Better targeting of superannuation contributions tax breaks could save the budget $3.9 billion a year, argues this report.

Summary

Tax breaks for superannuation contributions and earnings should be targeted more tightly at their policy purpose. The current system is expensive and unfair.

Superannuation tax breaks mean that less tax is paid on super savings than is paid on other forms of income. These tax breaks should only be available when they serve a policy aim. Although the $2 trillion superannuation system does not have legislated aims, most believe it should encourage savings to supplement or replace the Age Pension.

Yet superannuation tax breaks often go well beyond this purpose and their costs are unsustainable. The tax breaks reduce income tax collections by more than $25 billion a year. More than half the benefits flow to the wealthiest 20 per cent of households who already have enough resources to fund their own retirement, and whose savings choices aren’t affected much by tax rates.

Three reforms are needed to target superannuation better.

‘Concessional contributions’ made from pre-tax income should be limited to $11,000 per year. Eighty per cent of contributions above this level come from the 20 per cent of taxpayers with the highest incomes, people likely to retire with enough assets to be ineligible for an Age Pension. This change would improve budget balances by $3.9 billion a year. Other options, such as levying higher taxes on contributions made by higher income earners, would be less well targeted and more complex to administer. Replacing the annual cap with a lifetime cap sounds attractive because it appears to allow people with broken work histories to catch up, but it would mainly turbocharge tax planning for wealthy older workers.

‘Non-concessional contributions’ made from post-tax income should be limited to $250,000 over a lifetime. Of the $33 billion in post-tax contributions each year, around half are made by just 200,000 people who already have at least $500,000 in super.

Earnings in retirement – currently untaxed – should be taxed at 15 per cent, the same as superannuation earnings before retirement. More than half of the benefit of tax-free earnings in retirement goes to the wealthiest 20 per cent of retirees. For the top 10 per cent of over 60s drawing on super, the tax benefits are extremely generous – they pay no tax on their average super earnings of $85,000 a year. A 15 per cent tax on all super earnings would improve budget balances by $2.7 billion a year today, and much more in future.

The proposed reforms are fair. Low-income earners and younger people would pay less in other taxes if super tax breaks for the wealthy were wound back. Those already retired would pay some tax on their superannuation savings, but they would pay much less tax than wage earners on similar incomes. For a small proportion of women with higher incomes later in life, the changes would reduce their catch-up contributions. Yet the changes would reduce the tax breaks far more for a lot of rich old men.

The changes to contributions taxes would be prospective. The changes to earnings tax rates, like changes to income tax rates, would apply to future earnings of assets already acquired.

Previous repeated changes to superannuation have been too timid. A wide gap remains between the purpose of the system and what it actually delivers. Decisive reform must target superannuation tax breaks at those who need them most.