With the battle lines being clearly drawn of superannuation policy in the upcoming July 2 election, I wanted to get a better understanding of the policies of both parties when it came to post-retirement.
I read with interest an article in the Australia Financial Review regarding modelling completed by Wills Towers Watson that outlined Labor’s super crackdown will hit harder than the Coalition’s policy on post-retirement. The problem I saw with the article was that it was only considering half the equation – an assessment of how the fund taxation on earnings will apply. What the modelling didn’t consider is the impact of how the proportioning rule will operate for each policy and how this impacts in the long-term when paying a death benefit to one or more non-tax dependants.
Comparing post-retirement policies
The Coalition government announced on budget night the introduction of a $1.6 million transfer cap amount from 1 July 2017 – that is, a ceiling on the purchase price of account based pensions. Where a member has more than $1.6 million in their super account, they can retain this money within the fund but the taxable earnings will be subject to a 15% tax rate (being in accumulation phase). Contrast this to Labor’s policy whereby they have previously announced a $75,000 earnings threshold per pension member on fund earnings – that is, the first $75,000 of income is exempt current pension income (ECPI), with any earnings above this threshold being subject to tax at 15%.
To best understand some of the issues, let’s take a look at the following example:
Mike is in receipt of an Account Based Pension (‘ABP’) from his SMSF with a current value of $2,500,000. He draws the minimum pension each year from his account balance.
When applying the Coalition’s policy to Mike’s circumstance, he will be required to rollback part of his existing pension to meet the transfer cap amount of $1,600,000. This means that $900,000 will remain in accumulation phase (assuming he doesn’t withdraw any amount from super). Contrast this with Labor’s policy, it appears that Mike does not have to make any changes to his existing account based pension – however from 1 July 2017, any earnings derived above $75,000 from this pension will be subject to a 15% tax rate.
The chart below models Mike’s account balance (lines) and tax payable (columns) over a 30 year time horizon, showing various earning rates derived by the super fund. As you can see in the horizontal axis, I have split the earning rate between income & growth when modelling the impact of both measures (applying rates of return between 2% and 10%).
What the chart above tells us from Mike’s situation is that a rate or return around 7% provides a comparable tax outcome from both party’s proposed measures. Where fund earnings start to outperform this mark, you see just how much a Labor Government will benefit from the earnings threshold approach against the Coalition’s transfer cap amount. In contrast, the Coalition is deriving tax from a much earlier starting point based upon the investment performance achieved by the fund.
One of the problems in endeavoring to fully understand Labor’s policy on pension earnings above $75,000 is how it will be defined – whilst on face value it would be determined on attributable taxable income (see former Labor party press release on proposed change in 2013), the devil will be in the detail of course!
One area that hasn’t been discussed at length though in this debate is the impact on the member components…
In referring back to Mike’s example, the outcomes of the above chart show a better outcome with Labor’s policy over the Coalitions when it comes to the impact on a member’s taxable component. Why? With the Coalition’s proposed measure, this will require Mike to rollback part of his existing pension to accumulation phase. This means that the proportioning rule will no longer apply to this benefit, with all future earnings applied to his taxable component rather than proportionately (as established initially with the pension).
This is important, because as you can see over the 30 year projected time period, the greater the rate of return derived by the SMSF, it is the Coalition’s policy that generates a greater taxable component. When paid to a non-tax dependant this means a greater level of tax revenue generated from the death benefit (tax at 17% if paid directly to beneficiaries or 15% via the deceased member’s estate). In contrast, it appears that Labor will not require any change to existing pensions, therefore having no impact on how the proportioning rule will continue to apply to income streams.
Give the Coalition’s proposed changes around the lifetime non-concessional contribution (NCC) cap of $500,000, the $1.6m pension transfer cap amount and the removal of anti-detriment, this outcome with the taxable component could be argued as a deliberate one as they focus their super policies towards utilising super for retirement and not to benefit as an estate planning tool.
What this highlights is that close attention will be required around the planning of pension balances through to 30 June 2017, regardless of the party elected on July 2.