Tracing capital gains tax in Australia back to the mid-80s

Let's go back forty years to 1985. Back then, the top income tax rate was 60 per cent on income above $35,000 a year and the company tax rate was a flat 46 per cent. Paul Keating was the Federal Treasurer, and he was hell-bent on tax reform. He initiated the National Tax Summit in July 1985, which led to a comprehensive tax package aimed at broadening the tax base, improving equity and reducing marginal tax rates to boost incentives for work and investment. Those rate cuts did not arrive overnight, but over the following years the top marginal rate fell sharply as the tax base was widened.

CGT was a centrepiece. The main selling point was that it was unfair to tax purely inflationary gains, so gains were indexed to inflation. It was also recognised that taxing a large gain in a single year at an individual's top marginal rate was inequitable, so averaging was introduced. And it wasn't just CGT on the radar. These changes were paired with major reforms to superannuation, including the introduction of a 15 per cent tax on fund earnings, new reasonable benefit limits, tighter lump-sum concessions, and proper integration of super into the income tax system. Super was deliberately repositioned as deferred wages rather than a tax shelter.

The next step came with the Ralph Review - a major overhaul commissioned by the Howard Government and delivered between 1999 and 2001. Chairman John Ralph's brief was to make Australia's tax system more competitive, more robust and less distortionary in a globalising economy. Its most important outcomes were a cut in the company tax rate from 36 per cent to 30 per cent, and the replacement of the complex CGT indexation with a flat discount: 50 per cent and 33.3 per cent for super funds.

This is broadly where the taxation of capital gains has sat ever since. The original concerns about taxing inflationary gains and the fair treatment of lumpy gains have largely faded from the debate, and the focus today is squarely on whether the 50 per cent discount represents an excessive concession to higher-income earners.

So what will be the outcome? Labor and the Greens have long argued for the 50 per cent discount to be reduced to 25 per cent. With the numbers now in parliament, it would be reasonable to assume such a change could be legislated. The formal review of the CGT discount is due to report by 17 March - barely two months before the expected May federal budget. While there will be plenty of submissions, it is unlikely the government will hear anything fundamentally new. That allows for a relatively swift decision. It is also clear that governments prefer to get unpopular decisions out of the way early in their term, giving voters time to move on before the next election. It is therefore reasonable to assume the May budget will include an increase in CGT payable on assets acquired after Budget night, by reducing the discount for individuals from 50 per cent to 25 per cent. The discount for superannuation funds may also be lowered or even abolished. That would fundamentally change after-tax returns, particularly for leveraged property investors and those relying on asset sales in retirement years. It would also favour shares over property, because CGT on shares can be managed incrementally, while property forces you to crystallise the entire gain in one hit.

The obvious question is: what should we do now? You must take advice and make up your own mind. But I see no rush to do anything before any announcements are made. Both the Greens and Labor have promised any changes would be grandfathered, meaning they should not apply to assets you already own. If you are thinking of acquiring a property in the next six months, it may be wise to do it sooner rather than later - but only if it represents good value.

Question: I have two superannuation accounts - one in pension phase with a balance of $700,000 and another in accumulation phase with $800,000. I understand I cannot simply transfer the accumulation balance into my existing pension account. Could I instead recontribute money from the pension account and then combine the two into a single pension account? If I did this, would it push me over the $1.9 million transfer balance cap(TBC) ? At present I have about $1.3 million of my cap remaining, having used $650,000 when I first set up the pension.

Answer: The TBC limits the amount you can transfer to pension mode. You can find out your actual unused cap from MyGov. What this will be will depend on when you made the first transfer. You can then transfer an amount up to the value of your unused TBC from accumulation mode to pension mode into a separate pension, or you could roll the existing pension back into accumulation, and then use the combined amount to start a new pension. I strongly suggest you take advice. It's difficult to negotiate this minefield on your own.

Question: Could you please explain the difference between an SMSF and a large public super fund, and which might be better to set up? What are the main advantages and disadvantages of each? For example, how would this apply to a couple - a plumber and his 45-year-old wife with $300,000 in a large public super fund.

Answer: A SMSF (self-managed super fund) is one where you, as trustee, make all the decisions about how the money is invested and managed. A large public super fund, by contrast, is run by professionals, with your money pooled alongside thousands of other members.

The attraction of an SMSF is flexibility. You can invest in almost anything, including property, shares and unlisted assets but with that flexibility comes cost and responsibility. Every SMSF must be audited annually and comply with strict rules, and trustees are personally liable if things go wrong. Unless balances are well above $500,000, and ideally closer to $1 million, the costs and workload often outweigh the benefits.

Large public super funds are the opposite. They are inexpensive, well regulated and offer broad diversification. You also get automatic access to insurance and don't have to worry about compliance. The trade-off is limited flexibility - you can't buy individual properties or unlisted assets, but this isn't an issue for most people. Unless you are an experienced investor with a fairly big superannuation balance and time to devote to running your own super fund, I suggest you leave it to the professionals.

Question: The papers often say you don't need much to retire. But they rarely mention inflation. While $75,000 a year may look fine today, what will it really buy in 20 years? As a self-funded retiree it's hard not to think you'll need more than the suggested amount, especially with low interest rates. And for people depending on support, will the age pension keep up with inflation and still provide enough security in the future?

Answer: Articles suggesting you don't need a large sum to retire usually assume you'll qualify for a part-age pension. But with governments under budget pressure, future entitlements could be reduced. Currently, couples with about $1,070,000 in assessable assets, plus their home, can receive a part pension, but there's no certainty these rules will last.

The best strategy is to take control now: prepare a budget using today's figures, leaving out work-related costs such as a second car or commuting. Then adjust the numbers for inflation using one of the many online calculators - 3 per cent is a realistic guide. Remember, the amount you'll need depends not just on what you have at retirement, but on how long your money must last and the returns you can earn once you start drawing an income.

This is the perfect time to engage a good financial adviser. They can review your current assets to ensure the mix is right for your goals, and prepare projections based on future expenses and expected returns. From there, an annual review and fine-tuning will help ensure your retirement plans remain on track.