As was widely publicised at the time, the Government has proposed sweeping superannuation changes in its 9 May 2006 budget.
We have carefully studied the 84 page document released by the Government (‘A Plan to Simplify and Streamline Superannuation’) and identified a number of opportunities presented by the proposals.
In most cases the opportunities have arisen due to further concessions announced by the Government.
In a few cases however, the Government has announced a removal or reduction in existing opportunities from 1 July 2007, thus effectively providing a window to 30 June 2007 to utilise the currently available strategy.
A few of the opportunities we have identified are outlined below.
It is very important to remember that the budget is merely an announcement at this stage and time will tell how many of the changes will actually become law. One would hope however, with the Coalition in control of Senate, the majority of the changes will ultimately see the light of day.
In recent forums the ATO have made no secret of concerns that there are significant troubles associated with the management of the current RBL system.
The system is incredibly complex and the ATO systems that currently receive and record RBL information are terribly inflexible.
The Government has taken the opportunity presented by a very significant revamp of the superannuation system to relieve itself of this headache. Henceforth Government control of end superannuation entitlements will be via limitations on contributions to superannuation, in preference to backend monitoring via the RBL system.
The result is a significant windfall to those who are already at the top end of what is currently their pension RBL ($1.3M for most).
Among our clients are many that had ceased contributing to superannuation for fear of the future RBL implications. The announced removal of the RBL system, the removal of superannuation contributions surcharge and the potential for zero tax on superannuation withdrawals (over age 60) means that wealth can once again be flowed into superannuation with very significant taxation benefits.For example, assume the following facts for Tim Ayers:
- Tim is 61 years old.
- Has no transitional RBL and is therefore subject to the standard pension RBL of approximately $1.3M.
- Tim has $1.25M in taxed superannuation benefits at present.
- Tim does not want to take a pension as yet because he receives a salary of $150,000 per year already.
- Tim has not contributed to superannuation for 2 years due to RBL concerns.
- Tim has no mortgage and his wife is working so he only requires $40,000 per annum to meet his living expenses.
Following the announcement Tim resolves to salary sacrifice $100,000 into superannuation at a tax saving of approximately $40,000 per annum.
When Tim ultimately draws on his superannuation entitlements he will receive either the income stream or the eligible termination payment tax free.
Tim is aware that there is a risk that the RBL system may not ultimately be abolished however he has assessed that the benefits exceed the costs associated with this risk.
The Government has announced that there will be no compulsory drawdown of superannuation entitlements from 1 July 2007.
This presents the opportunity to utilise superannuation as an even more effective estate planning tool.
Those with significant stores of wealth in superannuation may resolve to leave a proportion of their balance in accumulation phase to provide for the next generation.We have provided the example below of Gerard & Georgia Price to demonstrate.
- Both are 60 years old and have retired.
- They have combined superannuation balances of $1.4M (all post 83 component, they have equal balances).
- They have always lived frugally and don’t believe they will need more than $40K per annum in retirement.
- They have two daughters and would like to leave half of their superannuation entitlements to them however they don’t want to risk leaving themselves short.
In consultation with their adviser they resolve on the following strategy
- Draw a tax free ETP of $100K each (post 83 component tax free amount) and pay $100K to each of their two daughters.
- Draw an ETP of a further $20K each (post 83 component tax free amount) to finance their 2007 financial year living requirements.
- At 1 July 2007 both commence a new pension with a balance of $350,000 each.
- Assuming $90K in earnings over the course of the 2007 financial year the remaining $550K will sit in the accumulation phase with a view to benefiting their two daughters upon their death.
- After 1 July 2007 and before age 65 Gerard & Georgia withdraw the full amount of $550,000 ($150,000 each in 2008 yr, $125,000 each in 2009 financial year) from the fund and recontribute the amounts to superannuation.
The final point in the strategy is important as this recontribution strategy has the effect of turning taxed superannuation benefits into exempt superannuation benefits. This ensures that the capital base of $550,000 will be tax free when paid to the daughters of Gerard & Georgia. In the absence of this strategy the daughters would be taxed up to $82,500 ($41,250 each) when the benefits were paid to them.
This is one example of an opportunity that will not be available from 1 July 2007 if the relevant budget announcement proceed to law.
At present deductible contributions up to the age based limit can be obtained twice as both employer & member contributions. For an individual over age 50 this can mean superannuation contributions of over $200,000 flowing into superannuation at 15%, possibly in preference to tax at 48.5%.
To access personal deductible contributions employment income must constitute less than 10% of the total assessable income of the individual. Until pre retirement pensions this was a reality for only a very small portion of Australians, but pre retirement pensions gave an individual the opportunity to minimise their employment income and gain access to member deductible contributions.
Possibly in response to this the Government have announced that from 1 July 2007 the deductible contribution limit will be managed on a per member basis. Thus the contribution limit will be $50,000 ($100,000 for those aged 50 and over until 2012) and there will be no scope to access multiple limits.
This means that the 2007 financial year is potentially a very important year for those:
- Desiring to realise CGT assets and manage the CGT cost.
- Intending to transfer listed shares into superannuation at a low CGT cost.
Consider the example of Pamela Mills:
- Pam is 57 year old and earns a salary of $80,000 p.a.
- Her living requirements are $40,000 per year.
- She has current superannuation entitlements of $500,000.
- Pam loves her work and has no intention of retiring for at least 10 years.
- Pam has purchased listed shares at a cost of $300,000 with a current market value of $500,000.
- Pam is concerned that she is currently paying tax on the dividend income she is receiving even after imputation credits because she is on a high marginal rate of tax.
- Pam is also concerned that as she does not intend to retire for another ten years there will be a significant CGT liability on the transfer of her shares into a self managed superannuation fund.
Consider the following strategy for Pam:
- From 1 July 2006 Pam salary sacrifices her entire salary into superannuation as employer contributions.
- Pam commences a pre-retirement pension with the full balance of $500,000 that she has in her existing self managed superannuation fund.
- Pam draws a pension of $43,000 per annum from her allocated pension which, after tax of approximately $3,000, funds her living requirements.
- Pam transfers all of her listed shares into her self managed superannuation fund triggering a capital gain of $200,000.
- The 50% CGT discount reduces the net capital gain to $100,000. Pam then claims a $100,000 personal superannuation deduction in her personal return to cap the CGT cost at $15,000.
The result of the above is that the listed shares are now in a self managed superannuation fund at a tax rate of approximately 7.5% on the dividend income (noting that approximately half of the fund will be in pension phase). Consequently, in regard to the dividend income, the fund will receive a substantial refund of imputation credits each year. This can be utilising to manage the tax on contributions in the superannuation fund.
Pam has also managed what may have been a significant CGT liability upon future realisation of the shares.
Once Pam is over age 60 she will pay no tax on the pension she is drawing from the fund and any future increases in the value of the shares will not be taxed if the assets are treated as segregated assets of Pam’s pension account.
You will note that Pam has effectively contributed $180,000 in deductible superannuation contributions in the 2007 financial year. From the 2008 financial year it is proposed that Pam could only benefit from $100,000 in deductible superannuation contributions. In addition, from the 2013 financial year, Pam could only benefit from $50,000 in deductible contributions.
Amongst the Treasurers announcements was a reduction in the age pension taper rate from a $3.00 per fortnight reduction (per thousand dollars of assets above the threshold) to $1.50 per fortnight.
This effectively means that the age pension will fall away at half the rate once an individual or couples assets exceed the base asset test threshold.
Also announced was an end to the 50% assets test exemption on complying income streams such as the term allocated (market linked) pension and the complying lifetime pension from 20 September 2007. The reason being that the combination of the 50% asset test exemption combined with the decrease in the age pension taper rate would provide too significant a concession for those attempting to maximise age pension entitlements.
Nevertheless the Government provided a window of opportunity by announcing that any complying pensions commenced prior to 20 September 2007 would retain their 50% asset test exemption after that date.
Thus there is a significant opportunity to utilise, for example, a term allocated (market linked) pension commenced prior to 20 September 2007 to maximise age pension entitlements.
Consider for example the following facts for John Piper:
- He is a home owner.
- He is 66 years of age and has $450,000 in superannuation which, apart from his car, is his only asset.
- His entire balance is currently in the form of an allocated pension.
- Because John is in pension phase and he has selected an allocated pension he is over the assets test and not entitled to an age pension.
Following recommendations from his adviser on 19th September 2007 John restructures by ceasing his allocated pension and instead commencing a term allocated (market linked) pension.
Assuming John has an account balance of $480,000 at that time John’s assessment for the assets test will be $240,000 which will entitle him to an age pension of approximately $220 per fortnight at 19th September 2007. From 20th September 2007, following introduction of the decrease in the taper rate, his pension will increase to approximately $350 per fortnight.
The Government pension increases John’s standard of living substantially.
Note that John has had to sacrifice access to the capital balance of his superannuation to achieve this result (a requirement for the term allocated pension) however he is still very satisfied with the result.
If access to capital is a concern for John he may consider, for example, an allocated pension of $100,000 and a term allocated pension of $380,000. This would reduce his pension slightly but would ensure that John had access to $100,000 in capital.
The income test is also relevant when determining social security entitlements, however we note that the income test assessment for pensions is very generous and ordinarily it is the assets test that limits social security entitlements for income stream recipients.
The above are only a few of the attractive strategies available if the budget announcements ultimately become law.
Some of the strategies will be available years into the future while others have a shelf life that ends 30 June 2007.
For some there may also be significant benefits associated with making a measured decision to act before legislative certainty is obtained.
For further information contact our Superannuation Manager, Damien Passmore on 02 49 356 157 or email dpassmore@lawlerpartners.com.au
