A quiet storm is brewing around Australia’s retirees as the Labor Party begins its federal election funding promises. And if people aren’t awake to this storm, and if the polls prove to be right about a change of government, then retirees can expect less pension income and everyone else will likely see a hike in superannuation fees.
Australia’s superannuation system thrives because it has three equally important components that provide choice and balance.
Industry and retail funds serve people who prefer others to make decisions about how their contributions are invested. SMSFs form a critical third pillar of our superannuation sector. These are for people who want direct involvement in how their funds are invested. A neat side effect is they serve as an additional choice in the market and that added competition acts as an effective check on the fees charged by industry and retail funds to members.
Labor has proposed a removal of franking credit refunds that will drastically alter the pension income of an SMSF member. Data analysis by the SuperConcepts technical team confirms the average SMSF member will be 15 per cent worse off.
At the heart of the policy proposal is the failure to understand how the dividend imputation scheme functions for everyday retirees in Australia.
The objective of the dividend imputation system is to eliminate the double taxation of company profits, once at the corporate level and again on the distribution of those profits as dividends to shareholders. This is achieved by only requiring shareholders to pay the difference between the corporate tax rate and their marginal tax rate.
The refundable franking credit system supports these tax principles by ensuring resident taxpayers who don’t have sufficient non-dividend income to absorb all the imputation tax credits attaching to their company dividends don’t pay tax on those dividends at a higher rate than their marginal tax rate.
The dividend imputation system creates tax neutrality and a level playing field by taxing the same activity in the same way, irrespective of the underlying investment structure and the entity’s taxable income.
Refundable franking credits are an important feature of the dividend imputation system because they ensure the system operates as it should – imposing overall tax on distributed profits at the marginal tax rates of resident taxpayers.
Removing refundable franking credits would remove this tax neutrality as some investment structures would continue to benefit from refundable franking credits, while other structures would not. The proposed pensioner guarantee is designed to exempt individuals from the no franking credit regime, but this guarantee is likely to exacerbate the removal of this tax neutrality.
Individuals receiving a part or full age pension, disability support pension, carer payment, parenting payment, Newstart or sickness allowance would continue to be eligible to receive refundable franking credits. Similarly, an SMSF would be exempt from the no franking credit regime if one or more members of the fund were receiving one of the above-mentioned pensions or allowances on 28 March 2018.
However, a retirement-phase member in a public offer superannuation fund that offers member investment choice will continue to benefit from refundable franking credits regardless of whether the member is a self-funded retiree or receiving a Centrelink pension or allowance.
This means a self-funded retiree who is a member of a public offer fund that offers member investment choice will continue to receive a refund of franking credits, while that same member in a SMSF, assuming the SMSF is ineligible for the government guarantee, will no longer benefit from a refund of excess franking credits.
This is because the public offer fund is likely to have sufficient taxable income from taxable contributions and realised capital gains from members in the accumulation phase to fully use the imputation credits attached to members in the retirement phase. This will be the case regardless of whether the member is a self-funded retiree or is receiving a Centrelink pension.
In contrast, an SMSF with most of its assets supporting retirement-phase income streams is unlikely to have a sufficient level of taxable income to fully use its imputation credits.
Even though members in public offer funds may only have a retirement-phase interest in the fund, at the fund level the trustees are able to use franking credits that are notionally attached to the member’s retirement-phase interest. The fund is able to use these franking credits to reduce the tax otherwise payable by the fund, which results in an amount equivalent to the tax saving being transferred to the retirement-phase member.
Furthermore, the proposed pensioner guarantee creates complexity as SMSFs with members who were receiving the age pension before 28 March 2018 will be treated differently to those SMSFs with members who start to receive the age pension after this date.
It also is unclear what would happen if a member of the SMSF, who was receiving the age pension on 28 March 2018, subsequently becomes ineligible to receive Centrelink benefits.
Would their SMSF cease to be eligible for refundable franking credits from that point on? If so, an SMSF that was entitled to the pensioner guarantee on 28 March 2018 would need to have its eligibility to receive refundable franking credits assessed on a year-by-year basis thereafter.
Under the current imputation system, superannuation members benefit from refundable franking credits in much the same way no matter how their fund is structured. If refundable franking credits are removed, this will no longer be the case.
Retirement-phase members in an SMSF will pay tax on company dividends received at the company tax rate, while that same member in most industry and public offer funds will effectively pay no tax.
A similar distortion arises between members of a public offer fund and individuals who choose to save for their retirement outside of the superannuation system. A self-funded retiree with non-superannuation investments will be ineligible to receive a refund of excess franking credits, while that same individual in a public offer fund offering member investment choice will continue to benefit from refundable franking credits.
SMSFs have a legitimate claim to be part of the superannuation system as they represent those who are fully engaged with their retirement savings. Not only do SMSFs play a valuable role in allowing individuals the choice to exert more control over their retirement savings, they also provide a more competitive dynamic in the superannuation sector.
It is widely accepted the SMSF sector is a well-functioning part of the superannuation industry. The Cooper review, which concluded its review of the superannuation industry in 2010, found the SMSF sector was performing well, was efficient and allows many Australians to meet their retirement income goals.
The more recent Financial System Inquiry found significant scope for the superannuation system to better meet the needs of superannuation fund members and provide broader benefits to the financial system and the economy. SMSFs are well placed to meet the needs of members and the broader financial system as they foster full member engagement and self-reliance in retirement.
The existence and success of the SMSF sector over many years has put downward pressure on administration fees and continues to foster higher levels of investment choice and member engagement across the entire superannuation industry.
We don’t believe it’s necessary or appropriate for government to introduce a tax policy that reduces choice in the superannuation sector by favouring some segments over others and penalises individuals who decide to manage their own retirement savings.
It’s time for Labor to retire this policy proposal and develop ideas that actually help Australians thrive at the end of their working lives.
Natasha Fenech is chief executive of SuperConcepts.