Australian Flip Flops

Flip-flopping on Super

Flip flop is the American term for what we call thongs. But in googling ‘thongs’ looking for an image to go with this blog, I got an entirely different set of images….

If you have been trying to follow the Federal government’s changes to superannuation over the last few months, you would be forgiven for having a headache. There has been an awful lot of flip-flopping.

A point of contention
One of the most contentious areas of change concerns non-concessional contributions into super. A non-concessional contribution is one that is not taxed as it enters the fund. Consistent with that, the member who makes the contribution does not get a tax deduction for the contribution (hence the term ‘non-concessional).’ In contrast, concessional contributions do provide a tax benefit for the person making them.

For example, the money that employers contribute into super under the Superannuation Guarantee Charge is a concessional contribution because the employer gets a tax deduction for the contribution. The contribution is then taxed in the hands of the super fund. This is a general principle: if contributions are taxed as they arrive in a fund, the person making the contribution can usually claim a tax deduction for them.

If no immediate tax benefit, why make a non-concessional contribution?

The main reason is that a super fund is a lower-tax environment in which to invest the money used to make the contribution. Earnings within a super fund are taxed at just 15% on income (rent, dividends or interest) and just 10% on capital gains for assets held for more than 12 months. And that is while the fund is in accumulation mode. Once the fund commences paying a pension (which in most cases means when the member turns 60), earnings are not taxed at all. From the point of view of tax, super is superb!!

Imagine you inherit $300,000
You have a well-paid job and pay marginal income tax at a rate of 37%. If you invest the $300,000 in your own name, then the earnings on the investment will be taxed at (at least) 37%. Let’s say you bought shares and they provided a 5% dividend yield. That’s $15,000 of dividends a year. This would give rise to tax bill payable by you of $5,550 a year at a tax rate of 37%.

As a sensible, long term, buy and hold investor.  Let’s say you did not intend to retire for 20 years.  20 years x $5,550 = $111,000 in tax payable by yourself.

Now let’s imagine you establish a self-managed super fund (SMSF) and make a non-concessional contribution of $300,000 into it. The SMSF makes the exact same investment. The $15,000 in dividends give rise to tax of just $2,250 (tax rate is 15%). This is less than half the tax you would pay if the investment was made in your own name.

This table summarises the situation

$300,000 Inheritance Invested Directly (37% Tax) Invested via SMSF (15% Tax)
5% Dividend $15,000 $15,000
Tax Payable p.a. $5,550 $2,250
Total Tax over 20 years $111,000 $45,000

 

The same investment made via your SMSF would save you $66,000 ($111,000-$45,000) in tax by the time you retire.

Plus
If you have already turned 60, you don’t even need to be retired from work to start taking a private ‘pension’ payment from your self-managed super fund.

At this point, there is absolutely no tax to be paid on either the dividend income or any capital gains if you then chose to sell some or all of the shares. No tax on income or capital gains in this ‘pension phase’ creates $10,000’s if not $100,000’s of tax benefits on top of the $66,000 tax saving above from one single $300,000 investment made 20 years prior.

The May 2016 Budget
Under the rules that applied before the Budget, a member could essentially contribute $540,000 in non-concessional contributions into a super fund every three years. They could do this until they turned 65. There was no absolute limit: as long as the person did not exceed $540,000 in the three year period, they could repeat this every three years until they turned 65.

This was changed on Budget night. From that night, the Treasurer proposed a lifetime limit on non-concessional contributions of $500,000 – and non-concessional contributions that had already been made were included in the limit. This is why many people argued that the changes were ‘retrospective.’

The Flip Flop
A couple of weeks ago as referenced in this article the Government announced a change to its most recent change. That is, the Government flip-flopped. They announced that there would now be an annual limit of $100,000 of non-concessional contributions per member. This would again be allowed to be smoothed over three years, such that the limit is effectively $300,000 per member per three years. And the changes take effect on 1 July 2017, meaning that the limit for the current financial year is now back to $180,000.

These contributions can only be made while the member’s super balance is less than $1.6 million. Once this limit is reached, no more non-concessional contributions can be made.

This limit of $1.6 million is about twice the threshold for the aged pension assets test. $1.6 million is becoming something of a marker. It is also the limit on the superannuation assets which can be dedicated towards a superannuation pension such that the fund does not pay tax on its earnings.

Government Encouraging Super
From the overall policy perspective it looks like the Government is saying that it will offer maximum encouragement to people to acquire superannuation assets, until those assets reach a level that is twice the assets threshold for the aged pension ($1.6 million).

Super benefits of this size will mean that the member stays away from the aged pension – which is why the Government encourages super in the first place. But once the super assets rise to the level where the aged pension is off the table, the tax incentives fall away.

A Good Idea for Most
Most people have much less than $1.6 million in super. This means that non-concessional contributions remain a very good idea for most people. This is especially the case if you receive a lump sum amount, such as an inheritance or the sale of an asset such as your family home.

So, if a life circumstance has created or may create a situation where you think you could make a non-concessional contribution, contact us today to make sure you invest to achieve the maximum result for your circumstances.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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