The term ‘superannuation’ means ‘money which people pay regularly into a special fund so that when they retire from their job they will receive money regularly as a pension’ (Ref: Collins Dictionary).
A person ‘superannuates’ themselves by paying regularly into a superannuation fund with the objective of drawing a pension income in retirement.
Unlike some countries, Australia does not have a universal pension scheme that all Australians pay into. Instead, the Federal governments mandates that superannuation contributions are made on behalf of employees (and others) at a certain rate – known as the ‘Superannuation Guarantee Contribution (SGC)’ rate – and then allows superannuants to draw on their superannuation entitlements once they have reached their ‘preservation age’.
The Federal government does provide an Age Pension, but this is means tested with both an income test and an assets test. For more details on eligibility for the Age Pension, go to the following link.
In essence, the Australian government says to Australians ‘you are on your own’ in terms of providing for your retirement but ‘we will help you to get there’ by mandating contributions during your working life. For those that are not able to save up enough via their ‘super’ the Age Pension is a back stop to prevent older Australians from becoming impoverished.
The ‘father of superannuation’ is ex-Prime Minister, Paul Keating. Whilst superannuation had been round for decades, prior to 1992, superannuation was not compulsory. That all changed when the Keating Labor Government brought in a compulsory employer contribution scheme which was part of a wider reform package addressing Australia’s retirement income dilemma.
It had been demonstrated that Australia, along with many other Western nations, would experience a major demographic shift in the coming decades, of the aging of the population, and it was claimed that this would result in increased age pension payments that would place an unaffordable strain on the Australian economy.
Many countries have multi pillar schemes and Australia’s ‘three pillars’ are as follows:
- Compulsory employer contributions to superannuation funds.
- Further contributions to superannuation funds and other investments – i.e., non-mandatory saving and investing.
- A means tested Age Pension as a safety net in the event that Australians have not saved enough to have a ‘dignified retirement’ based on their own financial resources.
The Superannuation Guarantee (SG) was introduced at a rate of 3%, which was obviously not high enough for most employees to build up sufficient retirement savings over a 40-year working life. The rate needed to be significantly increased if retirement incomes were going to get anywhere near the levels of income employees had enjoyed whilst working.
The SG rate has continued to be increased by successive governments. The latest SG rate and future expected rates are shown at the following link.
Often employers will quote their ‘package’ as including the SG, which means the employer is then not on the hook for funding increase in the SG as they are legislated.
Whilst Paul Keating initially had a target of the SG rate being increased to 15%, he has recently abandoned the proposition.
In an Australian Financial Review article, ‘the former prime minister and ACTU secretary said their original target of 15 per cent compulsory super contributions “had run its race”, and they would no longer pursue it’.
One thing that has changed is that the returns generated by industry and retail funds have been much higher in the last decade than Keating had anticipated and he therefore now believes that a 12% SG rate will be adequate for most Australians to fund their future retirement.
Whilst this may be Keatings’ current view, he hasn’t been Prime Minister since March 1996 and is not calling the shots today (other than informally briefing the Treasurer). The fact that he thinks that the SG should be capped at 12% doesn’t mean it won’t increase in future years.
However, because superannuation is taxed at concessional rates, the government is forgoing tax revenue by allowing the SG rate to increase. The trade-off between allowing tax benefits for saving via super as against the savings that super itself provides to future governments in terms of lower Age Pension payments is a hotly debated issue.
Simple snapshot of how super works
Because there are so many rules that apply to super and the rules are seemingly ever-changing, it is hard to explain in simple terms how the system works. Nevertheless, the following diagram programs a view of the basic operation of the system:
In essence, money goes into an Accumulation account as either Concessional or Non-Concessional Contribution and the money then accumulates over time. The tax rates that apply during the Accumulation phase are 15% on income and 10% on capital gains. When you switch to the Pension phase (not a Transition to Retirement Pension) you no longer have to pay tax on the income generated in the Pension account or any capital gains realised. There is also no tax on pension payments.
Of course, there are limits as to how much you can contribute to super, so your tax-free pension will effectively be capped.
Once you go into the Pension phase, you must draw pension payments out each year based on the minimum drawdown rates mentioned above. These have been discounted in past years when the Federal government felt generous and allowed more money to stay in super accounts should the pensioner not need to draw the full amount.
You can see that the minimum pension drawdowns ramp up a lot from age 80 and this is because the Federal government wants superannuants to use up their retirement savings in retirement, and yet most Australians don’t. A recent Sydney Morning Herald article indicated that one quarter of retirees will die with their super intact.
Most retirees would see this as a positive thing – at least many retirees are not running out of money!
How can super benefit expats?
From an expat’s point of view, if you are intending to retire to Australia you should find out about how super can benefit you. If SG contributions are not being made on your behalf for the time you are working overseas, you have to consider how to ‘catch up’ and to make up for lost time. This is possible by making a combination of Concessional and Non-Concessional Contributions at an accelerated rate after returning Australia.
If you are not intending to retire to Australia, you may be interested in how to get money out of the super system in the most tax effective way.
In both cases, you should seek advice from a suitably qualified Australian financial adviser.