This post is inspired by a paragraph near the end of this blog post by Marsha-laine Dungog:
We would encourage U.S. expats to seize the current momentum and push for legislation that will “enshrine” the Super’s objectives as one that will “provide income in retirement to substitute or supplement the Age Pension.” This would conclusively lay all doubts to rest that the Super should be analyzed in a manner that is consistent with (and therefore taxed similarly to) U.S. Social Security. The treatment of SG Contributions as foreign social security is consistent with the statutory mandate under Australian Superannuation law requiring employer contributions to be made pursuant to the taxing authority of the Commonwealth of Australia (Commonwealth) and not on account of a contractual relationship between employer and employee. Consequently, earnings accrued on SG contributions and distributions therefrom should also be classified as foreign social security benefits which are already excluded from U.S. taxation under Article 18(2) of the Tax Treaty.
This got me thinking. In what ways is Super equivalent to Social Security? And does the proposed legislation1 actually do anything? Finally, what action is needed in Australia to clarify this issue?
Super vs Social Security
If you’re employed in Australia, your employer is required by law to contribute 9.5% of your salary to a complying Australian Superannuation fund. If you’re employed in the US, your employer is required to pay a 6.2% FICA tax in addition to withholding 6.2% from your salary (there is also withholding for medicare). So, for employed persons, the super and social security are quite similar.
If you’re self-employed in Australia, you may (but are not required to) make a tax-deductible contribution to a complying superannuation fund. If you’re self-employed in the US, you are required to pay self-employment tax of 15% which includes 12.4% for social security.
Of course, the obvious difference between super and social security is that super is a fully funded defined contribution plan for most people, while social security is an unfunded defined benefit plan.
While the Australia/US Income Tax Treaty is silent on superannuation, there is another agreement between Australia and the US which does mention superannuation, the Social Security Agreement between Australia and the United States of America, also known as the totalisation agreement. This agreement spells out which set of provisions apply to Australians working in the US and to Americans working in Australia. It also provides for retirees claiming benefits who may not otherwise be eligible in one or both countries.
For employees, the totalisation agreement allows workers on temporary assignment in the other country to apply the rules of their home country. Australians temporarily working for an Australian employer in the US can continue to make superannuation contributions as if they were in Australia. Americans temporarily working for a US employer in Australia can be covered under the Social Security system (FICA withholding) instead of contributing to super. So, for this purpose, super is equivalent to social security.
For self-employed persons the agreement states that only the laws of the resident country apply – so US nationals who are self-employed in Australia are not subject to US self-employment tax (though to take advantage of this provision of the agreement you must apply for an exemption certificate). There doesn’t appear to be any requirement that the self-employed person living in Australia is actually contributing to superannuation to be exempt from US self-employment tax.
When it comes to benefits, however, Social Security benefits received (after reduction for WEP), will be deducted from your entitlement to the Age Pension in Australia (I commented on this computation in the Facebook group).
Social Security benefits are reduced under the Windfall Elimination Provision (WEP) based on Superannuation benefits. I have been unable to locate an exact formula for this, though from the documentation on the Social Security website, it is not clear whether the Social Security Administration distinguishes between the required employer contributions and voluntary (concessional or non-concessional) contributions.2 Most likely, they don’t really understand the distinction. If super reduces social security benefits, why is any part of super taxable on US tax returns?
So, back to one of my original questions: Does the budget proposal on clarifying the objective of superannuation actually do anything?
A bit of history. In December 2014, the Financial System Inquiry, chaired by Mr David Murray AO, released its final report. One of the recommended actions in the Superannuation chapter of the report was:
Set clear objectives for the superannuation system. A clear statement of the system’s objectives is necessary to target policy settings better and make them more stable. Clearly articulated objectives that have broad community support would help to align policy settings, industry initiatives and community expectations.
The Government response to FSI was released in October 2015. In response to the objectives of the superannuation system:
We will enshrine the objective of the superannuation system in legislation. This will help align policy settings, industry initiative and community expectations.
But, will this actually do anything? The existing legislation on superannuation already expresses the objectives of the system through the “sole purpose test” and other provisions (see this submission by the Law Council for further detail).
What can we do?
I see two possible avenues for addressing this issue.
- The Competent Authorities under the Tax Treaty could be encouraged to resolve the issue under Article 24 of the current treaty by agreeing between themselves that Superannuation (either the total balance or just that balance attributable to the required employee contributions) is the equivalent of Social Security. This determination should be coordinated with the computation of Social Security benefits under WEP.
- When the Treaty is renegotiated, the retirement savings provisions (Articles 17 and 18 of the 2016 US Model Treaty) should explicitly state what part of superannuation savings is equivalent to social security, and not taxable in the US. At the same time, this provision should be coordinated with the computation of Social Security benefits under WEP.
- This is only a budget proposal, if anyone has a link to the actual proposed legislation, please leave it in the comments
- If anyone has experience with WEP and superannuation, please let me know either in the comments or by email to email@example.com.