|Submission No. 295||Back to full list of submissions|
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Tax Reform: Retirement Income Issues
ARISA is concerned that currently the proposed changes to the taxation regime for life insurers and pension funds could impact negatively on the cash flows of around 270,000 pensioners and annuitants. This is a significant outcome for older Australians and one that has the potential to disrupt many well established retirement plans.
Before considering the taxation regime that should apply to retirement income investments it is worth considering first the function and role of these products in Australias retirement savings system.
2. What are Retirement Income Streams?
Retirement income streams are special purpose investment vehicles designed to provide investors with a regular series of income payments and the basis for managing ongoing income and spending patterns in retirement. With most income streams, tax instalments are deducted from the gross payments providing investors with a familiar "take home pay" or "salary" concept.
There are two main types of retirement income streams - pensions and annuities. Although there is a legal difference between investing in an annuity contract with a life insurance company or electing to receive pension payments from a superannuation fund, from a practical viewpoint both types of income streams operate in a similar way for consumers.
3. Outstanding issues for retirees
The current taxation proposals raise a range of issues for retirees to consider, including:
All of which suggests that without careful consideration and implementation, the taxation reform process has the potential to inadvertently disrupt the retirement plans (ie. incomes) of hundreds and thousands of older Australians.
4. Consumer acceptance
A measure of the consumer acceptance of Australias current retirement income system can be ascertained from considering some basic market statistics.
According to the most recently published ARISA Report (data provided by Simon Solomon & Associates, Consulting Actuaries), retirement income streams continue to grow with total funds under management exceeding $26 Bn (as at 31 December 1998). Annual sales were $6.8 Bn with around 72% of sales (or $4.9 Bn) coming from superannuation money.
As a result of the introduction of the new social security rules, there was a significant shift by retirees into longer term retirement income streams at the expense of short term annuities and pensions over the December quarter. This is in direct response to the new rules which can provide a more generous social security outcome for retirees who are prepared to invest in a longer term income.
Sales of guaranteed lifetime and fixed term retirement income stream products, which do not provide for a return of capital at the end of a fixed term or on death, represented around 23% of total sales for the quarter. An estimated $320 million was invested in guaranteed lifetime and 15 year plus income streams for the quarter, representing around 15% of total sales.
Although early days, this data highlights the impact that government policy can have on the market by encouraging more retirees to use their accumulated retirement capital for income generating purposes rather than simply taking lump sum benefits in cash. This observation is reflected in recent comments by Senator Newman in the 1999 Federal Budget Paper titled "Delivering on Our Commitments to Women", where she states: "The Government.....has improved the Age Pension means test to encourage the takeup of retirement income streams."
5. Issues with Tax Reform
Although a major component of tax reform is simplifying existing taxation arrangements with a view to making them more consistent and equitable, it is important to balance this against macro retirement income policy objectives in general. This means ensuring that taxation reform continues to support the genuine self-provision of income in retirement as part of an integrated retirement policy. This issue is of increasing importance for Australia with an ageing population and burgeoning unfunded public sector liability.
Superannuation has been the subject of constant policy change since 1983, with a major element involving changing taxation arrangements (eg. earnings tax, lump sum tax, RBLs and surcharge tax). Given the long term nature of retirement savings plans, frequent changes to the rules unsettles investors and raises concerns over the ongoing viability of previous savings decisions. Adverse taxation changes to retirement income policy telegraphs a negative retirement savings message to both current and potential retirees.
In delivering a new taxation system care must be taken to minimise the impact on retirees - many of whom have existing long term investment arrangements in place and are unable to rearrange their affairs accordingly.
6. Assessment of potential impact
ARISA is concerned that overall the proposed changes create an increase in the taxation liabilities of superannuation funds and life insurers with respect to their pension and annuity business. Ultimately, an increase in the taxation of the provider of the income stream will lead to lower income stream payments to retirees, or in the case of allocated retirement income streams, a reduction in the capital value of retirees investments.
In particular, ARISA is concerned as to how the new measures will apply to all existing pension and annuity business, much of which has been priced on the assumption of zero fund tax rates for long periods into the future. This issue is particularly relevant where long term products have already been priced and accepted by customers on the basis of current taxation rules (eg. long dated fixed term and lifetime contracts; ref: Appendix C).
The recent positive changes made to the social security treatment of retirement income streams (from 20 September 1998) are designed to encourage more Australians to consider long term products based around life expectancy - products that must also be non-commutable (ie. not able to be cashed) and usually guaranteed. Accordingly, any adverse taxation changes here risk undermining an otherwise positive government policy initiative for retirees with a corresponding increase in government pension outlays (due to lower private retirement incomes). The lower the income generated, the higher the potential age pension liability.
Current tax reform proposals support the notion of applying similar taxation treatment to similar economic activities. On this basis, there would seem to be a strong case for keeping the current consistent taxation treatment of all pensions and annuities - given the fundamental similarity of the two product types.
Taxing the underlying pension income of superannuation funds at 15% and the annuity business of life companies at the company tax rate (eg. 36%) poses several problems:
Fundamentally, as a minimum there would seem to be a case for ensuring that the reserves on annuity business are taxed effectively at no more than 15% to align this taxation treatment with superannuation funds paying similar types of pensions.
7. Finding a solution
Introducing taxation at source on the underlying assets supporting retirement income liabilities of both superannuation funds and life companies is a fundamental shift in retirement income policy. In fact, it represents "double taxation" as the accumulated retirement savings used to purchase the income streams are already tax paid funds.
Currently income stream products work (and are priced) on the assumption that earnings are taxed in the hands of the individual when they are ultimately paid out in cash. This means that reserves used to smooth long term income returns do not suffer any form of with holding tax. Coupled with this is the fact that income stream investments are taxed on a PAYE basis (generating regular tax instalment deductions), unlike any other form of managed or pooled investment. They are also subject to strict legislative parameters.
There is a strong argument to suggest that retirement income investments are unique investment propositions. Unlike superannuation or other ordinary savings vehicles, retirement income streams are designed to return regular income (plus capital) over time in exchange for the investment of an initial capital sum. This is in direct contrast to accumulating savings (either regularly or irregularly) to receive a lump sum value at some future point in time.
In this way, retirement income streams can be classified as a fundamentally different type of economic activity and lay claim to a different taxation basis to other forms of investment. This is quite apart from any overriding policy imperative given Australias ageing population.
To date, Australia still lacks an integrated retirement income system. This involves consistent taxation and social security policy that encourages long term savings and the self provision of income in retirement. Or to put it another way, integrating the taxation of retirement savings with the determination and assessment of private retirement incomes.
In the context of business taxation reform, ARISA is concerned that the treatment of different investment entities does not dominate the proper assessment of different investment types (irrespective of the actual entity involved). Otherwise artificial distinctions can easily arise between the retirement incomes offered by life insurance companies (annuities) and public offer superannuation funds (pensions). It is vital that tax reform reflects recent social security policy in this key aspect which ensures that both product types are treated in exactly the same manner - irrespective of the product name.
Balancing equity and simplicity with the potential impact on existing clients is never easy and tax reform is no exception. However, as demonstrated through the recent 1998 changes to social security policy, it is possible to achieve a workable solution through extensive consultation and bi-partisan support.
ARISA believes that the current taxation reform process needs to quarantine any changes to the treatment of retirement incomes that have the potential to generate a negative impact on older Australians - from both a cash flow and net income perspective.
The maintenance of existing retirement income policy could be achieved through retaining the current zero tax rate on pension and annuity assets within the fund (albeit potentially with limits on excess reserving policies). Alternatively, consideration should be given to allowing pension and annuity funds to distribute franking credits to individual income recipients where the fund assets are subject to any form of taxation. This would have the effect of ensuring that those who are less able to afford increased taxation in retirement receive the full benefit of being assessed at lower marginal tax rates.
The key principle here is that some mechanism needs to be examined to ensure that retirees accumulated savings are not adversely impacted as a result of taxation reform.
8. Expanding the income offer
As part of the taxation reform process, ARISA believes there is the opportunity to review the current range of superannuation and non-superannuation retirement products on offer. Only two main product types currently exist; guaranteed and market linked income streams and market linked income streams can only be purchased with an eligible termination payment (ie. superannuation money). Given the changing demographics of the population and the flow through of the baby boomer effect, this limited range is inadequate to meet consumer needs or address increased reliance on government funded benefits.
Expanding the range of income streams (and potentially providers) that can be offered requires changes to existing legislation and government policy. ARISA believes that the treatment of retirement incomes is sufficiently important to warrant special attention and is concerned that given the time table for taxation reform, this places unnecessary strain on available government and private sector resources.
ARISA recommends that a dedicated unit be established (with industry) to review the taxation treatment of retirement incomes generally - separate to current taxation reform and outside any other review process. This includes examining the changes that need to be made to the existing legislative framework in order to expand the range of products provided to consumers.
The result will be a better integrated and consistent retirement income systemt that provides increased consumer choice and appropriate encouragement for the sefl-provision of income in retirement.