The following article was published in Money Magazine, November 18th, 2015.
It seems clear Australia is heading towards an adjustment to the rate of Goods and Services Tax (GST). It is possible that the scope of the GST could be extended to goods and services that were previously exempt, one of which is financial products. It has been suggested that tax arrangements will be needed to compensate low income earners, and company tax rates will be adjusted downwards. As a result of the anticipated changes, we describe a scenario that could have a significant impact on the pension schemes of retirees. Indeed it is possible that private pension arrangements for most people may become unnecessary.
A possible scenario
Based on the low income compensation arrangements that were introduced with the “carbon tax,” we can speculate that a lift in the GST may result in an adjustment to the tax free threshold. For instance, a GST lift from 10% to 15% should justify a lift in the tax free income threshold to $30,000pa. This is because low income earners spend more of their after tax income on consumption. A consumption tax hits them hardest.
Concurrently, an adjustment to Corporations Tax may also be made; a tax rate of 25% could be contemplated.
These two changes, if implemented, would have a dramatic effect on the requirement for and benefits of a private pension fund. To explain this, consider the average retirement funds of a typical Australian couple. An average retired couple, that has accumulated super for 30 years, would have about $500k combined in their pension funds (i.e. about $300k for the male and $200k for the female).
Upon retirement, this couple could earn about $60k a year tax free from their investments outside of pensions, before any other tax benefits from aged benefits, etc. In passing, we note that today this income approximates the full rate of pension for qualifying pensioners.
$60k would be a return of 12% on the investable funds of this couple. This is a level of return that well exceeds the target for most balanced super funds, given the low interest rates that now exist. Further, a drop in the corporate tax rate will likely see the benefits of franking credits decline from a 30% franking credit to a 25% franking credit. Thus more will need to be invested in equities to generate the same franking credits as today.
All of the above will put pressure on advisors to tell their retiring clients to cash in (and take a lump sum out) their accumulated super, for there is no tax or cost benefit in staying inside a pension fund. Indeed the maintenance of a personal pension fund will accrue compliance, administration, taxation and advisory costs that are not even tax deductible!
The critical question becomes: why have a pension fund if better returns can be had outside its stringent requirements?
While future policy changes are stage still unknown, the above leads to the conclusion that the anticipated changes in taxation and super will be significant. We suspect that a contributory national scheme will be required to meet the retirement needs for the 65% of the population who will always need to draw upon part or all of the age pension.
Written by John Abernethy, Chief Investment Officer.