The 2016 Commonwealth budget saw the most significant changes to superannuation in more than a decade. However it was not the particular tax changes in themselves that are the most critical; it was the philosophy behind the changes.
The changes were driven by two distinct but equally important philosophies: fairness and revenue.
In terms of fairness, we saw the introduction of the $1.6 million pension transfer cap to limit the amount of tax exempt investment earnings for retirees with significant pension pots. The level of tax concessions was also reduced for those with incomes between $250,000 and $300,000. Finally, the low income superannuation contribution was extended and replaced with LISTO (Low Income Superannuation Tax Offset). These changes are to be applauded on the grounds of fairness and are also broadly consistent with the opposition’s policies. Hence it is likely they will become permanent features of our new super landscape.
In terms of revenue, there were significant changes in respect of non-concessional contributions and transition to retirement pensions. Both these changes mean that certain behaviour in these areas will be limited in the future and are therefore likely to generate considerable revenue in coming years.
FIS’s recommendation on purpose of super accepted
The most significant driver of these changes has been the government’s acceptance of the recommendation from the Financial System Inquiry that the primary objective of superannuation is “to provide income in retirement to substitute or supplement the age pension”. That is, the government’s goal for superannuation is to reduce future age pension costs. It is instructive there is no mention of adequate retirement incomes or maintaining previous living standards, even within certain limits.
This overall approach, with the age pension as a focus, is confirmed by the fact that the $1.6 million pension cap is about double the level of assets at which the age pension runs out for a single person. Furthermore, the indexation of this cap is to be CPI related, in line with the assets test thresholds, and not indexed to AWOTE (average weekly ordinary time earnings), as used for all superannuation thresholds.
The super game has changed for ever. Whilst it is true that most of the budget announcements will not affect the majority of Australians, superannuation is clearly not as attractive for high income earners or those with significant wealth. However superannuation remains concessionally taxed, as it should be, for there are significant limitations on accessing one’s savings prior to retirement, and it is likely to reduce the capacity of many retirees to receive the full age pension during their retirement.
The budget also announced important initiatives to improve the flexibility of making superannuation contributions, including the expansion of the opportunity to make tax deductible contributions.
So with the taxation of superannuation now fairer and more flexible, albeit with an objective that is somewhat restrictive over the longer term, what remains to be done for Australia to rise above its current third placing in the Melbourne Mercer Global Pension Index?
Room for improvement
I suggest the following four developments would further improve the adequacy and sustainability of our overall retirement income system.
- Extend the SG system to the self-employed. As our labour force becomes increasingly less formal, more Australians will not have superannuation coverage. Already, our super coverage is less than Denmark and the Netherlands and this difference is likely to increase in the future.
- Ensure that most retirees have some longevity protection beyond the age pension. Currently many retirees self-insure by living a frugal lifestyle and thereby limit the effectiveness of the system. For retirees with benefits between $250,000 and $1.6 million, default retirement products should include some longevity pooling or protection.
- The current level of the Superannuation Guarantee has stalled at 9.5 per cent. We need an ongoing commitment that it will rise to 12 per cent which, in turn, will reduce future age pension costs. This increase is even more important as investment earnings have fallen, insurance premiums have risen and our retirement years continue to increase.
- The current age pension entitlement age is gradually increasing from age 65 to 67. This age needs to be linked to life expectancy so there is an automatic future adjustment as we continue to live longer.
None of these changes will be without controversy. However, each will ensure that our system delivers improved retirement incomes in a sustainable manner.
Dr David Knox is a senior partner at Mercer