For too long complex rules about “retirement income streams” have hindered the development of innovative new products for Australian retirees. Much of the commentary around the 2016/17 Federal Budget has focused on the contribution limit and tax changes with superannuation – overlooking the promising changes to retirement income streams which promise to simplify a needlessly complex area of law. In this thinking piece we examine some of the significant changes on the horizon.
Australia’s superannuation laws are complex. Industry outsiders might not be surprised to learn that incredibly detailed rules limit how your superannuation savings may be used. “Retirement income streams” (such as pensions and annuities) have limitations such as maximum and minimum withdrawal amounts in order to receive concessional tax treatment. Should the Government’s proposals in the 2016/17 Federal Budget be enacted, new rules will also restrict superannuation accounts in the payment phase to a maximum $1.6 million balance.
While these limitations are intended to prevent the accumulation of low-tax savings in superannuation accounts for estate planning purposes, these rules have also prevented retirees from being properly able to manage risks associated with longevity, investment and inflation. Appropriate management of longevity, investment and inflation risks is an important challenge. However, many commentators have argued that an appropriate balance can be struck between financial product innovation and balancing Australia’s superannuation system.
“Longevity risk” is the risk of one outliving their retirement savings. Financial products such as a ‘deferred lifetime annuity’ are not currently a tax effective way of managing longevity risk as it does not satisfy the rules – specifically, such a product does not make annual payments to the retiree. A deferred lifetime annuity is like an insurance policy – it guards against longevity risk as the seller of the annuity promises to pay a particular amount to the buyer (the retiree) should the buyer attain a particular age.
While the age pension is an existing method of managing longevity risk, its future is not assured. Further tightening of payment rates and eligibility requirements is inevitable given Australia’s aging population and the Federal Government’s fiscal pressures.
But a brief paragraph in the Treasurer’s media release on Budget night is set to change this. Significantly, the Government is proposing to “remove tax barriers to the development of new retirement income products by extending the tax exemption on earnings in the retirement phase to products such as deferred lifetime annuities and group self-annuitisation products”. Changing the rules to ensure equally favourable tax treatment for these alternative products is a win for all Australians interested in prudently managing their future retirement plans.
This recent outcome has had a very long lead time (not to mention the many false starts that preceded it). Consultation began on these reforms in July 2014 with the release of a Discussion Paper, culminating with the release of the Inquiry’s Final Report in May 2016. The Final Report’s release coincided with the Treasurer’s announcement that the Government had accepted all of the recommendations of the Retirement Income Streams Review, which includes recommendations:
- to develop an additional set of income stream rules to allow lifetime products to qualify for the earnings tax exemption provided they meet a declining capital access schedule;
- that the alternative product rules be designed to accommodate purchases of products via multiple premiums; and
- a coordinated process is implemented to streamline administrative dealings with multiple government agencies.
However, these reforms will come at a cost. While promoting a benefit of no restrictions on the actual income stream from the product (which may be deferred, variable or paid over multiple periods), the inquiry’s proposal requires the product complies with a diminishing “capital access schedule”.
The capital access schedule is a maximum cap on the value of any lump sum that could be returned to the product holder if they withdrew from the product. It represents a straight-line depreciation of the original purchase price to zero over the purchaser’s life expectancy.
While the Inquiry’s preferred approach enables products with more flexible payment structures to qualify for the earnings tax concession, such an approach requires amendment to the Superannuation Industry (Supervision) Regulations 1994 (Cth)to expand the existing definitions of pension and annuity to include products which comply with the capital access schedule. Consequential amendments to various income tax statutes will also be required.
Further refinement of the rules is essential for encouraging prudent retirement savings for all Australians. Although ultimately a positive step towards reducing Australia’s regulatory burden, until legislation is passed through parliament simplifying these burdensome rules, true reform will remain at the mercy of the changing policy priorities of the government of the day.