RDP 9603: Australia's Retirement Income System: Implications for Saving and Capital Markets 3. Tax Treatment

The tax rules for superannuation are extremely complex and can only briefly be outlined here. Important changes to the tax rules were made in 1983, 1988, 1992, and 1996, which generally reduced the tax benefits to superannuation, although the treatment remained concessional. These changes, and the current system, are described in detail in Appendix A. Changes were generally grandfathered at each stage, so that retirees would receive benefits taxed under a variety of rules depending on when contributions were made. The following description outlines basic features of the rules as they currently apply to new contributions.

The system distinguishes between contributions by employees (which are still largely voluntary) and those made by employers.^[8]

Employee contributions are made from after-tax income. These contributions, in nominal terms and excluding the earnings they generate, are effectively available to be returned to the contributor after retirement without being further taxed. Earnings however are taxed in the same way as earnings from employer contributions, as outlined below.

Employer contributions, and earnings on contributions from either source, are taxed in the following way. Contributions are tax deductible to the employer, but are subject to a 15 per cent tax on entry to the fund. Following changes announced in the 1996/97 Budget, this tax rate rises to 30 per cent for high income earners (see Appendix A for details). Fund earnings are then subject to a 15 per cent tax each year as they accrue.^[9] The taxation of final benefits financed by employer contributions and earnings depends on the form in which the benefits are taken. Annuities are subject to normal personal income tax as payments are made, less a 15 per cent rebate which is a form of compensation for the tax already paid on entry to the fund. Lump sum payouts are taxed at a standard rate of 15 per cent (plus the Medicare levy) on amounts in excess of a tax-exempt minimum. The relative attractiveness of the two types of benefit will depend on a number of factors including the size of the overall benefit and the retiree's income from other sources.^[10]

All of the concessional treatment implicit in these arrangements is subject to Reasonable Benefit Limits (RBLs). These set the maximum amount of concessionally-taxed benefits a person may receive in a lifetime, so that benefits exceeding those limits are subject to standard marginal tax rates. The limits are higher for benefits taken in the form of annuities than for lump sums, a mechanism for discouraging the use of lump sum benefits. Changes introduced in 1992 substantially reduced the RBLs for high income earners, by expressing RBLs as flat rates rather than as multiples of income.

In its broad structure the tax system for superannuation can be described as embodying a hybrid between expenditure-tax and income-tax principles.^[11] Under a pure expenditure-tax treatment, saved income (that is, contributions and fund earnings) would be tax-free while post-retirement expenditure (roughly equivalent to the annuity payment) would be taxed at standard rates. The various concessional elements in the tax treatment outlined above go some way toward approximating such an outcome. For employer contributions, if we do the mental exercise of offsetting the contributions tax against the post-retirement rebate, then contributions would be viewed as tax-free, with annuity benefits taxed at the standard marginal rate. Since fund earnings are only lightly taxed during the accumulation phase, the overall treatment of employer contributions could therefore be said to resemble that of an expenditure tax. Employee contributions are less favourably treated, because they are made from after-tax income but still give rise to taxable earnings during the accumulation period and in retirement. Again, however, the taxation of earnings on these savings is considerably lower than would be the case outside the superannuation system.

The tax concessions for superannuation have a significant revenue cost, estimated in 1994/95 to be $7.3 billion, or around 1.6 per cent of GDP. Most of this cost is accounted for, in roughly equal amounts, by the concessional tax rates applying to employer contributions and to fund earnings. These estimates are calculated relative to a baseline under which superannuation is taxed in the same way as other financial saving, which in Australia is essentially an income-taxation system. Some commentators such as Bateman and Piggott (1996) and FitzGerald (1996) argue that this is not the appropriate baseline and that the revenue costs are therefore overstated.

Footnotes

Special rules apply to the self-employed, effectively allowing them ‘employer’ tax treatment on part of their contributions, which is more favourable than ‘employee’ treatment. [8]

The actual tax paid is much less because funds are able to benefit from imputation credits for company tax already paid on their dividend receipts. These credits can be applied against taxable income from other sources, substantially reducing the overall tax liability. [9]

For an analysis, see Atkinson, Creedy and Knox (1995). [10]

A similar view is expressed by Covick and Lewis (1993). [11]