By the time I’m 70, my retirement will hopefully begin. I’ve wanted to retire earlier but my $1.6 million (if I’m lucky) won’t be accessible tax-free until then. There was controversy in 2037 when the New Democrats indexed preservation age to our life expectancy but most people agreed it was time to tweak the system. After all, it had been many years since the now defunct Labor and Liberal parties had agreed not to touch the super system for two decades to provide some retirement planning certainty…
This is, of course, a fantasy and given the Government-of-the-day’s proclivities to tinker with the super system, unlikely to ever become a reality. In the context of the major changes announced in the Turnbull Government’s inaugural Federal Budget, it is worth reflecting on the landmark years of the super system:
- 1992: mandatory super contributions are introduced
- 2006: taxation is simplified and super choice is enabled
- 2016: the objective of super is enshrined.
Milennialls will look back on the most recent changes as a defining moment that reframed the super system around this objective:
“To provide income in retirement to substitute or supplement the Age Pension.”
The six biggest changes
Underpinning this objective, a number of changes to the taxation and access rules of super were flagged. However, there were six in particular that have the potential to significantly redefine the retirement of future generations:
- A lifetime cap on tax-free pensions: is $1.6 million enough to live comfortably in retirement? The Liberal Government is betting that it is by restricting tax-free pension account balances to this amount. This will have an enormous industry-wide impact, making administration more complex for superannuation providers and requiring advisers to rethink their wealth accumulation plans for clients.
- Restricting voluntary contributions: it just got even more difficult for workers to make contributions above the mandated employer contribution level. For the young who are salary sacrificing into super, the limit on pre-tax contributions (i.e. concessional) will be reduced to $25,000 p.a. For those closer to retirement or who have received a one-off windfall, your ability to make after-tax contributions (i.e. non-concessional) has now been reduced to a lifetime limit of $500,000. Importantly, this lifetime limit applies to non-concessional contributions made since 2007.
- Taxing transition to retirement earnings: the Government will remove the tax exempt status of earnings supporting a transition to retirement (TTR) pension. TTR pensions have been particularly popular with those that have been reducing their working hours whilst still earning a relatively high income. They have been even more popular with advisers recommending a re-contribution strategy. That will all end and TTR pensions will be treated more like accumulation accounts.
- Removing the work test: this has been a long time coming and will allow individuals to contribute to their super, regardless of their employment status. This will open up a range of contribution options to older Australians, including downsizing the family home and increasing the prevalence of spouse contributions.
- The untimely demise of anti-detriment payments: this was an unfamiliar benefit to most average Australians making super contributions but a well-known value-add by advisers that could find the right super fund. Essentially, a super fund could elect to provide a refund of a member’s lifetime contributions tax payments upon their death. This has been used heavily in estate planning but was inconsistently applied throughout the industry and won’t be available anymore.
- Resurrecting (tax-free) deferred annuities: deferred annuities have been seen by a number of insurance and superannuation providers as the silver bullet in the retirement income debate. Given the advantageous nature of these tax changes, expect to see a lot of innovation in this space and increasing focus on product-centric retirement income solutions.
Predicting the impact on Millennial retirements
These changes should be read in the context of the newly defined objective of the super system. Simon Swanson (Managing Director, Clearview) summed this up well in arecent interview:
“Superannuation is no longer a wealth accumulation game, it is a retirement income game.”
I see a number of long-term super industry trends emerging during my (and other Millennials’) working life as a result of these changes. Some will emerge rapidly, whereas others will be so imperceptible they will only be apparent in generational hindsight. In order of speed and likelihood of change:
- increasing system complexity: this one is a no-brainer and perhaps not the boldest prediction ever made. These changes add to the complexity of the system for both providers, advisers and most importantly members. Expect to see the consolidation of superannuation funds accelerate as the costs of administration become too much for sub-scale providers. Quality advisers will continue to be worth their weight in gold to members trying to navigate the murky retirement waters.
- diversifying retirement product mix: expect to see a comeback in insurance-based products including deferred annuities and insurance bonds. A mix of these products, along with an account-based pensions may become a more affordable and compelling proposition. Automated decision support tools will proliferate assisting members to determine their optimal product mix to achieve their desired retirement income and lifestyle.
- encouraging self-employment and entrepreneurship: a subtle aspect of the changes is how they benefit the self-employed by making it easier for them to contribute to super. At the same time, as the company tax rate falls to 25%, there may be incentives for the self-employed to restructure more income through their companies. Furthermore, high income earners will have to find other investment opportunities outside of superannuation such as equity crowdfunding and investing in small businesses. This prediction is slightly more far-fetched but I wonder if it will be an unintended consequence of Malcolm’s much-touted innovation economy.
- inter-generational poverty: in many ways, the wealth of current pre-retirees has been built on the twin pillars of home ownership and superannuation. This may be slightly controversial, but what if these super changes merely add to the growing body of thought that younger Australians are being affected by one of the worst examples of inter-generational poverty visited in history? As house prices continue to rise (perpetuated by negative gearing tax concessions that continue to be preserved by the latest budget), the likelihood of Millennials owning their own home decreases by the year. Combine this with the new objective of super and there is the potential for Millennials to have less tax-effective wealth accumulation opportunities than their predecessors. We could even see the emergence of a new advice specialty – overseas retirement planning – as Millennials with limited retirement incomes, but freed from the shackles of home ownership, set sail for fairer (and cheaper) shores.
You can read my series on ideas transforming Australia’s wealth in 2016 below:
Idea #1 – Goals-based investing
Idea #3 – Roboadvice
Please note: this article is for general information and illustrative purposes only and should not be relied upon for any purpose. The accuracy of the information contained within cannot be guaranteed. You should consult a financial adviser before making any personal financial decisions.