The proposal to tax unrealised capital gains in super/pension funds above $3 million has an origin story – it is a consequence of poorly designed policies adopted by the Australian Parliament almost two decades ago.
Let’s review the context and wind back to 2005/06.
Parliament had just closed the unfunded pension benefits flowing to defined benefit public servants in 2005. These pension benefits had the potential to blow future Australian budgets apart. Indeed, they committed future generations to pay for the excessive pension entitlements of some Commonwealth public servants. These pensions entitlements were neither properly scoped, nor appropriately funded, inside future forecast consolidated revenue (i.e. from tax receipts).
After closing Defined Benefits, the Parliament then restructured superannuation and pension rules for the public. In doing so it created and set into motion both excessive contribution opportunity and an excessively low super tax regime, for those that could fully access it (i.e. very wealthy people).
It was a well cloaked arrangement between the Parliament and Australia’s influential and wealthy - to retain excessive indexed pension entitlements for retired and retiring public servants, (including politicians and senior bureaucrats) whilst granting benefits to a wealthy elite.
It is important to acknowledge that Defined Benefit beneficiaries dominated the seats of Parliament of 2006. Today, we can clearly identify the personal conflicts of the parliamentary members in these decisions, and it should have been more deeply scrutinised at that time.
In that bygone era – 2005/06 – the Australian Government was flush with funds. A budget surplus with little debt after many public assets were sold. Then looking at the growing future financial liability, the Parliament closed the 1990 Public Sector Superannuation Scheme (PSS) to new entrants (public servants including politicians).
However, it also effectively grandfathered the generous entitlements of those in the scheme and did so without a proper analysis of the cost of doing so. That cost has become horrendous.
The cost of Defined Benefits to taxpayers is far greater than the tax benefits in superannuation accounts that are larger than $3 million, noting that in 2016 transfer balance caps were introduced.
The PSS and the Future Fund
Depending on the individual circumstances of a PSS member, the retirement benefit can be taken as a CPI indexed pension, or a lump sum amount, or a combination of both. The PSS replaced the original Commonwealth Superannuation Scheme (CSS) that was closed in 1990. It is interesting to reflect that the CSS had less favourable after-tax benefits than the PSS. However, tax is levied, after rebates, on both PSS and CSS pensions.
Concurrently, the Future Fund (FF) was established in 2006 to 'make sure' the Government (i.e. the taxpayer) was able to meet its “unfunded defined pension liability”. In 2006 the FF was designed to match the funds required to pay every PSS and CSS pension out to 2046. The original concept and structure, under advice from Treasury and the Commonwealth Actuary, was that the FF could not be accessed until either the year 2020 or until the FF accumulated $140 billion.
Remember the actuary said that $140 billion would match out the Defined Benefit liability. How wrong they have been!
Today the FF has $240 billion of assets, and it is not expected to pay a pension until 2032 at the earliest. In fact, it was the delayed closure of the Military and Benefits Scheme Superannuation (for eligible ADF personnel) in 2016, that has exacerbated the financial debacle for Australian taxpayers.
Current budget estimates suggest the FF is underfunded by over $80 billion. But it would not be unreasonable to suggest the underfunding is still hundreds of billions, with Defence personnel pensions to grow through to 2060 (see FY25 budget papers).
Australian taxpayers are being misled and treated with contempt. The AFR noted this week that consolidated revenue, which is mainly the taxes of Australian taxpayers, is paying about $20 billion in defined benefit pensions in FY25.
Inside the cohort of defined benefit beneficiaries are mostly people who are modestly and appropriately paid a CSS and PSS pension. These are people who worked hard for the Australia public service and deserve appropriate treatment.
However, there are also some seriously well-off recipients of defined benefits who will receive many millions of dollars of payments over their retirement years. All resulting from the 2006 decisions of the Howard Government that were flagged through by the Labor Opposition. A Parliament that was full of conflicted of interests.
To understand the diabolical issues of defined benefits, let us consider the benefits flowing to a high profile ex-politician, or an ex-Defence Senior officer, or an ex High Court judge, who is reported as receiving a $300k defined benefit pension in FY25. Further, let’s assume that they are in their early 70s.
These pensions will be indexed each year and so let’s assume this is at the rate of 3% per annum. The result is as follows:
- At 75 years the pension rises to $327k.
- At 80 years it rises to $380k.
- At 85 years it rises to $440k.
- At 90 years it rises to $510k.
- At 95 years it rises to $590k.
Think about the numbers and you see that over the ten years to 85, the pension receipts aggregate to about $4 million, and over the ten years to 95 it aggregates to over $5 million.
Would a 90-year-old need $510k a year to live on?
Therefore, is it likely that these funds would flow from the beneficiary to others in a type of living estate?
Is that what Defined Benefits pensions designed to do and are they consistent with Australia’s superannuation policy?
Let’s be honest with the superannuation tax debate
This brings us to the current debate. In its essence it is about what an appropriate balance is to have in a pension fund. The Government seems to suggest that $3 million is excessive and therefore is legislating for the tax benefits that were created in 2006, to be reset.
The policy restructure, and the introduction of unrealised capital gains tax, is proposed under the guise of our retirement policy that declares:
“The Australian superannuation and pension system is designed to fund a dignified retirement and not to be a tax-effective vehicle for intergenerational wealth transfers”.
If that is the case, then a ‘reasonable’ reset of the tax benefits that flow to large super accounts is proper BUT so too is the reset of the defined benefit pensions that can be regarded, on any reasonable basis, as being grossly excessive.
Australia’s superannuation and pension policy needs to be reset and done so with a focus on integrity, transparency, and fairness. This is sadly lacking at present.
John Abernethy is Founder and Chairman of Clime Investment Management Limited, a sponsor of Firstlinks. The information contained in this article is of a general nature only. The author has not taken into account the goals, objectives, or personal circumstances of any person (and is current as at the date of publishing).
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