The Labor Party has announced a policy that will deny the cash refund of excess imputation credits, and Bill Shorten said that people who do not pay tax should not get a tax refund. The subtext issue here, the one that working taxpayers (especially Gen Y) complain about, is that many retirees receive their superannuation benefits tax-free.
This debate will not progress further until the anger and envy is confronted. Even if we could educate the population on the merits of imputation credits (and that is unlikely) retirees would still be guilty in the public mind of not paying enough tax.
The real issue is the zero tax paid on pension income
Since 2007, super withdrawals (pensions and lumps sums) have been tax-exempt to retired members over the age of 60 (subject to caps introduced in July 2017). This was done because little tax was collected from this source and it coincided with a much more generous assets test for the age pension.
Many see the changes in 2007 as overly generous. Its lasting legacy is that it has led to the inter-generational politics of envy where the older (retired) generation pay little or no tax and the younger (working) generation pays progressively more tax as they earn more.
To working taxpayers, it seems incomprehensible and terribly unfair. Those who are old enough will remember:
- Before 2007, people paid tax on their superannuation pension at their marginal rate. Because this was money derived from super, they were also entitled to a tax rebate of 15% which was compensation for the 15% tax they paid on their contributions during their working life. Most important, this tax only applied to the proportion of the pension which was derived from the concessional (pre-tax) contributions in the fund. The after-tax proportion of a pension was tax-free as it was seen as the return of the contributor’s own money. That system still applies to people who draw a pension from their super before the age of 60.
- People whose contributions are limited to (pre-tax) employer contributions and salary sacrifice soon discover they never accumulate a large super balance from which to draw a pension. People only achieve large super balances at retirement by making large after-tax contributions. Before 2007, when taken as a pension, the larger that portion, the less tax was collected. Since 2007, it is all tax-free after 60 anyway.
- The combination of the higher tax-free threshold for retirees and the tax-exempt portion of pensions meant that few people paid much tax on their super pensions before 2007. This meant that Costello could appear to be generous but the actual cost to government revenue was quite small. It meant considerable political gain with little economic cost.
- There was no limit on after-tax contributions before 2007. That explains why some SMSFs have more than $10 million. Of course, the facility to make large after-tax contributions was limited after 2007 and since 2016 was only $100,000 per year. It is now impossible to make non-concessional contributions when super exceeds $1.6 million per person.
At present, about 50% of the population over the age of 65 depends on the age pension (which is $23,500 for a single person and $35,500 for a couple) for all their income needs. Another 25% or so receive a part pension because their assets and incomes are below the upper limits of the incomes and assets tests. Given the way these tests work, it is almost impossible for a couple on a part pension to earn more than $50,000. The AFSA standard for a comfortable retirement as a couple is $60,000.
Only 25% of the senior population is self-funded and that proportion declines with age as retirement savings, including super, are depleted. Of course, there is no way of knowing from Centrelink data if a self-funded retiree has failed to qualify for a part-pension by only a small amount or if they have $100 million at their disposal. But because there is no data this is often treated as a homogenous group, so they are all considered multi-millionaires.
Retired people have always paid little tax
No age pensioner pays tax on their pension and most part-pensioners do not pay any tax because of the Senior Australian Pensioners Tax Offset (SAPTO). Many self-funded retirees paid little tax on their pensions before 2007 and access tax-exempt pensions from their super funds now.
No government since 2007 has tried to undo the concession that allows tax-exempt withdrawals from super after age 60, to the chagrin of many workers and commentators and so the politics of envy continues. The $1.6 million cap on super in pension phase went some way to limiting the benefits.
In response to that confusion and envy, the blunt instrument proposed by Labor will cause much collateral damage. For all taxpayers on low marginal tax rates (especially retirees), the tax paid on dividends from Australian shares will be higher than other sources of income. As this increased tax will lower their income, this will distort investment decisions.
While the tax-exempt payments from super remain unaffected, this policy harshly affects the fund that pays a super pension, especially an SMSF where many self-funded retirees hold their retirement savings. Depending on the asset allocation to Australian shares it would mean a reduction in the fund’s income of up to 30%. A lower investment return due to a tax increase means super balances will be depleted sooner. A reduced capacity to pay retirement benefits to their members will place greater pressure on the age pension which is already under strain. It is difficult to see how this is good policy.
There has been insufficient consideration of the signals and incentives this policy sends, or the likely behaviour changes it will usher in.
Update as Labor announces a policy variation
In response to the public outcry, Labor has announced that pensioners and part-pensioners will be exempt from this policy. This extends the cynical approach of maximising political gain without too much cost to government revenue. To receive a full pension, a home-owner couple must have assets below $380,500. For a part pension, the limit is $837,000. It is unlikely that these non-home assets would all be invested in fully franked Australian shares. But if this were the case, for the couple on the full pension, the dividend (earning 5%) would be $19,025, the imputation credit refund is around $8,000 plus they would also receive the full pension, giving them an income of $62,600.
For the home-owner couple with $837,000, the dividend would be $41,850, the imputation credit refund would be less than $18,000 giving them a total income of almost $60,000, but those assets would reduce the age pension to zero. Note that more assets deliver a lower income. Refunded imputation credits are really the refund of tax already paid, but politicians seem to believe that any money handed back by the ATO is a tax concession. Even seen in that light, the cost to government revenue here is $18,000, but this couple saves the taxpayer the cost of the age pension which is now $35,500 for a couple.
SMSFs in pension mode pay zero tax on income or capital gain so they are clearly the target on the policy (although SMSFs with at least one pensioner member as at 28 March 2018 will also be exempt). To see how this policy plays out, take a SMSF in pension mode with two ‘non-pensioner’ members, and the fund’s balance is $1.4 million earning 5% from fully franked Australian shares. This couple have saved hard to be self-funded retirees, but the fund balance is well short of the $1.6 million per member currently allowed. The fund’s income from dividends is $70,000 and the imputation credit refund is $30,000. Since 2000, excess tax credits have been refunded in cash and this couple’s income from their SMSF is $100,000, and that is a comfortable retirement by any definition. The cost to government revenue is $30,000 but this couple has also saved the taxpayer the cost of the age pension of $35,500. Under this policy the members of the SMSF are ineligible for the age pension because their assets exceed the limit, but the income they draw from the fund has been cut by 30% from $100,000 to $70,000.
The couple with $1.4 million in their SMSF now has an income of $70,000. This compares with the couple on the full age pension, having saved $380,000 who has an after-tax income of $62,000. Similarly, the couple on the part-age pension has saved $837,000 and has an after-tax income of less than $60,000. It does not seem such a great return for all that sacrifice to save to become self-funded retirees! The question many members of SMSFs will be asking is: “Why would anyone bother?”
Jon Kalkman is a former Director and Vice President of the Australian Investors Association.