BILLS DIGEST NO. 133, 2014–15              24 June 2015

Social Services Legislation Amendment (Defined Benefit Income Streams) Bill 2015

Michael Klapdor
Social Policy Section 

Date introduced: 23 June 2015

House:  House of Representatives

Portfolio: Social Services

Commencement:  Schedule 1 on 1 January 2016 and remaining sections on Royal Assent.

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website.

Purpose and history of the Bill

The Social Services Legislation Amendment (Defined Benefit Income Streams) Bill 2015 (the Bill) will amend the Social Security Act 1991 (the SS Act) to place a cap on the amount of income from certain defined benefit superannuation schemes that can be excluded from the social security income test. From 1 January 2016 the amount that can be excluded, known as the ‘deductible amount’, will be capped at ten per cent of the gross amount payable from the defined benefit scheme in that year. Those who receive income streams from military superannuation defined benefit schemes will not be subject to the proposed cap.

The Bill’s provisions were previously contained in Schedule 1 of the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015 (the previous Bill) introduced into the Parliament on 4 June 2015.[1] On 22 June 2015, the Government moved amendments in the House of Representatives to remove Schedules 1, 2, 4, 5 and 6 from the previous Bill in order to facilitate passage of Schedule 3 (which made changes to the social security assets test).[2] The previous Bill, as amended, was passed by both Houses on 22 June 2015.

The Bill reintroduces the provisions contained in Schedule 1 of the previous Bill. The Supplementary Explanatory Memorandum to the previous Bill states that the Schedules that were removed ‘will be reintroduced in [a] separate Bill in due course’.[3] Schedule 4 of the previous Bill contained provisions similar to a Bill that was already before the Senate, the Social Services and Other Legislation Amendment (Seniors Supplement Cessation) Bill 2014 (the Seniors Supplement Bill).[4] The Seniors Supplement Bill was also amended (primarily to change the commencement date) and passed by both Houses on 22 June 2015.[5] At the time of writing, no legislation containing Schedules 2, 5 and 6 of the previous Bill has been introduced.

Committee consideration

At the time of writing, the Bill has not been referred to any committees.

Policy position of non-government parties/independents

The Labor Opposition has stated that it would support the changes to the income test treatment of certain defined benefit schemes, as proposed by the Bill.[6] The Greens have previously stated that they were still considering the measure (as it was presented in the previous Bill).[7] The position of crossbench Senators on this particular measure is unclear.

Position of major interest groups

The Australian Council of Social Services and the National Welfare Rights Network have stated that they support the changes.[8]

The Australian Council of Public Sector Retiree Organisations Inc. and the Tasmanian Association of State Superannuants have suggested the measure may be unfair on those who made decisions based on the existing or previous income test arrangements and that existing defined benefit income stream recipients should be grandfathered.[9] The Combined Pensioners and Superannuants Association also expressed a concern that those affected made retirement decisions under the current rules and may be unable to reverse those decisions.[10]

The Police Federation of Australia called for police in defined benefit schemes to be made exempt from the measure.[11]

UniSuper submitted that the measure will have unintended impacts, particularly on members of non-public sector defined benefit schemes, and suggested a cap of at least 35 per cent (rather than the proposed ten per cent cap).[12]

Financial implications

The Explanatory Memorandum to the Bill states that the measure will provide a budget saving of $465.5 million over the forward estimates.[13]

Statement of Compatibility with Human Rights

As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible because the amendments ‘do not limit access to social security’.[14]

Background

Defined benefit superannuation schemes are those which pay a set benefit, determined by a formula based on an employee’s earning history, years of service and their age.[15] The benefit is usually a multiple of the employee’s annual salary or average final salary (over the last three years for example) with full benefits payable only to those with a considerable length of service. The formula may also account for employer or employee contributions to the superannuation fund. Defined benefit funds are primarily public sector or large corporate funds and most are now closed to new members.[16] For these types of funds, the employer or the fund generally takes on the investment risk because the benefits owed to members are not linked to the investment performance of the fund. This sets defined benefit schemes apart from the other, more common type of superannuation scheme: accumulation funds. Benefits paid from accumulation funds are usually based on contributions (from both employers and employees) as well as amounts the fund earns from investing these contribution amounts. For accumulation funds, it is the members that bear the investment risk as their benefits upon retirement can be affected by any investment profits or losses.[17]

Superannuation income streams and the pension means test

Social security payments are means tested to ensure they are only provided to those that do not have adequate means to support themselves. The Age Pension means testing regime attempts to calculate an individual or couple’s ability to support themselves in retirement via tests on both income and assets. Income or assets over certain threshold values can either reduce a person’s pension payment rate or preclude them from receiving a pension at all.

The assessment of superannuation income and assets is complex with different tests applying to different types of superannuation schemes and depending on when a person started to draw income from their superannuation fund. For accumulation funds, which are primarily ‘account-based’, both the income and assets test will be applied and whichever results in the lower pension rate will be used.[18] The invested capital in this type of superannuation scheme (the account balance) is assessed under the assets test. The income test for account-based superannuation schemes assesses a deemed rate of income from the account balance (regardless of the actual income drawn down).[19] Prior to 1 January 2015, a different income test applied and pensioners who were in receipt of an account-based superannuation income stream prior to this date still have their income assessed under the old rules.[20] Because income from account-based superannuation schemes generally includes a part of the invested capital (not just the earnings on the investment) the old income test rules deduct from the income stream an amount which represents the ‘return of capital’ or a return of the purchase price of the product.[21] This was to ensure that the income test only assesses income earned from the asset. However, the way this return of capital is calculated often results in little or no income being assessed for these products as it falls under the relevant income test threshold.[22] This was the reason why the new deemed income method was applied to account-based superannuation products purchased from 1 January 2015.

Defined benefit superannuation schemes are treated differently from account-based schemes under the social security means test. Most defined benefit schemes are exempt from asset testing—this is because the income streams derived from such schemes are not attached to any specific capital value (as with account-based schemes) and people receiving defined benefits are unable to access the capital funding the income stream.[23] The income test applied to defined benefit income streams is also different—from 1 July 2007, it assesses the annual payment from the scheme minus a deductible amount. The ‘deductible amount’ is intended to represent the amount of after-tax contributions provided directly by the member of a defined benefit scheme. The deductible amount is a proportion of the superannuation interest which gives rise to the income stream—it is the proportion that the sum of all the tax-free components of the superannuation interest comprises of the total interest.[24] So if the sum of these components equals 15 per cent of the defined benefit interest, then 15 per cent of the person’s annual payment is excluded from the social security income test. Some income support recipients who started receiving their defined benefit income stream prior to 1 July 2007 have their deductible amount worked out under different rules if it results in a higher deductible amount than the sum of the tax-free components. These rules calculate the deductible amount based on the ‘undeducted purchase price’ of the benefit, or the tax definition that applied during the period between 1998 and 1 July 2007.[25]

2007 tax changes created income test anomaly

In the 2006–07 Budget, the Howard Government introduced the Simpler Super package of reforms which included some changes to the social security assets test and indirect changes to the way income from certain superannuation schemes was assessed under the income test due to changes to the tax assessment of these schemes.[26] Some of the reforms were aimed at equalising the tax treatment of different superannuation schemes—significant differences had arisen in the after-tax value of defined benefit income streams considered taxed-source (where tax had been paid on contributions and fund earnings since 1988) and untaxed-source (where tax had not been paid on contributions and/or fund earnings).[27] The Simpler Super reforms made the tax treatment of income streams from these different defined benefit schemes more equal but in doing so provided an indirect benefit to those in receipt of income from taxed-sourced defined benefit income streams. To recognise the tax paid by taxed-source schemes, the Simpler Super reforms saw taxed-source pensions assigned a tax-free component, the ‘pre-1 July 1983 component’, that would be included in the ‘deductible amount’ that is excluded from the Age Pension income test.[28] The pre-1 July 1983 component is the proportion of the person’s benefit equal to the proportion of the member’s pre-1 July 1983 service out of their total eligible service period. The Department of Social Services (DSS) explains that the design of this component meant the pension income test was skewed in favour of those with taxed-source income streams (compared to other superannuants):

-          The change in the calculation of the deductible amount resulted in people with service prior to 30 June 1983 having a significant amount of up front employer contributions treated as personal after-tax contributions.

-          This higher deductible amount was also changed from a fixed amount to a percentage of annual income, which meant it increased as income stream payments increased.

-          Together these changes resulted in a higher deductible amount, and consequently higher income support payments, even though nothing had changed for the defined benefit recipient in terms of their contribution. For example, as at 30 June 2006, only 2.6 per cent of income support recipients had a deductible amount greater than 10 percent.[29]

Impact of the anomaly

The effect of the 2007 changes has been that some defined benefit income stream recipients receive a concessional treatment of their income under the pension income test. DSS states that there are currently around 140,000 income support payment recipients with defined benefit income streams.[30] Around 55 per cent of this group have no deductible amount and around ten per cent have a deductible amount less than ten per cent of their superannuation benefit.[31] Around 35 per cent have a deductible amount of ten per cent or more, meaning they will be affected by the proposed limit on the deductible amount (ten per cent).[32] Of those affected, around 20 per cent receive an income stream from a Federal Government scheme, 75 per cent are part of a state or local government scheme and around five per cent are part of corporate defined benefit schemes.[33]

The Minister for Social Services, Scott Morrison, described the anomaly as a loophole that was ‘allowing 48,000 superannuants on higher incomes … to effectively fly under the radar on the income test for the pension’.[34] Articles in News Ltd. newspapers described those with deductible amounts over ten per cent as ‘wealthy fat-cats’ and ‘public servant fat cats’.[35] In explaining the rationale for the measure the Minister gave an example of a couple with a defined benefit income stream of $120,000 who had 50 per cent of this income excluded from the pension income test (meaning they would also qualify for a part-pension of $7,500 per year).[36] However, figures provided by DSS at Budget estimates hearings indicate that only a small number of the affected group had income streams of this magnitude—around 60 per cent had annual defined benefit income streams less than $30,000:

Table 1: Affected income support recipients’ income from their defined benefit income stream

Income range

Number in the income range

Less than $5,000

2,517

$5,000–$10,000

4,295

$10,000–$15,000

4,888

$15,000–$20,000

5,198

$20,000–$25,000

5,810

$25,000– $30,000

5,585

$30,000– $35,000

4,271

$35,000–$40,000

3,776

$40,000–$45,000

3,507

$45,000–$50,000

2,795

$50,000–$55,000

1,651

$55,000–$60,000

1,227

$60,000–$65,000

662

$65,000–$70,000

415

$70,000–$75,000

170

$75,000–$80,000

95

Over $80,000

120

Total

46,982

Source: Senate Community Affairs Legislation Committee, Official committee Hansard, [proof copy], 4 June 2015, p. 105, accessed 16 June 2015.

Key issues and provisions

The provisions in Schedule 1 of the Bill will limit the deductible amount an individual in receipt of a defined benefit income stream can exclude from the social security income test assessment to ten per cent of the amount payable under the income stream for the year. Those in receipt of military superannuation defined benefit income streams are exempt from the proposed limit on the deductible amount. As noted above, the Government expects around 47,700 people will be affected from 1 January 2016 with around 46,000 income support recipients receiving a reduced pension or allowance payment (with an average reduction of $2,150 per year) and approximately 1,700 income support recipients having their payment cancelled.[37]

Item 1 inserts a definition of military defined benefit income stream at subsection 9(1) of the Social Security Act 1991 (SS Act)[38] which includes schemes provided for under the Defence Forces Retirement Benefits Act 1948, the Defence Force Retirement and Death Benefits Act 1973 and section 4 of the Military Superannuation and Benefits Act 1991. Additional schemes can be added to this definition by legislative instrument, provided for by new paragraph 9(2) inserted by item 2.

Items 4 and 5 insert new subsection 1099A(2) into the SS Act which provides for the deductible amount for asset-test exempt defined benefit income streams (which are not military defined benefit income streams) to be limited to ten per cent of the income stream amount for the year if the deductible amount would otherwise exceed ten per cent of the income stream amount for the year. This means that the amount of income from an asset-test exempt defined benefit income stream that is to be assessed under the social security income test is: the annual payment – the deductible amount (where the deductible amount is limited to a maximum of ten per cent of the annual payment). Deductible amount is defined at subsection 9(1) of the SS Act as the sum of the tax free components of the income stream (worked out under Subdivision 307-C of the Income Tax Assessment Act 1997 or, if applicable, section 307-125 of the Income Tax (Transitional Provisions) Act 1997).

Item 7 inserts an identical provision at the end of subsection 1099D of the SS Act to apply to asset-tested defined benefit schemes which are not military defined benefit income streams.

Item 8 inserts new subclause 136(3A) into Schedule 1A of the SS Act so that the ten per cent limit on defined benefit schemes’ deductible amounts will apply in cases where a deductible amount is worked out under the transitional provisions at clause 136 of Schedule 1A.

Comment

The measure improves the targeting of the Age Pension and provides for more equitable treatment of different superannuation income streams. A small number of relatively high-income pensioners will lose their income support payment as a result while others will receive lower rate pension (but their superannuation income stream will be unaffected).

One significant issue for the measure is that it affects retirees who have made decisions about their financial arrangements based on the existing rules (such as whether to take lump sums or regular pension payments or a mix of both). These retirees may have made different decisions if the proposed cap on the deductible amount had been in place but now they are not in a position to do so. As noted above, the Australian Council of Public Sector Retiree Organisations Inc. have suggested the measure may be unfair on those who made decisions based on the existing or previous income test arrangements and that existing defined benefit income stream recipients should be grandfathered.[39] Any grandfathering arrangement would, however, undermine the intent of the measure and the expected savings.

Military defined benefit income stream recipients will be exempt from the deductible amount cap ‘in recognition of the unique nature of military service’. Military superannuants have not necessarily served during conflicts or in war zones, while other government employees who are not exempt may also argue that their service is unique (and dangerous): such as police and firefighters. In its submission to the Senate committee inquiry into the Bill, the Police Federation of Australia called for police in defined benefit schemes to be made exempt from the measure.[40]

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[1].              Parliament of Australia, ‘Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015 homepage’, Australian Parliament website, accessed 23 June 2015.

[2].              See M Klapdor, Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, Bills digest, 129, 2014–15, Parliamentary Library, Canberra, 2015, accessed 23 June 2015; ‘Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015: Amendments’, 18 June 2015, accessed 19 June 2015.

[3].              Supplementary Explanatory Memorandum, Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, accessed 19 June 2015.

[4].              Parliament of Australia, ‘Social Services and Other Legislation Amendment (Seniors Supplement Cessation) Bill 2014 homepage’, Australian Parliament website, accessed 23 June 2015.

[5].              Ibid.

[6].              B Shorten (Opposition Leader) and J Macklin (Shadow Minister for Families and Payments), Transcript of press conference, Parliament House, Canberra, media release, 16 June 2015, accessed 23 June 2015.

[7].              R Di Natale and R Siewert, Greens to reverse Howard-era pension mistake, secure retirement income review, media release, 16 June 2015, accessed 23 June 2015.

[8].              ACOSS, Submission to Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 16 June 2015, p. 6, accessed 23 June 2015; National Welfare Rights Network, Submission to Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 12 June 2015, p. 4, accessed 23 June 2015.

[9].              Australian Council of Public Sector Retiree Organisations Inc., Submission to the Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 12 June 2015, p. 2, accessed 16 June 2015; Tasmanian Association of State Superannuants, Submission to the Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, June 2015, p. 3, accessed 23 June 2015.

[10].              Combined Pensioners and Superannuants Association, Submission to the Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 11 June 2015, p. 3, accessed 23 June 2015.

[11].              Police Federation of Australia, Submission to the Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 11 June 2015, pp. 1–2, accessed 23 June 2015.

[12].              UniSuper, Submission to the Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 19 June 2015, p. 5, accessed 23 June 2015.

[13].              Explanatory Memorandum, Social Services Legislation Amendment (Defined Benefit Income Streams) Bill 2015, p. 1, accessed 23 June 2015.

[14].              The Statement of Compatibility with Human Rights can be found at page 4 of the Explanatory Memorandum to the Bill. Explanatory Memorandum, Social Services Legislation Amendment (Defined Benefit Income Streams) Bill 2015, p. 4, accessed 23 June 2015.

[15].              Australian Securities and Investment Commission (ASIC), ‘Types of super funds’, Moneysmart website, accessed 15 June 2015.

[16].              Ibid.

[17].              Ibid.

[18].              An account-based superannuation income stream is a form of retirement investment that provide holders with a tax-free retirement income stream and flexible access to their capital. Holders have an investment account within a relevant superannuation or insurance fund. The account balance will increase when investment earnings are added to the account and will decrease as the holder draws down regular income payments. See Department of Families, Community Services and Indigenous Affairs (FaCSIA), Retirement income streams, FaCSIA, Canberra, 2007, pp. 15–22, accessed 15 June 2015.

[19].              DSS, ‘Deeming information’, DSS website, accessed 15 June 2015.

[20].              See A Biggs, L Buckmaster, C Ey and M Klapdor, Social Services and Other Legislation Amendment 2013, Bills digest, 29, 2013–14, Parliamentary Library, Canberra, 2013, p. 33, accessed 15 June 2015.

[21].              T Power, ‘Start planning! New income test rules mean less Age Pension’, SuperGuide website, 12 May 2015, accessed 15 June 2015.

[22].              Statement of Compatibility with Human Rights, Explanatory Memorandum, Social Services and Other Legislation Amendment Bill 2013, p. 25, accessed 15 June 2015.

[23].              As part of reforms to the means testing of superannuation income streams in 1998, existing defined benefit schemes were granted specific exemptions from asset testing. DSS, Submission to Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 11 June 2015, p. 3, accessed 15 June 2015; DSS, ‘4.9.2.20 Extension of asset-test exemption to pre-20/9/98 defined benefit income streams’, Guide to Social Security Law, DSS website, accessed 15 June 2015. For the means test treatment of schemes that do not meet the definition of asset-test exempt, see DSS, ‘4.9.1.20 General provisions for assessing income streams’, Guide to Social Security Law, DSS website, accessed 15 June 2015.

[24].              Interest here refers to the value of the defined benefit entitlement as calculated for tax purposes (which is typically tied to previous salary, or average salary over a number of years). The tax free components are worked out under subdivision 307-C of the Income Tax Assessment Act 1997 or if applicable, subsection 307-125 of the Income Tax (Transitional Provisions) Act 1997. DSS, ‘4.9.2.30 Income tax assessment of asset-test exempt income streams’, Guide to Social Security Law, DSS website, accessed 15 June 2015.

[25].              The undeducted purchase price is worked out in accordance with subsection 27H(2) of the Income Tax Assessment Act 1936 (as in force just before 1 July 2007). Or, if a person was receiving a social security benefit and payments from a defined benefit income stream on or before 19 September 1998 the undeducted purchase price definition used is the pre-1 July 1994 definition in the Income Tax Assessment Act 1936. DSS, ‘4.9.2.30 Income tax assessment of asset-test exempt income streams’, Guide to Social Security Law, DSS website, accessed 15 June 2015.

[26].              Australian Government, Budget 2006–07: a plan to simplify and streamline superannuation, 9 May 2006, pp. 9–11, accessed 16 June 2015; Australian Government, A plan to simplify and streamline superannuation: detailed outline, May 2006, accessed 16 June 2015

[27].              South Australian Government Superannuated Employees Association, Towards more equitable taxation and means testing treatment of untaxed-source defined benefit pensions, Submission to the Tax Forum, Canberra, 4–5 October 2011, pp. 1–2, accessed 16 June 2015.

[28].              Ibid., p. 1.

[29].              DSS, Submission to Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, op. cit., p. 4.

[30].              Ibid., p. 2.

[31].              Ibid.

[32].              Ibid.

[33].              Ibid.

[34].              S Morrison (Minister for Social Services), Press conference, Sydney, media release, 7 May 2015, accessed 16 June 2015.

[35].              S Benson, ‘Morrison to stop wealthy fat cats double-dipping the super system’, The Courier-Mail, 7 May 2015, accessed 16 June 2015.

[36].              S Morrison, Press conference, Sydney, op. cit.

[37].              DSS, Submission to Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, op. cit., pp. 2–3.

[38].              Social Security Act 1991 (SS Act), accessed 23 June 2015.

[39].              Australian Council of Public Sector Retiree Organisations Inc., Submission to the Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 12 June 2015, p. 2, accessed 16 June 2015.

[40].              Police Federation of Australia, Submission to the Senate Community Affairs Legislation Committee, Inquiry into the Social Services Legislation Amendment (Fair and Sustainable Pensions) Bill 2015, 11 June 2015, pp. 1–2, accessed 23 June 2015.