A Short History of a $3 Million Super Fund

This week’s decision by the government to double the tax rates on earnings from superannuation balances worth more than $3 million is another interesting step in the evolution of superannuation.

The decision touches on a challenge both sides of the political divide have tried to tackle: how to balance the tax advantages that come with superannuation against the extent to which any individual should be able to use those advantages to build wealth beyond a level that is reasonable to support retirement.

The Cost of Concessions

Let’s start with the benefits that are extended through superannuation, with a particular focus on the ‘accumulation’ phase, or the phase where money is being contributed to the superannuation fund.

Seeing we are talking about $3 million superannuation balances, let’s consider the tax benefit for someone earning $150,000 per year in taxable income. Employer contributions to superannuation are taxed at 15 per cent. A person receiving 10.5 per cent employer contributions on a $150,000 income would have an annual contribution of $15,750, on which the superannuation contributions tax would be $2,362.50.

If, instead of receiving that $15,750 as a superannuation contribution, they had it added to their $150,000 of taxable income, they would be paying tax at the rate of 37% (excluding Medicare), tax of $5,827.50, or an extra $3,465 in tax.

Superannuation also has the benefit of concessionally taxed earnings.

Let’s assume the person in question has $1.5 million in their superannuation account – halfway toward the $3 million cap. If their fund earned gross income of $75,000 (a 5 per cent gross yield across all their assets), the superannuation fund would pay tax at a rate of 15 per cent, or $11,250 in tax.

If they had that $1.5 million invested outside of superannuation earning $75,000 in income, and taxed at a rate of 37 per cent, they would have paid $27,750 in tax, or an extra $16,500 in tax.

In both cases, tax would have been offset with the use of franking credits. For simplicity I have assumed that investment earnings are income or short-term capital gains, rather than adding the complexity of discount capital gains to the calculation. I have also assumed that the super fund does not have any personal contributions where a tax deduction has not been claimed.

This simple case study demonstrates the way a relatively high-income earner with a $1.5 million superannuation balance can save about $20,000 in tax per year using superannuation tax rates compared to their income tax rates.

To take this calculation to an extreme, let’s consider a superannuation account with a $3 million balance, made up of tax-deductible superannuation contributions and superannuation fund earnings. You would imagine that the person in question will have had to have worked for 40 years, making the maximum tax-deductible contribution (currently $27,500 per year) close to every year to accumulate $3 million in assets. They will have had a total of $3.53 million in contributions and fund earnings, on which 15 per cent tax ($530,000) is paid, leaving $3 million. Had they earned $3.53 million in income from work and investments at a tax rate of 37 per cent, they would have paid $1.3 million in tax.

It is possible to argue that a $3 million superannuation accumulation (ignoring non-tax deductible contributions) has ‘cost’ around $770,000 in income tax foregone.

Retiring With $3 Million

The core question to answer, now that a $3 million account limit seems to be firmly on the table, is: what is a reasonable drawdown rate on a superannuation balance? An answer to this question gives us insight into the income received by someone with a $3 million superannuation balance.

It is not surprising that for someone with this level of assets, we can ignore the possibility of receiving any age pension benefits. While the ‘4% rule’ is often referred to as a conservative long-term retirement withdrawal rate, I think in Australia, with the refundability of excess franking credits, a low-cost portfolio made up of at least 60 per cent growth assets should be able to accommodate a 4.5 per cent annual withdrawal rate, increasing with inflation.

On that basis, a $3 million superannuation balance should sustainably provide $135,000 as the tax-free foundation of retirement.

It is worth noting that the current tax-free threshold is $18,200, meaning a person could have a further $400,000 invested in their own name, generating $18,000 of extra income, and still pay no tax.

For a single person this is a tax-free retirement income of $153,000. For a couple this can be doubled.

A Short History

Generous superannuation tax concessions and limiting the extent of access to these concessions has been a bipartisan balancing act over time. Evidence of this can be seen at the ATO page that outlines the various rates, limits and caps here (link: Contributions caps | Australian Taxation Office (ato.gov.au))

Some of restrictions over time have included:

·Reasonable Benefit Limits (up until 2007) that put a limit on the value of concessionally taxed superannuation that could be accessed as a lump sum or pension

·A Transfer Balance Cap (from 2017/18) that limited the amount of superannuation that could be transferred into the retirement phase. In 2022/23 this limit is $1.7 million

·Minimum superannuation payments on income streams, which limits assets being kept in the highly tax-effective superannuation-pension environment, for example, to be passed on as part of an estate

·Superannuation contributions limits, for example, through the concessional contributions cap which limits the amount of superannuation contributions where a tax-deduction has been claimed (e.g. employer contributions and salary sacrifice contributions) from the 2015 financial year where it was $30,000 if under 49 or $35,000 if 49 or over, to the 2018 financial year where it was $25,000 for anyone and, with indexation, is now $27,500 for the 2023 financial year.

Conclusion

While we are all watching the announcement of another proposed limit being placed on the tax-effective superannuation environment, perhaps we are missing the main point. Someone with $3 million in a superannuation fund will still be able to create a tax-free income stream of more than $150,000 and a couple both having $3 million in their account, more than $300,000. Paying some tax after that should not be a huge deal and, for the few people impacted, it will be a manageable situation.

The main game might be that, once again, we are tinkering with superannuation rules. Six or seven years ago the previous government moved to legislate a number of superannuation changes, including transfer balance caps to limit access to the tax effective superannuation pension environment – and here we are again.

Perhaps we should be less concerned about the bipartisan efforts to balance superannuation’s generous tax advantages with appropriate limits, and instead start to question whether we can ever have our superannuation without the ongoing legislative tinkering. 

Not only does it erode certainty, each change tends to add another level of complexity we need to understand and be compliant with. Now the $3 million account balance becomes another rule we have to be aware of, alongside contribution limits, transfer caps and minimum pension withdrawals.