Wednesday 6 May 2009

Revised my retirement projections

It looks like the Australian Labor government will slash the superannuation tax deduction available to "high" income earners in next week's budget. The rumour currently doing the rounds (it's an Australian tradition for the government to leak the budget bad news in the weeks leading up to budget night, so that only the good news items come as a surprise) is that the current $50K cap for salary sacrifice superannuation contributions (which get taxed at 15% rather than the tax-payers marginal tax rate) will be slashed to $25K for under 50s, and the $100K cap available for over 50s until 2012 (that was introduced as part of the "simpler super" reforms of the previous Liberal government) will be replaced by a $50K cap for over 50s. We'll have to wait for the May budget next Tuesday night to find out details such as whether or not these caps will be CPI-indexed.

There haven't been any rumours regarding the reintroduction of tax of superannuation pension payments, but I wouldn't be surprised if a Labor government introduces a progressive tax scale to superannuation pension payments in the future.

Anyhow, with the drop in value of my superannuation account since 2007, a lower expectation for investment returns in future (I'm now using 8% ROI for "high growth" investment option over the long-term, rather than 11%), and the rumoured changes to contribution limits, I decided to do some new projections of my likely superannuation accumulation until retirement age (65) and possible self-funded pension income to age 90.

According to my current projections, provided I work until 65 and make the maximum allowed salary sacrifice contributions, I should be able to self-fund a pension equivalent to my current gross salary ($85K) until age 90. IF my SMSF investments achieve an average 8% total ROI and inflation averages 3%.

I haven't bothered doing a Monte Carlo simulation of possible outcomes as I already know that a few years of below-average returns, or a lower average ROI, would slash the pension rate I could sustain until 90. Perhaps I'll get lucky and not live as long as my Paternal Grandparents (94). In reality I will attempt to compensate for periods of poor returns by "topping up" my SMSF account balance by making additional "after-tax" contributions.

I should still be able to achieve a comfortable retirement by making the maximum pre-tax contributions allowed under the proposed changes, but it will increase the risk of us suffering a drop in living standard during retirement if I have any unexpected set-backs (such as a lengthy period of unemployment). It's also unfortunate timing for us in that the $25K cap will only apply to me over the next three years (until I reach 50), which corresponds with the period before DS2 starts school. Aside from paying 15% more tax (30% marginal tax rate, rather than 15% superannuation contribution tax) on the extra $25K of taxable income (about $3,750), this change will probably also mean that we are no longer eligible for child care benefit payments or child care tax rebate (we currently get back about half of the $80 a day we pay for DS2's long day care), and that DW will no longer get any Family Tax Benefit payments (despite getting very little net income from working two days a week after taking into account the cost of day care). Total cost of this change to us will probably be around $8K pa - which seems rather harsh for a 'working family' with close to average household income.

It is also rumoured that the budget will disallow tax deductions for "hobby farm" losses against other income sources. As a partner in my parent's alpaca stud, this change would increase my annual tax bill by an extra $1K or so...

Despite a likely "horror budget" (from my point of view), it appears that the government is planning to run "temporary" budget deficits for the next 5 or 6 years. Unfortunately no one seems to have told the treasurer that the economic cycle is typically that long - so the NEXT recession is likely to put Australia into a permanent budget deficit. Since Australia is likely to change government after 2-3 terms anyhow, this probably doesn't worry the Prime Minister and Treasurer too much.

It will be interesting to see what impact an increase in the aged pension has on the projected long-term budget balance and required tax rate (as % of GDP), given the aging population and higher average unemployment rate likely for the decade or two. Perhaps We won't get an updated intergenerational report in this year's budget papers.

Subscribe to Enough Wealth. Copyright 2006-2008


mOOm said...

As I understood it after the last budget they were going to add back in superannuation salary sacrificing etc. into the income used for computing eligibility for benefits? Or that was only a partial move I seem to remember, but definitely the trend was in that direction. Tax free super payouts were firewalled in the Henry tax review so there is no chance that they will revert to taxing them any time soon I think, but taxes will likely go up on contributions (Howard did that too). It would make the most sense to turn the super system into the equivalent of the Roth system in the US with no concessions on contributions but no tax on earnings or payouts. With no tax on earnings all the admin would be so much simpler as it is for all types of US retirement accounts which are either taxed going in or going out but not while in the fund. said...

There was talk about including salary sacrificed income in the income used for means testing family tax benefits, but I'm only comparing the current situation with what will happen if I can't sacrifice 25K that I currently sacrifice. The other change may have had the same effect, but there weren't enough details provided to work out the impact (for example, SGL employer contributions are lumped together with salary sacrifice amounts, so it would be hard to tell them apart - especially as an employer can choose to contribute more than the 9% minimum (for example your uni super and Snork Maiden's public service super are both >9%). I suppose they could have simply included any employer super contributions above 9% in income calculations for welfare means testing.

Replacing 15% contribution tax and 15% tax on earnings and 10% CG tax within super with an increased contribution tax and no tax on earnings may not be such a good thing. If your super has a sizeable investment in Australian equities (directly or via managed funds) the tax on superannuation investment earnings will be significantly offset by the imputed tax credits on the Australian share dividends. If the tax rate on super earnings was 0% you could loose that benefit (although I think maybe franking credits might still be able to offset contribution tax?)

Also, any increase in super contributions tax would be highly regressive for tax payers with a marginal tax rate below 30%.

The main reason the government would like to tax contributios more and not tax earnings and payouts is that it brings forward all the tax revenue to the current period (and so benefits the incumbent government, at the expense of tax income in the future). It's the similar to the reason why retail super funds were pushing for LOWER tax on contributions instead of cutting out the tax on pension benefits - it would have increased the amount of money that was subject to annual fees!

If nothing else, any changes to superannuation tax arrangements and rules in the budget (and later on from the Henry tax review) will simply reinforce people's opinion that the legislative risk of super is very high, so it's not worth locking away savings until 65.

mOOm said...

Good points... in the end they took the easiest route and cut the limits on contributions. But they are floating raising the age when super benefits will be accessible after raising the age when the age pension will be accessible.

The US has mainly fiddled with raising and lowering the contribution limits over time. And adding new classes of retirement accounts like the Roth IRA rather than mess much with the basic set-up of each account. Australia has ended up with a lot of complexity due to the need to tax earnings of funds during the accumulation stage (which no US account does) and keeping changing the rules and grandfathering things.