Over decades of compulsory contributions, Australians have amassed $4 trillion in retirement savings. But behind this headline success lies a range of unresolved policy problems.
The promise was a more comfortable retirement. The reality is a taxpayer-subsidised inheritance scheme.
Listen to our CEO Aruna Sathanapally in conversation with Grattan’s superannuation policy experts, Brendan Coates and Joey Moloney, as they critique a system that needs reform.
Transcript
Aruna Sathanapally: Here in Australia, the dust has settled on last month’s federal election in which the Albanese government gained a thumping majority in the lower house.
Through the campaign, there was a great deal of focus on energy policy, on housing and on healthcare, but almost immediately after the results were in the public discourse took a deep dive into the finer details of superannuation tax. Super is without a doubt, a critical policy area for us to get right.
Over four plus decades of compulsory contributions, we’ve amassed $4 trillion in retirement savings. But hidden behind this headline success is a range of policy problems that remain unresolved. Chief among these is the growing size of super tax breaks and deeper still are concerns around whether with so much money now set aside super is really delivering on the promise of a more comfortable retirement.
Welcome back to the Grattan Institute podcast. I’m CEO Aruna Sathanapally. And to unpack these issues, I’m joined today by our resident super experts, Brendan Coates and Joey Moloney.
So, Brendan, why are we talking about reforms to super tax?
Brendan Coates: Well, the short answer is because super taxation or the concessions available through superannuation, they are very generous. You know, combine the taxes on all the concessions on contributions and earnings, uh, worth about $50 billion a year. That’s foregone revenue that the government doesn’t have to spend elsewhere.
Those concessions will, you know, in short order cost more than the age pension, which is, you know, how most Australians in retirement are supported by the government. And those tax concessions, you know, it’s not just that they’re large, it’s that a lot of them don’t support any plausible policy aims.
You know, those tax breaks boost the retirement saving super, super fund members. They ensure that workers don’t pay punitively high in compounding effective tax rates on long-term savings held in super. You’re compelled to save in your twenties. You know, you don’t get access to that money until you’re in your sixties.
But two thirds of the value of those concessions are supporting the top 20% of income earners who are already saving enough for retirement and whose savings choices aren’t affected much by tax rates.
Also, not a lot of this money looks like it’s actually being spent in retirement. The typical super fund member is a net saver in retirement.
Their balances continue to grow for decades after they retire. And by 2060, the Federal Treasury expects that one third of all withdrawals from super will be via bequest. So, it’s really turned into a taxpayer subsidized inheritance scheme.
Aruna Sathanapally: So, Brendan, what exactly is the government proposing to do at this point in time?
Brendan Coates: Well, the government’s basically proposing for those that have super balance of more than $3 million to double the tax rate on the earnings. So, the dividends, the interest on bonds that, um, that is collated within the super fund, so doubling that tax rate from 15% to 30%.
And they’re proposing to do that where they’re not going to index the threshold, so it’ll stay at $3 million. And the, because of the challenges in how you actually tax earnings in super, it’s taxed at the fund level, not the individual level. They’re proposing to do it by simply looking at the difference between the balance at the start and the end of the period and apply the tax to that, which means it will capture things like unrealized capital gains.
So, the government first proposed this in 2023, was not able to get it through the Senate at the time.
But following the federal election, there’s now a clearer path for the policy to become law. Basically, because the Labor Party only needs the support of the Greens in order for this, uh, to pass the Parliament, which is why it’s seen such renewed attention and focus since the federal election.
Aruna Sathanapally: So, these are the two big things we’ve been hearing about, uh, worries around taxation of unrealized gains, but also that the lack of indexation is something that’s gonna really hit young people very hard.
Joey, what do you think about that?
Joey Moloney: I think it’s an exaggeration that’ll really hit young people hard. And I think it’s not unprecedented to have unindexed thresholds in our tax system. You know, the most important tax thresholds there are the personal income tax scales. They’re not indexed, right? And we have recurring debates about whether they should be reset.
You know, there’s people forecasting 30, 40 plus years into the future as if this threshold will never change. That strikes me as a very bold assumption, ‘because there’ll be 10 electoral cycles in between that. And you know, like the question is, if you leave it unindexed, how many more people is it gonna affect over time?
And $3 million is such a generous threshold. That we projected in 30 years, it’s still probably gonna only hit the top 10% of income earners. For sort of all the commentary about this is gonna screw typical middle class young people in the future, which seems a little exaggerated to us. What would be a better policy?
So, we’ve recommended maybe the threshold should come down to 2 million on the grounds that there’s probably not a strong rationale for tax breaks on balances between two and 3 million. If you zoom out and think what’s the purpose of the super system? Well, it’s to deliver income in retirement. You know, tax breaks on balances above $2 million is money that’s going to someone who’s already got enough for a comfortable retirement.
And then if you reduce it to 2 million, you could index it straight away, and then you’ve set up the policy for the long term. And then we don’t have to have a recurring debate about what the right level is.
Aruna Sathanapally: Let’s talk a little bit about this idea of, of taxing unrealized gains. Now, this isn’t something that most people spend a lot of time thinking about. Uh, it’s not immediately evident to people what the problem is. And I guess the first thing to start with is, is this something we do in our tax system?
Do we ever tax unrealized gains?
Joey Moloney: It’s a great question because there’s certainly been arguments to the effect of this is unprecedented. So, what are we talking about right? When a capital gain is, when the value of an asset that’s in your name appreciates that’s a gain. You’ve made a gain on the capital value of that asset. Normally in our tax system, we do have a capital gains tax, but it’s applied when you sell the asset, and you’ve got the cashflow to pay for the tax. But that doesn’t mean that it’s unprecedented in our system, that paper gains. So capital gains that aren’t realized don’t impact some tax bill that you have.
So, for example, all states levy land taxes. Uh, if the value of your land goes up, your tax bill goes up, even though you haven’t realized that gain.
Aruna Sathanapally: And this is one of the things that people have commented on this idea of taxing unrealized gains as being a Rubicon that we don’t wanna cross, something that we should never do in our tax system. Joey, what do we think about that contention, that taxing, unrealized gains is somehow unprincipled or something that we should never do?
Joey Moloney: Now look the reason that it’s controversial is probably people worry about this question of cash flow. So, you would’ve picked up from what I’m saying is that if you levy your tax on a gain that hasn’t been realized yet, you’re levying it on a paper gain.
It’s not actually like cash that people have in their hands, right? It’s not income readily available to pay the tax. Now, I think there’s a couple of reasons to just be a little circumspect when jumping to the conclusion that the taxation of unrealized gains in this instance in the super system is gonna put people into a really difficult situation where they don’t have cashflow to pay the tax, and maybe it’s gonna force the sale of some assets that they weren’t ready to sell. So, first reason is there’s regulations that basically say you should have a diversified investment strategy. Um, and this particularly pertinent to SM SFS
Aruna Sathanapally: To be clear, those are self-managed super funds, right?
Joey Moloney: Yeah, thanks Aruna. Sorry I get a bit caught up in the jargon sometimes. So, uh, you know, it basically says you should have a diversified investment strategy with enough liquidity to discharge your liability. So, you know, there’s been a lot of lead time for this tax and anyone who had a particularly liquid investment strategy probably has some time to adjust.
But probably a more important point is that of the people with more than $3 million in super, 85% of them are over the age of 60. Which is the age that you’re allowed to access your super. And so, then there’s a good chance that they’re in the retirement phase of their super. And if your super’s in the retirement phase, there’s these other rules called the minimum drawdowns, which dictate the amount that you have to be taking outta your super as income each year. So already you’ve got a requirement there to have cash flow. And then probably in a more important point again, is that you don’t have to pay the tax with money from your super. You can pay it with cash from anywhere, and people with $3 million in super have as much or more assets outside of super producing cash flow. So, I don’t anticipate that the cash flow angle of taxing, unrealized gains is gonna be a big problem in this instance.
Aruna Sathanapally: Yeah. So, it sounds like really this is a question of implementation and design. There are some trade-offs to be made as to how to serve the interest of the scheme in terms of not being excessive in its tax breaks. That maybe, you know, there’s had to be a bit of balance into how to do it, but it’s more a question of implementation than it is a question of like deep tax principle ‘cause it sounds like this is something that we would do in other, other circumstances. We just need to think about how does it play out in the context of, of super. Now we’re on the record saying that there are other things also that need to be done on super tax beyond a change like this.
What do you think that the government should do next, assuming that it, it manages to get this particular proposal through?
Brendan Coates: So, our work would show that there’s a lot left to do to curb superannuation tax concessions that don’t have a plausible purpose given the objective of super, to help people have a comfortable retirement, a dignified retirement to help them provide those incentives to save. There’s a lot of concessions going to those that you know are already saving more than enough for the right retirement.
So, when we are talking about concessions in super, superannuation is taxed concessionally when you make contributions. During the accumulation phase, earnings are taxed at 15% rather than your marginal rate.
And then when you retire, earnings for the first $2 million in super is tax free. Whereas earnings above that are currently taxed at 15% and would be taxed at 30% for those above 3 million if the government has its way. So, on those contributions, tax breaks, we think there’s about three to 4 billion a year of money that could be taken out of the system.
That would boost the budget bottom line or be able to be used to reduce other more economically harmful taxes by curbing those contributions, tax concessions that exist today. So that includes things like there’s a higher tax rate that applies on your contributions if you’ve got more earning more than $250,000 a year.
So, when we’re thinking about specific changes to contributions, tax breaks, the first is uh, division 2 9 3 tax, which currently kicks in at for those earning above $220,000 a year, their contributions are taxed at 30% rather than 15% for those below that level. We would like to see that threshold drop to 220,000, and we would like to see the rate raised to 35% rather than 30%.
That would save $1.1 billion a year and only affect the top 10% of taxpayers. And it would just mean they have a lower, less, uh, of a concession per dollar they contribute to super than lower income earners.
We would also like to see the pre-tax cap on contributions to the amount you’re allowed to put into super on a pre-tax basis, lowered from 30,000 down to 20,000. That would save upwards of $1.6 billion a year.
Most of that would come from the top 20% of taxpayers because it reflects the fact that most of those contributions each year above $20,000 you know, a lot of that looks like tax planning rather than genuine retirement saving. And it’s saving that is leading to people having much more in super than they need for a comfortable retirement.
And then there are a series of, you know, rats and mice, there’s co-contributions. So, when you put money into super, the government does a matching contribution. Uh, that research has shown that is largely used by the low-income spouses of high-income households to really tax plan to boost those, the spouse’s, uh, contributions uh, when the high-income earner is exhausted what they can put into super themselves.
There’s a post-tax contributions cap, so you can put money into super after you’ve paid tax on it at your marginal rate. That’s currently upwards of a hundred thousand dollars. We’d like that reduced to $50,000.
Those changes would raise another $1.1 billion. So together you’re talking about budget savings of close to $4 billion a year from super, mainly affecting the top 10% of income earners and things that the government could probably do without an enormous amount of political blowback.
I think one thing we’ve learned is there’s always gonna be a lot of blowback on super tax changes, whether it was a 1 billion a year policy or a 4 billion a year policy. The real Rubicon to cross here is the fact in retirement your earnings on your super, your dividends and interest. They are tax free for the first $2 million, whereas when you are working your earnings a tax of 15%, that is the policy that means that only one in six retirees pay any income tax whatsoever.
And it’s allowing a generation of older Australians to basically check out at the tax system at the very point when their demands on services rise. So, taxing all earnings at 15% in retirement from the first dollar would raise essentially, between five and $7 billion a year. It would simplify the system because people would just have one super fund their whole way through their life. It would raise revenue from the precise cohort who are drawing more on government services later in life and help fix that intergenerational fiscal bargain. It’s just a bit a more challenging policy for a government to adopt to tax earnings from the first dollar, including people that may be receiving the age pension.
Aruna Sathanapally: Yeah. And it does seem like this is one of those issues that we’ve kicked into the long grass, right? Like governments for decades now have pushed this one away because it was a, a difficult debate, but we always knew we would get to this point where the boomers would start to retire. We’d start to see that pressure on our health system, on our aged care system and at the same time, these settings mean they are checking outta the tax system. And so, we see that in, in the fiscal challenges over the coming decades. So, it’s a really important issue. Now, we’ve talked a little bit about the value of, of super tax breaks showing up as inheritances. And this idea that we are really putting too much savings into the system for what people are spending or potentially can even spend during their retirement.
I’d like to talk a little bit about why it is that people aren’t spending their super. People seem stressed and anxious about spending it down once they do hit the retirement phase, but actually, you know, the whole point of this system was to eliminate that stress and anxiety and, and to make retirement better.
So, what’s going wrong, Joey?
Joey Moloney: It’s a really, really interesting and slightly depressing observation, and it’s one that we pulled apart in the report we released earlier this year. And you’re right, we’ve done all this hard work to amass $4 trillion in savings balances at retirement are growing. People have more resources than ever to fund better living standards in retirement, but we’ve got this great tragedy. Where 80% of people find retirement planning too complicated. 60% don’t believe their retirement’s gonna be stress free. This is despite the fact they’ve got enough resources for a good standard of living, but they’re just not sure how to use those resources to fund their standard of living. And that’s manifesting in people not spending down their savings in retirement.
That’s why Treasury is projecting that bequests from the system are gonna grow pretty dramatically over time. So fundamentally, it’s a problem of complexity, right? You are given a balance at retirement, or you’ve accumulated your balance at retirement, then you’ve got two unknowns about the future. One is you don’t know what the future investment returns on that balance are gonna be. Which means that affects how confidently you can spend it down. So, you need to self-insure against potential future investment losses. Probably more fundamentally, more importantly, you don’t know how long you’re gonna live, right?
There’s an average life expectancy, but there’s a pretty wide distribution around that. So, everyone has this pot of money. How long does it need to last? I don’t know. No one knows, right? This is why William Sharp, the Nobel laureate, he called trying to draw down a fixed amount of savings over an unknown time horizon is the hardest, nastiest problem in finance.
On top of that, in the Australian system we’ve got a means tested age pension that interacts dynamically with how you use your super in retirement. So that just further complicates the equation. I have enough trouble trying to model this system. I can’t imagine what regular people, encounter when they try to figure out how to use their savings in retirement.
Aruna Sathanapally: It seems like the thing we should be looking for is a safe and a simple way for retirees to turn that uncertainty into certainty, so to turn that super balance into an income stream that they can rely upon no matter how long they live. Now, Brendan, this isn’t an impossibility, is it?
How can we do this?
Brendan Coates: This is something Aruna that most retirement income systems around the world have largely solved for. You know, in other systems there’s a high degree of paternalism, not just in working life where you are forced to contribute to super, but also more support and guidance in the retirement phase to guide people towards what are the right choices.
Because what we see in the literature is people are highly sensitive to the options that you put in front of them. At the moment, the option we put in front of people is an account-based pension. And what other countries do and what we should be looking more to do is to change that initial offer, to essentially say to people, the first offer that’s put in front of people is for a lot of people going to be an annuity. As in an income that’s guaranteed to last as long as they do. What we have recommended Aruna is that basically people be encouraged via that first offer to put 80% of the super balance they have at retirement that exceeds $250,000 into that annuity. So, if you’ve got half a million in super, you’d put $200,000 into the annuity. If you’ve got a million in super, you’d put 600,000. And that accounts for the fact that we also have an annuity in the in the retirement system, which is the age pension.
And what that would do is that means that most people could rely on an income that lasts as long as they do for the bulk of their retirement income. Whether they’re relying on the age pension and not really needing the annuity with a low balance, or they’ve got 500,000 plus and they make it a bit of pension and a lot of annuity.
Or if they’re, um, you know, got a million dollars or more, they’d be getting the annuity and no age pension. And what research shows is that encourages people to spend comparing like for like retirees in the US those that have annuities tend to spend quite a lot more and they’re less stressed because the problem is solved for them. They don’t longer have to this impossible problem on their own.
Aruna Sathanapally: So, if we were to have an annuity of this kind, Brendan who should be providing it? And if it’s the private market providing it, how do we make sure that there’s a competitive, private market? Because once you pick an annuity, you’ve really, you’ve picked it.
You can’t really switch.
Brendan Coates: That’s right. Like these are essentially what economists call one shot games. Once you’re in, you kind of can’t get out. And that’s the whole point because your, your balance is pooled with other people’s balances. And, you know, if I die early, then it’s my balance is paying for say, you and Joey who live longer to keep getting paid the annuity into your nineties or, beyond.
And so, the challenge here is that, you know, there’s not really great examples around the world of countries that have got quote unquote unregulated annuities markets. They might be prudentially regulated to make sure the super fund doesn’t fall over or go bankrupt, but there’s not really examples of countries that just rely on private consumers just picking the right option and then getting competitive results.
And so, where we landed was that the best option is probably for government to offer it directly, to essentially use the Future Fund to manage the assets. And to have that be offered directly to people because that reduces the risk that people would perceive that the annuity provider might go bankrupt.
You know, it doesn’t happen very often, but we saw this with say, AIG, during the financial crisis, one of the US’ biggest insurers went bankrupt. So, it would increase take up, and we have examples of that from, say, the home equity release scheme, which was basically where you can borrow from the government against the value of your house in retirement.
But there may be ways of doing it with a private provider, but you would have to think really hard about how you design that regulatory system, and we’ve not yet seen a way of doing that. Hence, we recommend the government option.
Aruna Sathanapally: Now this is just one piece of a bigger tax reform puzzle. We’ve been hearing a lot about tax reform. I think we’re gonna be hearing a lot about tax reform in the years to come.
Joey, what does the way this debate is playing out get you thinking about when you’re thinking about prospects of tax reform that we really need? You know, just zooming out for a second and thinking about the scale of the fiscal challenge we’ve got in the decades ahead.
Joey Moloney: It’s hard to not be a little disheartened, by the way this debate has played out. We’ve spilled a lot of ink quibbling about a couple of gremlins in a relatively modest proposal that only affects, the top 0.5% of super balances. And we’ve probably lost track of the reason that we need to talk about tax reform, which is that we have a long-term structural budget challenge. We have that ‘cause we’ve got an aging population, but we’ve also got a bunch of things that as a society we’ve decided are important for us to fund, which is an NDIS that makes sure that people with disabilities can live dignified lives participating in society and the economy, that we provide high quality aged care. All these things cost money. And so, the reason that we keep circling this debate about tax reform is because we need to find a way to put the budget on sustainable footing. And that’s probably something that’s been unfortunately lost for the, from this debate. This new super tax is only a small piece of the tax reform puzzle. And we’ve gonna argue this much about this something, this modest. It does give you a little bit of pause for thought about what the future might hold.
Aruna Sathanapally: It’s definitely the case that there’s more to be done to making the most of the super system we have. We’re very fortunate to have the savings that we do at setting us up for good, comfortable retirements, but definitely a few more steps to make sure that we really get there and that we don’t over egg the tax concessions on the way in so that we’re also able to pay for all the other things that make for a good quality of life here in Australia.
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