Understanding the superannuation guarantee changes
OnePath's technical team takes a look at the superannuation guarantee increase and finds the more things change the more they stay the same.
There’s no doubt that superannuation has been subject to never ending change as far back as we care to remember.
The pace of that change seems to have quickened as the impact of the Stronger Super changes starts to reach its final stages and we wait to see what will make it into legislation.
The recent announcements by the Government to gradually increase the superannuation guarantee rate from 9 per cent to 12 per cent by 2020, the reduction in the co-contribution, as well as the introduction of the low income earners’ superannuation contribution seem to indicate that the concessions for superannuation are being squeezed yet again – “not more change”, I hear you say.
Depending on your client’s situation, if you take some of the changes in isolation you may come to the conclusion they are worse off, or at best, no better off.
However, when the overall impact of the changes is considered, things may be better than they seem in the longer term. Let’s compare the increase in the superannuation guarantee and the proposed reduction in the co-contribution.
Superannuation guarantee has been around approaching 20 years and has had a huge impact on the retirement savings of Australians.
In many cases, any person who has been an employee during that time has received the benefit of additional retirement savings being accumulated in superannuation for them.
Anyone who is less than about age 40 may have received superannuation guarantee coverage for the vast bulk of their working lives as an employee.
The gradual increase in the SG percentage from 9 per cent to 12 per cent of a person’s ordinary time earnings by 2019/20 may not increase the coverage of the workforce, but it will have the effect of increasing the amount being accumulated in superannuation for most employees.
The additional amount being accumulated in superannuation will depend on the current age of the person and any earnings on those amounts until the accumulation has been drawn down.
The younger the person and the longer the amount is left in the fund, the greater the amount available for retirement.
As an example, a person who is age 25 when commencing work today and earning $25,000 per annum will have accumulated approximately another $108,000 by the time they are age 60, and about another $164,000 at age 65 merely due to the increase in the SG percentage.
This is based on the salary being indexed at 4 per cent, with income of 3 per cent and capital gains of 4 per cent before tax, with a 20 per cent franking rate.
A person who is age 25 when commencing work today and earning $50,000 today will end up with approximately $217,000 more by age 60 and $329,000 more by age 65 based on the same assumptions.
Of course, a person earning more than these amounts will benefit even more with the increase.
At the other end of the scale will be those 50,000 or so employees who are older than age 70.
They will benefit from the new requirement to have SG paid no matter what their age.
With the aging population and increased life expectancies, it can only be expected that the number of people over age 70 being provided with SG will increase significantly.
In contrast to the increase in the SG, the co-contribution has had more of a chequered history.
It started out from an encouraging base, with the Government matching a person’s non-concessional superannuation contributions at the rate of $1.50 for each $1 up to a maximum of $1,500. Other factors for qualification depended on the person’s occupation and income level. In one year, the co-contribution was doubled.
However, over recent years the co-contribution has been reduced, thresholds frozen, and the current proposal suggests further reduction.
The recently announced proposal to reduce the amount of the co-contribution to 50 cents for each $1 of after tax contributions from 1 July 2012 will reduce the amount accumulating for retirement.
In addition, qualifying for the co-contribution is also impacted by the reduction in the maximum adjusted income at which the co-contribution cuts out to $46,920.
These changes have mainly arisen due to the cost of the co-contribution system to the Government and its popularity for those who make after tax contributions to superannuation.
If we assume a person who is 25 years old is currently earning $25,000 p.a. the decease in the co-contribution would mean about $62,000 less in retirement savings at age 60 and about $87,000 less at age 65.
For someone who earns $50,000 at age 25, the difference is about $98,000 less at age 60 and nearly $140,000 by the time they reach age 65. The impact is due to the reduction in the upper adjusted income threshold from 1 July 2012.
The differences assume the person is able to make after tax contributions of $1,000 in each year and the co-contribution remains constant for the whole period. Assumptions relating to earnings, indexation and franking are the same as those for the change in the SG rate above.
If the increase in the SG rate is combined with the reduction in the co-contribution, the overall impact is that a person would be better off compared to the continuation of the current system of 9 per cent SG and a maximum co-contribution of $1,000.
However, for a person age 25 and earning $25,000 today, the break-even point where the person would be in the same position had the current system remained would not be reached until they reached age 39. For someone earning $50,000, the break-even point would occur at age 36.
What this means, is that the changes to the balance of government support for superannuation concessions and subsidies will require a greater level of non-concessional contributions made to the fund over a longer period.
By OnePath’s technical services team.
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