In last week's Firstlinks newsletter, we featured an interview that the ABC’s Geraldine Doogue did with Jeremy Cooper, a former ASIC deputy chair and former chairman of retirement income at Challenger, on potential changes to the superannuation system. In the interview, Cooper outlined super’s purpose as a consumption smoothing mechanism and how that purpose had been distorted as the system had become more complicated. He described his caution about super possibly being used for national development projects such as infrastructure and housing. And he said no changes to super should be urgent given their long-term implications.
It was Cooper’s comments on the inequities of super tax breaks for retirees which provoked the greatest reaction among Firstlinks' readers and we thought it was worth sharing some of these comments to shed further light on the debate.
First, let’s look at what Cooper said on the issue. He broadly agreed with Doogue that the tax concessions to retirees cannot last:
"...it's not about the budget for me. It's about basically equity and fairness. So, just consider somebody – let's just assume that I'm nearing retirement. I could go into retirement soon, and I could be earning, let's just say, several hundred thousand dollars a year upon which I would pay absolutely no tax and even better than that for me personally, but not so much for society, I would actually probably receive franking credit rebates as well, possibly in the tens of thousands of dollars. Let's just think I've got two kids who are 30 somethings. They're carrying HECS debts. They're trying to buy a house in Sydney at the moment. They're on relatively modest incomes upon which they're paying more tax than I would be...
...I'd be interested in who could explain to me why that's an equitable setting. It's embarrassing. I sort of choke having just said that. It's just unequal and illogical and frankly, dangerous. I mean, when you set up parts of a society in different age groups and on different income bands, that's just so unequal, it's just not good policy. Now, of course, that's easy for me to say. I'm not a politician going out there and actually rendering that change. I mean, once you've given – particularly retirees, once you've given somebody a state of affairs, winding it back, it's very difficult. But that's not to say that we shouldn't be having the conversations. People have picked a figure of $5 million. If you've got $5 million in super, the excess above that should be treated as effectively being in the ordinary economy, not being in super, and should be taxed appropriately."
Firstlinks reader, Brian, says he agrees with Cooper, as super was never designed as a tax shelter for high-net-worth individuals:
“There should be an upper limit to how much can be held in super not an open opportunity to minimise tax. If the current status is retained, then advisors and tax agents will only be doing their job for their clients if they utilise super to minimise tax.”
However, another reader, Jack, thinks it’s silly to compare retirees with a younger generation:
“…by definition, retirees have had a working life of asset accumulation. A more valid comparison would look at the standard of living of young families today, with the retired cohort 40 years ago. We could talk mortgage rates and childcare and home prices etc. but young families always do it tough, and retirees are always more comfortable because the kids have left home, and the mortgage is paid off or very nearly. Therefore, Jeremy’s argument fails at the first hurdle.
Then we could talk about why super is tax-free in retirement because, as Jeremy admits, this is still a source of great confusion.”
Reader, Ian, suggests people can have opinions though there’s little doubt that changes to super are coming:
“A tax on super balances over $5m is coming for sure. Maybe the cut-off will be less than 5. Grattan suggests 2. That will encourage even more money to be redirected to investment in the tax-free family home (of both the superannuants or their kids/grandkids). Happy kids.”
Meanwhile, another reader, James, thinks super was flawed from the get-go and changes now will remove the incentive to lock away money in super:
“Keating decided to tax the input and the earnings. Overseas, usually input and earnings are untaxed (maximum compounding ability), and drawdown is taxed. This is arguably as it should be. To tax a superannuation pension now breaks the governments compact with the people that incentivises locking away your money in superannuation…
…Take away the incentive to save in superannuation and people will choose to live it up and spend almost all of it. Hit 67 and draw a full single or couple's pension indexed for life, and aim to have only the maximum allowable in assessable assets (home owner singles $280,000, couples $419,000) to supplement the pension. Which is preferable, richer retirees spending more in the economy (paying more GST, stamp duties, fuel excise etc) or poorer retirees who are welfare dependent who will consume and spend less?”
Reader, Jon Kalkman, says Cooper has made a more fundamental mistake in his analysis:
“Jeremy has made the classic mistake of confusing his super fund’s assets with his own. The hundreds of thousands of dollars he mentioned, are earned by his super fund, not by him. A super fund is a separate entity, much like a company, with its own assets, rules and tax return. As a shareholder of CBA, it’s $10 billion profit has no impact on me until I get a distribution from those profits. I certainly wouldn’t count the company’s profit as my income.
We need to differentiate between the tax paid by the super fund as a separate entity, from the tax paid by a member when they receive a distribution from that fund. You may control the entity as director or trustee, but you cannot mix its assets with your own.
Super funds in accumulation phase pay 15% tax on concessional contributions and investment earnings. Super funds in pension phase are tax exempt. These tax arrangements have remained unchanged since the start of compulsory super in 1992.”
Regular reader and past Firstlinks’ contributor, Warren Bird, sought to unpack the question of capital versus income in pension payments from super:
“If I put $10,000 in a term deposit for 3 years at 4% per annum interest, then after 3 years I leave $5,000 in the bank and withdraw the rest am I taxed on the $6,200 that I've taken out? No. I'm taxed on the $1,200 that was interest income. It's similar with super. When you withdraw money from your super account, if the amount you take is more than the income you earned then that means some of it was taking out capital. In super ... you have ALREADY PAID TAX on that. You don't get taxed when you take money out of your bank account and you shouldn't be taxed when you take capital out of your super.
When you take income out of super, well if that income was earned on $1.7mn that's in a pension phase account, it's currently tax free. I argue that this is absolutely fair and reasonable…But what would be totally unfair would be for people to fail to distinguish between capital withdrawals and income, resulting in taxing that person twice.”
And Warren Bird also takes issue with Cooper and other readers’ suggestions that having $1.7 million in a pension phase account can generate several hundreds of thousands of dollars in income:
$1.7 million in a pension phase account cannot generate $200k a year in income. That would be a yield of 12% and that's not going to happen in a sensible portfolio. So the cap on the size of the fund that can generate the tax free retirement income also limits the income that is generated. More like $80-100k is what you should be thinking.
The comparison then becomes with someone earning $80k on which they'd pay $16,000 in tax.
Second, you need to take into account that the reason society, through successive governments, has encouraged people to save for their own retirement is that the person with $1.7 million in pension account does not now get the old age pension. That effectively means that they ARE being 'taxed' on their earnings, to the tune of $27k a year. That's more than the person paying $16k in income tax.
Look at the big picture and you'll see that there's a very fair base to our retirement income system. What would be unfair would be to not only deny the retired person the old age pension, but to tax the income they've earned on the funds they've put away for decades to get into that position.”
We hope this article has amplified and clarified some of Jeremy Cooper’s comments. Firstlinks appreciates all of the reader feedback on the issue.
James Gruber is an Assistant Editor at Firstlinks and Morningstar.