The superannuation reforms are beginning to look uncomfortably like the 1996 super tax surcharge furore caused by Peter Costello in his first Budget. This measure lasted for 10 years, annoyed most high-income earners and created a confusing, costly administration nightmare for the whole industry.
Now, 20 years later, we have the same potential situation emerging. The reasons are eerily similar to 1996: once again Canberra has failed to consult with the superannuation industry before acting; most people (including many ministers) don’t understand the full implications of the legislation and there is no certainty, even after the election.
It didn’t have to be like this. The pensions changes are an attempt to reform the overgenerous moves by Peter Costello a decade ago for a major simplification of taxes on pensions when times were flush. And despite complaints, the transition to retirement reforms merely close a loophole, which many were exploiting.
The proposed policy (which is yet to be legislated or passed by Parliament) caps lifetime contributions at $500,000 and puts a $1.6 million cap on the amount allowed in pension-producing accounts for a tax-free income.
The problem is that $1.6 million is unrealistically low in current investment conditions and the contribution cap (no matter what ministers say) reaches back to 2007. The government has made it worse by initially insisting that an unrealistically low number of people will be affected.
But the big sleeper is that, in the current investment climate, this policy will cause most SMSFs with the maximum capped amount to struggle to earn meaningful incomes. Interest rates are at record lows, and might still fall further, and there even is talk of negative rates and uncertainty about stock market returns.
Even over a short term, this is a recipe for a run-down in total invested funds since pension funds are required to pay out a minimum pension even if fund earnings are negative. You can forget government ministers’ forecasts of returns of 5% or $80,000 on $1.6 million invested – APRA figures show negative returns on assets by all funds in three of the last five quarters.
Those APRA numbers are for a portfolio averaging about two-thirds in shares and only 13% in cash, which is probably less than half what prudent pension SMSFs would be running at present. Using current annual returns from Morningstar data, a retirement SMSF with, say, 50% in shares (30% local, 20% overseas); 10% in fixed interest; 10% in listed property and 30% in cash would be struggling to return 2.5%.
That’s about $38,000 or only about $7000 a year above the standard age pension and about $4000 a year under what the major industry body ASFA calculates is needed for a modest living standard in retirement.
The government requires retirement funds to pay out 4% of the fund’s balance each year for members under 65, then 5% for those 65-74; 6% for 75-79 and 7% for members 80-84.
If interest rates turn negative and/or we see a stock market setback, funds have no ability to replenish their tax-free capital amount. This is precisely why many fiercely independent SMSF members aim to accumulate enough funds to get through market setbacks and remain independent of the age pension.
Treasurer Scott Morrison is only discovering, like past treasurers, that superannuation is a complex beast and there are always unintended consequences. And super fund members get angry when governments change the rules on which they have based long-term retirement plans – in which, it should be remembered, they bear all the investment risk.
Now, in the extraordinary climate of very low interest rates, it looks like the Government, in an attempt to compensate for its previous over-generosity, has swung too far the other way.
Only a few years ago, $1.6 million invested would have assured a comfortable retirement income and passed punters’ “pub test.” Now, with drastically changed markets, the potential earnings might barely provide the equivalent of the age pension. Where’s the incentive for potential retirees to save $1.6 million over a lifetime and then rely on volatile markets to produce a bare pension?
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