Superannuation and Taxation – Part 1 


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By- Uday Mitra

In the 2016 Federal Budget, the Government announced several changes to the taxation rules applicable to superannuation. Following the sizeable changes previously made in 2007, these proposed changes reflect a repetition.

The 2007 changes were extremely generous, especially for those on a higher income and sizable asset levels. Since then, decisions were made to wind back these highly concessional tax arrangements.  The 2016 Budget announcements are a response to them. Hence, people with high income and asset levels are unhappy with the Government’s proposed changes.

In this series of articles, I intend to put light on the connection between the superannuation and taxation rules to achieve an understanding of their operation; the cost to the public in providing the taxation concessions and its relative fairness.

What is Superannuation?

The term “superannuation” refers to the lump sum or income payments received after a person has ceased working for income, typically, after reaching an age of say 65 years. These payments are known as “retirement payments”.

The most appropriate example of these retirement payments is the age pensions paid by the Commonwealth Government to people who have reached a certain age i.e. 65 years. This age pension is universal and paid to every qualified person. Since the age pension is intended to be need-based, certain income and asset tests apply to identify those who should receive these taxpayer-funded pensions.

The concept of providing income in retirement has been existence for many years. However, before 1986, provision of retirement payments was primarily the domain of large private sector employers such as banks, large corporations, and the government. Hence, only employees engaged by large private sector corporations and the public sector (i.e. Governments and Government owned companies) received retirement payments.

Defined Benefit Vs Accumulation Benefits

Prior to 1986, most retirement payments fell into the defined benefits category. A defined benefit refers to a payment based on a formula set out in a document governing these payments. For example, a person who has worked for a particular employer for 30 years might receive regular retirement (annual) payments calculated at 1.5% for each year of service based on the average annual salary for, say, the last three years before retirement. So, in our example, the retired person will receive an annual pension of 45% (i.e. 1.5% x 30 years) of the annual average salary for the last three years. So, if the annual average salary were $100,000, the person’s annual pension would be $45,000. This annual pension could be paid twelve monthly instalments of $3,750.

In such cases, most often, the annual pension would be significantly reduced or even eliminated, if the particular employee left the employer’s employment before reaching the specified retirement age, or did not complete the minimum required years of service. So, in many cases, these retirement payments acted as a “golden handcuff” to retain high-value employees in the employer’s service.

An important feature of these defined benefit payments is that these are financed by employers, and do not depend on fluctuating economic conditions. In many cases, employers having the obligation to provide these retirement payments periodically set aside funds to meet their future payment obligations.

Frequently, the employer funding of these benefits is held in a “trust” outside the employer’s business. Thus, the employer makes periodical contributions into such a trust and the trust invests the funds outside the employer’s business. This provides a level of security, so the availability of funds to make the retirement payments does not depend on upon fluctuating fortunes of the employer’s business. This also means that employers incur a lower cost if the funds invested externally generated good returns, and vice versa. The employees of such employers are protected from the vagaries of fluctuating economic conditions.

On the other hand, under an accumulation benefit arrangement, employees only received the amounts accumulated for them based upon the actual contributions made by employers, plus any investment earnings thereon.

Contributory v Non-contributory

Another important aspect of accumulation of funds for retirement payments is whether or not employees are required to contribute to the trust for the purpose of receiving the specified retirement payments. For example, a retirement scheme might provide that employees participating in the scheme would need to contribute on a regular basis 5% of their salaries to earn the right to receive the specified retirement incomes. These arrangements are known as “contributory arrangements.” When the participating employees are not required to contribute, the scheme is known as a ‘non-contributory” arrangement.

Obviously, from an employee’s viewpoint for a given level of retirement benefit, a non-contributory arrangement is more attractive than a contributory method.

Award Superannuation

Prior to 1986, availability of superannuation to a large body of private sector employees was largely discretionary to employers. Hence, many unionised and low paid workers were not covered by such superannuation arrangements. In 1986, Unions, Governments, Employers and the Arbitration Commission as part of a wages negotiation, agreed that a part of the proposed increases in wages (3% of gross wages) for the next three years would be paid by employers to superannuation funds for the purpose of making retirement payments to employees covered by wages awards.

Thus, it was a case of the employees foregoing their current wages in return of accumulating funds for receiving retirement payments. From the employees’ viewpoint, this was a case of “deferred wages”. These award contributions fall into the category of contributory arrangements.

Superannuation Guarantee

While the concept of award superannuation usually covered employees who were protected by the “award wages” system, coverage for employee superannuation has been widened as from 1 July 1992 through the compulsory superannuation guarantee requirements. The minimum contributions required of employers have also increased progressively from 3% of gross wages to the current 9.5% gross wages.

These contributions are regarded as “contributory” by employees and in effect, are deferred wages.

In the next part of this series, I will explore the relationship between superannuation and taxation.

Uday Mitra is a practising chartered accountant and tax adviser.

The Indian Telegraph Sydney Australia

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