The Benefits of Simplified Superannuation Reform

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1 The Benefits of Simplified Superannuation Reform Prafula Fernandez School of Business Law Curtin University of Technology Abstract This paper considers the recent Superannuation tax reforms in the Tax Laws Amendments (Simplified Superannuation) Act The legislation came into effect on 1 July 2007 and is likely to affect many people and organisations involved in the agriculture industry. This paper examines the problems with the existing system and outlines the benefits of the reform. 1

2 Introduction The Australian Government has committed to a $7.2 billion 1 superannuation fund reform that has the potential to affect over 10 million individuals, 1.3 million employers and more than 310,000 superannuation funds. 2 Given the size and scope of the reform, those affected are likely to include both individuals and employers in the agriculture industry who should therefore be aware of the changes to the superannuation laws. The changes which simplify the superannuation laws are summarised in this article, so that people in the agriculture industry can understand them and take them into consideration in financial planning for their retirement. This article describes the purpose of the reform and identifies the problems with the pre-july 2007 system. 3 The proposed changes are then summarised both at the entry and exit level of contributions. Finally the benefits of the simplified superannuation reform are outlined so that individuals in the agriculture industry can make informed decisions regarding their superannuation. Purpose of superannuation reform The pre-july 2007 superannuation rules were complex and prescriptive. The policy objective of the reform is to simplify superannuation for retirees, making it easier to understand, improve incentives to work and save, and introduce greater flexibility with regard to the withdrawal of superannuation savings upon retirement. In order to alleviate poverty, re-distribute wealth, increase private savings, improve retirement income and promote workforce participation, the reforms are also intended to satisfy the following 3-pillar approach endorsed by the World Bank: 1. Provide a means tested age pension for Australians who cannot support themselves in retirement; 2. Ensure that employees have superannuation savings by making it compulsory for employers to make contribution for employees; and 3. Ensure that the superannuation laws promote voluntary private superannuation and savings. 4 1 Treasurer, Simplified Superannuation Final Decision (Press release, 5 September 2006). 2 Treasurer, Completion of Consultation on the Government s Plan to Simplify and Streamline Superannuation (Press release, 9 August 2006). 3 This article examines the current law as at March 2007 and the reforms that took effect on 1 July See discussion by P. Fernandez, Big Changes Ahead for Australia s Superannuation System (2007) 46(12), Tax Analysts: Tax Notes International, Commonwealth of Australia Explanatory Memoranda, Tax Laws Amendment (Simplified Superannuation) Bill 2006, para

3 The current reforms were announced by the Australian Government in the 2006/07 budget. The Government released a document called, A Plan to Simplify and Streamline Superannuation on 9 May After a 3 month open consultation period, the Government announced its final policy decision on 5 September On 7 December 2006, the Australian Government introduced the Tax Laws Amendment (Simplified Superannuation) Bill 2006 together with other bills and draft regulations to support the simplification of the superannuation system. The Bill received royal assent on 15 March The Tax Laws Amendment (Simplified Superannuation) Act 2007 and supporting acts implement the Government s simplified superannuation reforms and rewrite other areas of superannuation taxation law contained in the Income Tax Assessment Act The new legislation came into effect on 1 July The centrepiece of the act is that Australians aged 60 or over will be able to access their superannuation benefits free from taxation after 1 July 2007 if they are paid from a taxed superannuation fund. Problems with the pre-july 2007 system 6 The pre-july 2007 system was complex and the complexity impacted on all retirees, irrespective of the amount of money they had accumulated in superannuation. The complex rules made it difficult for people to make retirement decisions. Most people therefore had to pay for professional advice, and spend a vast number of hours trying to understand the tax treatment of their superannuation. The pre-july 2007 system was based on a Reasonable Benefit Limit ( RBL ) whereby only superannuation contributions up to the RBL attracted concessional taxation treatment. RBL s were the maximum amount of retirement and employment benefits that a person could receive over their lifetime at a reduced tax rate. There were two flat dollar RBL limits, the lump sum RBL and pension RBL. The lump sum RBL for 2006/07 was $678,149 and the pension RBL was $1,356,291. To qualify for the higher pension RBL, a number of conditions needed to be satisfied. Where a superannuation lump sum or income stream exceeded the lump sum or pension RBL, the excess was taxed at the higher rate of 48.5%. The Australian Taxation Office determined whether a person had exceeded their RBL limits by adding the reported RBL benefit to amounts previously received. This made the system very complex. The Australian taxation of superannuation had been very high and discouraged voluntary superannuation contributions. Taxation was imposed at 3 points - the entry level, the accumulation level and the exit level. Contributions could be taxed at the concessional rate of 15% at the entry level with a further 15% tax imposed on earnings. The exit tax of superannuation benefits could vary depending upon a number of factors, such as the proportion of contributions relating to service period before or after 1 July 1983, and 5 Tables of Tax Acts for (2007) The Treasury <http://www.treasury.gov.au/documents/977/rtf/070316_tax_acts_for_2007.rtf> at 20 March Commonwealth of Australia Explanatory Memoranda, Tax Laws Amendment (Simplified Superannuation) Bill 2006, para 8.1 to

4 whether the person withdrew their benefit as a lump sum or as a pension. The most complex area was the taxation at the exit level, where, for example, a lump sum taken out of a superannuation fund could include 8 different components taxed in 7 different ways. Taxing superannuation at 3 points made it very onerous to calculate the amount of tax payable, and accordingly imposed high compliance costs. 7 Under the pre-july 2007 system, employers were able to claim a full deduction for contributions made on behalf of an employee up to the employees age based limit. For 2006/07, the limits were: $15,260 for ages under 35; $42,385 for ages between 35 and 49; $105,113 for ages between 50 and These limits discouraged contributions into the superannuation system. The age based limit of $15,260 provided very little incentive for individuals to make larger contributions through salary sacrifice at a younger age. In addition, the pre-july 2007 superannuation system was over-regulated. It forced individuals to withdraw payment of superannuation benefits once the individual reached 65 and no longer satisfied the work test, i.e. 40 hours gainful employment during a 30 day consecutive period in the financial year. This limited individual choice, discouraged market innovation, and incurred unnecessary costs in administering a work test for people aged between 65 and 74 who had not taken their benefits. People over 75 would have had to be gainfully employed for at least 30 hours per week to keep their benefits in the superannuation system. Self-employed individuals under the pre-july 2007 system had less incentive to contribute to superannuation as they were only entitled to a limited deduction. The self-employed were only entitled to claim a tax deduction for the first $5,000 of contributions, plus 75% of the amount by which contributions exceeded $5,000 with the maximum deduction available being equal to the age based limit. The changes made by the Tax Laws Amendment (Simplified Superannuation) Act The key measures adopted by the Federal Government to simplify the superannuation system from 1 July 2007 include the following: At the entry level 7 See comments made by Treasurer at media interview with Philip Clark, 2GB quoting Peter Hendy and Dick Warburton report on International Comparison of Australia s Taxes, <http://www.treasurer.gov.au/tsr/content/transcripts/2006/039.asp> at 21 March 2007). 8 Income Tax Assessment Act 1936 s 82AAC(2). 9 C. Ketsakidis and J. Sudano, The Super Reform Legislation Program 1: Contribution Rules (2007) Television Education Network Pty Ltd, <http://first.tved.net.au> at 16 March

5 A concessional treatment of 15% entry tax will apply to taxable contributions of up to $50, per person per annum. This replaces the age based limits. Amounts in excess of $50,000 will be taxed at top marginal rate. 11 A five year transitional cap of $100,000 per person per year will apply for people aged over 50 for the financial years 2007/08 to 2011/12, even if they turn 50 during this timeframe; 12 The age based deduction limit is abolished. Employers will be entitled to a full deduction for all contributions to superannuation funds on behalf of their employees aged under 75. The selfemployed get the same deduction as an employer; Payment to a superannuation fund from after tax income of an individual is not taxed at the entry level in the superannuation fund. These contributions are to be called non-concessional contributions. A cap of $150,000 per year is set on the amount of non-concessional contributions to superannuation funds. 13 People under 65 years of age will be able to bring forward 3 years worth of contributions amounting to $450,000. For example, if $450,000 is contributed in the 2007/08 financial year, then no further contributions can be made until the 2010/11 financial year. 14 Amounts in excess of this will be taxed at the maximum marginal rate. A cap of $1 million applies for non-concessional contributions made between 10 May 2006 and 30 June 2007 who satisfy the work test; There is a $1 million (indexed) capital gains tax (CGT) cap for contributions made into the superannuation from disposals of qualifying business assets, 15 recognising that small business people invest in their business rather than make regular contributions into superannuation. The CGT cap allows these small business owners to later use the sale proceeds from their business to fund their retirement. At the exit level Superannuation benefits withdrawn from a taxed fund paid as a lump sum or as a pension is tax free for people aged 60 and over. Benefits paid to people under 60 will now be taxed under two components, tax exempt and a taxable component, with the preservation age in the range of 55 to 60 years remaining unchanged; 16 Pensions are required to meet simplified minimum standards, allowing pensioners to withdraw as much as they wish above the minimum limits; 10 The $50,000 limit is indexed in line with AWOTE and rounded to nearest 5, Income Tax Assessment Act 1997 s Income Tax (Transitional Provisions) Act 1997 s Income Tax Assessment Act 1997 ss and (1). 14 Income Tax Assessment Act 1997 s (3) and (4). 15 Income Tax Assessment Act 1997div Income Tax Assessment Act 1997 s

6 The requirement for compulsory payment of benefits to members over 65 who do not meet the work test is removed; The RBL is abolished. As with all employers, employees and the self-employed, these changes will benefit those involved in the agriculture industry. Benefits of the simplified superannuation reforms Under the pre-july 2007 system, individuals under the age of 35 years were entitled to concessional treatment 17 on contributions up to $15,260 for the 2006/07 tax year. However, under the new reforms, the concessional treatment limit for 2007/08 is $50, Individuals over the age of 50 were entitled under the pre-july 2007 system to concessional treatment on contributions up to $105,113 for 2006/07 year. The $50,000 limit under the new reforms would have disadvantaged them. Therefore from 2007/08 until 2011/12, individuals are entitled to concessional tax treatment on $100,000. This will revert to $50,000 per person per annum from 2012/13. Thus the pre-july 2007 system has only encouraged retirement planning as people get older. However, under the new system, people are encouraged to transfer money into superannuation early in the working life rather than leaving until the last few years of their working life. With the removal of age based limits, employers in the agriculture industry will benefit by being able to claim a full deduction for contributions made on behalf of employees up to 75 years of age. The selfemployed in the agriculture industry will also be treated the same as employees and will also be able to claim a full deduction for all contributions made to qualifying superannuation funds up to age 75. Individuals in the agriculture industry may wish to transfer taxed income into a superannuation fund to take advantage of the concessional tax rate in the fund and the generous exit rules. A limit of $150,000 per year has been placed on the amount of non-concessional contributions a person can make. Farmers under the age of 65 can now bring forward two years worth of contributions, with a cap of $450,000 over 3 years. Thus a farmer aged 63 and 64 and who is still working can contribute $450,000 in the 2007/08 year but will then be unable to make further non-concessional contributions until the 2010/11 tax year. However individuals would suffer further tax at the maximum marginal rate on any excess above these limits. It is not worth exceeding these limits as the earnings that are put into superannuation could have already suffered tax at the maximum marginal rate and will be exposed to a further input tax at the maximum marginal rate. 17 The concessional treatment is the contribution tax at 15%. 18 Where the person s concessional contributions exceed $50,000 in the financial year, the excess of the top marginal rate plus medicare levy is applied to the individual and not the fund. 6

7 The exit tax benefit components is reduced from 8 to 2, being the exempt component and a taxable component. The exempt component is tax free and incorporates the 5 components under the existing system, being the pre-july 1983 component, the CGT exempt component, the post-june 1994 invalidity component, the concessional component, and the undeducted contribution component. The pre-july 1983 exempt benefit component is frozen at 30 June The taxable component comprises of the existing post June 1983 component. However, payments to individuals aged 60 or above from a post-june 1983 component is not taxable. If the payment is made to a person less than 55 years of age and it is not an exempt component, the tax rate will be 20% plus Medicare levy. The rate of 15% plus Medicare levy above an exempt threshold ($135,590 in 2006/07 and $140,000 indexed from 2007/08) will apply to persons between 55 and 59 years. 19 The Tax Laws Amendment (Simplified Superannuation) Act 2007 has simplified the superannuation rules by abolishing the exit tax for benefits withdrawn after the retiree reaches 60 years of age. Retirees aged over 60 will not have to declare any lump sum or pension payments in their tax return if the payments are made from a superannuation fund that has paid the contribution and earnings tax. 20 This will not only have a significant impact on the retirees income, but a retiree with no other income will not have to prepare a tax return. By not including the pension or the lump sum superannuation benefit in the taxable income of the retiree, the overall tax rate is reduced, thereby lowering the tax paid on other income of the retiree. 21 By removing the complexity of the exit tax for retirees aged over 60, retirees will be spared the cost of expensive expert advice. To receive the tax free superannuation benefits, retirees may choose to remain in the workforce until the age of 60. This means that retirees will benefit from additional contributions, additional earnings and no tax on these benefits when finally withdrawn. Retirees will also benefit from the reduced administration costs incurred by superannuation funds, as they will no longer need to account for the complexity of the exit tax such as the requirement to withhold tax instalments and providing payment summaries to retirees. The exit rules are further simplified by allowing members to retain benefits in their superannuation fund once they reach 65 years of age. Similarly a person is not forced to withdraw his or her benefits from their superannuation fund on reaching 75 years of age, which is necessary under the current legislation. The abolition of compulsory withdrawal provides retirees with greater freedom and flexibility, depending on the person s individual requirements. This freedom is extended by abolishing the RBL. 19 Income Tax Assessment Act 1997 div 301-B. 20 Based on 2004/05 tax returns, around 152,000 taxpayers will not have to lodge tax returns. 21 A superannuation benefit paid to a person aged 60 is not assessable income and is not exempt income. Nonassessable non-exempt income is defined in section 6-23 of the Income Tax Assessment Act 1997 and it means that the person does not have to pay income tax on it. It simply means it is tax free. 7

8 The RBL system determined the maximum amount of superannuation benefit a person could receive applying the concessional tax treatment. For 2006/07, the pension RBL was $1,356,291 and the lump sum RBL was $678, The abolition of the RBL and the exit taxation for retirees over 60 is likely to create an incentive to maintain assets within the concessionally taxed superannuation system. With the growth in superannuation savings, there is likely to be an increase in investments in Australian equity markets, resulting in increased returns for investors through both superannuation and other investment vehicles. The total pool of superannuation funds under management is already very large and it is likely to grow further with these changes to the legislation. Superannuation funds under management have already reached $945.6 billion, holding 95% of GDP and are likely to tally $1.8 trillion by 2011, and $3.3 trillion by This growth in superannuation and the new benefits available to individuals should be utilised by people in the agriculture industry and by all Australians to maximise their retirement benefits. Increased retirement benefits will result in a more enriched future for those who take action now. Conclusion To most people involved in the agriculture industry, the taxation of superannuation can be very complicated. Therefore, the Australian Government s superannuation reforms enacted in the Tax Laws Amendments (Simplified Superannuation) Act 2007 should be welcome news. The biggest news is that superannuation benefit payments made to retirees aged 60 and over from a taxed super fund is tax free. Since members aged over 65 will no longer have to compulsorily withdraw their superannuation benefit, and with the abolition of RBL, the new rules give greater flexibility to members, giving them a choice of when they wish to draw on their superannuation. The rules governing contributions have also been simplified with the removal of the aged based limit and substituting it with limits on concessional contributions and non-concessional contributions per person per year of $50,000 and $150,000 respectively. In planning for retirement, farmers should not only take into consideration the benefits of simplified superannuation reforms, but also the capital gains tax changes to retirement exemptions applicable to small businesses. 24 Farmers now have a lifetime limit of $1 million from the sale of small business assets that is 22 Income Tax Assessment Act 1936 div W. Swan, MP, Second Reading Speech to Tax Laws Amendment (Simplified Superannuation) Bill 2006 House Hansard, Canberra, 13 Feb Income Tax Assessment Act 1997 div

9 not subject to the contributions limits that otherwise apply to superannuation. Ideally, a farmer may benefit by transferring the sale proceeds of their farming business into superannuation in order that their post-age 60 retirement income remain in the form of a tax free superannuation, rather than from sources outside superannuation that would be subject to tax. Superannuation may now be compared by farmers to other investment vehicles such as property and equity investment as it is considered an attractive vehicle for the investment of savings for retirement. 9

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