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Zero tax rate on pensions is right and fair

In my article and subsequent comments about Labor’s proposed removal of franking credits for shareholders on a zero tax rate, I've not addressed whether the system should change to make the targeted retirees pay tax. I’ve said merely that if that’s the goal, then it should be addressed directly through a change in their tax rate, not through the back door of the imputation system change.

However, much of the discussion about this policy is focussed only on the alleged wealth of these retired folk with their multi-million dollar SMSFs and six figure pension payments. If that’s all that is said about them, then it's an easy ‘social justice’ argument to say that they’re benefitting from a rort and should be made to pay more tax.

I don’t believe this thinking is correct. Everyone should understand how such retirees reached the current situation and what is actually fair in terms of their taxation.

How are large SMSF balances accumulated?

Let’s look at BB (for Baby Boomer) who has $1.6 million in their super fund. We need to understand clearly where that money came from and what tax BB has already paid on it.

The first source is the contributions under the Superannuation Guarantee paid by BB’s employers. This was taxed at 15% when it was invested. At the very least when this is withdrawn, whatever tax rate BB is on should be reduced by that 15% or BB will be double taxed.

The second source was non-concessional contributions, paid by BB out of after-tax salary. This money has already been taxed at BB’s full tax rate. There should be no more tax on this withdrawal or BB will have been double taxed.

The third source is income that’s been earned on the investments in the fund, which will of course largely be compounded earnings. This has also been taxed at 15%, so whatever BB’s current marginal rate is, these withdrawals should be taxed at least 15% less.

OK, the $1.6 million from accumulation mode now goes into a pension account and is split into those three components. For simplicity, let’s say that 25% comes from non-concessional contributions, 15% from concessional and the rest from accumulated earnings. When BB makes a withdrawal from this fund as a pension payment in retirement, the tax already paid needs to be recognised in any tax obligation.

Let’s say BB immediately withdraws $100,000 upon retirement. The most tax that should be levied on that amount should be:

  • Zero on the $25,000 that is the proportionate withdrawal of the fully taxed non-concessional contributions
  • BB’s marginal tax rate minus 15% on the $15,000 from concessional contributions
  • BB’s marginal tax rate minus 15% on the remaining $60,000 of accumulated earnings.

If BB is in, say, the 32.5% marginal bracket from other earnings when this withdrawal is made, then this means a tax rate of 17.5% would apply to $75,000, which is 13.125% of the $100,000 amount.

The tax incentives have a social purpose

The money was invested into super because of the promise of a tax-effective long-term saving vehicle to fund retirement rather than drawing an age pension from the public purse. During the 1980s in particular, we faced projections of an ageing population that would become a burden on the budget because of age pension requirements. We also had a current account deficit that was portrayed as a domestic savings deficiency (e.g. in Vince Fitzgerald’s report on National Saving).

This social contract is not the result of a conspiracy against Gen Ys or other younger people in 2018! It is based upon sound economic and fiscal policy thinking. More retirees will fund their own lives rather than Gen Y's taxes having to be even higher to pay more old age pensions.

The flat tax rate of 15% on earnings within a super fund is one way the social contract is expressed in policy, as it’s lower than the marginal rate for many investors. The system also provides for a lower than normal marginal tax rate on withdrawals in retirement. This means that the tax rate when those accumulated funds are drawn should be discounted by more than the 15% tax already paid.

Thus, for BB, the tax on this $100,000 withdrawal from their fund should be less than 13.125% to honour the social contract that led them to defer spending their income earlier in life. The current regime levies zero tax on withdrawals for those over 60 in retirement. It’s a tax discount that for BB is approximately 13%, but would be a bit more or a bit less depending on the exact mix of the source of the funds.

The message to those who think this is unfair on subsequent generations is simple: it’s not a rort but a perfectly fair arrangement for those who’ve saved the way they’ve been urged to by the government. Tax has already been paid and to demand that full tax be paid again now is not only unwarranted, but would be punitive.

Limits placed on the amount in superannuation

We’ve also had policies to limit super, such as reasonable benefit limits and contribution caps. The superannuation system allows ordinary folk to accumulate a reasonable amount to fund their retirement, but not give the wealthy a tax haven. Peter Costello opened the window too much 10 years ago, but that’s been closed now with the $1.6 million cap – a perfectly reasonable policy change, albeit disappointing for those who had counted on the previous level of generosity.

Furthermore, those who earn more than $250,000 per annum (until recently this threshold was $300,000) pay 30% on their contributions, not just 15%. If our friend BB was in this camp, then the calculation above of how to tax a $100,000 withdrawal from their fund means 2.5% on $15,000 plus 17.5% on $60,000, which is 10.875% of the $100,000 amount. The tax discount in the current tax-free regime is thus only a discount of about 10%.

Of course, nothing is ever that simple. The $1.6 million that BB has built up in a pension account will now earn income that is tax free in the fund. Therefore, an ongoing stream of cash flow to BB out of the fund will include components from that income. Even then it may also include a component that is withdrawing from the accumulated $1.6 million that should be taxed at no more than 17.5%.

Tax treatment on income in pension account

Let’s say that BB is between 60 and 65 and draws a pension of 4% a year, or $64,000 from the $1.6 million. How should we think about this payment? The answer depends on what the fund’s income earnings have been.

If the fund earned more than 4% in income, then all of the $64,000 should be treated as being paid out of investment earnings that have not yet been taxed. At the moment the rule is that this is tax-free to BB. If the ordinary personal income tax scale was applied to this amount, however, then BB would be sitting in the 32.5% marginal tax bracket and pay $12,347 in tax. This is 19.3% of the income. Some untaxed earnings would remain in the fund.

If the fund earned less than 4% in income, however, then a portion of BB’s $64,000 payment is drawing down capital and the calculations above should apply to that portion, which would result in an overall tax rate of less than 19.3%.

Fairness, therefore, calls for no more tax to be levied on retirement incomes than these sorts of amounts, which will of course vary from person to person. My own view is that, it’s simpler and honours the long-standing social contract with BB to just stick with the tax-free arrangement we have at present on this relatively modest amount. Average weekly earnings at the moment are running at around $88,000 per annum, so a pension account income of $64,000 does not make BB a wealthy person!

People who have money in super over and above the $1.6 million that can be put into a pension account face, rightly, a higher tax obligation when they withdraw from that excess amount. Again, recognition should be given to the tax already paid on the money that they have invested in super, but calls for full marginal taxation of withdrawals from super funds are wide of the mark.

The reality is that when people draw an ‘income’ from their super, it’s not the same as earning more dividends or interest or rent that hasn’t had tax paid on it yet. Much of it – especially later in life when the required withdrawal rate is well above interest and dividend earnings rates - is simply withdrawing from a pool of contributed capital and investment earnings that has already been taxed at an appropriate rate. The boundaries already in place, such as the $1.6 million cap on the size of that pool, are adequate to restrain any ‘rorting’.

Final comment

I’m not a tax expert. I’ve checked everything in this article with the ATO website, but no doubt there are nuances I’ve missed.

However, I hope that the framework I’ve outlined can serve the interests of an informed discussion about appropriate tax policy towards self-funded retirees rather than the class and inter-generational warfare arguments that have been too prevalent. What we want is a fair tax system and decent retirement income policy. We have a better chance of getting those outcomes if we base our discussions on facts and not emotion.


Warren Bird is Executive Director of Uniting Financial Services, a division of the Uniting Church (NSW & ACT). He has 30 years’ experience in fixed income investing. He also serves as an Independent Member of the GESB Investment Committee. These are Warren's personal views and don't necessarily reflect those of any organisation for which he works.

November 22, 2018

Regarding the social contract:

"The money was invested into super because of the promise of a tax-effective long-term saving vehicle to fund retirement rather than drawing an age pension from the public purse"

Super contributions are compulsory, so there is no tax-effective savings incentive to contribute to Super unless we are talking about non-concessional contributions or concessional contributions above the 9.5%.

There may be a case for taxing compulsory contributions and earnings at the marginal rate and excess contributions at lower rates.

Regarding the 15% tax rate for contributions and earnings, isn't this grossly impacting low income earners whose marginal rates are lower than this.

Regarding the conspiracy against Gen Ys, I don't really understand this as Gen Ys will also be the beneficiaries of this system once they get to retirement (more so than BBs as they will be in the system longer). Unless the idea is that the rules should be changed now in order to reduce taxes on the Gen Ys now, and then changed back again once the Gen Ys get to old age :).

Warren Bird
November 22, 2018

The SGC became compulsory as the result of a deal done under the Accord framework that substituted wage increases for employer contributions to super. That's what I mean, in part, by there being a social contract. The government agreed with workers (initially via the ACTU) that if they allowed the system to force them to save for the long term, then that system would treat them favourably.

In relation to the unfairness of the 15% contributions tax on low income earners, this has been recognised by governments since 2010. The current policy is in transition to a new system - see the ATO website for details:

September 23, 2018

Thanks for your articles Warren, they have been educational to many people. I am a self funded retiree with a SMSF. While it has become commonplace for people to blame everyone else for their circumstances nearly all have the same opportunity to reach this position based on choices. Shortens policy is a simple policy, stupid but simple. The consequences have been covered before - people spending up and going on the pension, capital outflow from Australia, companies facing a double whammy of increased interest rates and SMSF sell downs, beware of shorters. While small balance retirees will bear the brunt of this double tax the larger account holders have multiple options to avoid it.
Looking at other options taxing a withdrawal (which is a forced percentage withdrawal), as another comment states, is the same as taxing any other account - bank ac. etc
Another option taxing the earnings - earnings need to be defined. If it is dividends then the cost of earning the dividend must be a deduction ie on shares:- tax paid, brokerage, office expenses etc. On property similar. If it included capital gains their will be deductions, their will certainly be market disruptions and considerably more work for trustees.
Warren am I correct? Am I alone after working two jobs most of my life in being prepared to do whatever is possible to not support Shortens waste?
The 1.6 mil cap largely took care of larger balances. The current system is simple and fair and should remain to give people something to aspire to

Chris O'Neill
September 23, 2018

"The money was invested into super because of the promise of a tax-effective long-term saving vehicle to fund retirement rather than drawing an age pension from the public purse."

This means that people receiving superannuation tax concessions, even if they end up getting no Age Pension, are effectively getting some of the value of an Age Pension in those concessions. So the superannuation tax concessions are effectively watering down the impact of the Age Pension means test in a way that depends on how well the person accesses those concessions.

September 21, 2018

If tax is applied to withdrawals then to maintain the retired lifestyle either increased withdrawals or disposal of other assets will be required. This will reduce the Super and assets much quicker. This could eventually put a burden back on the aged pension which is contrary to the purpose of superannuation.

Chris O'Neill
September 24, 2018

“The money was invested into super because of the promise of a tax-effective long-term saving vehicle to fund retirement rather than drawing an age pension from the public purse.”

Another funny thing is that people can get the benefit of super tax concessions (i.e. take money out and spend it on anything they want) BEFORE the starting age for an Age Pension.

Those super tax concessions look like an even better deal for giving up some of the Age Pension. More so for those who don't hit the means test.

Michael Lockwood
September 20, 2018

I am one of the fortunate self funded retirees paying no tax on my account based pension payments and also no tax on my other income from investments and UK pensions. I think that the taxation as set up by Keating was fair, modified to the extent that the proportion of the pension payments from non-concessional contributions is tax free, with the remainder taxable but subject to a 15% rebate. I believe that it was an unintended consequence of the tax free status of super after 60 introduced by Howard and Costello that other income in retirement, for example from investments and overseas pensions would in effect be tax-free as a result, especially when the LITO and SAPTO are taken into account.

September 20, 2018

Thanks for the article but I was not aware that anyone in their right mind would be advocating paying tax on taking your money out of Super. But I do understand some were suggesting paying tax on earnings when in pension mode.

If you think of your Super in the same way as a savings account at a bank - you would be pretty upset if someone suggested you pay tax when you went to withdraw money from your bank account - but quite happy to pay tax on the earnings (interest) received.

As others have mentioned the suggestion (ALP policy) that franking credits be non-refundable is truly appalling policy. Quite distorting and most unfair and discriminatory. Effectively a 30% minimum tax rate for those in SMSF who are fully invested in fully franked shares.

If it is deemed that Superannuants in pension mode should not be tax free after all, then decide what is a fair rate (5% or 7.5% or whatever) and apply it to the earnings of ALL super accounts in pension mode. But don't discriminate - leave franking credits refundable and also don't start taxing one's money when you go to withdraw it!

Warren Bird
September 21, 2018

Geoff, unfortunately I've seen lots of comments that reveal many people think that all payments from your super are up for grabs tax-wise. Many people, especially younger peoople who think super is a rort designed against their interests, have argued that withdrawals from all super funds should be treated as income and 'taxed in full' etc.

So, yes, I realise that the vast majority of Cuffelinks readers will see what I've said as blindingly obvious. But there are plenty out there who haven't put in the effort to understand how those pools of $1.6 million might have been accumulated and advocate for unfair levels of taxation on them. They seem oblivious to the fact that a huge chunk of all payments is return of capital and not a fresh income stream.

Your final comment has been my oft-repeated statement since Mr Shorten first unnecessarily raised this issue. However, for the reasons outlined in this paper I don't believe that the income from funds in pension mode for retirees should be taxed at all, not even at 5%. On earnings in funds outside the $1.6 million pool, yes, but not on the earnings on the pension fund.

Warren Bird
May 01, 2019

Just bumping this article up because I'm seeing many comments on other articles that reveal an ignorance of the fact that withdrawals from super are mostly withdrawals of capital and earnings that have already been taxed. If there's going to be a tax on "pensions" from super, then it MUST only be levied on new income, not on the full withdrawal.

Chris O'Neill
September 23, 2018

"I was not aware that anyone in their right mind would be advocating paying tax on taking your money out of Super."

This was only in the now hypothetical situation that no income tax is paid on the contributions to, and the earnings in, superannuation funds. This actually was the situation until Keating wanted to extract more revenue from superannuation. The whole existing mess originated from that money-hungry government choice.

Michael Ellis
September 20, 2018

Thank you Warren for a sound article, in same vein I would like your thoughts on -

Death Taxes
the substantial tax to be collected on the death of BB should she/he not have a surviving spouse, and even then, the tax to be paid on the death of the surviving spouse, if paid to adult non-dependent children.

I am constantly reminded about the ageing Australian population, so could there a significant sum to be collected when they all drop off the perch? I suspect the ATO has the numbers and could calculate the potential death taxes collectible

Warren Bird
September 21, 2018

Michael, I'd rather keep my comments to the specific issue of the consequences of Mr Shorten's franking credits proposal. All I'll say is that, rightly or wrongly, what you have raised does mean that we effectively had death duties, so there's no need for a specific death duty to be introduced.

Graham Hand
September 21, 2018

Hi Michael, as Noel Whittaker wrote in Cuffelinks recently, there are ways this 'death tax' can be avoided:

Jan H
September 20, 2018

Tim: If earnings of super fund were taxed at marginal tax rates on preservation age, what then would be the point of having one's money in super? Because, as I see it, earnings would be taxed at same rate in or out of the fund. But outside fund, no fees and expenses tax deductible. Also, people over 65 are eligible for (seniors and pensioners tax offset) SAPTO as well as Low Income offsets, if eligible. As Warren explains, contributions have already been taxed either at 15% pre-tax or at marginal tax rates post tax so ought not be double taxed.

In addition, as I have commented already, the franking credits refunds were intended by the Howard Govt to offset the impact of the GST on retirees no longer employable or eligible for business refund. The GST still exists and some advocate raising it even higher. How then will the Govt of the day compensate low income retirees? Or will they? Labor's policy to cut cash refunds is regressive taxation on vulnerable, often chronically-ill and aged retirees and punishes them for saving throughout their working lives to fund their own retirements instead of relying on the public purse. In fact, this was the very reason Keating introduced the super system because he foresaw that the Aged Pension would be a burden to fund as the ageing demographic grew.

I note, now that Labor has stated it will contribute to women's super, given they have much lower super balances and less capacity to contribute to super. At the same time, it is supporting cutting the incomes of women (and men) retirees by up to 30%. Go figure!

Warren: I hope you will submit your article to the Inquiry.

September 22, 2018

Jan, you're right there would be little benefit/difference in my proposal of having your nest egg in Super or Individual name post preservation age apart from avoiding unrealised capital gains.

The idea of Super during working years would be to build a nest egg in a tax advantage vehicle that compounds away in a low tax environment until preservation age reached. Yes contributions are taxed at 15%, but if those funds were not contributed they would have been taxed at marginal rates + medicare, and the earnings only taxed at 15%, and long term capital gains at 10% which is likely to be much more advantaged than marginal there would still be big enough incentive to build retirement nest egg inside Super structure.

I would leave the franking as it currently is.

Warren Bird
October 15, 2018

Jan H (and anyone else interested) I have done so. At least, I've turned it from an article into a submission.

Warren Bird
September 20, 2018

Tim, that would be one way of giving effect to the ideas I'm trying to convey. Just need to be very clear on exactly what is being taxed and how to do so at a rate that honours the social contract that is the superannuation system. Glad you appreciated the article.

Bill Watson
September 20, 2018

Thanks for that discussion. Looking at the tax paid in accumulation of super is an interesting variation on the usual emotional and incorrect focus of some, that return of imputation credits is somehow a rort or a loophole favouring people with SMSFs. We need to point out at every opportunity, that refund of franking credits is simply a refund of tax already paid by retirees who are supposed to be in a nil tax on SMSF earnings environment. If people think that nil tax on SMSF earnings is inappropriate (to fund their own pension), then they should propose a tax on such earnings, and not hide behind the smokescreen of imputation credits.
Bill W

September 20, 2018

Thanks for the article Warren,

Rather than the complicated methods of taxing withdrawals....I would think a simple and fair way to tax super in retirement may be to tax earnings of the fund at individual marginal tax rates once preservation age is reached as opposed to the current 15% in accumulation and 0% on upto $1.6m in the pension account.

September 20, 2018

My memory is that when super was setup, Keating wanted the money in the government coffers sooner, hence the tax being targeted at contributions and accumulation.

Warren Bird
September 21, 2018

Yes, Peter, that's essentially correct. The initial idea was to tax on withdrawal, but the fiscal delay was deemed to long so the contributions tax was introduced.

Chris O'Neill
September 23, 2018

On his election to government, Keating wanted to get more tax from super lump sum payouts which he did with a 30% tax on such payouts from the 1/7/1983. Funds such as the Federal government scheme did not have distinct untaxed employer contributions going into a fund but as such contributions became more widespread Keating saw an opportunity to collect more revenue by imposing the 15% contributions and earnings tax in 1988.


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