Australia's Future Tax System

Retirement Income Consultation Paper

3. An acceptable retirement income system

The parameters of the retirement income system need to be acceptable to the community. Issues can include: the effect of compulsory saving on pre‑retirement standards of living; whether an individual's circumstances affect access to compulsory saving or tax concessions; and the perceived equity of the arrangements across the income scale.

Summary of key messages from submissions

A frequent message in submissions is the need to increase compulsory savings with targets being 12 or 15 per cent of remuneration common. The proposals include increasing the SG or requiring higher employee contributions. This is seen as particularly important for individuals with broken work patterns to increase their retirement income.

There is broad support for superannuation tax concessions. Submissions refer to the findings in the Australian Treasury's 2008 paper Architecture of Australia's tax and transfer system (Architecture paper) that around 2.4 million individuals either receive no or negligible concessions on their superannuation contributions. A number of submissions propose a rebate of tax to compensate low income earners for contributions tax paid. Another submission suggested removing tax on compulsory contributions.

Many submissions suggest increasing the government co‑contribution and extending it to more individuals to encourage greater voluntary savings.

Some submissions raise the current taxation of superannuation and the benefits it provides higher income earners. One submission considered that an efficient system of tax concessions would encourage saving by low‑income to middle‑income earners rather than high‑income earners. Another submission suggests superannuation contributions should be treated as remuneration and taxed as such.

A submission argues that it is inequitable for assets supporting superannuation income streams to be tax‑free. It argues this is particularly the case with transition to retirement pensions which allow older working Australians to shift their superannuation fund assets into tax‑free pension products.

Access to concessions is raised in many submissions, in particular: greater deductibility of contributions; the length of time individuals can make superannuation contributions; and the treatment of non‑superannuation income of members of taxed and untaxed funds.

Some submissions consider that insurance purchased outside of superannuation should be deductible, as it is if purchased within a superannuation fund.

The effect of compulsory saving on pre‑retirement living standards

Various submissions recommend increasing the level of compulsory saving. Proposals include increasing the SG or requiring employees to make additional contributions. Under either proposal the increased payments are likely to fall on the employee, either directly from their wages or, if the SG is increased, potentially through reduced wages growth. An implication of increasing compulsory savings is that it will require individuals to have a lower standard of living during their working life, to increase their standard of living in retirement.

Compulsory saving may not be acceptable to individuals if they have to forgo too much consumption before they retire. It is generally accepted that for most individuals a replacement rate of less than 100 per cent is appropriate, as they do not have costs associated with working, raising children, paying off their mortgage or accumulating wealth.

Increasing the amount of saving through superannuation may also be inconsistent with preferences about the form in which savings are held. For example, individuals with periods outside the workforce may prefer to have their savings in a more accessible vehicle than superannuation, so they can draw on them during these periods. This may also apply to groups with lower life expectancies. Others may prefer more flexibility to allow investment in housing or other assets.

An increase in the SG could increase employer costs, especially in the short‑term, if they are unable to share the cost with employees. If an employer is unable to absorb these costs they may retrench workers or not take on new employees. The overall impact on employment would depend on the economic circumstances at the time of any increase in the SG.

The effects of an increase in compulsory saving on replacement rates are shown in Table 3.1.

Table 3.1: Effect of increasing compulsory saving on replacement rates(a)

Saving rate AWOTE(b)
  0.75
%
1.0
%
1.5
%
2.5
%
9 per cent SG 79 68 56 48
12 per cent SG 84 74 62 55
15 per cent SG 88 78 67 59
  1. Appendices D and E provide further discussion of replacement rates and how they are calculated.
  2. AWOTE is average weekly ordinary time earnings and is approximately $1,150 a week.

Source: Australian Treasury projections.

Increasing the SG to 12 per cent for an individual on median earnings (around 75 per cent of AWOTE) would increase aggregate retirement expenditure by around $50,600 (over 23 years), while reducing pre‑retirement expenditure by $33,840 (over 35 years). Increasing the SG to 15 per cent would change expenditure by $78,643 and $61,457, respectively.

Increasing the SG rate also has a cost to government revenue as superannuation contributions are generally taxed less than income. If the increase were phased in at 1 per cent every two years, the cost to revenue in 2014‑15 (the year it would reach 12 per cent) is estimated to be $1.9 billion per year. Although superannuation tax revenue would rise, this would be more than offset by a loss of personal income tax revenue. There would be a longer‑term saving on Age Pension outlays.

Taxation and other concessions

In addition to the Age Pension, the government supports the retirement income system through taxation and other concessions such as the government superannuation co‑contribution for low‑income and middle‑income earners. Page 25 of the Architecture paper outlines the taxation of superannuation.

The Age Pension is regarded as taxable income. However, the effect of the pensioner tax offset means that individuals receiving a full rate Age Pension do not pay tax. The senior Australians tax offset and the low income tax offset also reduce the tax paid by many part rate pensioners. The taxation of older Australians is outlined in Section 4.1 of the Panel's Consultation paper.

Rationale for concessional taxation arrangements

Tax concessions were part of the two pillar retirement income system that existed before the SG was introduced. The concessions sought to encourage individuals to save for their retirement and reduce their reliance on the Age Pension. One stated reason for introducing the SG was that these concessions were not effective in encouraging private voluntary savings. However, following the introduction of the SG, both compulsory and voluntary savings through superannuation continued to be concessionally taxed.

Concessions for compulsory savings act as an additional level of government support for the provision of retirement income. The tax concessions for compulsory savings do not encourage savings but may be seen to compensate individuals for the inability to use these savings for other purposes, which they may value more highly than retirement savings. Providing concessions to compulsory saving may also reduce the need for individuals to make additional voluntary saving.

The incentives to make voluntary contributions, such as salary sacrifice, support an individual's decision to make additional savings if they want a retirement income higher than that available under the Age Pension and SG. Individuals who are ineligible for the SG can claim a deduction on their superannuation contributions. This provides some support to individuals such as the self‑employed. However, it is unclear from research whether tax concessions encourage additional saving.

The taxation of other voluntary saving is discussed in Sections 3.2 and 6.7 of the Panel's Consultation paper.

Individuals can access their superannuation from age 55 years as an income stream without the need to retire. This policy assists individuals in their transition to retirement, by using their superannuation to support a move from full‑time to part‑time work. An emerging strategy among older workers, aged 60 years or older, is to use this policy to receive a tax‑free income from superannuation at the same time as making salary sacrifice superannuation contributions from their work income. This reduces the effective rate of tax on part of their work income to the 15 per cent tax paid on their superannuation contributions. Table 3.2 shows the effect of this strategy on the amount of tax paid.

Table 3.2: Transition to retirement strategy — tax impact

  Salary
  $50,000
$
$100,000
$
Without transition to retirement    
Income tax and Medicare 8,850 27,500
Net income 41,150 72,500
With transition to retirement    
Salary sacrifice 25,000 50,000
Superannuation income 16,525 31,350
Income tax and Medicare on remaining $25,000/$50,000 375 8,850
Tax on super contributions 3,750 7,500
Net income 41,150 72,500
Reduction in total tax 4,725 11,150

Note: 2008‑09 tax scales are used. The individual is assumed to have no income other than salary and is aged 60 to 64 years.

The examples are constructed to achieve the same after‑tax income — that is, the tax saving is applied to achieve higher superannuation balances. To receive a transition to retirement pension of the amounts shown, the individual must have a superannuation balance of at least 10 times the pension.

Source: Australian Treasury estimates.

Equity of the taxation arrangements

Savings invested in superannuation are generally not taxed at the individual investor's personal tax rate (income streams paid from an untaxed superannuation fund are taxed at personal tax rates with a rebate). Instead superannuation contributions and earnings are taxed at a flat rate of 15 per cent within the fund. This tax structure means that superannuation concessions are higher for an individual on a higher personal tax rate while an individual on a low personal tax rate receives little concession on their contributions.

The proportion of concessions that flow to individuals on higher personal tax rates has been increasing in recent years due to reductions in personal income tax. For 2005‑06, it is estimated that 5 per cent of individuals accounted for over 37 per cent of concessional superannuation contributions. Concessionally taxed contributions include SG contributions, salary sacrifice and deductible contributions by the self‑employed. This distribution reflects the fact that these individuals are paid more SG contributions, and have greater capacity to make voluntary superannuation contributions within the contribution limits.

To limit the concessions available to an individual there are two caps on the amount of contributions an individual can make each year. Individuals can make up to $50,000 a year (indexed) of before‑tax (concessional) contributions (those made by an employer or that are tax deductible). Individuals aged 50 years or older can contribute up to $100,000 a year until 30 June 2012. A cap of $150,000 a year (indexed) applies to personal contributions made from after‑tax income. Individuals under age 65 years can bring forward up to two years of future after‑tax contributions.

Higher income earners are also likely to benefit to a greater extent from the tax exemption on earnings on assets supporting superannuation income streams, as they have more assets and are likely to live longer on average than individuals from lower income groups.

While the taxation concessions benefit those on higher incomes, this is reduced to an extent by other components of the retirement income system. In particular, the Age Pension income and assets test arrangements are more likely to affect higher‑income earners than low‑income earners.

The government superannuation co‑contribution also targets benefits to those on low to middle incomes. In this way the co‑contribution distributes concessions to individuals on middle personal tax rates who are able to make additional contributions.

Box 3.1: Concessionality of the superannuation taxation arrangements(a)

Under a comprehensive income tax benchmark the concession to superannuation is the difference between the tax paid if the superannuation contribution and the earnings were taxed as income at the individual's personal tax rate (plus the Medicare levy) and the tax paid in the fund (generally 15 per cent). Under this benchmark the superannuation concessions have an estimated cost to revenue of over $26 billion in 2007‑08 (Australian Treasury 2007).

An alternative way to calculate the value of the tax concession is to use an expenditure tax benchmark. The two types of expenditure tax benchmarks are: a pre‑paid expenditure tax based on direct taxation of labour income with an exemption for saving; and a post‑paid expenditure tax based on the taxation of a direct measure of expenditure or of goods and services.

Under the pre‑paid expenditure tax benchmark, the value of the concession is the difference between the tax paid if the superannuation contribution were taxed as income at the individual's personal tax rate (plus the Medicare levy) and the tax paid in the fund, less the tax paid on earnings in the fund. Benefits are tax exempt under this benchmark, which is consistent with the tax exemption of superannuation benefits in Australia's retirement income system. Under this benchmark, the superannuation tax concessions would have an estimated aggregate cost to revenue of $4.6 billion in 2007‑08.

Under the post‑paid expenditure tax benchmark, both contributions and earnings would be tax‑exempt but benefits would be fully taxable when paid. Under this benchmark the tax concession is expected to be less than under the pre‑paid expenditure tax benchmark, as individuals will generally have a lower tax rate on their retirement income than their income while working.

Under all these benchmarks, superannuation is taxed concessionally. However, the concessions are heavily weighted to individuals on higher personal tax rates.

  1. These estimates are not necessarily indicative of the cost of the superannuation concessions over the long term. The tax concessions help to reduce budgetary expenses in future years, particularly Age Pension payments, through the effect of the means tests.

Access to concessions

The superannuation tax concessions are not universally accessible. Some submissions note that employees who cannot make salary sacrifice contributions do not have the same access to contributions as employees who can. Other submissions raise a concern that individuals aged over 70 years are not paid the SG and those aged 75 years or older are unable to make superannuation contributions and must pay tax on their non‑superannuation investment income. There are also concerns that self‑funded retirees are not eligible for the concessions paid to Age pensioners.

Some submissions raise concerns about the tax treatment of benefits from a taxed and untaxed superannuation fund, especially the flow‑on effect to the taxation of other income. Benefits from a taxed superannuation fund are tax exempt when paid to an individual aged 60 years or older, while benefits from an untaxed superannuation fund are included in assessable income but are eligible for a 10 per cent offset. This affects the taxation of the non‑superannuation income received by a member of an untaxed fund. The example in Table 3.3 was submitted to the Panel.

Table 3.3: Tax treatment of non‑superannuation income of members of taxed and untaxed funds

  Superannuation income
  Taxed
$
Untaxed
$
Superannuation pension 40,000 40,000
Non‑superannuation income 20,000 20,000
Total income 60,000 60,000
Tax(a) 1,169 8,900
Net income 58,831 51,100
Tax on $20,000 non‑superannuation income 1,169 7,100
  1. 2008‑09 tax scales and individual below Age Pension age. The calculation for the untaxed fund member includes the 10 per cent offset.

Source: Superannuated Commonwealth Officers' Associations (Federal Council) Inc. submission (2008).

The example reflects taxes at the point the pensions are paid. The individual taking a pension from the taxed fund has already pre‑paid tax on this pension amount. If it is assumed that this is at the rate of 15 per cent the member of the taxed fund has already paid tax on their pension of $7,058. This increases the tax paid by the member of the taxed fund in the above example to $8,227. Tax paid in this example reduces to $7,058 if the individual is eligible for the senior Australians tax offset.

There are other examples where the retirement income system treats individuals differently. An individual can make contributions up to age 65 years without having to work but must work to make contributions after age 65 years. The SG is paid up to age 70 years. After that age, an individual is not paid SG but can ask their employer to make salary sacrifice contributions up to age 75 years.

Consultation questions

Q3.1 Do the settings of the retirement income system, such as the level of SG and access to concessions, adequately consider the needs and preferences of individuals both before and after retirement?

Q3.2 Is the current level of superannuation income tax concessions appropriate and sustainable into the future? Are the current concessions properly targeted and, if not, how should they be reformed?