tax-paid funds to boost their superannuation levels.
And I think this is a real tragedy for Australia. For those approaching or in their 50s, superannuation is by far the best way of saving given that once you reach the age of 60, superannuation fund money can be put into a pension mode, so income and distribution are totally tax-free.
When Peter Costello made superannuation benefits tax-free for those aged over 60, Treasury responded by making it harder and harder to put money into super and gain the 15% concession rate. They have also in this budget put an extra tax on superannuation contributions for those earning more than $300,000. But that tax is just not relevant: If you are earning $300,000, then almost certainly you will have money available to put large sums into your fund on a tax-paid basis as a voluntary contribution. The extra tax on part of the $25,000 contribution doesn’t really change the landscape for people in this income bracket. It was a PR exercise to mask the change that really hits people – the reduction in low-tax contributions.
I believe one of the challenges the next government will face is to make it easier for people to put concessional taxed money into superannuation. I think the only way the government will be able to fund this is through a change in the negative gearing rules. Right now, for an individual, negative gearing is probably the most attractive tax reduction exercise that’s available. You can borrow, say, $1 million, and prepay interest for a year and gain an immediate tax deduction of, say, $70,000 or $80,000, depending on what interest rates you pay. Of course, the money must be invested in a risk-bearing asset like a house or shares, and in the current climate borrowing on both those assets clearly has a degree of risk.
Nevertheless, it is an extraordinarily generous arrangement to encourage people to subscribe to risk assets. At the moment, the investment of borrowed funds into houses has declined due to the fall in dwelling prices. Similarly, there have been very big falls in the amount of margin lending on shares because of the performance of the sharemarkets. But this will not always be so and so if you do see an opportunity to leverage assets that you believe have a real chance of increasing in capital value in the current environment then, in the next year or two, it will be a good opportunity to take advantage of negative gearing. I don’t think current negative gearing rules are going to be a permanent part of our landscape because we need to change the superannuation contribution rate to enable people to reach self-funded retirement without working into their 70s and 80s.
Meanwhile, if you are in the financial position to inject after-tax money as a voluntary contribution to superannuation, and you are in your 50s, then you should take up that entitlement and not be put off by the clamps on the low-tax injection amounts.
My belief is that Treasury basically wants superannuation funded with after-tax income and because of the attraction of superannuation, it will still be economic.
Finally, during the week I had dinner with a group of bankers who were quite open that it’s self-funded retirees who are funding the rise in Australian bank deposits. And they are sensitive to the term deposit rates that are on offer. There have been reductions in term deposit rates over the last year, but after the recent Reserve Bank reduction in official interest rates by half a per cent, initially term deposits went down very little. The banks were nervous about frightening away self-funded retirees and there was considerable competition for the money. But in the last few days, bankers have lowered their term deposit rates, with CBA the last one to move. The banks have effectively lowered term deposit rates by close to half a per cent – the same as the official rate decrease. If the fall holds, this is good for bank profits. At this stage, most term deposits still offer 5% or more.
There is a general view among bankers that if they lower term deposit rates to below 5%, a great many self-managed super funds will take their money out and buy bank shares, hybrids or other higher-income producing assets.
Clearly, if we have a global economic crisis the quest for safety would, of course, change that equation. But as it now stands, banks will be very reluctant to lower their deposit rates much further than their current levels and as a result, the flow through to mortgage rates from Reserve Bank official rate reductions will continue to be much less than normal.
It underlines the fact that in this process of lessening our dependence on overseas wholesale money, bank lending is being curtailed. As it happens, the demand for loan funds from the business sector is considerably lower than it has been, so it’s a case of demand and supply moving in the same direction.
Meanwhile, when you talk to your bank manager, make sure you underline the fact that your term deposits rates are getting very close to the point where the money has to find other homes and that will happen if the rates offered go below 5%. The bank managers will pass your sentiments on to their already nervous bosses.