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Keep mandatory super pension drawdowns halved

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.

Age

Factor

<65

4.00%

65-74

5.00%

75-79

6.00%

80-84

7.00%

85-89

9.00%

90-94

11.00%

>95

14.00%

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.

 

18 Comments
David
May 30, 2022

As I get older, and the drawdown percentage increases, it seems to me that the only way to preserve capital in my SMSF is to work it harder, by increasing risk. Dividends, even if fully franked, won't be enough. Carefully chosen "penny dreadfuls" with good potential capital gains will be needed to suplement. If I lose the lot, then there will be the pension to fall back on. By then I will be past caring.

Dudley
June 18, 2022

"the only way to preserve capital in my SMSF":

Capital can be preserved outside super. By not spending it, and not incurring capital losses, required minimum capital withdrawals from super accumulate in personal accounts. For senior (SAPTO) couple the tax free threshold for fy 2021-22 is $31,926 gross each / y at which marginal tax rate on extra $1 is 32%.

Alan
May 30, 2022

Some good points, some nonsense, in comments so far. I retired aged 67 with two modest super pensions. I'm now nearing 79 with 11 years experience in the self-funded pension system.
First, if a reasonably conservative investment approach is taken (as it should be for retirees), returns are going to be 5-6%, that's considerably less than the benchmark returns touted by super funds. Second, if a major economic crisis occurs, as happened in 2007-8, the results are catastrophic. My funds lost 20% of capital almost overnight and before drawdown relief was laggardly introduced.Third, if major downturns occur during a year, even if they are temporary, while you are receiving monthly payments, your capital will likely be going backwards, as mine have in two of the past three years, even using in part the limited drawdown facility (I couldn't afford to take only 50%). Meanwhile my living costs, in particular medical costs and health insurance, have risen steeply.
I made a submission for more flexibility in drawdowns some years ago to the last Federal review of compulsory drawdown percentages, but the final report, full of actuarial gobbledygook, changed nothing. It bore no relation to real life whatsoever.
I believe modestly self-funded retirees of my age who are in good health (and there are far more of us nowadays) fear two things the most: skyrocketing age-care costs, and falling back on the age pension and into the dreaded clutches of Centrelink.
For these reasons I agree with those who say compulsory drawdown rates should be reviewed to reflect today's realities, or at least provide for more flexibility as a permanent feature.

Evie
May 27, 2022

Very apt comments, Jon. Why are we exacerbating sequencing and longevity risk at the expense of the taxpayer funding the age pension? I for one, have no intention of conveniently expiring at age 87. Obviously, there are alternatives to satisfying the aims of the ATO. Let's go further and do away with minimum drawdowns for superannuation, except for those retirees who are likely to leave large amounts of money in their funds after the maximum predicted date of death, rather than the 'average' predicted date.

Denial
May 26, 2022

The policy is now all over the shop to say the least given the Retirement Income Covenant requires trustees to assist in maximizing retirement income....aka maximizing what is drawn down from super. The underlying intent is clear with the guidance that bequests are not to be considered.

Ironically any ongoing debate of inequity for large versus small balance is simply farcical given the Age Pension (best guaranteed income available) will continue to be provided to +70% of current and future retirees. A full entitlement has a NPV of +$1M. Indeed, there is now a disincentive to get a balance between $400k-$800k given the taper rates. Only is Australia.

Dudley
May 26, 2022

"full entitlement has a NPV of +$1M":
With average life expectancy at 67 and $0 value at death:?
= PV(0%, (67 + 18.6868 - 67), 26 * 1488.8, 0, 0)
= -$723,343.60 (- = deposit in fund at age 67)

"disincentive to get a balance between $400k-$800k given the taper rates":
To never receive any Age Pension due to assts >= $901,500:
= PV(0%, (67 + 18.6868 - 67), 26 * 1488.8, 901500)
= -$1,624,843.60 (- = deposit in fund at age 67)

David
May 22, 2022

Post election, with Labour in power, this is a hopeless cause.

Dudley
May 22, 2022

"hopeless cause":

Labor may have to horse trade with one or more independents.

Those independents might be of the persuasion / persuaded that reducing the mandatory Super withdrawals serves useful purposes such as reducing the financial incentives for retirees to stay in / renovate / upsize their larger family homes using the excess mandatory Super withdrawals - freeing larger homes for larger younger families.

Chris Jankowski
May 19, 2022

I believe that the government should put a cap on how much can be kept in superannuation in total (accumulation and pension account) per person. This may be fairly generous e.g. 3 x max TBC i.e $5.1 million. Any money above this cap would need to be withdrawn from the tax privileged superannuation account. This will immediately and permanently deal super balances of SMSFs with more than $10 million.
This should be politically a very easy decision to make. There is really no reason for the government to allow people to have more than $5 million for the remaining 20 to 30 years of their life kept in a highly privileged tax environment.
The government would gain extra income tax revenue. This can be estimated as ~10,000 people x $10 million x 8% x 15% = $1.2 billion per annum. There will also be some capital gains tax.

Janine
May 22, 2022

Very sensible suggestion

Elizabeth
May 30, 2022

A sensible suggestion. Superannuation is for Retirement. $544million is hardly a retirement fund and to pretend it is so, is just silly. There is now a reasonable limit for "Pension phase", time to introduce a limit in Accumulation phase, funds in excess of the limit, say total of both phases $5 million, to be taxed at standard rates.

Irene
June 17, 2022

As I understand, at present the limit of superannuation which is transfer to allocated pension is capped at 1.7m. Any amount over 1.7m limit needs to be tax at 15%

DJD
May 19, 2022

The argument to retain the reduced mandatory drawdown makes sense with increasing longevity. If necessary retirees can withdraw more.

john
May 19, 2022

Minimum drawdowns are now virtually irrelevant because people are able to contribute to super until they turn 75 - if drawdowns were higher, it would mean more contributions - assuming of course that you don't have enough to exceed the maximum pension transfer limit. So the only people that the minimum drawdown effects are those who have over $1.7m in super, ie the wealthy

Cam
May 19, 2022

Halving makes no difference to people with small super balances as they need to receive above these reduced minimums for monthly living expenses. For a couple with larger balances though it allows them to keep more money in a 0% tax environment.
If they have to withdraw money its not lost, it just sits in their personal name and can generate taxable income.
So halving just saves tax for wealthier people, and provides a larger inheritance to their children.

Dudley
May 19, 2022

Retirees with small super balances receive Age Pension income tax free - no contribution required. Government guaranteed free CPI indexed money. Personal income in excess of that earnt within super.

They achieve the small super balances by withdrawing from Super that exceeding $405,000 and stuffing it into capital gains tax free home possibly to be inherited tax free by their children.

Kym Bailey
May 19, 2022

The original pension factors were actuarially determined to notionally expire a super balance in a person's notional lifetime. Whether the 30 year old factors are still correct needs to be re-examined. Simply halving them is too arbitrary.
If the new rules implemented in 2017 were aimed at reducing the chances of super being an intergenerational/estate asset, I would assume that higher drawdowns won't be contested. However, a rework of the basis for the factors is warranted to test the rationale.

philip
May 19, 2022

the factors were reviewed in 2016 and it was decided to leave them as is. This aligns similarly with what happened with the old allocated pension factors which were originally calculated for 1 July 1994 and not changed until January 2006.

Also the actuarial calculation used in the factors are based on a rate of return as being the rate in excess of inflation based on long term averages not a headline rate of return

 

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