There has recently been a lot of hype in the Australian media recently about reforming our Superannuation system from both sides of politics, some of the concerns raised have been warranted and some not so much. In addition to this some of the suggested changes have been ones i believe need to happen whilst others i believe will be counterproductive.
Our superannuation system is envied by countries and governments all over the world and for good reason. We’ve managed to build a system that has largely delivered on its goals without compromising the ability for other areas of our society to function. That being said it is not a perfect system and can, and should be improved upon.
Currently we have 2 sides of politics battling it out to decide on whether or not to:
- Continue raising the mandatory contribution rate from 9.5% to 12% of an employees salary, getting there by 0.5% increases per year over the next few years
- Scrap the system entirely because it benefits the rich too much and hurts those on low incomes.
Before we dive into how I believe it can be improved, instead of throwing the proverbial baby out with the bathwater, let's first look at what it is, what it is supposed to achieve, and what the current results are after its near 30 year history.
Providing for Retirement
Superannuation and the Aged Pension are the two intertwined mechanisms for assisting and protecting Australian’s standard of living in the final innings of their lives
The Aged Pension system is basically a government managed ponzi scheme, where the younger generations are taxed and that money is provided to the older generations to live on in retirement. It works really well in a growing economy (where you have more young people paying into the system than old people drawing down on it), but fairs very poorly in a stagnant or declining economy. The baby boomers have been a major cause of fear for Governments in planning their budgets, as this bubble in the population moves through from the stage of life from being workers and taxpayers in our society, contributing to the government's tax revenue to those collecting pensions and increasing the government’s budget spending.
It is not a sustainable model and has wreaked havoc all over the world. Greece is a glaring example of this, but there are many others that don’t get as much of the spotlight.
Superannuation by contrast is a system whereby workers are required to put money aside as they work, for the day they retire and need an income to live off, without going to work everyday.
Because it is not reliant on government handouts it works just as well in a growing, flat lining or declining economy.
The main issues with this model however are:
- Making sure you work long enough to accumulate enough of a nest egg to live off in retirement
- Balancing the time working with time retired (retiring 10 years earlier will reduce the amount you’ve contributed to your retirement funding whilst also increasing the drain on it)
The superannuation system was designed, back in 1991 to assist as many Australians as possible to self fund their retirement and not rely on the government for the Aged Pension in retirement.
A few key points here, that are often glossed over. The people it helps the most are those on opposite extremes of the spectrum
- Those in low income jobs who don’t have the financial discipline or competency to save & invest adequately for their own retirement. They are being saved from themselves, because if it were not for the superannuation system they would spend it all in the few days after they get paid, and never have anything to live on come their time to retire
- The way the tax concessions currently stand the higher your personal income tax bracket is, the more you benefit from the flat 15% tax rate in super, which yes means the top income earners in the country benefit the most when it comes to reduced rates of tax on funds within their superannuation.
So if the Aged Pension is an unsustainable ponzi scheme and the Superannuation system is the best way, why are we not already living in a financial utopia? What’s gone wrong? If our system is envied globally why are we still bickering about it?
Since its introduction it has been co-opted and abused by many people and organisations with different vested interests, Governments both left wing and right, unions, big business lobby groups and the superannuation funds themselves, now financial behemoths globally in their own right, with trillions of funds under management, and thousands of people employed.
We need to take superannuation back to its fundamental goal, and it has only one:
Assist Australians in self funding their retirement to the point they no longer need any government assistance (The Aged Pension)
Anything outside this remit is misplaced, and should be removed from the system
The super system should be geared such that it accelerates everyone to the point they can self fund their own retirement, then scale back, as soon as that goal has been achieved. Any government funds (tax breaks and concessions) should not go toward further helping people amass fortunes inside super, they should instead be dedicated to all the other meaningful programs that are required to keep our society going, many of which are starved for funds by budget constraints
What is not working and what can be done to fix these issues?
So now that we know what our aims are, how do we go about fixing our Super system:
- The Aged Pension is $24,268 per year
- The Minimum Wage is $38,480 per year
And the point that your Aged Pension cuts off, the amount you need to earn to no longer qualify for any government assistance is $53,040
So if we use these figures as our benchmarks and want to create a system that provides people with an annual income of $50,000 we find, by using an average rate of return of 5% (based on standard Financial Planning consensus) that we need $1,000,000 in your superannuation fund at retirement to provide this to you as an income in perpetuity. Also noting that even when invested very conservatively in basic assets like simple index funds in the Australian share market, this will continue to increase both in total value and annual earnings so as to prevent erosion by inflation.
Our goal stated above then becomes, as a superannuation system, to make it such that it accelerates everyone to a position that they have a nest egg of $1,000,000 and then scale back once this goal is achieved.
Currently super is taxed as such
- Contributions (income earned by salary or wage diverted into superannuation mandatorily (Super Guarantee) or by choice (Salary Sacrifice)) are taxed at 15%
- Contributions (eg the above) where the taxpayer has a personal taxable income in excess of $250,000 are taxed at 30%
- Earnings generated by superannuation fund assets are taxed at 15%
- Earnings on super balances under $1,600,000 are taxed at 0% if they are in pension phase (you are drawing down your super to live on)
It’s pretty obvious when you do the calculations who benefits most from these.
If you are earning less than $18,200 a year any money contributed to super (voluntarily or mandatorily) will go from being taxed 0% in your personal name to now being taxed at 15% in super, that’s a worse tax rate!! If however you are earning $200,000 a year, instead of paying 45% you'll be taxed at 15% (keep in mind there is only a sweet spot for this of those earning between $180,000 and $250,000, because as soon as you earn over $250,000 per year your superannuation tax rate goes up to 30% from 15% and the benefit drops substantially)
Now we know what the rates are and who is benefiting most, we can address how to fix this to get back to our ultimate goal, reworded with specific details:
Accelerate everyone to a position that they have a nest egg of $1,000,000 in Superannuation as quickly as possible and then scale back once this goal is achieved.
To this end the tax rate for super funds should not be based on the income you earn, but on the nest egg you have accumulated. I therefore propose these rate rates and bands:
0 - 1,000,000 = NIL (0 - 50,000 Annual Income)
1,000,000 - 4,000,000 = 15% (50,000 - 200,000 Annual Income)
4,000,000 - 10,000,000 = 30% (200,000 - 500,000 Annual Income)
10,000,000+ = 45% (500,000+ Annual Income)
We should also remove all the 0% tax on earnings concession for those in pension phase and tax earnings at the same rate regardless of what phase they are in “accumulation/working” or “pension/retirement”.
The contribution caps could also be removed entirely as this change to the way income is taxed within super removes the incentive for rich people to keep cramming as much money into their superannuation funds, above the 45% top tax rate
It also solves the inequality conundrum where those in the lowest tax bracket are taxed MORE in super and those in the top tax brackets are taxed far less
And in addition also solves the issue of the super system costing the government more than it would otherwise cost to just scrap it entirely and give everyone the Aged Pension, as it would raise considerably more revenue for the government, either directly inside the super system, or as a result of pushing taxpayers to invest more outside super and pay tax in their own names
These improvements i feel would set the course for the Australian Superannuation industry to continue to set the golden standard for retirement schemes around the world. Building on the impressive legacy we have already set, learning from what loop holes have been exploited so far by plugging those holes, and reinforcing what it was intended to do.
Assist Australians in self funding their retirement by accelerating everyone to a position that they have a nest egg sufficient to retire on through Superannuation as quickly as possible, and no longer need any government assistance (The Aged Pension) then scale back tax breaks and support measures for these people as soon as this goal is achieved.