It’s all about Reasonable Benefit Limits

The government recently announced the retirement income review. Consequently, we have seen the re-stirring of a number of views on what superannuation is, how the old age pensions sits alongside the superannuation system, and the old chestnut of franking credits.

This note is not about the upcoming review, but about stepping back in time and looking at certain aspects of the superannuation system as proposed by the then treasurer Paul Keating, 1992.

In a nutshell, the government*[1] of the era realised that we were aging as a population. The burden of this ageing population may not easily be supported by the old model – government based pension. Hence, compulsory super came into being and the government of the day set some simple rules to start the process. The key rules that I understood to be important were:

  1. A contribution rate of (initially) – the Superannuation Guarantee.
  2. The rate to move to 12% over time, this being a generally accepted funding rate to achieve self-sufficiency in retirement.
  3. The introduction of a 15% tax rate on earnings and contributions.
  4. To compensate for this new 15% tax rate, super funds were allowed to use their excess franking credits to offset other super tax liabilities such as contribution tax.
  5. To ensure that Superannuation was used for what it was intended a Reasonable Benefit Limit was to be adhered to.
  6. The RBL was indexed at the , and its fundamental purpose was to control the amount of savings put away .
  7. Benefits paid above the RBL were taxed at the highest personal tax rate.

Tax on contributions was set at a flat 15% for all participants, and the SG was part of a universal saving theme for all workers (you had to be employed to be eligible for the SG).

The next major change that occurred was in year 2006/07.

Key points of those changes were:          

  • The abolition of the RBL
  • Excess franking credits were refunded (previously these were not)
  • Tax on pension payments from superannuation set to 0%, and
  • Bring forward top-up contributions allowed

The changes proposed by the then government were in response to a view that the system still had a shortfall in terms of achieving inadequate savings and these measures would permit the shortfall to be narrowed.

In the recent federal election, it appeared that the most contentious of these issues was the “franking rebate” change and this led to some very polarised views. The election is now history but the newly announced review has opened old wounds and in general a number of misnomers.

I personally want to focus more on the RBL control mechanism and the impact it had once it was removed.

Impact of RBL removal

The removal of the RBL was the single one change that allowed additional contributions to be made to grow a fund’s value without limit – because the “penalty tax rate” for asset above the RBL no longer applied. The consequence of this growth was that you could use Super as an asset storage vehicle that would be taxed at 15%, and hence we have seen the rise of some large super balances.

Once the Super fund grew to a certain size, the ability to minimise tax also became an issue – since superfund tax rate (15%) is generally below most PAYG tax rates.  It also meant that franking credits could be accessed at a rate that was not consistent with a member’s general tax rate (hence the claim by some that franking credits were the issue – because individuals on high tax brackets could still get the full rebate via their superfund). 

Restoring the RBL would remove excessive value being stored in certain superfunds without penalty. It would also defray the argument that excess franking credits should not be cash rebated because implications on wealth of large superfunds.

Proposed restoration of the RBL and the method of restoration

The RBL at the time of its removal was set at

Year

Lump Sum

Pension

2006-07

$678,149

$1,356,291

The 2018-19 RBL derived using AWOTE indexation would be

$1,050,539

$2,101,078

We can see that if we had maintained the RBL concept the RBL for  2018-19 re  Pension payments would not be that dissimilar to the current  The main difference being that tax on amounts above the TBC are still at 15%, whereas any amounts above the RBL would be taxed at the top marginal tax rate.

Proposed change:

Reinstate the RBL concept (can be the TBC) as the main control mechanism to ensure that excess amounts are not stored within a superfund.

Current amounts above the RBL to be taxed at the top marginal tax rate from the date of the reintroduction of the RBL  (with the additional right that members can withdraw the excess  amount without penalty but such amounts now exposed to non-superannuation tax rates). This is a variation to the original penalty structure in that it is immediate, not at the point when the benefit is taken.

The main benefits of the proposed changes would be:

  • Restoration of limits on total savings for the purpose of superannuation.
  • The removal of large excessive amounts from the superannuation system.
  • The restoration of tax revenue from such large amounts.

Conclusion:

The construct of the superannuation system back in 1992 was well thought out. Removal of the RBL control mechanism has been the largest contributor to anomalies – large balances that have the ability to optimise tax.

Restoration of the RBL will reinstate an original intent of the system (control), with the one variation being that excess benefits in the fund are taxed at the top marginal rate upon this change (or are withdrawn without penalty but now exposed to non-superfund tax rates).

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Comments

Image of Mark Heydon
Mark Heydon says

12 June 2020

Thanks Alan.
I don't know what the "TBC" is. However your idea to reintroduce RBLs seems pretty sensible to me. In my view, superannuation beyond amounts required to fund a reasonable retirement constitute taxpayer support for those that do not need taxpayer support.

Image of Sheila Colls
Sheila Colls says

13 June 2020

It's an interesting suggestion, Alan. As I recall, a number of people were able to claim a much higher RBL, and the imposition of RBL limits also led to SMSFs setting up complying pensions supported by significant reserves (which did not count towards the RBL) and provided a new line of business for some actuaries.
The current limits on contributions should reduce the likelihood of large super balances at retirement.
Let us also remember the chaos of the superannuation surcharge which resulted in revisions of liabilities going on for many years, and bear in mind that many of those large sums in SMSFs will be outside the super environment on the death of the members, before changing only one feature of the system.


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