In theory regulatory and legislative actions in a democracy will benefit the majority of the population. In practice smaller segments of society with political clout are often able to influence regulations and legislation to their benefit. Segments of society without political clout can be overlooked. These are often the most vulnerable members of the population.

I’ve taken an in-depth look at one of these case studies in Dollarmites. It is a great example where regulatory decisions were introduced too late to protect consumers. A company was able to influence and market to children which created substandard outcomes for many Australians.

I believe there are some places where our system is failing the vulnerable as it relates to super tax policy. The whole point of the marginal tax rate is to lead to a more equitable society. However, we see that there are several parts of the system that leave the most vulnerable out in the cold. The impact, although in many cases, may seem minor, result in long-term impacts that reduce their quality of life meaningfully. Whether this be through a reduction in retirement outcomes, or at some of the most vulnerable times of their life.

I look at some of these areas where we are waiting for government policy to catch up, or progress in its ability to reduce inequality. There is little, in many of these situations, that those impacted can do to advocate for themselves and reduce the inequality that the system imposes. However, there are some options for them to consider until regulation catches up. It often means that the financial decisions that you make may differ from the generally accepted advice that applies to most people.

Ultimately, one of the best things that you can do is investing in yourself. Understanding your situation and making informed decisions about your financial circumstances will ensure that you maximise your outcomes based on your circumstances. It starts with investing in yourself through financial education. There are many free resources now, including Morningstar’s, that are looking to help with this gap.

Tax reform forgetting 10% of the population

We recently saw the implementation of the Stage 3 tax cuts, which simplified the marginal tax rates and attempted to reset bracket creep. Its implementation, however, has inadvertently increased a significant gap in equity where the superannuation and tax systems converge.

The intention of the tax cut was to address bracket creep through wage growth. For instance, people making up to $45,000 had their marginal tax rate drop from 19% to 16%. While tax rates were lowered the threshold for the Low-Income Superannuation Tax Offset (LISTO) remains unchanged. This limit has not been updated to align with rising wages, or the taxation rates of individuals.

An individual that makes $45,000 a year would pay a 10.80% effective tax rate. That is, except for money contributed to super which would face a 15% tax rate. Individuals earning more than $37,000 do not have access to LISTO, a mechanism that is designed to offset tax on superannuation contributions for low-income earners. For the 10% of the population that makes more than $37,000 and less than $45,000 there is no incentive to contribute to super.

This is where Australia’s tax system is somewhat unique. There are no automatic resets of tax rates due to rising incomes and inflation. This isn’t the case in most countries. Changes have to be legislated and result in budget impacts and political considerations. That makes it easy to ignore constituencies without political power.

Without offsets like LISTO, superannuation provides great tax relief for those on higher marginal tax rates, with those earning between $37,000 and $45,000 being left out in the cold. For many, the inability to access LISTO represents a significant missed opportunity to boost superannuation balances. It creates a larger gap between those that can save for retirement with incentives, and those that have less free cashflow and minimal incentives to save (below).

Tax rates LISTO

 

*Effective tax rate at top of tax bracket, including Medicare levy.

This incentive disparity is representative of legislation that has failed to keep pace with inflation and wage growth. There needs to be more responsiveness to low-income earners to allow them to prepare for retirement. Policymakers can start with LISTO – and removing the entrenched disadvantage.

What can individuals in this situation do? Use the Moneysmart Superannuation Optimiser. Although the general rule is that it is always good to contribute to your retirement savings, it can give you an understanding of whether there are any incentives to do so. If not, it may make your decision-making process easier about whether you voluntarily contribute extra or can explore other options such as investing outside of super, where there are no conditions of release.

A 22% tax on those that are struggling

Recently, we saw 2.5 million Australians access superannuation funds during the Morrison government’s early release stimulus package. $38 billion was drained from superannuation accounts without any strict condition of release.

Those that did access their superannuation reduced their balances by 51%. This implies that it was mostly younger Australians or those that were self-employed who accessed their super. 75% withdrew the maximum amount available to them. It was colloquially named the ‘$120,000 pizza’, referring to the fact that a large amount of the money was spent on takeaway food and it will result in, on average, $120,000 less in individuals’ accounts at retirement. Gambling was one of the largest expenditures for the funds.

However, outside of the extenuating circumstances of a pandemic, you are able to access your superannuation if you are experiencing severe financial hardship. These claims may include if you have lost your job and cannot meet your mortgage obligations. It could also mean if you are experiencing severe illness which does not allow you to work and you cannot meet your bills and living expenses. Ultimately, you must meet stringent standards to access your superannuation early and it involves an application process to your superannuation fund trustee who must make a determination about whether you are experiencing severe financial hardship.

This of course, contrasts to the loose requirements and application process for the two occurrences during the pandemic where you were able to access your superannuation. Given that it was used for non-essential spending such as take out and gambling, it was not, for the most part, accessed by those who needed it.

For those that are in severe financial hardship have to go through a stringent test and application process. Those that can prove that there is no other way for them to meet their obligations due to illness or losing their income – they are taxed a further 22% when they take their funds out.

I have looked at financial hardship claims in a past role. To gain approval to access superannuation requires extreme hardship. During one of the hardest times of their lives they are expected to pay 22%, on top of the tax that they have already paid on their superannuation funds. For many people who are in the lowest marginal tax rate, they are paying well above their usual rate of tax to access their super – as a last resort.

I do not condone accessing superannuation or allowing access for most reasons (including housing). However, I do understand that there are exceptional circumstances where people have no other place to turn. Super is the only savings to make it through this difficult time. They should not be taxed 22%, when those who did not need the funds were taxed 0%. Or, as some retirees with multi-million dollar accounts access the same pool without a donation to the ATO.

What can those Australians applying for financial hardship do? Think wisely about the amount that you access. You are going through an incredibly tough time in your life. If you are accessing your superannuation, it is likely as a last resort. You are eligible to take out $10,000 in any 12-month period if you have met the eligibility criteria. Think about whether $10,000 is needed. Understand your short-term expenses and obligations until you get back on your feet.

Taxing young Australians more, who are trying to invest for the future

In 2022-2023, there were 2.9 million Australians with a HECS/HELP debt. These are Australians who have taken out a student loan to further their education. I’ve written about HECS/HELP before. The way that this loan is structured means that repayments start when the individual starts earning over a certain threshold.

Many of these individuals hold onto this debt for years after their career starts, with the average person taking 9.5 years to pay it off after finishing their studies. This is during a period where many individuals are trying to establish their lives and secure their financial futures. I’ve written before about the difference taking your superannuation seriously early can make. The contributions that you make earlier on in life have an outsized impact on your retirement savings because it compounds over decades.

HECS/HELP is the worst of both worlds for individuals that hold it when it comes to how it is calculated. The amount owed is based on your gross pay, but it also does not reduce your gross salary when establishing your income tax liability. Adding to this, any repayments that individuals make towards their balance during the year aren’t counted towards their balance when indexation is calculated.

Further, if you choose to make voluntary contributions to your super, you still will owe HECS/HELP repayments on that amount. HECS/HELP repayments are calculated on your gross income. This means that for a decade, any voluntary contributions that these individuals are making will attract a tax debt for that financial year.

This can cause cashflow issues for many younger people who are just starting to build their lives.

This is not advocating for individuals to avoid paying their HECS/HELP debts. It is advocating for younger people establishing their lives to be treated equally. For any other individual, you do not end up with a debt to the ATO when making voluntary contributions to their retirement. For example, you do not owe the Medicare levy on the contributions that have been made to your superannuation.

What can Australians with a HECS/HELP debt do? Most people who start contributing to their superannuation early on do not realise the basis that their HECS/HELP repayment is calculated on. Ensure you have managed your cashflow if you are putting funds into super and anticipate the tax bill.

Super fees inherently disadvantaging those with smaller, and slower growing balances

Flat administration fees in superannuation disproportionately disadvantage people with lower incomes and smaller super balances, as these fees represent a larger percentage of their overall savings.

For example, the average superannuation balance for low-income earners (earning less than $37,000 annually) is approximately $25,000 (APRA). If a super fund charges a flat administration fee of $100 annually, this equates to adding 0.4% to the fees incurred. In contrast, someone with a $200,000 balance would pay just 0.05% in administration fees.

This inequity reduces the compounding growth potential for lower-income earners and can lead to a significant difference to their balance over long time horizons. Let’s take that same $100 annual administration fee on a $25,000 balance. Over 30 years, the balance would grow to $67,196 (investment return of 5%). Add a $100 administration fee, and the balance would grow to $61,825.

What can lower income Australians do? They can carefully consider funds and the total fees that they’re paying. Don’t ignore the administration fee when you’re comparing your superannuation options. Look at the fee structures and try to find the best balance between low flat administration fees, and percentage-based management fees. For many low-income earners, superannuation may not be their top financial priority. However, optimising it early can ensure that outcomes are maximised.

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