Why the tax on pension income will never happen

SMSF technical expert and columnist for The Australian newspaper
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The re-born Rudd government is on record as saying they won’t introduce any super changes for the next five years and that they’ll continue to implement all the Gillard government’s super policy changes. This presumably includes the idea to impose a 15% tax on pension income when it exceeds $100,000 from 1 July 2014.

Over the years I’ve argued that the Federal boffins should leave the super system alone for a while, so people can be more confident with their retirement planning. I can hardly complain when a political party finally picks up this idea.

The Coalition, on the other hand, has said that they’re not prepared to rule out any more super changes over the next five years if those amendments improved the super system. They’ve also reserved the right to implement the Gillard government’s super changes to help fix up the federal government’s budgetary position.

Tax on pensions is doomed to fail

The government expects that the $100,000 pension policy will earn it about $350 million in 2015/16 and 2016/17. In my view, this pension policy is doomed to fail – someone either needs to man up and ditch it, or watch as it sinks under the weight of its own complexity.

I’m highly sceptical about the estimated revenue the government expects to raise. One reason for my doubt is that Treasury regularly over-estimates the revenue impact of proposed government policy and under-estimates expenses.

In any case, this policy is simply unenforceable especially for large super funds. To work out the income for tax purposes, it’s necessary to work out realised gains and income paid for each pension member of a super fund and life insurance annuity.

But this is NOT how most large super fund pension’s work or how life insurance companies structure annuities. I’ll use large super funds to explain what I mean.

The problem large super funds face

In most cases, people in large super funds invest in unlisted unitized managed funds, which means they’re investing day to day in units. The unit price reflects the value of the underlying investments, as well as reflecting the total return of these investments.

A total return fund is one that combines all income, capital gains, expenses and capital losses into one unit price. A managed fund’s accounting and administration department works out what the unit price should be, based on all monetary flows into and out of a managed fund and the market value of the underlying investments.

It is simply not possible for these large unitised super funds to tell you how much each “unit” has earned in realised gains and income at an individual account level or member level (where they might have more than one pension account).

For example, suppose an investor puts $200,000 into a managed fund that has a $1.00 unit price, which means they “own” 200,000 units. Suppose that after several years, the unit price has increased to $2.00. Their 200,000 units are now worth $400,000. If the investor wanted to pay themselves $20,000 in income from this fund, they would need to sell 10,000 units if the unit price was $2.00.

Now suppose that the price of the units has crashed to 75 cents but they still wish to pay themselves $20,000 income. They now need to sell 26,666.66 units. Under this second scenario, units are walking out the door as income. This problem is exacerbated because fund managers must value all their assets at the prevailing market price.

Note that the unit price is an amalgam of realised and unrealised gains, actual and expected income and expenses and investor inflows and outflows.

Many “policy” changes are unworkable

There’s no doubt politicians from time to time persevere with policy changes even when it becomes painfully obvious the policy is pretty stupid. The super surcharge (introduced by the Howard Government in 1996) and Reasonable Benefit Limits (formally introduced by the Hawke Government in 1987) are two such candidates. More recently, the suggestion of a higher concessional contributions cap for those members with balances under $500,000.

The surcharge was such a ridiculous idea that it cost more to administer the tax that it actually raised in revenue.

This pension tax policy will produce the same outcome – it’ll cost a bundle to administer and won’t raise too much revenue. Hopefully, the politicians will see some sense and ditch it before it does any real damage.

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.

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