Tax on benefits, and the ‘Contribution Tax Offset’

Most super funds in Australia are taxed funds, which are taxed in 3 ways:

1. On the way in – employer contributions and salary sacrifice contributions are taxed at 15%
2. In the scheme – earnings on investments are taxed at 15%
3. On the way out – depending on how you take your super and your age, you may be taxed when you withdraw your super.

However, some public sector schemes (such as the ETSA scheme before privatisation) are exempt from this and are known as ‘untaxed funds’. This is because the tax is only paid when the member takes their money, not on the way in. The tax on the benefits is higher than it would be for a taxed fund.

When ETSA was privatised, the scheme moved from being an untaxed fund with higher taxes on benefits to being a taxed fund with lower taxes on benefits, but with tax on employer contributions and investment earnings.

A lump sum benefit is split into several parts for calculating tax. The main 2 are the parts of the benefit that are due to service before 1983 (called the ‘pre-83 portion’) and the service after 1983 (‘the post-83 portion’).

The change in tax is on the post-83 portion. For retirement benefits, the tax rate on this part went down by either 15% or 16.5%, depending on the amount of the benefit.

All pension benefits are taxed as normal income (regardless of the fund) but pensions paid from a taxed fund are entitled to a 15% tax rebate on the entire pension.

In some cases, benefit may be higher. For example, when the offset on pensions is calculated we assume that the pension is your only income. If you have other income (from investments or part-time work) you may be better off.

Pre-privatisation, the Scheme didn’t pay tax at all, and the members paid tax on their benefits at a higher rate than most super benefits.

Now, ElectricSuper pays tax on contributions and returns, and the members pay less tax on their benefits. If benefits were unaffected, the members would get higher net benefits (due to less tax on benefits), but the cost of running ElectricSuper would go up (due to the tax that is now paid by ElectricSuper).

The legislation covering privatisation allowed benefits to be reduced to offset the increased cost of the Scheme. This is the contribution tax offset.

A simple example may make this clearer:

The steps involved are:

1. Calculate the gross benefit according to the Scheme rules
2. Calculate the net benefit assuming it was paid from an untaxed Scheme (ie before privatisation)
3. Calculate the gross benefit payable from a taxed Scheme that would give the same net benefit

The Contribution Tax Offset is the difference between 1 and 3.

For lump sum benefits, the Contribution Tax Offset is limited to 15% of the part of the gross benefit due to membership after 1983. This is because, when the scheme was untaxed, members always had the option of rolling a benefit over to a taxed scheme. This would result in tax of 15% being deducted on rolling over, which was effectively a Contribution Tax Offset of 15%.

There is no such limit to the offset on pension benefits.

The reduction will depend on the amount of the pension and the tax rates at the time the pension starts, amongst other things.

This means that the offset, as a percentage of your original pension, can be greater than 15%.

Why is this?

Because the improvement in the tax on pensions due to the change in the Scheme’s tax gets more valuable as your pension (and your average marginal tax rate) increases.

The main thing to remember is that the offset will not leave you worse off after tax at the time your benefit is paid. The offset does not affect the indexation of pensions.

The Contribution Tax Offset applies to all benefits paid from Divisions 2, 3 and 4.

Benefits in Division 5 were adjusted for tax in 2002, and tax has been deducted from contributions credited to member’s accounts since that time.

You can talk to ElectricSuper on 1300 307 844 or via email at inquiries@electricsuper.com.au.