Forget splashing cash for the poor, Josh’s budget gift is great for the rich

Lots to celebrate. Image: @tylerfarmer, Unsplash

Nestled in the maelstrom of budget announcements is a measure that turns private pension funds into the financial equivalent of a magic pudding; precious, inexhaustible and tax-sheltered until it is ready to be passed on to the next generation. Harry Chemay unveils the quadrella of self-managed pension funds that favor wealthy retirees.

As many Australians sought to ease cost-of-living pressures, wealthy pensioners had another reason to celebrate the recently introduced budget. He is pursuing a measure that turns their private pension funds into the financial equivalent of a magic pudding; precious, inexhaustible and tax-sheltered until it is ready to be passed on to the next generation.

Nestled in the maelstrom of budget announcements, barely noticeable among various searing cost-of-living measures, is one that will warm the hearts of Australian pensioners.

Well, not all retirees exactly, but certainly those with substantial means, for whom this measure allows the maintenance of a neat little device to keep a large family heritage out of the reach of the taxman.

After being announced on social media in the run-up to budget night, it was no surprise to hear Treasurer Frydenberg confirm that the 50% reduction in the super pension minimum withdrawal factor would be retained for 2022. -2023.

This is the extension of a measure first announced in March 2020 as one of the first responses to COVID-19, bringing the reduction into its fourth consecutive fiscal year, as shown in the table below .

Beneficiary’s age Temporary retirement factor(2019-20 to 2022-23) Normal pension factor(2013-14 to 2018-19)
Under 65 2% 4%
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%

Source: Super Guide

Flexibility for the lucky

Outlining the measure, the budget documents say that “given the current volatility, this change will allow retirees to avoid selling assets in order to meet minimum drawdown requirements.”

Two questions arise. First, what ongoing volatility? And second, which retirees?

Because, despite a nervous March 2020, COVID-19 was anything but brutal for investors. The Australian equity market has risen 55% since then. According to market researcher Rainmaker, super funds returned 15% in 2021, the third best calendar year return in 17 years. And 51% for the five years up to December 31, 2021, two of which include the impact of COVID-19.

Which leads to the question of which retirees will benefit the most, given that the average (median) super balances for Australians aged 60-64 are currently around $180,000 for men and $140,000 for the women. These retirees voluntarily reducing their super pensions to $3,600 and $2,800 respectively (2%) would seem at odds with the need for sufficient income, given that one now has to wait until age 67 for the old age pension. .

The weight of evidence indicates that self-managed pension funds (SMSFs) are the main beneficiaries of continued relief. And the bigger the SMSF, the bigger the profit.

Oversized SMSFs

Originally conceived as a way for farmers, small business owners and independent professionals to plan for their retirement years, this once sleepy part of the retirement system is far from soporific today.

The last 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 of June 30, 2021.

This effectively represents one in four dollars in the entire pension system.

While SMSF balances average $1.3 million, this measure is heavily skewed by a relatively small number of truly outsized funds. Information provided by the ATO to the Treasury’s 2020 Pension Income Review and obtained by the Australian Financial Review under freedom of information, showed that the 100 largest SMSFs collectively held $9.64 billion. dollars in fiscal year 2019.

The smallest of them was a “measly” 51 million dollars, the largest an almost incomprehensible half a billion dollars. 27 SMSFs had assets over $100 million.

The party is in boarding mode

Anyone with a modicum of pension knowledge can see that the generous tax breaks available within the super are disproportionately accessible by the ultra-rich.

The game is to house as much wealth as possible in supermarkets where the maximum income tax while working is 15%, but very much achievable in the single digits with the help of postage credit refunds.

The party, however, really kicks off in retirement mode, where since 2007 earnings from assets supporting pensions are tax-free for people aged 60 and over.

The deluge of SMSF money by the over-60s was such that the government was forced to reduce some of this largesse in 2017, capping the amount of tax-free pension assets that can be transferred into retirement mode, currently at $1.7 million per person.

At $3.4 million per couple, that still represents a level of tax-free wealth 10 times greater than that enjoyed by the typical retired couple, with the balance still able to accumulate at a maximum rate of 15%.

Despite the end of pre-2017 free-for-all, ATO stats reveal how skewed SMSF balances are from the retirement phase. For members whose balance is between $1 million and $1.6 million, only 5% of individuals are in the accumulation phase, while nearly 17% are in the retirement phase.

Across all of SMSF’s 1.1 million members, it’s also no coincidence that the average member age is 61, just past the age when the (probably negative) zero tax magic start.

These observations certainly did not escape the eye of Michael Callaghan, the former senior Treasury official who ran the Retirement Income Review, noting in his latest 2020 report this “It appears that large balances are being held in the pension system primarily as part of a tax minimization strategy, separate from any retirement income objective”.

That’s a view shared by public policy think tank Grattan Institute, which estimates that half of all retirement tax breaks go to the top 20% of households.

… half of all pension tax cuts go to the richest 20% of households.

Boat with a taxpayer safety net

One need only review SMSF investment strategies in retirement mode to see how this drawdown relief is the gift that keeps on giving.

According to ATO data, the top three funded SMSF investment portfolios in FY 2020, and their retirement-stage equivalents were:

Asset type Accumulation phase Retreat phase
Cash and term deposits 19.8% 21.2%
Listed Australian stocks 19.1% 30.8%
Property financed by debt 16.1% 1.5%
55.0% 53.5%

Source: ATO SMSF Statistical Overview 2019-20

Two observations to note. First, at over 21% once in retirement mode, there would be enough cash and cash-like assets to make retirement payments at standard drawdown factors, regardless of financial market volatility.

The budget reasoning of “allowing retirees to avoid selling assets in order to meet minimum drawdown requirements” is therefore complete fury.

The other notable observation is the significant shift in assets from debt-financed property (Limited Recourse Borrowing Arrangements) to listed Australian equities once in retirement mode.

And why not when, including franking credit repayments, the effective return in the Australian equity market is currently north of 5% for a retiree in pension mode.

A win-win

The bottom line: Even with standard drawdown factors, wealthy SMSF retirees would struggle to see their retirement accounts shrink rather than grow well into their 80s, absent a large and sustained market decline. actions.

Couple that with a government offering downside protection at the first sign of a market sniffle, and the rational strategy after hitting 60 is to start the farm on growth assets, especially fully franked Australian equities. Why not, when you are essentially in a no-loss position?

The leading markets continue to rise and your returns far exceed the minimum pension requirement, turning your pension account into a tax-negative perpetual growth machine that you can pass on to your children when you die.

Tail markets take the shape of a pear, the government cuts your required withdrawal in half, you sell nothing and wait for normal service to resume.

A uniquely Australian approach to capitalism; if that’s not a clear example of moral hazard, I don’t know what it would be.

And when you finally get rid of that deadly coil, maybe just a little shy to get that letter from Buckingham Palace, your kids (themselves probably retired or close to retirement) can get your super, including the balance of the SMSF pension that you have never exhausted, at very advantageous tax rates. Perhaps to contribute to their SMSF accounts to the maximum extent allowed.

This is how the whole virtuous circle of asset management begins again.

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