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Forward Thinking Magazine : August 2010
14 Macquarie Adviser Services What is understood by the term ‘exempt’ (E) is generally clear and without controversy. However, the term ‘taxed’ (T) is not so clear. Generally T is intended to represent the progressive marginal tax rates applicable to individual taxpayers’ income, but it can often represent the progressive marginal tax rate less some tax concession. T can be different for lump sums and pensions at the benefit payment point, and for employer and individually funded contributions or benefits. In Australia we generally consider T to be 15%, but that is a simplification. For example, although we might consider the earnings tax rate to be 15%, the effective rate on capital gains is often much less, and earnings tax in pension phase may be zero. In addition in some countries (e.g. New Zealand) capital gains remain untaxed, both within and outside of the relevant retirement income model. So the taxing point representation has inherent limitations. In general it is most useful in comparison of contributory, funded retirement savings systems. Nonetheless it may be a useful method for beginning to understand and compare different countries’ retirement income models. What does the taxing point representation tell us? Answer: simply where each model’s taxing points lie. In reality the taxing point representation tells us very little about the overall level of tax concessions of a retirement income system. Table 2 illustrates that choosing appropriate tax rates in the different models can produce similar overall results, despite the taxing point model chosen. Table 2: EET TEE TTE ETT Contribution $100.00 $100.00 $100.00 $100.00 Tax Rate 25% 25% 18.4% 18.4% Tax - $25.00 $18.40 - Net in fund $100.00 $75.00 $81.60 $100.00 Net investment return $61.05 $45.79 $39.39 $48.02 Fund value at retirement $161.05 $120.79 $120.79 $148.02 Tax on benefit $40.26 - - $27.23 Net benefit $120.79 $120.79 $120.79 $120.79 NPV of tax paid $25.00 $25.00 $25.00 $25.00 Source: Adapted from Warburton & Hendy, International Comparison of Australia’s Taxes (2006) 228, sourced from Whitehouse (1999). Note: Assumes 10% pa return (nominal), 5 yr investment term, 10% pa discount rate, 25% tax rate for EET/TEE, 18.4% tax rate for TTE/ETT.