What are the implications of the proposed changes to superannuation rules?
The Government proposed two significant changes to the superannuation rules in the 2010 Federal Budget. One change is to retain the $50,000 concessional contribution cap for people aged 50 or more. The other is to increase the Super Guarantee rate from 9% to 12%. In this report we look at aspects of the implications of these changes – should they become law – for the retirement savings of Australian workers.
1. Retaining the $50,000 concessional contribution cap will improve the effectiveness of the Transition to Retirement strategy
Workers aged 50 or more are currently allowed to contribute $50,000 p.a. to super on a tax concessional basis. This is due to reduce to just $25,000 p.a. from 1 July 2012.
However the Government is now proposing that the $50,000 cap is retained indefinitely.
This will of course – assuming it becomes law – be beneficial in helping workers aged 50+ to build their super faster as long as they can take advantage of the salary sacrificing provisions.
The proposed rule change will also make the Transition to Retirement (TtR) strategy attractive once again. This strategy is useful if you want to stay working full‐time, but need to build up your super – or your spouse’s super.
Here’s how the strategy works. You can choose to sacrifice part of your salary so it is invested in your super fund (or your spouse’s super fund via the super splitting rules). And, if you wish, you can start an account based pension (ABP) from age 55 to pay you income to make up part or all of the income you sacrificed… even though you are still working full‐time.
The benefit here is that salary sacrificing and ABP income are much more tax effective than paying PAYG tax on your full salary. In addition, you can accumulate money in super and withdraw it free of tax (as a lump sum in full or part, or as a pension) after age 60.
However, there are limits on how much you can contribute to super on a tax deductible basis, and they are currently $50,000 p.a. for those aged 50+, but reducing to $25,000 in 2012/13 under the current rules.
The proposed rule change of retaining the $50,000 cap will make a significant difference to the TtR strategy, as shown in the case study below.
Case Study: ‘Transition’ rule result improves by $54,907 under proposed changes
Let’s say Mary is 55 and is currently earning $90,000 a year which gives her $67,400 after tax. From this Mary invests $19,400 into super, leaving her with $48,000 p.a. to live on each year.
Mary currently has $220,000 in her super fund (all preserved). She enjoys her job and plans to keep working for another 10 years – but realises she needs to increase her superannuation balance at a faster rate.
One solution could be as follows:
- Transfer her super to an ABP under the ‘transition to retirement’ rule
- Draw income of $9,843p.a. from the ABP
- Salary sacrifice $41,900 p.a. to super from her gross salary.
This should result in Mary having the same income to live on each year, made up of:
Salary (before tax & after super) $48,100
ABP income $ 9,843
Less tax ($9,943)
Net Income $48,000
Under the current rules, Mary will accumulate $89,057 more in retirement savings over the next ten years than if she had not adopted this strategy. This improvement arises solely because of the tax benefits applying to the TtR strategy.
However, under the proposed rules, Mary’s TtR strategy will result in an additional $54,907 being in her super fund at age 65, as shown in Chart 1 below. That’s a $143,964 improvement overall. This improvement arises because of the additional $25,000 p.a. in concessional contributions Mary is allowed to make in the years 2013/14 to 2019/20 under the proposed rules.
Importantly this benefit is made with no loss of net income. And, once Mary has reached age 60, her income from the ABP is completely tax free. She does not even have to include it in her tax return.
Note: Salary $90,000 p.a. gross. Mary already has $220,000 in retirement savings. Assumes ABP earns 8.0% p.a. net and Super earns 6.8% p.a. net. We have used the 2010/11 income tax rates and thresholds. Both cases include Mary’s employer’s Super Guarantee contributions.
2. The proposed increase in Super Guarantee only significant for workers new‐ish to workforce
The Federal Government’s proposal to increase the super guarantee rate gradually from 9% to 12% by 2019/20 will have different implications depending on a worker’s circumstances.
Those close to retirement will not gain any significant benefit because the rate increase will not be in effect long enough for them.
However those who are 30+ years away from retirement will be significantly better off. This is because these people will have many years with the higher rate plus they will benefit from the “magic of compounding” on those extra contributions.
Let’s look at a case study to determine the effect of this proposed rule change. We’ll assume that each person earns $50,000 p.a., they all retire at age 65, their super earns 6.8% p.a. and their only contributions to super are via the Super Guarantee (SG).
The extra each person would have in super – due solely to the increase in SG rate – on retirement at age 65 would be:
*Assumptions used in this study: Salary $50,000 p.a. Salaries and cpi both increase by 3% pa. Super earns 6.8% pa after fees and taxes. Amounts in inflation‐adjusted dollars.
The other major factors impacting superannuation account balances
A factor more influential than the proposed increase in the SG rate is the earning rate of super. We have used 6.8% p.a. net in this study as a conservative long term number. If our
25 year old had achieved one percent better than that (i.e.7.8%) then even without the increase in SG they would be $87,624 (in today’s dollars) better off at retirement.
The other factor which has a significant impact on final account balances is the ability to make additional contributions to super either on a tax deductible basis or via non‐concessional contributions. For example, if our 25 year old could contribute an extra $17,000 today, they would have an extra $67,800 (in today’s dollars) in their super fund at age 65.
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