Wry & Dry

Superannuation: if there is a $1.6m tax-free pension fund cap, why have a contribution cap?

Astute readers will be aware that W&D is very grumpy about the government's budget changes to the superannuation system.

And as a resident of a 'safe' Liberal seat, let W&D give you the whisper, the knives (silver, of course) are out.  Fury is too modest a term.  

The fury is not at the $1.6m retirement tax-free cap (it's seen as sort of fair) or, indeed, the $25,000 concessional (or tax-deductible) annual cap.  Although W&D thinks that cap is absurdly low.

The fury is at the $500,000 lifetime cap on non-concessional contributions.  Because the government will actually lose tax revenue.  This is one of the most stupid policies ever released.  

Work with W&D on this.

Firstly, superannuation 101.  Essentially, there are two phases to superannuation, with the current regime being:

Accumulation phase,

accumulate...more or less before retirement.  Tax-deductible ('concessional') contributions are generally allowed up to $30,000 p.a.  After-tax ('non-concessional') contributions - NCCs - are allowed up to $180,000 p.a.  Income and capital gains are taxed at 15%, with capital gains taxed at 10% on investments held for greater than 12 months.

Pension phase,

keep calm

...more or less post-retirement.  Income and capital gains are taxed at 0%.  And withdrawals are taxed at 0%.  Minimum amounts, defined by a member's age and account balance, must be withdrawn each year.

Ignore the issue of backdating the lifetime contribution limit to 2007 and just focus on a $500,000 NCC cap.  The government argues that this cap is there as a tax-saving measure, to stop the superannuation system being used as a tax-shelter.

But the government has a pension phase tax-free account cap of $1.6m.  That is, funds in a pension account up to $1.6m will not be taxed.  Anything more than that will be taxed at 15%, i.e. as if in accumulation phase.

Therefore, assuming a member has used up his/ her lifetime limit, the government's tax saving is the difference in tax it gets from:

  1. funds in, as it were, the retirement accumulation phase (flat tax rate of 15%); and
  2. funds hypothetically invested outside superannuation (tax at the member's marginal tax rate).

Assuming this $500,000 lump sum is ready for investment and a 6% net investment return giving income of $30,000:  

In the first case, the tax is $4,500.

In the second case, assuming the member has no other retirement savings, then with low rate thresholds, reasonable offsets and deductions, the tax on that amount is... $0.

So, how smart is this?   

Tax the government receives if the $500,000 is invested under the old policy: $4,500

Tax the government receives if the $500,000 is invested under its new policy: $0

What tax saving?