Tucked away in the maelstrom of Budget announcements is a measure which turns private pension funds into the financial equivalent of a magic pudding; valuable, inexhaustible and sheltered from tax until ready to be passed on to the next generation. Harry Chemay unveils the quadrella of self-managed superannuation lurks which favour wealthy retirees.
While many Australians were looking for relief from cost of living pressures, wealthy retirees had another reason to celebrate the recently delivered Budget. It continues a measure that turns their private pension funds into the financial equivalent of a magic pudding; valuable, inexhaustible and sheltered from tax until ready to be passed on to the next generation.
Tucked away in the maelstrom of Budget announcements, barely noticeable among various hot-button cost of living measures, sits one that will warm the hearts of Australia’s retirees.
Well, not all retirees exactly, but certainly those of substantial means, for whom this measure allows the continuance of a neat little device to keep significant family wealth out of reach of the tax office.
Having been announced on social media in the lead up to Budget night, it was no surprise to hear Treasurer Frydenberg confirm the 50 per cent reduction in the minimum super pension drawdown factor would be retained for 2022-23.
This marked an extension of a measure first announced in March 2020 as one of the earliest responses to COVID-19, taking the reduction into its fourth consecutive financial year as indicated in the table below.
|Age of beneficiary||Temporary pension factor(2019-20 to 2022-23)||Normal pension factor(2013-14 to 2018-19)|
|65 to 74||2.5%||5%|
|75 to 79||3%||6%|
|80 to 84||3.5%||7%|
|85 to 89||4.5%||9%|
|90 to 94||5.5%||11%|
|95 or older||7%||14%|
Flexibility for the fortunate
In outlining the measure, the Budget papers indicate that “given ongoing volatility, this change will allow retirees to avoid selling down assets in order to satisfy the minimum drawdown requirements”.
Two questions arise. First, what ongoing volatility? And second, which retirees?
Because, a nervous March 2020 notwithstanding, COVID-19 has been anything but brutal to investors. The Australian share market is up 55 per cent since then. According to market researcher Rainmaker, super funds returned 15 per cent in 2021, the third best year calendar year return in 17 years. And 51 per cent for the five years to 31 December 2021, two of which incorporate the COVID-19 impact.
Which leads to the question of which retirees will benefit most, given that average (median) super balances for Australians aged between 60 and 64 are currently some $180,000 for males and $140,000 for females. Such retirees voluntarily cutting their super pensions to $3,600 and $2,800 respectively (2%) would seem at odds with the need for a liveable income, given the wait now until age 67 for the Age Pension.
The weight of evidence points to Self-Managed Superannuation Funds (SMSF) as the main beneficiaries of the continued relief. And the larger the SMSF, the bigger the benefit.
Originally conceived as a way for farmers, small business owners and self-employed professionals to make provision for their retirement years, this once sleepy part of the superannuation system is far from soporific today.
The latest annual SMSF statistical analysis by the Australian Taxation Office shows a segment that collectively held some $820 billion in nearly 600,000 SMSFs, on behalf of some 1.1 million Australians, as at 30 June 2021.
That’s effectively one dollar in every four in the entire superannuation system.
While SMSF balances average $1.3 million, that metric is heavily skewed by a relatively few truly ginormous funds. Information provided by the ATO to Treasury’s 2020 Retirement Income Review, and obtained by the Australian Financial Review under Freedom of Information, showed the top 100 largest SMSFs collectively holding $9.64 billion during financial year 2019.
The smallest of these was a ‘meagre’ $51 million, the largest a near-incomprehensible half a billion dollars. 27 SMSFs had assets greater than $100 million.
The Party’s in Pension Mode
Anyone with a modicum of superannuation knowledge can see that the generous tax concessions available within super are disproportionately accessible by the ultra-wealthy.
The party, however, really kicks off in pension mode, where since 2007 earnings on assets supporting pensions are tax free for those aged 60 and over.
Such has been the deluge of SMSF money by the over-60s that the government was forced to wind back some of this largess in 2017, capping the amount of tax free pension assets able to be moved into pension mode, currently $1.7 million per person.
At $3.4 million a couple, that’s still a level of tax-free wealth 10 times greater than the typical retiree couple enjoys, the balance still able to accumulate at a maximum rate of 15 per cent.
Despite an end to the pre-2017 free-for-all, the ATO statistics reveal just how skewed SMSF balances are to the retirement phase. For member balances between $1 million and $1.6 million, only 5 per cent of individuals are in accumulation phase while almost 17 per cent are in pension phase.
Across all 1.1 million SMSF members, it is also no accident that the average member age is 61, just past the age when the zero (likely negative) tax magic begins.
These observations certainly have not escaped the eye of Michael Callaghan, the former senior Treasury official who headed the Retirement Income Review, noting in his final 2020 report that “It appears that large balances are held in the superannuation system mainly as a tax minimisation strategy, separate to any retirement income goals”.
It’s a view shared by public policy think-tank Grattan Institute, which estimates that half of all superannuation tax concessions flow to the wealthiest 20 per cent of households.
… half of all superannuation tax concessions flow to the wealthiest 20 per cent of households.
Punting with a Taxpayer Backstop
One only needs to review the investment strategies of SMSFs in pension mode to see how this drawdown relief is the gift that keeps on giving.
According to the ATO data, the three biggest investment holdings for SMSFs in accumulation mode during the 2020 financial year, and their pension phase equivalents were as follows:
|Asset type||Accumulation phase||Pension phase|
|Cash and Term Deposits||19.8%||21.2%|
|Listed Australian Shares||19.1%||30.8%|
Source: ATO SMSF Statistical Overview 2019-20
Two observations of note. First, at over 21% once in pension mode, there would be ample cash and cash-like assets to make pension payments at the standard drawdown factors, irrespective of financial market volatility.
The Budget reasoning of ‘allowing retirees to avoid selling down assets in order to satisfy the minimum drawdown requirements’ is thus a complete furphy.
The other notable observation is the significant shift of assets from debt-funded property (Limited Recourse Borrowing Arrangements) to listed Australian shares once in pension mode.
And why not when, inclusive of franking credit refunds, the effective yield on the Aussie share market is somewhere north of 5 per cent at present for a retiree in pension mode.
The bottom line: even under the standard drawdown factors wealthy SMSF retirees would be hard pressed to have their pension accounts shrink rather than grow much before their 80s, in the absence of a large and sustained share market decline.
Add to that a government providing downside protection at the first sign of a market sniffle, and the rational strategy after turning 60 is to punt the farm on growth assets, particularly fully-franked Aussie shares. Why ever not, when you’re essentially in a no-lose position?
Heads markets continue to power ahead and your returns far exceed the minimum required pension, thus effectively turning your pension account into a negative tax perpetual growth machine you can bequeath your children upon passing.
Tails markets go pear-shaped, the government helpfully halves your required withdrawal, you sell nothing and wait until normal service resumes.
A uniquely Australian approach to capitalism; if that isn’t a clear example of a moral hazard, I’m not sure what would be.
And when you do finally shuffle off this mortal coil, perhaps just a little shy of getting that letter from Buckingham Palace, your children (themselves now likely in or nearing retirement) can receive your super, including the balance of the SMSF pension you never exhausted, at highly concessional tax rates. Perhaps to contribute into their SMSF accounts to the maximum permissible extent.
And so begin the entire virtuous estate wealth management circle anew.
Harry Chemay has more than two decades of experience across both wealth management and institutional asset consulting. An active participant within the wealth and superannuation space, Harry is a regular contributor to investment websites in Australia and overseas, writing on investing and financial planning.
He has also been appointed an Australian ambassador to the Transparency Task Force, a UK-led initiative to bring greater transparency and accountability to financial services.