The Government recently extended the reduced mandatory drawdown rates required for superannuation pensions for a further 12 months to 30 June 2023.
Mandatory withdrawals from a pension fund are the flip side of the benefit of having a super fund that pays no tax on its earnings in retirement. Prior to 2007, withdrawals from a super fund were governed by annual maximum and minimum factors which were set by a person’s life expectancy and so they changed annually. The changes in 2007 removed a maximum and set the minimum withdrawals into the following bands that have remained unchanged since.
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Age
|
Factor
|
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<65
|
4.00%
|
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65-74
|
5.00%
|
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75-79
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6.00%
|
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80-84
|
7.00%
|
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85-89
|
9.00%
|
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90-94
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11.00%
|
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>95
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14.00%
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Why we have mandatory withdrawals
The purpose and effect is to reduce the amount of tax-advantaged money remaining in the fund at death to be passed on to beneficiaries. It does this because, at the point where the fund’s investment earnings are insufficient, super funds need to liquidate assets to satisfy this regulation.
A super pension fund cannot accept new contributions, so assets thus sold or money drawn out cannot be replaced and are unavailable to support the pension in later years.
The Government has modified these drawdown rates in times of increased market volatility, such as the GFC and the COVID pandemic. In such times, the argument goes, super funds may need to liquidate assets at fire-sale prices and thereby increase the rate of asset depletion.
The Retirement Income Review identified that claims on the age pension increase with age as superannuation assets become exhausted. Increased rates of asset depletion and higher mandatory drawdowns, accelerate this process.
Changed circumstances since 2007
Even without periods of extreme volatility, our economic circumstances have changed since 2007, as follows:
1. Lower investment returns
Many retirees are very conservative in their investments, preferring the certainty and lower returns of cash and fixed interest to the risk and higher returns of other investments. Money held in a term deposit in 2007 could earn 8%. The same investment today might earn 1%. This dramatic reduction in income has meant the liquidation of assets much sooner than anticipated, or a search for yield higher up the risk curve which brings its own volatility. Lower returns hasten the day when the super pension fund is exhausted and retirees claim the age pension.
2. Longevity risk
This is an increased risk that retirees will outlive their money. The risk can be minimised by starting with more money, earning a higher return on our investments, or not living too long (!).
Although none of us know how long we will live, the life tables offer some guidance. A male age 65 might expect to live for another 20 years and a female of the same age might expect to live for another 22 years. Many retirees will have partners and for over 70% of them, one member of the couple will reach age 90. If these retirees are to remain self-funded, their super fund needs provide a pension for many years, but these high drawdown rates work against them.
Prior to the 2013 election, the Coalition, then in opposition, promised to review these drawdown rates to take account of our increased longevity. That promise was never kept. The present system forces people to take more money from their super than they need when they are relatively young, leaving them with less as they age.
Paul Keating, the original architect of the super system, has admitted that under his original design, super was not expected to last beyond the age of about 85 and suggested that we introduce some sort of longevity bond to manage this risk. Clearly both sides of politics acknowledge that the present super arrangements do not manage longevity risk very well.
Transfer Balance Cap now limits super
The Retirement Income Review identified 11,000 people with more than $5 million in super and the AFR reported (16 July 2021),
“Twenty-seven of Australia’s biggest self-managed super funds held more than $100 million each in concessionally taxed savings in the 2019 financial year, including one mega-SMSF that has hoarded $544 million.”
By contrast, the average SMSF size in 2020 according to the ATO was $1.3 million, but this is an average of all SMSFs including those just beginning, along with those with very large super balances. The median SMSF was only $733,000, or half the size of the average.
A retired couple with a median SMSF would still be eligible for a part age pension.
These large super funds exist because prior to 2007, unlimited non-concessional contributions were allowed. Prior to 2017, these funds would have been held in zero-taxed pension funds in retirement to take advantage of the tax-free environment.
Therefore, mandated drawdowns in pension funds were logical because they forced increasing amounts of money out of this generous tax environment to face normal tax rates.
The Transfer Balance Cap (TBC) introduced in 2017 fundamentally changed this situation.
The TBC forced the transfer of money in excess of the cap into accumulation funds. These funds are now subject to (concessional) tax on income, but importantly, these funds are no longer subject to mandatory drawdowns and so they continue to grow while enjoying generous tax concessions. Eventually, these funds will disappear because death is a cashed-out event but until then they make excellent estate planning investment vehicles.
However, the money remaining in super pension funds, under the TBC, is still subject to mandatory drawdowns that were designed to deal with quite a different situation.
Taxing super pension funds would make them redundant
The presence of these large accumulation funds distorts the discussion of tax concessions to super and so-called subsidies to the wealthy. There are frequent suggestions that super pension funds should be taxed at 15% to reign in super tax concessions even though pension funds have been tax-exempt since 1992 when these funds had much larger balances.
It is even less applicable now that there are these large concessionally-taxed accumulation funds that would not be subject to a new pension tax. Indeed, with the introduction of such a tax, pension funds would become redundant because accumulation funds would offer the same tax concessions without mandatory withdrawals. That really would encourage the use of super for estate planning.
The concern about tax concessions going to pension funds is misplaced because the TBC has already severely limited these tax concessions. Pension funds now only support retirees who are trying to manage asset allocation against cash-flow as well as inflation risk, market risk and longevity risk over a long retirement.
The current halving of mandatory drawdowns for superannuation pensions does not limit how much retirees can withdraw from their super but it provides them with much greater flexibility in these uncertain times of low investment returns, rising inflation and increased longevity. If the government is serious about encouraging self-funded retirees to remain self-funded for as long as possible, thereby ensuring that super reduces the long-term cost of the age pension, it should make the halving of these mandatory pensions, permanent.
Jon Kalkman is a former director of the Australian Investors Association. This article is for general information purposes only and does not consider the circumstances of any investor. This article is based on an understanding of the rules at the time of writing.