In a recent article, the founders of the First Home Buyers Australia made their case for re-introducing the First Home Saver Accounts (FHSA) and proposed some tweaks to the original system to encourage a greater take up of these accounts. While I don’t think there is an appetite for the government to reintroduce the failed program (the policy was abandoned in 2015 when very few accounts were opened and active) I thought it would be worthwhile addressing the proposed changes and challenge the effectiveness of each.
In totality, I see these proposals as adding unnecessary complexity to what was originally designed as a bank account and providing an inequitable outcome through the tax system, benefiting higher income earners who should otherwise have the capacity to save and enter the property market. So let’s go through each proposal in turn and better understand why.
Allow first homebuyers to salary sacrifice their pre-tax wages in to an account taxed at 15%
This is the biggest change from the original scheme. Originally, the accounts were just bank accounts with some basic preservation rules and a reduced tax rate on earnings. All contributions paid to the FHSA would be from after-tax balances. This proposed change would make these accounts much more attractive given the significant tax saving on offer.
When we consider salary sacrifice to superannuation, the limitation of the strategy comes down to the preservation of funds. You are extended a tax discount because by boosting your retirement savings, you reduce your reliance on the age pension when you reach retirement – saving the government money in the long run. For younger people, with retirement 30-40 years away (and preservation ages creeping up) locking a large chunk of disposable income away for that length of time can be daunting, particularly if cash-flow is restricted or an emergency fund hasn’t been saved.
With the proposed changes however, the downside of a salary sacrifice strategy for young people is removed with money being available after only a few years. While I fear that this could be open to rorting, that would depend on the actual drafting of any legislation. My gut instinct though is that there would be loopholes that would be exploited and the government would be out of pocket.
Also, I think the scheme misses the mark a little bit. To my mind, any such scheme should encourage and assist lower income earners with their goal of home ownership. On current tax rates an employee with taxable income of $45,000 pays an effective tax rate of 15%. This would mean there is minimal to no tax benefit for lower income earners and the higher your income then the more you stand to gain. Except an employee on higher than average income has a greater capacity to save already and should not need the added incentive of tax savings to do so.
Interest free earnings on funds held inside this account
This is a reasonable proposal but I think given the lack of tax revenue from the invested balance the government would be likely to place even greater restrictions on access and perhaps apply some complex penalties if the funds are eventually withdrawn from the account and not used in the purchase of one’s first home. However this does balance the tables a little given for those who already own homes can place their savings in an offset account, effectively generating a guaranteed return in terms of interest saved. Since it is an implicit saving and not interest paid, not only do the savings go untaxed by the government but the effective return exceeds that available through other cash deposit products.
Overall, I think this is the best of the proposals put forward by the First Home Buyers Australia.
Allow investment in shares or managed funds to target greater returns
This proposal sounds good on paper given the long term historic average returns available through the share market and managed funds although it does increase the complexity of these accounts and places people’s home savings at risk. They haven’t specified whether deposits would be invested by default in risky assets, but the suggestion that these accounts act like superannuation funds with loose preservation rules would hint at that fact. And given the loose preservation of funds they would undo one of the foundational concepts of superannuation (and investing in risky assets) – time is your ally.
If people are looking to save over a 3-5 year period, investing in risky assets carries a significantly higher possibility of an ultimate negative return. When investing for longer periods (10+ years) the short term volatility of financial markets is smoothed out and it’s from these long term trends that we derive the high average returns of risky portfolios. Now, don’t get me wrong, the short-term volatility could work in the favour of the investor and provide significant returns if the markets have strong performance over the term of the investment. But it does seem to me to be built less on the solid foundation of prudent financial management and more on gambling on the markets.
And all this is ignoring the fact that many people disregard their superannuation funds in part because of the complexity of the system, their lack of knowledge around investing and the costs associated with seeking financial advice. I think this again favours those who have more sophisticated investment knowledge and skills that the average punter wouldn’t have. Or funds are invested by default on behalf of investors and their ultimate outcome may be no different than a visit to the casino.
Provide a generous co-contribution to a maximum of $750 per annum
This proposal seems like double dipping on tax savings particularly if offering both a discounted tax rate through salary sacrifice and a co-contribution. Based on the proposal, if you deposit at least $1,500 in a financial year, the government will contribute an additional $750. If the co-contribution were available even when making salary sacrifice contributions, one could deposit up to $5,000 per year in to the account completely tax free. Again, this is an attractive proposal which becomes more attractive the higher your income and consequently your marginal tax rate. I can see this open to exploitation by those who could otherwise afford to save a home deposit quickly.
Generally speaking, a co-contribution is made available to offset tax already paid on after-tax money while also encouraging people to take the desired course of action. With superannuation for example, if you compare the co-contribution rules with salary sacrifice, the strategy results in the same outcome (when only contributing a small amount) – basically allowing those who may not have access to salary sacrifice arrangements to still have some encouragement to contribute to super.
Require a minimum annual contribution of $1,000 each year over at least three separate financial years
This is more clarification around the preservation of balances in these accounts. Previously there was a four year preservation period so this is bringing the timeframe back one year. But if viewed in light of the co-contribution, the government would be out of pocket $500 each financial year for each account holder based on the minimum required contribution and this is a low entry point to gain the full co-contribution.
Also, under the former scheme, by making the minimum contribution you would only be eligible for 1/6th of the maximum available co-contribution however under these proposals you would be eligible for 1/3rd of the maximum available contribution. That’s a significant incentive and a very generous government offer of ‘free’ money. And as has been the case in the past, when generous schemes are offered by governments and legislation is not airtight, it opens the door to rorting and exploitation – certainly not aims of a sustainable housing affordability policy.