In this episode, we look at the places where our system is failing some Aussies as it relates to super tax policy. We offer some guidance about what they can do until the system catches up.

Shani's article on this topic can be found here. You can also find the HECS/HELP article mentioned during the podcast here.

Listen on:

 

Get more of Morningstar's articles in your inbox

 

Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Mark LaMonica: Okay. Before we get into today's episode, we do have an announcement, actually two announcements. One will be embarrassing for you, Shani. And then one...

Jayamanne: The other one is embarrassing for you?

LaMonica: No.

Jayamanne: Okay.

LaMonica: None of this is embarrassing to me. The first one is you got promoted. And I know this happens constantly, but would you like to talk a little bit about your promotion or would you like me just to go through it?

Jayamanne: I think you can go through it. I wouldn’t know what to say.

LaMonica: Well, you got promoted and it's exciting and it's very well deserved. And you are now a director. You put it on LinkedIn and like 140 people commented, which is more than would comment if they put my death announcement on LinkedIn, which was exciting.

Jayamanne: But people wouldn't like it.

LaMonica: I mean, who knows? And you replied to every one of them, which is very nice. So anyway, a big congratulations. I'm sure everyone listening shares that with me. The other announcement, which is not embarrassing for anybody at this point, is people might have noticed that despite Shani telling me I have a face for radio, we have been filming these things and putting them on YouTube. And one of the nice things about YouTube is you can put a comment in there. Also, if you listen on Spotify, you can also put a comment or question in there. And of course, we always share my email address. So if you have any questions or comments, you can email me and we're going to start doing more questions during the podcast. So whether you're watching on YouTube, whether you're on Spotify, whether you want to email me, we'll answer the question. And we thought that would be a good way to make this more interactive.

Jayamanne: Sounds good.

LaMonica: All right. So we're out of announcements.

Jayamanne: Send them in.

LaMonica: Yes, send them in or comment away. And you can comment on Shani's promotion and how exciting it is. I'm excited.

Jayamanne: I'm excited too.

LaMonica: But of course, I've known about it for a week and a half. But anyway, let's get started. Tell us about today's episode.

Jayamanne: Okay. So we're doing a little bit of a different episode today. Normally, we focus on investing. But today, we're going to speak a little bit more about the system that governs it.

LaMonica: Okay. And I think they're still related. Specifically, we're going to talk about super. So obviously, a good topic for everyone since most people have super. And we're going to talk about the gaps that we see in the super system that make it unfair on some Australians, specifically Australians on lower incomes. And we're going to talk about how we think that this makes a really big impact on their quality of life.

Jayamanne: Yeah. And I think that's a very fair point to make. There's plenty of policies on high income earners that might seem unjust as well. But the impact on quality of life is much more severe when we look at the long-term impacts of these gaps.

LaMonica: And we're not going to do, although frankly, Shani considered this, we're not going to do like a one-hour Shani rant on legislation. We, of course, have, there's nothing we can do other than vote in terms of changing policy. So what we're going to do is we're going to actually provide guidance on how you can improve your situation if you fall into one of these groups, given the constraints from the regulatory and legislative environment.

Jayamanne: And I think an important point to note here is that when we're looking at these groups, it isn't just surface level. It isn't just low-income Aussies. It could be all of us or any of us. It could be people that take time off work for caring responsibilities. It could be many of us that leave university with student debt and carry it for about a decade on average. It could also be us when we've fallen into unfortunate circumstances, which none of us can predict and need to claim financial hardship.

LaMonica: And ultimately, in theory, regulatory and legislative actions and a democracy will benefit the majority of the population. But of course, what we see in practice is that smaller segments of society that do have political clout are often able to influence regulations and legislation to their benefit. So that, of course, means segments of society without political clout can be overlooked. And these are often the most vulnerable parts of society. And that's really what we're going to look at today in relation to super tax policy.

Jayamanne: And I think important what they can do until legislation and the regulatory changes do catch up. And often this means that the financial decisions that these people do make are generally different from the generally accepted advice that applies to most people.

LaMonica: That's very optimistic of you to say, until it catches up.

Jayamanne: You hope. You've always got to have hope.

LaMonica: That is important. So we do say all the time on this podcast, but one of the best things that you can do is, of course, invest in yourself. And you need to understand your situation and make informed decisions about your financial circumstances, because that will mean you're able to maximize the outcome you're able to achieve. So starts with investing yourself through financial education. You're doing a great job already if you're listening to the podcast. So A plus there or whatever you guys do in Australia, high distinction.

Jayamanne: We get HDs, mate.

LaMonica: Well, if I was in Australia either way, just like I didn't get A pluses in the U.S., I would not have gotten HDs here.

Jayamanne: Well, they say P's make degrees.

LaMonica: I don't know what P, pass.

Jayamanne: Pass, yeah.

LaMonica: I occasionally pass things. Sometimes not so much.

Jayamanne: So why don't we get to it? Okay. First is that tax reform is (forgetting) about 10% of the population.

LaMonica: Okay. So as everyone or as most people are probably aware, we recently saw the implementation of the Stage 3 tax cuts. And basically what that did is that simplified the marginal tax rates and it attempted to reset bracket creep. So its implementation, however, has inadvertently increased a significant gap in fairness where the superannuation and tax systems converge.

Jayamanne: So 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 dropped from 19% to 16%. While tax rates were lowered, the threshold for the low income superannuation tax offset, which a lot of people call LISTO.

LaMonica: A lot of people or just you.

Jayamanne: Just people that are on the ATO website browsing through tax.

LaMonica: So mostly just you.

Jayamanne: So LISTO remains unchanged.

LaMonica: And LISTO for those who do not know is a mechanism that is designed to offset tax and superannuation contributions for low income earners. This limit has not been updated to align with rising wages or the changing taxation rates on individuals.

Jayamanne: And individuals that make $45,000 a year would pay a 10.8% 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. So for the 10% of the population, that makes more than $37,000 and less than $45,000. There's no incentive to contribute to super.

LaMonica: But of course, you have to do it.

Jayamanne: Yes.

LaMonica: Which is the problem. So this is a situation where, as the token American on the podcast, where Australia's tax system is somewhat unique. So there are no automatic resets of tax rates due to rising incomes and inflation. And this isn't the case in most countries, probably as you can guess, it's not the case in the U.S., which is why I'm saying this. So in Australia, instead of those automatic changes in tax brackets, you have to go and any change has to go through legislation. And then of course, with all legislation, everyone discusses the budget impacts, and there are political considerations to make. And so it does make it easy, of course, to ignore constituencies without political power.

Jayamanne: So I think without offsets like LISTO, superannuation provides great tax relief for those on high marginal tax rates with those earning between $37,000 and $45,000 being left out in the cold. And for many, the inability to access LISTO represents a significant missed opportunity to boost those superannuation balances. And it creates a larger gap between those who can save for retirement with incentives and those who have less free cash flow and minimal incentives to save.

LaMonica: And unsurprisingly, Shani wrote an article on this. So we will put a link to that article in the notes for this podcast, we're doing a podcast, right?

Jayamanne: And a video at the same time.

LaMonica: There you go. And it does have some tables and graphs that Shani slaved over to put in there. So check that out.

Jayamanne: So the incentive disparity is really representative of the fact that legislation has failed to keep pace with inflation and with wage growth. And there needs to be more responsiveness to low income earners to allow them to prepare for retirement. And we think that policymakers can start with LISTO and remove that entrenched disadvantage. But today, we're talking to you and not to policymakers.

LaMonica: Right. So what can individuals actually do? Well, one of Shani's favorite things to do is go to the Moneysmart Superannuation Optimizer. So the general rule is that it's always good to contribute to your retirement savings. It can give you an understanding of whether there are any incentives to do so, this tool in Moneysmart. So if not, it may make your decision making process easier about whether you voluntarily contribute extra or you can explore other options such as investing outside of super where there are no conditions of release.

William Ton: I'm Will, producer of Investing Compass. And each week, I'll be bringing you some highlighted articles on Morningstar.com.au. Resilience can't compete with the popular portrayal of successful investors who stare down risk and are rewarded with mountains of cash. What is lost in this inaccurate portrayal is the impact of randomness on results. Mark's Unconventional Wisdom column goes through how to build resilience into portfolios and why that is important for investors. Shani's Future Focus column outlines the reason why she doesn't hold cash. It ties in with reducing complexity in her portfolio, but she also runs through volatility, tactical allocations and inflation.

As well as being a successful writer, Richard Koch is known for turning an early stage investment in Betfair into a nine figure amount. In the latest edition of Bookworm, Joseph sees if Koch's star principle for investors, employees and entrepreneurs can be applied to finding promising companies in the stock market. Sim takes a deep dive into the value of university. As we head into the federal election this year, the rising cost of education and levels of student debt form a key battleground topic for voters. A sinking number of domestic enrolments indicates individuals are now thinking twice before jumping into the higher education system, which begs the question, is going to uni still worth it? Links to these articles are available in the episode notes. Now it's back to Mark and Shani.

Jayamanne: All right, should we move on to the next gap?

LaMonica: Let's do it.

Jayamanne: Okay. So the next gap we're going to talk about is a 22% tax on those that are struggling.

LaMonica: So recently, we saw, and not so recently anymore. I mean, this was like five years ago at this point, but 2.5 million Australians accessed their superannuation funds during the Morrison government's early release stimulus package. $38 billion was taken out from superannuation because there were no conditions of release, basically.

Jayamanne: Yeah, it wasn't strict at all. And you could just kind of reach in and grab what you want.

LaMonica: Sounds great.

Jayamanne: Those that did access their superannuation reduced their balances by 51%. And this implies that it was mostly younger Australians or those that were self-employed who accessed their super because they don't have to contribute that mandatory amount to their super like those with employees do. 75% withdrew the maximum amount available to them. And it was colloquially named the $120,000 pizza. And that refers to the fact that a large amount of the money was spent on takeaway food and it will, on average, result in $120,000 less in individuals' accounts at retirement. And again, takeaway food was part of that expenditure, but also gambling. Gambling was one of the largest expenditures for the funds.

LaMonica: I mean, I think one of the sad things is that this occurred in a country with such low-quality pizza.

Jayamanne: You don't know. They used pizza as the example, but you don't know.

LaMonica: I know. I just hope they ordered something else. But yeah, gambling and pizza.

Jayamanne: The $120,000 burger. You don't like our burgers either, apart from the Gidley one.

LaMonica: Yes, I'm very judgmental. But yeah, anyway, gambling and pizza sounds kind of fun, but not a good use of superannuation funds. So outside of the pandemic, you are able to access your super if you are experiencing severe financial hardship. So these claims may include losing your job and you can't meet your mortgage obligations. It could mean that you're experiencing severe illness, which does not allow you to work and you can't pay your bills and living expenses. But you ultimately have to go through these very strict standards in order to access your super early. And you have to go through this application process, it goes through your superannuation fund trustee. And they have to make a determination about whether you are experiencing severe financial hardship.

Jayamanne: And this of course contrasts to the loose requirements that we spoke about. And the application process for the two occurrences during the pandemic where you were able to access superannuation. And given that it was used for non-essential spending such as takeout and gambling, it was not for the most part accessed by those who actually needed it.

LaMonica: Okay, so if you are in severe financial hardship, you go through this strict testing and application process. And if you of course get accepted, then guess what happens? You're taxed 22% of what you take out.

Jayamanne: And I've in a past role had to look at financial hardship claims and submit them to superannuation trustees.

LaMonica: Did you reject them all?

Jayamanne: It wasn't my job to reject them. I just had to make sure everything was there. There's a lot of paperwork you need.

LaMonica: Okay, that must have been good for you since you are very organized.

Jayamanne: And to gain approval to access superannuation requires extreme hardship. And during one of the hardest times of these people's lives, they're expected to pay 22% on top of the tax that they've already paid for their superannuation funds. And for many people who are in the lowest marginal tax rate, they're paying well above their usual rate of tax to access their super as a last resort.

LaMonica: Yeah, 37% if you want to add up that 15 and 22.

Jayamanne: But I think Mark and I are kind of on the same page here. We don't condone accessing your superannuation or allowing access for most reasons, including housing. We think it's purely for your retirement. But we do understand that there are exceptional circumstances where people really have no place to turn other than their super. And super is the only savings that they have to make it through a really difficult time. And they shouldn't be taxed 22% when those that did not need the funds were taxed 0%. Or as some retirees with multimillion-dollar accounts access the same pool without a donation to the ATO.

LaMonica: Okay. But we're going to be positive and we're going to come up with stuff that you can do if you find yourself in the situation, right? So, what can you do if you are going through financial hardship? Well, I think first thing is be very, very careful and thoughtful about the amount that you access. So, you're obviously going through an incredibly tough time in your life. If you are accessing super, it's probably a last resort. So, you're eligible to take out $10,000 in any 12-month period if you have met this eligibility criteria. So, think about whether $10,000 is needed. Understand your short-term expenses and obligations until you can get back on your feet.

Jayamanne: All right. Next one. Taxing young Aussies. I feel like this is going to get some chins wagging.

LaMonica: Chins wagging? I take it I do not count as a young Aussie.

Jayamanne: You're a young Aussie.

LaMonica: Are you a young Aussie?

Jayamanne: I don't think so, not anymore.

LaMonica: Shani's about to turn 32 in what, a little over a month at this point. All right. So, let's talk about these young Aussies, which apparently only includes me and not Shani. I'm young because I've only been in the country 10 years and I've only been an Australian for five years. So, how about that? All right. In 2022 and 2023, there were 2.9 million Australians with HECS or HELP debt. These are Australians who have taken out, of course, a student loan to further their education. Shani's written on HECS-HELP before and when it should be paid off outside of the general advice of its best loan you'll ever get, just kind of let it go. So, we'll put a link in the bio. This is like Shani's episode. So, all these links to all of her articles, we'll put a link to that one in the bio too. So, the way that the loan is structured means that repayments start when the individual starts earning over a certain threshold.

Jayamanne: And 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. We did a podcast on why you need to take your super seriously early and it can really make a difference. The contributions that you make earlier on in your life have an outsized impact on your retirement savings because it compounds over decades.

LaMonica: So, HECS-HELP is the worst of both worlds for individuals that hold it when it comes to how it's 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 the balance when the indexation is calculated.

Jayamanne: Further, if you choose to make voluntary contributions to your super, you will still owe HECS-HELP repayments on that amount. HECS-HELP repayments are calculated on your gross income. So, that means for a decade, any voluntary contributions that you make to your superannuation will attract a tax debt for that financial year.

LaMonica: And this can cause cash flow issues for many younger people who are starting to build their lives. So, this is of course not advocating for individuals to avoid paying their HECS-HELP debts. It's 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 retirement. For example, do you do not owe the Medicare levy on the contributions that have been made to your superannuation?

Jayamanne: So, what can Aussies with a HECS-HELP debt do? And it's not much, unfortunately.

LaMonica: Wow, this is great advice. So, you've outlined the problem and then said you're just stuck with it.

Jayamanne: Yes, exactly. But what you can do is you can properly plan to avoid tax bill shock. So, most people who start contributing to their super early don't realize the basis that their HECS-HELP repayment is calculated on. So, ensuring that you've managed your cash flow means that you're able to put funds into super and anticipate the tax bill.

LaMonica: Okay, we're on the last of Shani's rants.

Jayamanne: Have any of these been rants?

LaMonica: No, you've said it all very calmly. But I know you're angry about it because I remember you writing the article and you were very fired up. All right. So, last one. And this is more to do with the industry than it does with legislation or policy. And that is that super fees inherently disadvantage those with smaller and slower growing balances.

Jayamanne: So, flat admin fees in superannuation disproportionately disadvantage people on lower incomes and smaller superannuation balances because these fees represent a larger percentage of their overall savings. And it's really simple math, but let's go through it.

LaMonica: Simple math. So, she assigns it to me. The average superannuation balance for low income earners earning less than $37,000 annually is approximately $25,000 according to APRA. The 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 admin fees. So, this inequity reduces the compounding growth potential for lower income earners and can lead to a significant difference in their balance over long time horizons. So, let's take that same $100 annual admin fee on a $25,000 balance over 30 years. The balance would grow to $67,196 if you got an investment return of 5% a year. You add that $100 administration fee and the balance would only be $61,825. And I'll do some extra math for you there, but that's about 10% less.

Jayamanne: That's a lot.

LaMonica: It is a lot.

Jayamanne: So, what can lower income Aussies do? They can carefully consider funds and the total fees that they're paying. So, don't ignore those admin fees. I know that sometimes it just seems like a dollar a week or a dollar 50 a week, which is the industry average for industry super funds, but it does add up over time. And look at the fee structures and try to find the best balance between low flat admin fees and percentage-based management fees. For many lower income earners, superannuation may not be their top financial priority, but optimizing it early can ensure that the outcomes are maximized.

LaMonica: All right. So, newly promoted Shani has gotten a lot off of her chest. Are you feeling better about things now? A little bit, yeah. Okay. Well, that's good. And thank you guys very much for listening. As we said, comments, questions, show suggestions, put them in Spotify, put them on our YouTube channel, put them in an email to me, and we will spend some time answering some of those questions.

Jayamanne: Wecan be contacted in a lot of ways.

LaMonica: None of these ways contact you. I can be contacted in a lot of ways. But anyway, thank you guys very much for listening.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)