Beyond the Budget – 250,000 investors needing solutions

Despite the increase in the SG to 12%, the attractiveness of super has been on a slippery slope since the election of the ALP government. From the halving of concessional contribution limits and ad hoc pauses in limit indexation, through to the Federal Budget doubling contributions tax for high income earners and delaying contribution limit restoration for the over 50’s, super has been eroded one slice at a time.

The effect has been largest for the high income earners targeted in this Budget:

– In 2009 they could contribute $50,000 to super, at a contributions tax rate of 15%. With indexation, that amount would likely have reached $60,000 in 2013.

–The actual situation for 2013 is now $25,000, at a tax rate of 30%.

So by 2013 this group has lost about 80% of their contributions concessions.

This article is not a debate about the fairness or equity of this outcome – although that being said, one might ask whether an evening up of tax benefits reconciles with an 80% withdrawal. It’s about whether higher income earners remain engaged with super going forward.

In favour of this are the two key remaining tax concessions – the 15% / 0% tax on earnings; and tax free pensions. That certainly remains very attractive for money already in the system. But what about future contributions? For these concessions to be sufficiently attractive to entice people into locking up new money for many years, with virtually no tax break on the way in, two conditions would have to be satisfied:

– You have to be confident that the remaining concessions will actually remain in place – not just for now but for perhaps decades to come.

– You have to be able to get enough new money into the system for the remaining concessions to be worth enough.

You could be forgiven for feeling rather cynical about the former, but in fact the latter may be the bigger problem. Here’s why.

The maximum you can get into the system as concessional contributions (net of tax) is $25,000 less 15%; ie $21,250. Let’s assume you need to make net contributions of 12% of salary for a reasonable retirement relative to your prior living standards. With a maximum net contribution of $21,250, this will only be the case for people earning up to $177,000. Someone on $300,000 can only get $25,000 less 30% tax = $17,500 into the system – less than 6% of their income.

This suggests that super can only be a reasonably complete retirement strategy if you are earning up to, say, $180,000. Coincidentally this is where the highest marginal tax rate kicks in. Beyond that you can’t get enough concessional contributions into the system to be confident of a comfortable retirement.

So while all the focus has been on the 128,000 high income earners on $300,000 plus, access to sufficient concessional contributions becomes a problem for anyone on the highest marginal tax rate – some 209,000 people in 2009-10 according to the ATO.

As the numbers will have grown since then, we can say that there are around a quarter of a million people who are either already considering the alternatives to supplement super; or should be.

This is a pretty bad outcome for super. Not only do funds start losing their effectiveness to serve members’ retirement needs once they hit the top marginal tax bracket, there is increased risk that those members – who have some of the highest balances – will defect if they have to go elsewhere for tax advice and non-super investments.

On the other hand it’s a great outcome for accountants (yet again), financial planners, lenders, institutional / investment banks, and asset managers which can provide:

– Alternative structures such as trusts.

– “Next best” tax-effective strategies such as gearing (where there has been some innovation such as no-margin call loans), structured products and perhaps even insurance bonds.

– Tax friendly assets to go with such strategies, such as equities paying franked dividends, real estate, low turnover equity funds, and ETFs.

This has been a good example of failing to consider the cumulative effect of small changes. Each change has been sold as minor or affecting only a small number of people. But put them together, and here we are questioning the future role of super for anyone on the top tax bracket.