The major changes to superannuation contribution rules set to start on July 1, 2017, dramatically reduce the value of generous employer super schemes to middle- and higher-income members. Limiting the annual maximum tax-deductible contribution to $25,000 removes all the tax advantages of employer super contributions once employer contributions exceed this amount.
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All super contributions are now tied up and untouchable until at least age 56 or later retirement. Excess employer super contributions will thus be of no benefit to employees especially those with mortgage and family commitments. Higher-income members of accumulation funds will as a result need to ensure that their employers recognise this fact.
Furthermore, such a low contribution cap virtually signals the death knell of defined benefit schemes with high actual or notional employer contributions. For example, the employer contribution to the UniSuper defined benefit fund is currently 17 per cent of salary, with employees contributing 7 per cent of salary.
The arithmetic is simple. Once annual salaries exceed about $150,000, employer contributions will exceed the $25,000 cap and trigger annual penalty tax bills. Vice-chancellors with annual salaries over $500,000 will, when the present exemption of defined benefit members from the penalty tax regime is removed, face annual penalty tax bills of at least $20,000 annually.
Unlike the Commonwealth's defined benefit funds, which have been closed to new members, UniSuper still accepts new members and prevents existing members from exiting the scheme after 24 months' membership. Given that the universities no longer guarantee the payment of the defined benefits, the budget changes when implemented will further reduce the attractions for higher-income employees of continuing membership of this fund.
While similarly affected by the changes, federal defined benefit fund members may still benefit from paying penalty tax bills to stay in the fund for several reasons. Even after paying any penalty tax, the employer-provided benefits of lifetime indexed pensions based on 1922 mortality factors are highly attractive in today's low interest rate environment.
Unlike private sector annuities, the pension payments are also exempt from the age pension assets test and guaranteed by the government. At a personal level, defined benefit fund members will need to evaluate whether paying penalty tax bills provides tangible benefits.
In the future, accumulation or defined contribution fund members will be able to avoid penalty tax bills if their employer caps the employer contribution at $25,000 annually. Employers will be able to facilitate this by incorporating existing employer contributions into a total remuneration package and then allow employees to choose either the current compulsory super contribution or up to $25,000 annually.
This strategy is already used by employers wanting to meet their super obligations and give employees maximum flexibility.
Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au
