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Two courageous responses to the Retirement Income Review

Whilst media commentary is mainly looking at the Retirement Income Review through the Superannuation Guarantee (SG) rate prism, there are some strategic observations in the Final Report which suggest other more courageous alternatives are needed.

The Report finds reduced complexity and increased efficiency could improve retirement income outcomes without increasing the SG. Two suggestions I have in this area relate to Death and Disability Insurance and Contributions Tax.

1. Separate insurance cover from superannuation

The original policy development of SG focused on retirement income supplementing age pension as well as allowing portability of super as people changed jobs. Whilst existing company employee benefit schemes had death and disability benefits (sometimes outside super as well as inside) the administration of SG contributions has morphed into it also funding these insurances.

This evolution was partly due to competing industry funds promoting additional bells and whistles and partly from insurance companies pushing (unsustainably ‘cheap’) group-insured products to fund trustees.

Such insurance cover is a deduction from a member’s total superannuation balance. Members find out at the end of the year what it cost. If the member’s balance is only derived from 9.5% SG accumulation, then insurance is effectively financed by the SG contribution.

It was a magic pudding for insurance companies and as revealed in the Financial Services Royal Commission, open to abuse as 'junk insurance' was often provided on an opt-out basis and without analysis of the level of cover that people really needed. The Government’s response (the ‘Protecting Your Super and Putting Members’ Interests First’ reforms) aims to prevent the erosion of small balances by requiring at least $6,000 and age 25 before starting insurance and some as-yet-unregulated prudential changes regarding consideration of needs. In the meantime, insurance premiums have steadily increased.

If we are focused on maximising the retirement income produced from SG, then the accumulation from SG contributions should in future be quarantined from insurance. Employees and employers should finance this separately if employees really need it. In fact, it is more tax effective to provide temporary disability insurance (a major proportion of the cost) outside super where the premiums are tax deductible to employees.

In summary, there remain adequate and flexible voluntary contribution options in funds for employees (and employers) to voluntarily fund death and disability benefits and for members to match them better to their family circumstances, without using SG contributions for this.

I estimate this would allow on average an additional 0.5% of pay to accumulate towards retirement from SG.

2. Eliminate Contributions Tax

My second suggestion is to eliminate the 15% Contributions Tax on SG contributions to produce a more equitable and efficient taxing regime and a better retirement policy outcome. It would reduce the complexity of the compulsory super system and allow about an extra 1.5% of pay from existing SG contributions to be accumulated towards retirement.

There would need to be consequential changes to how retirement benefits are taxed due to the removal of Contributions Tax. I will not address this in detail here but I believe a progressive end-benefit tax focused on income wealth in retirement would produce a better policy outcome.

Firstly, a bit of background on the 15% Contributions Tax. This is a legacy from the Hawke Government’s introduction of imputation of company tax and is unrelated to superannuation. The imputation policy curried favour with the business community (when company tax rates were higher than now) in the 1980s and was very costly to revenue.

The compensation for revenue loss from introducing imputation came from the so-called ‘bring forward’ of superannuation benefit tax in the form of the 15% Contributions Tax. This 35-year-old gimmick has been the main cause of the complexity in people’s attempt to reconcile 9.5% pay with how their SG-related retirement savings accumulate. It is a historical anomaly just waiting for a good opportunity to get rid of it and now is as good a time as any.

The 15% Contribution Tax (just from SG contributions) currently provides about $10 billion to the Federal Budget. This could be replaced by an indirect consumption tax. The current GST rate of 10% is well behind New Zealand's 15% and below rates of consumption tax in many comparable countries. 

Some additional indirect tax should be raised now to cover the unfunded portion of the NDIS and to provide extra funding for post-COVID health system needs. The recent Medicare levy increase to cover NDIS still leaves about $5 billion per annum of future fully-implemented NDIS cost unfunded.

Peter Costello’s legislative handcuffing of any change to the GST is a practical road block to increasing the GST rate. I suggest a courageous government could now define a new additional consumption tax to be collected alongside the existing mechanism of the GST. 

I would suggest that this new consumption tax – call it a Health System Tax or HST) - could be set at 5% with half to be distributed to states on a pure per capita ratio without the much-maligned Horizontal Fiscal Equalisation adjustment. Latest annual GST collections were $65 billion. Based on this figure, a HST of 5% would raise about $32 billion with $16 billion for the states for their health systems and $16 billion for Federal revenue. The Federal revenue share would balance the $10 billion loss of Contributions Tax plus the unfunded $5 billion for NDIS with some left over to stabilise ongoing debt interest funding from COVID programmes.

Two changes to build super

The two changes above would add about 2% of pay to accumulate towards retirement without changing the current 9.5% SG rate.

 

Bruce Gregor is a demographer and actuary, and Founder of Financial Demographics and OzDemographics. This article is general information only and does not consider the circumstances of any investor.

 

13 Comments
Bruce Gregor
December 11, 2020

From the comments it seems worth adding to the future policy agenda, restriction of compulsory insurance from SG to death only. With regard to what level of death cover SG finances I would go further and set the insurance as a standard insurance formula of Years remaining to age pension age (currently 67) times SG Rate times AWOTE (currently about $75,000). For a 25 year old that would be insurance of about $300,000. On death of the member, this amount could be added to a dependents SG account and therefore be available at retirement to replace SG accumulation the dependant may have relied on in retirement from the member's future working life. This insurance would progressively reduce as the member ages and years remaining to 67 reduce.

I note comments on taxing end benefits in retirement if contributions tax is eliminated. My view is that we should be heading towards the day when all drawdowns in retirement from SG are taxed as income with a deductible in any year of 150% of annual age pension (and current compulsory drawdown minimums would be abolished). This would still be (over lifetime) concessional at low to middle income and would discourage excessive super accumulation for high income people. For transition to this new world, existing members could do a one off transfer of existing super to this new world or stay with the ramshakle mess of current contributions tax and contribution rules.

John
December 17, 2020

Multiple retirement schemes can have different taxing points. In the US, members often have two retirement plans accordingly. e.g. 401(k) versus Roth IRA have differing tax timing. We spend much longer working and accumulating than we do in pension phase and in the latter years of work or in retirement many of us leave the funds we were with while working and set up an SMSF, in part to minimise fees on our nest egg. My biggest concern with replacing the 15% contributions tax with a pension phase tax is that it leaves even more FUM for fund managers to clip for 40 years of accumulation, without regard to performance.

Paul Rogers
December 11, 2020

Hi Bruce, Interesting article. I think on the insurance component, only having death cover in super is better as disability insurance makes more logical outside super. My reasoning is that for certain employees, disability insurance is more relevant that others so allow this to be more an individual based decision. However, death cover is relevant to everyone, its just the timing. The idea of removing the contribution tax and replacing it with an effective widening of the GST is interesting but sadly the politics will be tough.

Jan H
August 05, 2021

Death insurance and/or life insurance cover is NOT relevant to those without dependents.
The GST is a regressive tax so increasing will fall much more heavily on those on lower incomes. Tax loopholes used by the wealthy should be removed instead.
The contributions tax also disadvantages the less well-off. 15% is more or less at their marginal tax rate or greater. There should be a sliding tax rate on super.

Chris
December 11, 2020

Any thoughts on transitional arrangements...eg...all those accounts (and retirees) that have paid the contributions tax...?

John De Ravin
December 11, 2020

That's a great point Chris. It would be patently unfair to tax people at pension stage on contributions that they have already paid tax on. So equity would seem to require an 80-year transitional period. Shouldn't we be trying to simplify our super environment rather than adding still more complexity?

Peter
December 10, 2020

I realise that this is a bit off topic but a major reform to eliminate aged care bonds forever would simplify retirement and alleviate the fear of many older people that they won't have the entry price to aged care when they are in their latter years. Funding the aged care industry on more of a user pays basis as in North America would help people plan.
For example: knowing that aged care will cost me $60,000 a year if needed is less scary than knowing that the nice aged care place in my area requests a million dollar entry bond.

joan
December 17, 2020

joan yes Peter aged care bonds need to be explored well before entering a aged care home If one is there for a few years before dying the lar can be changed by money hungry governments. A lot of faith needed to expect that the one million dollar bond would find its way back into your estate,

Trevor Zaretzky
December 10, 2020

The problem I had with the insurance being link to my SG, was the rate at which the Super fund increased my cover and as the cover increased the insurance premium increased ... moving $$ away from the SG. Whilst the cover was appreciated early in life, as my super accumulated the insurance cover was to much...

Max Warren
December 10, 2020

I like the 2 suggestions to increase the net SG by 2 %.
Rather than adding HST to a flawed GST with all its exemptions, why not extend the Covid change to a totally cashless economy and apply a transaction tax with no exemptions. Then with time we may head toward true taxation reform that all politicians are afraid to address.

John De Ravin
December 10, 2020

Hi Bruce,

Thank you for your interesting article. However I would query the merits of abandoning insurance within superannuation: it is simply the cheapest way to get lump sum cover due to the purchasing power of the super funds. And at some times the insurance margins have been materially negative!

With regard to the contributions tax, I am not quite sure what is the main motivation for a shift from ttE to EtT would be. Partly you seem to dislike the fact that people don’t realise why their super balance isn’t as large as they expected but this does not seem to be a strong enough rationale to jump horses midstream. But perhaps you will argue that there are also equity considerations that you have not yet elaborated?

Flight
December 10, 2020

Remove contributions tax and impose a new consumption tax?

Tell him he's dreaming. No votes in that.

Aussie HIFIRE
December 10, 2020

I agree that in an ideal world personal insurance would be separate from retirement savings. In the world which we actually live in though, very few people have personal insurance beyond whatever the default is in their super funds, and it seems unlikely to me that there would be a huge takeup of insurance in their own names if the insurance within their super was cancelled.

So the result would be that yes there would be more money saved for retirement for most people, but almost everyone would be uninsured or underinsured and a decent percentage of those people would at some stage have something happen to them and there would be no insurance payout to help them get through it.

And although personally I think if people have chosen not to get insurance in place then they should have to take both the good (lower expenses due to no insurance) with the bad (no money coming in if you do have an accident) it seems unlikely to me that this won't be another problem where it will be decreed that the government must take responsibility for it, and we'll be throwing however many billions of dollars at the problem at some point in the future.

 

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