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How super became a poor deal for SMSF pensioners

There’s an old saying that two wrongs don’t make a right. In the current refundable franking credits brouhaha, it’s possible that if Labor is elected, we will have been treated to three wrongs.

We have experienced:

  • Wrong 1 - the introduction in 2007 by the Liberals of tax exemption of superannuation fund benefit payments to individuals aged over 60.

  • Wrong 2 - the introduction in 2017 by the Liberals of the $1.6 million pension cap which attempted to claw back part of the Wrong 1 tax exemption for wealthier superannuants, but with added complexity.

  • Wrong 3 - the proposed introduction in 2019 by Labor of the removal of franking credit refunds, in particular from superannuation funds.

Why can we say that the three wrongs don’t make a right? The answer is that, to the extent that an SMSF pensioner invests in Australian shares, the three steps together will leave that pensioner in a worse financial position than when superannuation pensions were taxable up until 2007.

This is the incredible result nobody talks about, but it isn’t the only reason.

For many SMSF pensioners with modest pensions, holding Australian shares for income rather than trading, the changes will even leave them worse off than had they been holding the same shares outside the superannuation system.

Current income outside super versus SMSF after Labor franking

Before turning to the historical superannuation taxation regime, let’s compare the after-personal-tax positions for three different SMSF income levels under the Labor 2019 scenario with the current non-super taxation arrangements.

(The tax shown has been calculated at the personal tax rates applicable in the 2018/19 financial year, ignoring Medicare and any other variations that might apply in individual cases.

In practice, there is no restriction on the amount of pension income that can be taken in any year beyond an age-related minimum. To compare like with like, I have assumed that net fund income is taken as a pension, although both lower and higher amounts could be taken, subject to the age-related minimum.

The reason that an SMSF pensioner is worse off inside super is because the Labor policy effectively results in a flat tax rate of 30% being applied to share income. In contrast, personal tax is levied at graduated rates with any individual’s average rate of tax being less than his or her marginal rate. An individual’s average tax rate doesn’t reach 30% until taxable income reaches about $180,000 (or about $140,000 with the 2% Medicare levy included).

It was better when superannuation pensions were taxed 

Now let’s turn to a comparison with the historical superannuation taxation regime. In the years until 2007, franking credits were refundable, but superannuation pensions were taxable.

It was a perfectly equitable arrangement and did not draw any criticism back then.

(Again, the personal tax rates are those applicable in the 2018/19 financial year, ignoring Medicare and any other variations that might apply in individual cases).

What is different in the personal tax calculations in the second table above is the deduction from personal tax of a 15% rebate (a rebate that still applies today for superannuation pensioners older than their preservation age but under 60).

This table makes clear that SMSF pensioners invested in Australian shares will be much worse off under the Labor policy than in the ‘bad old days’ when their pensions were taxed.

And further calculations show that the same conclusion applies pro-rata to those with anything above a slowly-increasing income-related allocation to Australian shares, i.e., many if not most SMSF pensioners.

Is the 15% rebate an undeserved concession for superannuation pensioners?

Let’s look at how the 15% rebate came about.

Prior to 1983, superannuation pensions were taxed in full as income (apart from any return of undeducted contributions). In contrast, superannuation lump sums largely escaped tax, which was why lump-sum tax was increased to 30% in 1983. Pensions remained fully taxed.

However, because of its gradual phasing-in, the 1983 lump-sum tax (levied at the personal level) would have taken years to raise significant revenue. Thus in 1988, superannuation fund taxation was introduced at the rate of 15%, specifically to bring forward half of the 1983 30% personal lump-sum tax, the rate of which was then reduced to 15%. Both contributions and investment income were legislated as taxable income.

But because the superannuation fund tax applied to all contributions and income, and not just the contributions and income used to ultimately finance lump sums, it was necessary to grant a corresponding reduction in tax to individuals becoming entitled to a superannuation pension. This was achieved by the granting of a personal 15% rebate, which recognised the pre-payment of brought-forward tax in respect of taxable superannuation pensions.

For example, if a taxable superannuation pension of $50,000 generated a personal tax liability of $10,000, then this was reduced by 15% of $50,000 = $7,500 so that the final tax payable was $2,500.

There are those who like to present any reduction in taxation liability as a concession. But in fact, a so-called concession may in fact be an anti-detriment provision, which is clearly the case for the 15% rebate in respect of taxable superannuation pensions.

In fact, it can be argued that the rebate is insufficient to provide full anti-detriment since:

  • it is non-refundable, adversely impacting those on lower incomes; and
  • it allows only for the tax on contributions and not that on investment income.

Conclusions on the best and fairest system

I believe the purest and fairest superannuation tax system was that operating between 2000 and 2007, when refunds on franking credits were granted to funds, but they were then taxed as part of the overall pension income when paid to the superannuation pensioner.

This perfectly equitable system was broken by the Liberals in 2007 when they made super payments tax free for the over-60s.

Not surprisingly, in recent times, governments have been looking at ways of reining in the cost of tax freedom of superannuation pensions. The 2017 $1.6 million cap, with its dauntingly complex administration, would never have been necessary had super pensions remained taxable.

Why are politicians unable to countenance the source of the perceived problem?

The real villain in this long-playing tragedy is not the refunding of franking credits to superannuation funds but the 2007 tax freedom of superannuation benefits to over 60s. Why is hardly anyone, including leading economic commentators, complaining about the cost to revenue of beneficiaries receiving retirement income free of tax?


Geoff Walker is a former Chief Actuary at the State Bank of New South Wales and winner of the 1989 JASSA Prize for published research on the implications of the then relatively-new dividend imputation system. 

Geoff Walker
March 09, 2019

I don’t want to single out anyone in particular, but there have been a number of well-informed comments, for which I thank those responsible.

However, a number of contributors have expended considerable effort mounting arguments as to what the ideal taxation arrangements for superannuation should be. Such arguments usually pass over the heads of many in the community, resulting in glazed eyeballs. Labor will swat those away easily.

IMHO these contributors have missed the point of the article, stated in its opening paragraph - that the Labor change will leave many SMSF pensioners in a worse after-tax position than when pensions were taxed, particularly those on lower marginal tax rates. What SMSF investors should be doing is shouting this from the rooftops. In contrast to intricacies of taxation policy, the community very easily understands the concept of being worse off.

And remember, we’re not talking simply about being worse off compared with recent years, for which many in the community rightly or wrongly have little sympathy, but being worse off than under the pre-2007 tax arrangements. That's unfair!

March 07, 2019

It's an interesting and thought provoking thread. With super being a complex mix of:

concessional contributions-a tax benefit, but not much at the low end, nice in the middle, less now after 30%
tax-deducted contributions-have to come out untaxed
income- 15% on accumulation, a tax benefit but not much again at low end
income-in pension mode-significant benefit, now capped
mandatory-deferred consumption
saves Government on age-pension-major saving

Clearly having taxed contributions up front and then a pooled mix of fully taxed and concessional contributions to get out as some form of pension/drawings is a mess.
Can you tax it just as one pension coming out or need to trace different pools? Need to start again? Is it justified at the low end-very tough on young families?

Jon Kalkman
March 07, 2019

Geoff Walker’s analysis suffers from a fundamental flaw. Before 2007 there was indeed a tax on pensions and there was also a 15% tax rebate, but both of those only applied to the proportion of the fund (and therefore the pension drawn from it) that was attributable to the concessional contributions within the fund. These tax arrangements are still in place for people who access their super before age 60 (when it becomes tax-free) and on the super death benefit paid to eligible beneficiaries, such as adult children or the estate.

Super funds only become excessively large through non-concessional (after-tax) contributions. For example, it would take 40 years of concessional (pre-tax) contributions of $25,000 to accumulate $1.6million. But before 2007, there was no limit on after-tax contributions and that explains why we still have some pension funds containing many millions of dollars.

Super funds with a large proportion of the fund comprised of after-tax contributions had a correspondingly a small proportion of the pension that was taxable and then it had the 15% tax rebate applied. Those pensions would have paid very little tax before 2007 and none at all after 2007. A return to the tax arrangements of pre2007 would collect little tax. No government has tried to overturn Costello’s decision to make super tax-free after 60 because the small tax receipts that flow are not worth the political pain.

It is these very large super funds with large tax-free incomes that is attractive to politicians. Mr Bowen is muddying the water by quoting that some funds have very large franking credit refunds (of $2.5million) which can only happen when the fund is extremely large. The deceit is in the pretence that all super funds are this size.

Costello’s response to this potential tax was to limit the size of annual of non-concessional contributions. After the outcry about the change, the transition year was changed to $1million in the first year. After that it was $150,000 per year with the provision of contributing 3 years’ worth ($450,000) in one go. With indexation that rose to $180,000 per or $540,000 over 3 years. That upper limit has been progressively reduced ever since, but it did not change anything for those funds who were well advised to contribute those millions before 2007.

Mr Shorten was Minister for Financial Services in 2010 and therefore responsible for superannuation. He saw no problem with any of this and made no changes.

Treasurer Morrison moved to limit the size of a tax-free pension fund, regardless of whether the source was pre-tax or after-tax contributions. At least now super funds with an excess above $1.6million are paying 15% tax on their income as that excess is moved to an accumulation fund. According to an early analysis this has resulted in a 90% increase in money held in accumulation accounts and therefore already subject to considerable tax collection even before Labor’s proposal to stop cash rebates of franking credit. This will be confirmed when the ATO publishes the summary of 2018 super fund tax returns.

What if we said that the aim of super is to supplement or replace the age pension and that it is determined that $1.6million per person is sufficient to have a comfortable retirement. In that case, all money in excess of $1.6m needs to be removed from super on retirement. We could go further, and ban accumulation funds in retirement because there is no obligation to draw down on them and their only purpose is to create a legacy for the estate. In that case the income from that capital in excess of $1.6m would be subject to normal tax, not just 15%.

We could then leave pension funds earnings tax-free as Keating (the original designer) intended and for very good reason. We could leave franking credits undisturbed because they only apply to relatively small accounts. And we could leave all these silly restrictions on contributions behind. It would be a simple matter of saying: the upper limit on a pension fund in retirement is $1.6m. We don’t care how you get there (concessional or non-concessional contributions) but you cannot have more than that.

The government would collect more tax from wealthy super funds but leave the mum-and-dad funds alone. It seems to me that would be both simple and fair.

Don Macca
March 08, 2019

HI Jon
Your comment is the simplest & the best.
All parliamentary parties should embrace it..
Can i restate your most important paragraph.
"What if we said that the aim of super is to supplement or replace the age pension and that it is determined that $1.6million per person is sufficient to have a comfortable retirement. In that case, all money in excess of $1.6m needs to be removed from super on retirement. We could go further, and ban accumulation funds in retirement because there is no obligation to draw down on them and their only purpose is to create a legacy for the estate. In that case the income from that capital in excess of $1.6m would be subject to normal tax, not just 15%."

The huge problem is that many predictions are being made, using, tax superannuation data for tax year ended 2015.

In the May 2017 Budget, the Liberal Government did the heavy lifting by introducing the $1.6m cap. This ensured those with large amounts in super paid 15% tax. Labors current proposal is a poor band aid. It appears to be an unfair tax,mainly affecting SMSF's under $1.6m. The same class of people with exactly the financial assets in APRA funds will not lose their "credit's".
If Labor's policy is adopted most will choose to remain in the accumulation phase. Those over 70 in the retirement phase do not have this choice.

Jon Kalkman
March 09, 2019

There is an article in today’s AFR (page 7) that illustrates my point. According to this report there is an estimated $187 billion sitting in SMSFs with balances of more than $5million each and the top 100 funds hold $7.9 billion collectively.

If you were a prospective Treasurer looking for some extra tax revenue to fund the next grand plan, when looking at the latest figures available (2014-15), these large funds look like money for jam. As most of these funds would have been in tax-free pension mode, all you have to do is turn off the tap of franking credit refunds, “hey presto” you end up with almost $6billion extra tax to be collected.

The problem for Mr Bowen is that the world changed in 2017. Funds with more than $1.6milion per member are now required to transfer the excess out of the tax-free pension into an accumulation fund where the income is subject to 15% tax. Under Bowen’s proposal a taxpayer (in this case the SMSF) can use their franking credits to offset their tax liability. So these large funds will be unaffected by Bowen’s proposal because they will now have enough tax liability to absorb their franking credits and Labor will collect nothing additional from these funds.

Meanwhile, funds with $1.6m or less will have no tax liability in pension mode and will lose ALL their franking credits. Instead of hitting the really wealthy, as Labor claims, they will hit the mum and dad funds the hardest. This is in the name of fairness.

It must be really embarrassing for Bowen to have to admit that he has made an awful mistake, but the reality is that Morrison beat him to it. By limiting the size of the tax-free pension to $1.6m, most of the additional tax that Bowen thought he was going to collect from these very wealthy funds, is already being collected.

If governments were really serious about limiting the tax concessions to super they would force the excess beyond $1.6m to be removed from super altogether and taxed at normal rates instead of 15%.

March 09, 2019

"article in today’s AFR":

Labor given steer on how to target the truly rich

"Labor's position was given a boost on Friday when the Committee for Economic Development of Australia said removing dividend imputation refundability would be good for the budget."

CEDA's point was what everyone knows: increasing tax is good for the [Commonwealth] budget.

I doubt that they were sufficiently interested to look beyond what everyone knows and a cursory 'Who could pay?' to 'Who should pay?'.

Christopher O'Neill
March 07, 2019

"The 2017 $1.6 million cap, with its dauntingly complex administration, would never have been necessary had super pensions remained taxable"

and the Reasonable Benefit Limits remained in place.

Treasury forecast how much the 2007 changes would cost up to 2009-10 for which the forecast was $2.6 billion.

The cost would be at least double that now and a lot of that would involve franking credit refunds. i.e. a lot of the growth in franking credit refunds has been fed by the 2007 superannuation tax reductions.

March 07, 2019

I think that it would be too complex to go back to the past. The sensible policy response is to tax all superannuation earnings at 15% and leave franking credits alone. Labor are too gutless to do this (maybe they are concerned that the people would understand what they are up to), so they embark on a deeply unfair and discriminatory policy that it is easy to obfuscate in the minds of the public.

Christopher O'Neill
March 07, 2019

"it would be too complex to go back to the past"

Why would it be too complex to go back to the past in a substantial way?

Making super pensions taxable should be a snap. Just change the tax label on the pension statement.

Reintroducing RBLs would be more complex but mainly because RBLs were always a little complex to administer anyway.

Even just taking away the super tax concession for >$1.6million balances would be a big help. There is simply no justification why any tax concessions should continue beyond $1.6million.

March 07, 2019

What we need to do is to tax the EARNINGS on pension mode super.

The pension paid out is then a return of capital which has been taxed already. Non-concessional contribuitons are taxed before they go in, concessional centributions are taxed at 15% (or 30%) and all earnings would be taxed at 15%. So all benefits paid out would then all be from after tax capital.

This change would be easy and would actually make the whole system less complex. There would be no difference in taxation for accumulation and pension mode so no caps or T-bar forms required.

To prevent people leaving their funds in super forever everyone over the age of 70 would be required to take out 5% of their total balance each year.

There would be plenty of opposition to this, but nobody could argue that it was unfair.

March 07, 2019

We don’t need any more taxes and we don’t need any more changes to superannuation. Governments should leave it alone before they totally destroy confidence in it.

Jan H
March 08, 2019

Loz: "To prevent people leaving their funds in super forever everyone over the age of 70 would be required to take out 5% of their total balance each year."

Current min withdrawal pension rates:
65-74 5%
75-79 6%
80-84 7%
85-89 9%
90-94 11%
95 plus 14%

March 07, 2019

Geoff Walker is definitely correct in concluding the simplest and fairest arrangement would be to tax super pension income; however Geoff has forgotten a “villain”: Labor’s initial decision to tax contributions and earnings in the accumulation phase. We now conclude that EVERY phase in the super life cycle should be taxed. But better this arrangement than the cumbersome Transfer Balance Caps we have now and arguments regarding the refunding of excess franking credits.

Bruce Gregor
March 07, 2019

Geoff Walker's 3 wrongs is the valid analysis rarely seen. The worst wrong was Costello's making super tax free after 60. Taxing super ensured that people would end up in a fair position after allowing for 15% rebates for Keating's bring froward 15% taxes on contributions and earnings. This change by Costello has now opened the door for multi millionaires getting tax free super and cash refunds on shares and a populist label for Labor's policy-absent franking credit scam.. Costello's change had nothing to do with encouraging saving - it was an attempt to curry shirt term favour with post 1996 disaffected superannuation surchare paying voters.

March 07, 2019

STEWART MONEY ..RE:" How about taxing the government age pension which for a married couple is worth about $40,000.00 per year" silly is this proposition. The FULL RATE OF AGE PENSION is $690.70pf or $17,958.20pa each. As this is under the tax free threshold which all tax payers are eligible to, why should should they be singled out to pay tax when others on the same level of income or much, much higher income (ie in the pension phase of super) don't pay tax. Age Pensions are paid by tax payers to ex-tax payers. Not all of which had compulsory super and not all had high paying jobs etc.

March 07, 2019

If Labor genuinely wants to remove the inequity from very large Superannuation balances then surely a simpler and fairer solution is to respect the current $1,600,000 million contribution cap and tax free status and franking credits make the contribution cap apply equally to accumulation and pension accounts.

5% on $1,600,000 without all the perks that come with the Gvt pension is not a big income.

If superannuation capital is limited to the contribution cap then returns on excess funds could be taxed at normal marginal rates.

Effectively any funds registered as supper attract a much higher tax free threshold above which standard marginal tax applies.

Ray Cameron
March 07, 2019

What is the likely outcome to Australian companies when many investors move their funds? Is one of the reasons Australia has the record of continuous growth because of the current franking policy and its benefits to investors and companies alike?

March 07, 2019

The reason for the tax exemption in 2007 was to encourage saving during retirement. If you don't want retirees to save (outside the family home), then simply carry on with such blundering policy changes as proposed by Labor.

March 07, 2019

I must be missing something....
Are they looking at Taxing super payments.? If you’ve paid your AFTER TAX savings into a Super Fund to have something to retire on.....why should you pay Tax on it again when you draw it out as an income. Sure...the fund earnings are Taxed , but to pay Tax on the drawings is ridiculous.
May as well just put it in a bank account.
What next......when you draw your money from an ATM you’ll get taxed on that?????

Christopher O'Neill
March 07, 2019

"The reason for the tax exemption in 2007 was to encourage saving during retirement."

So why was that encouragement restricted to only those who got a benefit from the change? i.e. those who end up with >$48,302 net superannuation pension?

Why should the government be throwing tax dollars at encouraging anyone to have a higher than $48,302 net superannuation pension anyway?

Stewart Money
March 07, 2019

How about taxing the government age pension which for a married couple is worth about $40,000.00 per year including perks and has an actuarial value of about $1,000,000.00 .
It is total lunacy to be punishing people who have done what Australian governments have been telling Australian citizens to do for the last quarter of a century which is they need to save enough to fund their own retirements because the government will not be able to afford to pay them a government pension in the future .

March 07, 2019

Low income people who are just outside Pension limits should still get a refund - say to $10.000 - as they have structured their investments to allow for them. Many such people who lose their franking credits may then qualify for a little pension - so where is the benefit to the country? People who get huge refunds and pay a little tax will continue to get their refunds - so I think it is a good idea but it needs more work.

March 07, 2019

It was never the intention that imputation would result in excess rebates. This has resulted in yet another recurring expenditure in the govt budget. There is also evidence that the demand for imputation credits from investors is altering both investment allocations by both public companies and investors alike. We need Australian companies to invest in growth and at the moment I feel that their decision making is being overly influenced by the demand for high payout ratios.

March 07, 2019

Tax refunds are not expenditure. They are just less income. Please detail how you have deduced the full intention of the original policy. I don't disbelieve you, but it's said a lot around here and I've yet to see any evidence for the assertion.

Geoff Larsen
March 07, 2019

"Excess rebates" "recurring expenditure"?

Please explain what is the difference to the ATO's budgetary bottom line between $10,000 of franking credits being refunded in cash compared to $10,000 of franking credits
being offset against tax liabilities?

Simarly at the same time what is the difference to the ATO's budgetary bottom line between $10,000 of franking credits being refunded in cash, within an SMSF, compared to $10,000 of franking credits being offset against accumulation members tax liabilities, in an AFRA fund, like Australian Super, whose members in accumulation far outweigh those in pension phase?

I'm intrigued as to the answer. I don't believe there is any difference.

Geoff Larsen
March 07, 2019

Last year , I believe, there were approximately $40 billion franking credits issued, with franked dividends, to Australian resident shareholders.(I'm not sure of the $40 billion includes non residents)

If all were Australian residents: -

Approximately $6 billion were processed as cash refunds and the other $34 billion were used by shareholders as offsets against their tax liabilities.

The budgetary cost to the ATO was $40 billion. However this is the cost of running a dividend imputation tax system and not double taxing dividends.

I don't see there's any difference in the cost to the ATO's budgetary bottom line between the $6 billion & the $36 billion. Just that the $6 billon stands out on the expenditure side of the ledger while the $36 billion is hidden within the revenue side. It's $36 billion revenue not received.

March 07, 2019

Survey - my reading is it was the initial intention, per the Campbell Review of 1981. The plan was for changes in 2 stages, one in 1987 and the second in 2000.
Geoff - a great way of making the point about the effect on the Budget of higher income earners using the majority of the franking credits

Christopher O'Neill
March 07, 2019

"It was never the intention that imputation would result in excess rebates."

Obviously wrong. The Campbell Report spelt out how imputation should be implemented and proposed an interim scheme that Keating adopted. Costello's scheme was the closest and most equitable of all the schemes so far implemented.

Jan H
March 08, 2019

For the 20 or so years since 1998, both in Government and Opposition, Labor have not criticised the policy of cash refunds of franking credits. In fact, there has been Labor endorsement for the cash refunds:

Former Labour Minister, and then Shadow Treasurer, Simon Crean, said in Parliament in 2000, that Labour had "no difficulty" in supporting the change, saying it "improved the taxation situation faced by low income investors, especially retired Australians"... "We have no difficulty supporting the proposal because it is OUR policy,”

Labor MP Michael Danby, who was first elected in 1998 and remains in his seat of Melbourne Ports, also voiced his support for the bill in 2000. “The proposed refunding of excess imputation credits contained in this bill is welcome,” he said. "In particular, self-funded retirees on low incomes will benefit from this policy.”

March 07, 2019

"Wrong 1 – the introduction in 2007 by the Liberals of tax exemption of superannuation fund benefit payments to individuals aged over 60.":

Super fund benefit payments are return of capital. Apart from untaxed capital gains just like payments from a savings account - no tax to pay.

March 07, 2019

This is the bit that people seem to miss - there is no tax when you withdraw money from a bank account, but apparently we're OK with taxing money withdrawn from a super account, assembled over many years according to the rules in force at the time.

It's just a different form of bank account.

Should there be tax on the earnings in super in pension phase? That's a different question. I believe that's reasonable, but taxing pension payments themselves is unconscionable, given it is, as you say, return of capital.

March 07, 2019

" taxing pension payments themselves":

The term 'pension' is a misnomer as there is no upper limit on the withdrawal rate meaning that withdrawals are not 'pension payments' but simply 'capital withdrawals'.

We have 'accumulation accounts'. The most appropriate names for 'pension accounts' might be 'decumulation accounts', or perhaps simply 'retiree accounts'.

Christopher O'Neill
March 07, 2019

"It’s just a different form of bank account."

Not even partly true until 1988.

The original conception of superannuation, even in Australia, was that untaxed income was put in an account on which no tax was paid on earnings and no tax was paid until a pension was withdrawn which was just taxable income plain and simple.

Along came Keating in 1988 who needed a cash grab so he put 15% tax on contributions and earnings but the account still remained taxable income when paid out as a pension but now had a 15% rebate.

It was only in 2007 that Costello made accounts unencumbered with any tax liability. His changes were a ridiculous "solution" to a non-problem.


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