R I S
Australian Retirement Income Streams Association Limited
Tax Reform: Retirement Income Issues
ARISA is concerned that currently the proposed changes to the taxation regime for life
insurers and pension funds could impact negatively on the cash flows of around 270,000
pensioners and annuitants. This is a significant outcome for older Australians and one that
has the potential to disrupt many well established retirement plans.
Before considering the taxation regime that should apply to retirement income investments
it is worth considering first the function and role of these products in Australia’s retirement
2. What are Retirement Income Streams?
Retirement income streams are special purpose investment vehicles designed to provide
investors with a regular series of income payments and the basis for managing ongoing
income and spending patterns in retirement. With most income streams, tax instalments
are deducted from the gross payments providing investors with a familiar “take home pay”
or “salary” concept.
There are two main types of retirement income streams - pensions and annuities.
Although there is a legal difference between investing in an annuity contract with a life
insurance company or electing to receive pension payments from a superannuation fund,
from a practical viewpoint both types of income streams operate in a similar way for
3. Outstanding issues for retirees
The current taxation proposals raise a range of issues for retirees to consider, including:
what impact will the taxation of reserves have on existing and future guaranteed income
rates for both pensions and annuities?
will existing income stream contracts be affected by taxation reform? If so, what options
exist to compensate retirees?
what ‘grandfathering’ provisions exist?
what are the costs to change existing retirement plans?
what impact will taxation changes have on current cash flow needs?
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what advantage remains to invest in retirement income streams over other forms of
investment - particularly given current legislative restrictions on retirement products?
will the same pension and annuity product produce the same after tax result?
what impact will increased retirement income taxation have on market competition?
what is the impact of spending accumulated savings and relying on the age pension?
All of which suggests that without careful consideration and implementation, the taxation
reform process has the potential to inadvertently disrupt the retirement plans (ie. incomes)
of hundreds and thousands of older Australians.
4. Consumer acceptance
A measure of the consumer acceptance of Australia’s current retirement income system can
be ascertained from considering some basic market statistics.
According to the most recently published ARISA Report (data provided by Simon
Solomon & Associates, Consulting Actuaries), retirement income streams continue to grow
with total funds under management exceeding $26 Bn (as at 31 December 1998). Annual
sales were $6.8 Bn with around 72% of sales (or $4.9 Bn) coming from superannuation
As a result of the introduction of the new social security rules, there was a significant shift
by retirees into longer term retirement income streams at the expense of short term
annuities and pensions over the December quarter. This is in direct response to the new
rules which can provide a more generous social security outcome for retirees who are
prepared to invest in a longer term income.
Sales of guaranteed lifetime and fixed term retirement income stream products, which do
not provide for a return of capital at the end of a fixed term or on death, represented around
23% of total sales for the quarter. An estimated $320 million was invested in guaranteed
lifetime and 15 year plus income streams for the quarter, representing around 15% of total
Although early days, this data highlights the impact that government policy can have on the
market by encouraging more retirees to use their accumulated retirement capital for income
generating purposes rather than simply taking lump sum benefits in cash. This
observation is reflected in recent comments by Senator Newman in the 1999 Federal
Budget Paper titled "Delivering on Our Commitments to Women", where she states: "The
Government.....has improved the Age Pension means test to encourage the takeup of
retirement income streams."
5. Issues with Tax Reform
Although a major component of tax reform is simplifying existing taxation arrangements
with a view to making them more consistent and equitable, it is important to balance this
against macro retirement income policy objectives in general. This means ensuring that
taxation reform continues to support the genuine self-provision of income in retirement as
part of an integrated retirement policy. This issue is of increasing importance for Australia
with an ageing population and burgeoning unfunded public sector liability.
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Superannuation has been the subject of constant policy change since 1983, with a major
element involving changing taxation arrangements (eg. earnings tax, lump sum tax, RBLs
and surcharge tax). Given the long term nature of retirement savings plans, frequent
changes to the rules unsettles investors and raises concerns over the ongoing viability of
previous savings decisions. Adverse taxation changes to retirement income policy
telegraphs a negative retirement savings message to both current and potential retirees.
In delivering a new taxation system care must be taken to minimise the impact on retirees -
many of whom have existing long term investment arrangements in place and are unable to
rearrange their affairs accordingly.
6. Assessment of potential impact
ARISA is concerned that overall the proposed changes create an increase in the taxation
liabilities of superannuation funds and life insurers with respect to their pension and
annuity business. Ultimately, an increase in the taxation of the provider of the income
stream will lead to lower income stream payments to retirees, or in the case of allocated
retirement income streams, a reduction in the capital value of retirees’ investments.
In particular, ARISA is concerned as to how the new measures will apply to all existing
pension and annuity business, much of which has been priced on the assumption of zero
fund tax rates for long periods into the future. This issue is particularly relevant where
long term products have already been priced and accepted by customers on the basis of
current taxation rules (eg. long dated fixed term and lifetime contracts; ref: Appendix C).
The recent positive changes made to the social security treatment of retirement income
streams (from 20 September 1998) are designed to encourage more Australians to consider
long term products based around life expectancy products that must also be
non-commutable (ie. not able to be cashed) and usually guaranteed. Accordingly, any
adverse taxation changes here risk undermining an otherwise positive government policy
initiative for retirees with a corresponding increase in government pension outlays (due to
lower private retirement incomes). The lower the income generated, the higher the
potential age pension liability.
Current tax reform proposals support the notion of applying similar taxation treatment to
similar economic activities. On this basis, there would seem to be a strong case for
keeping the current consistent taxation treatment of all pensions and annuities - given the
fundamental similarity of the two product types.
Taxing the underlying pension income of superannuation funds at 15% and the annuity
business of life companies at the company tax rate (eg. 36%) poses several problems:
similar economic activities are being taxed fundamentally differently
identical pensions and annuities will produce different outcomes for consumers
generating product bias (particularly where reserves are required to be held)
taxation discrepancies create confusion in the market aiding investor uncertainty and
undermining retirement plans
inconsistent taxation policy is in direct contrast to consistent social security policy
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Fundamentally, as a minimum there would seem to be a case for ensuring that the reserves
on annuity business are taxed effectively at no more than 15% to align this taxation
treatment with superannuation funds paying similar types of pensions.
7. Finding a solution
Introducing taxation at source on the underlying assets supporting retirement income
liabilities of both superannuation funds and life companies is a fundamental shift in
retirement income policy. In fact, it represents “double taxation” as the accumulated
retirement savings used to purchase the income streams are already tax paid funds.
Currently income stream products work (and are priced) on the assumption that earnings
are taxed in the hands of the individual when they are ultimately paid out in cash. This
means that reserves used to smooth long term income returns do not suffer any form of
‘with holding’ tax. Coupled with this is the fact that income stream investments are taxed
on a PAYE basis (generating regular tax instalment deductions), unlike any other form of
managed or ‘pooled’ investment. They are also subject to strict legislative parameters.
There is a strong argument to suggest that retirement income investments are unique
investment propositions. Unlike superannuation or other ordinary savings vehicles,
retirement income streams are designed to return regular income (plus capital) over time in
exchange for the investment of an initial capital sum. This is in direct contrast to
accumulating savings (either regularly or irregularly) to receive a lump sum value at some
future point in time.
In this way, retirement income streams can be classified as a fundamentally different type
of economic activity and lay claim to a different taxation basis to other forms of
investment. This is quite apart from any overriding policy imperative given Australia’s
To date, Australia still lacks an integrated retirement income system. This involves
consistent taxation and social security policy that encourages long term savings and the self
provision of income in retirement. Or to put it another way, integrating the taxation of
retirement savings with the determination and assessment of private retirement incomes.
In the context of business taxation reform, ARISA is concerned that the treatment of
different investment entities does not dominate the proper assessment of different
investment types (irrespective of the actual entity involved). Otherwise artificial
distinctions can easily arise between the retirement incomes offered by life insurance
companies (annuities) and public offer superannuation funds (pensions). It is vital that tax
reform reflects recent social security policy in this key aspect which ensures that both
product types are treated in exactly the same manner - irrespective of the product name.
Balancing equity and simplicity with the potential impact on existing clients is never easy
and tax reform is no exception. However, as demonstrated through the recent 1998
changes to social security policy, it is possible to achieve a workable solution through
extensive consultation and bi-partisan support.
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ARISA believes that the current taxation reform process needs to quarantine any changes to
the treatment of retirement incomes that have the potential to generate a negative impact on
older Australians - from both a cash flow and net income perspective.
The maintenance of existing retirement income policy could be achieved through retaining
the current zero tax rate on pension and annuity assets within the fund (albeit potentially
with limits on excess reserving policies). Alternatively, consideration should be given to
allowing pension and annuity funds to distribute franking credits to individual income
recipients where the fund assets are subject to any form of taxation. This would have the
effect of ensuring that those who are less able to afford increased taxation in retirement
receive the full benefit of being assessed at lower marginal tax rates.
The key principle here is that some mechanism needs to be examined to ensure that
retiree’s accumulated savings are not adversely impacted as a result of taxation reform.
8. Expanding the income offer
As part of the taxation reform process, ARISA believes there is the opportunity to review
the current range of superannuation and non-superannuation retirement products on offer.
Only two main product types currently exist; guaranteed and market linked income streams
and market linked income streams can only be purchased with an eligible termination
payment (ie. superannuation money). Given the changing demographics of the population
and the flow through of the ‘baby boomer’ effect, this limited range is inadequate to meet
consumer needs or address increased reliance on government funded benefits.
Expanding the range of income streams (and potentially providers) that can be offered
requires changes to existing legislation and government policy. ARISA believes that the
treatment of retirement incomes is sufficiently important to warrant special attention and is
concerned that given the time table for taxation reform, this places unnecessary strain on
available government and private sector resources.
ARISA recommends that a dedicated unit be established (with industry) to review the
taxation treatment of retirement incomes generally - separate to current taxation reform and
outside any other review process. This includes examining the changes that need to be
made to the existing legislative framework in order to expand the range of products
provided to consumers.
The result will be a better integrated and consistent retirement
income system that provides increased consumer choice and
appropriate encouragement for the self-provision of income in
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