The Government is talking big about tax reform and other changes to super. This week, I look at two important aspects of this discussion.

It would seem that we’re facing some tax increases, especially in relation to superannuation. In my view, this would be deeply unfair and inequitable, but remember, sometimes revenge is a dish best served cold at the ballot box.

Superannuation – a product for the middle income earners

Each of us pay income tax when we have income above a certain threshold each financial year. The more we earn, the more tax we pay. This is called a progressive tax system.

Based on how much income we earn, it’s possible to work out how much tax we’ll pay and then work out the average tax we pay. This is simply the tax we pay, divided by our income expressed as a percentage.

So, for example, someone with an income of $100,000 will pay $26,947 income tax and Medicare. At a basic level, therefore, their average tax rate is about 27%.

Now of course someone earning this level of income might have dependant children and be eligible for Family Tax Benefit Part A, which is effectively a tax refund. Their spouse may be eligible for Family Tax Benefit Part B, which is also a tax refund. They may receive the Child Care Benefit or Rebate, again another effective tax break.

They might also receive a number of other concessions, such as tax breaks on geared property or share market investments, which may further reduce the overall amount of tax payable.

All these refunds and tax breaks effectively reduce average tax rates.

Super funds have a flat tax rate

Our super funds are taxed differently – they always have a flat tax rate. In general, in the pre-retirement phase, super funds pay 15% tax for every dollar of income and realised capital gains they earn.

At a basic level if you earned around $47,000 in a financial year then you would pay an average of 15% tax and Medicare Levy on your income.

What does this mean? Well, it means that anyone earning less than $47,000 is paying less tax on their personal income than in their super fund.

Now here’s an interesting bit of information. In November 2013, the Australian Bureau of Statistics estimated that the median individual wage in Australia is just under $58,000. What is the median? It’s the middle number in a series of numbers. In this case, it means half of the working population earn less that about $58,000 and half earn more.

What’s the average tax rate, including Medicare Levy, for someone earning $58,000? It’s just under 20%.

So a large portion of wage and salary earners are forced to save in a vehicle that penalises them from a tax perspective.

What are the super tax concessions for?

These concessions are meant to serve as an incentive to contribute to fund your own retirement. But for half the working population, super isn’t tax effective, so why would they bother?

It’s also meant to compensate you for the long term nature of the investment. But again, for half of the working population, they receive no tax benefit.

There is concern about the amount of money the Government expends on the super system each year. A lot of that money is on tax deductions given to employers for the super contributions they make to super.

So here’s an idea – why not make super voluntary for those earning less than say, $50,000. They can either take the 9.5% employer super contributions as salary (and pay tax on it) or contribute into super. Based on current rules, many of the lower income earners will end up on the full aged pension. So why are they forced to use a vehicle that penalises them?

An alternative solution – tax super at the greater of your average tax rate, or the 15% tax rate. Such a policy wouldn’t be almost impossible to implement but it would be messy and costly to administer.

A quick note about the super-rich – in reality they don’t need superannuation. They have the resources to seek top flight tax advice that would see them legally shift money between various entities and countries to reduce their overall tax burden.

So who is super meant for? It’s meant for people who earn between $60,000 (add roughly $10,000 for each dependant child) and $500,000. That is, about half the workforce.

Would the Government want to be radical and restrict compulsory super to only half of all wage and salary earners? I doubt it.

What might happen if the preservation age were increased?

Your preservation age is when you can begin accessing your super.

For those born after July 1960, their preservation age is 60 but under current rules these people won’t be able to access the age pension until age 67. The Coalition Government has a policy to increase the minimum age pension age to 70.

Clearly there is a mismatch here.

The Productivity Commission has been looking into this issue and found that aligning this preservation age and the age pension age will not automatically mean many of us will work longer and therefore have larger retirement savings. It found that some of us:

• Stop work due to poor health or to care for a loved one – this applies to 28% of men and 25% of women aged between 60 and 64.
• Lose our job and can’t find new employment – this applies to 20% of men and 11% of women in the same age bracket.

The Commission’s modelling suggests that raising the preservation age would increase the number of people aged between 50 and 64 by 2%. It also thinks, on average, these people would work for an additional two years and their super balances would be 10% higher when they finally retire. A good outcome that probably comes at too great a political cost it would seem.

Is there any evidence that people are wasting their super lump sum withdrawals?

According to the Productivity Commission, gaining access to consistent data is difficult, but it says that it appears “both the absolute value and proportion of superannuation benefits taken as an income stream is increasing over time”. That is at present only about 16% of super money is withdrawn as a lump sum. Moreover, the majority of people who take pensions elect to receive the minimum pension.

So it would seem that overall retirees aren’t wasting their super monies. Anecdotally, I had reached this conclusion but it’s good to see some substantial research about this potential problem.

Most people, who take a full lump sum, have a modest amount in super. In any event there is little evidence that these monies are being wasted as the graph below indicates.

So it would seem that there is no need to ban lump sum withdrawals from the super system.

Given this research, it may be that we’re not close to seeing any limitation on taking a lump sum from super.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.