The rules surrounding excess contributions into super have been overhauled recently and have opened up new opportunities to implement tax-effective strategies, writes Grant Abbott.
I am a great fan of the current excess concessional contributions regime that was introduced with effect from 1 July 2013, where harsh penalties have given way to excess contributions being taxed at a member’s marginal tax rate. This measure hopefully puts an end to the many concessional contribution issues faced by tens of thousands of Australians who have inadvertently exceeded their caps during prior income years.
Looking on the bright side of the new marginal tax rate contribution rules, they provide the potential for a great tax deferral and potential permanent tax difference, which may be achieved if earnings and contributions tax are reduced inside the fund.
As an aside, the excess contributions tax laws also allow all individuals to withdraw from their super fund any excess concessional contributions made from 1 July 2013, but by way of a payment to the Australian Taxation Office (ATO) first. These rules will ensure individuals are taxed on excess concessional contributions in the same way as if they had received that money as salary or wages and had chosen to make a non-concessional contribution.
But as many have noted previously, one of the major drawbacks of making an excess concessional contribution is that it is a non-concessional contribution. Although with the non-concessional contribution cap rising to $180,000 a year from 1 July 2014, with a three-year bring forward for the under-65s of $540,000, there is great flexibility to limit taxable income for high-income earners and take advantage of being out of the pay-as-you-go (PAYG) system. However, go over the non-concessional cap and there is potential pain, or is there?
The government non-concessional contributions reforms
Not limiting itself to reforming concessional contributions, the federal government has also reformed the non-concessional contributions regime. In a prepared budget statement, Finance Minister Mathias Cormann said: “The Abbott government today has made the taxation of excess superannuation contributions fairer. Currently, superannuation contributions that exceed the non-concessional contributions cap are taxed punitively at the top marginal tax rate. Given non-concessional superannuation contributions come from income that had already previously been taxed, this can take the overall tax rate up to a staggering 93 per cent.
“Invariably these breaches of the non-concessional caps are inadvertent and can even be outside the direct control of the contributor. This punitive tax penalty is targeting people doing the right thing by saving more so they can look after their own needs in retirement, reducing their reliance on the age pension.
“In opposition we called on the previous government to fix this and promised that we would if they didn’t. Today, the Abbott government is honouring that election commitment by making sure inadvertent breaches of the non-concessional contributions cap do not incur a disproportionate penalty. This will ensure the treatment of excess concessional and non-concessional contributions is broadly consistent.
“For any excess contributions made after 1 July 2013, breaching the non-concessional cap, the government will allow individuals to withdraw those excess contributions and associated earnings. If an individual chooses this option, no excess contributions tax will be payable and any related earnings will be taxed at the individual’s marginal tax rate. Individuals who leave their excess contributions in the fund will continue to be taxed on these contributions at the top marginal rate.”
Test your SMSF skills
Question one:
Based on a recommendation, he has come to you for strategic advice. Taking into account the new rules around excess concessional contributions and his interest in starting a TRIS, how much should Brian salary sacrifice into his SMSF? At this time he only requires $60,000 net of tax to live on.
- At the very outset, given Brian’s significant salary and much smaller cash-flow needs, he should at least consider salary sacrificing up to the concessional contribution cap of $35,000 (for the 2015 income year), which would include his employer’s superannuation guarantee contribution.
Brian is over the age of 55, therefore we should consider starting a TRIS with his existing superannuation member account balance of $850,000 plus the $35,000 concessional contribution cap. - His current member account balance is now made up of 48 per cent tax-free income and 52 per cent taxable income following the salary sacrifice. Brian requires $60,000 net of tax to live on. Therefore, on a capital amount of $885,000, a 7 per cent drawdown is required – well under the 10 per cent maximum for a TRIS under Superannuation Industry (Supervision) (SIS) regulation 6.10. If this was Brian’s sole source of income, his individual tax assessment on the gross pension payment of $61,950 is nil. This is because the tax payable on the taxable income from the pension with a 52 per cent taxable component of $32,214 is $2662 and as a pension it has a 15 per cent tax offset of $4646 pursuant to section 301-25 of the Income Tax Assessment Act 1997. Brian could take more and still not pay tax.
- We have advised Brian to take at least $35,000 in salary sacrifice contributions. This will keep him under the excess concessional contributions cap. However, if all of his cash-flow needs are met by tax-free TRIS income, then we should investigate what his tax and financial position would be if he salary sacrificed – assuming his employer allows him to – $15,833 per month.
- Important note : At this stage there are no guidelines on which contributions will be treated as excessive, that is, contributions once the cap is reached. This is important as the excessive component is to be treated as a tax-free component. As such, it is a good idea to start a TRIS with the current components prior to putting in the excess concessional and non-concessional contributions, as it is to be all tax free. So the non-concessional contributions will go into a separate accumulation account and possibly a second TRIS is commenced to continue to maximise the tax-free component.
- As he is putting in $155,000 of excessive concessional contributions, which is to be treated as non-concessional, he stays under the higher non-concessional caps for the 2015 income year.
Question two:
Based on the above, what type of assets should Brian consider investing his superannuation into in order to reduce tax on taxable contributions in the fund? Note that the discussion is on tax minimisation in the fund and would need also to be viewed in terms of the fund’s investment strategy and long-term retirement planning objectives.
- Leveraged property to achieve negatively geared losses that will reduce the taxable contributions from the $190,000 contributed pre-tax into the fund. Non-cash expenses, that is, capital allowances and depreciation can also be claimed.
- Creating multiple limited recourse borrowing arrangements to invest in low-yield, high-growth investments, ensuring the investments per holding trust are a collection of assets and thus a single acquirable asset. Related-party loans may need to be undertaken.
- From a tax point of view, Australian equities that provide fully franked dividends provide the benefit of imputation credits and if in the TRIS tax-exempt pension side, carry a lot more weight in terms of tax breaks.
- Other considerations to reduce contributions tax within the fund:
- Carry forward revenue losses, that is, a deduction created from a prior year anti-detriment payment,
- Life/total and permanent disablement insurance premiums, and
- Accounting/audit/administration fees.
Note: We should consider warehousing the property at Noosa in the fund for future retirement purposes for Brian. He cannot use it until his retirement, when he can purchase it off the fund should he desire to live there, but selling his property in Brisbane to pay for it. At that time the property will be in the pension side of the fund and there will be no tax, but there will be stamp duty.
Question three:
What are the ‘tax benefits’ of implementing this strategy versus doing nothing and paying PAYG on gross salary?
- Do nothing:
- Pay PAYG: $52,295 throughout the year.
- Contributions tax on super guarantee of $16,087: $2413.
- Net position (net salary/net super contribution): $135,292.
- Salary sacrifice 100 per cent of salary, assuming that our investment strategy reduces contributions tax on excess contributions to 10 per cent:
- cir2014/15 concessional contributions cap: $35,000.
- Salary sacrifice excess concessional contribution: $155,000.
- Start a TRIS at 1 September 2014 with $850,000 plus concessional cap up to $35,000 (depending on timing of salary payments and the like), meaning the pension capital amount is $885,000.
- Draw down up to 7 per cent, that is, a gross pension payment of $61,950.
- As noted earlier, 48 per cent tax free and 52 per cent taxable approximately, depending on whether there is growth on the balance pre-TRIS.
- Tax payable on pension payment is nil. This is because the tax payable on the taxable income from the pension with 52 per cent taxable component of $32,214 is $2662 and as a pension it has a 15 per cent tax offset of $4646 pursuant to section 301-25 of the Income Tax Assessment Act 1997.
- Second TRIS commenced at end of financial year with excess concessional contributions cap of $155,000.
- First personal assessment in March 2016: nil. Taxable gross pension $32,214, but attracts a 15 per cent tax offset, so no tax payable.
- Trustee of the super fund lodges its tax return in March 2016 showing excess concessional contributions of $155,000.
- Amended assessment issued by the ATO at some time once both returns are married up in order to tax the excess contribution at Brian’s marginal tax rate. There will be an add back of the excess concessional contribution of $155,000 plus an excess concessional contribution charge.Tax assessment individual: $155,000 = $45,297, but with a 15 per cent tax offset of $23,250, so total tax payable personally is $22,047 within 21 days of receiving the amended assessment.
- Excess concessional contribution charge: $2256 from 1 July 2014 to 15 March 2016 and there will be shortfall interest charge if not paid within 21 days.
- Taxable contributions in the fund are $190,000. Possible tax payable in the fund is $28,500, but can be reduced by deductions, negative gearing and imputation credits. We have assumed there is a 10 per cent contributions tax on the $190,000 = $19,000.
- Net tax: $22,057 + $2256 + $19,000 = $43,313.
- Net position (net salary/net super contribution): $146,687.
- Net position v do nothing: $146,687 – 135,292 = $11,395.
This is a permanent tax difference but there is a timing difference as the $190,000 is in there from the start earning money in a concessionally taxed environment.
Case study: excess concessional contributions
2015 income year
Brian Jones is a 56-year-old architect with a mid-tier firm in Brisbane. He has an SMSF, the Jones Family Super Fund, which was established in July 2011. He is the only member of the fund and the sole director of the corporate trustee. His current member account balance is $850,000. This is split 50/50 between a tax-free and taxable component. It is currently invested in cash and term deposits, but he is interested in starting to diversify so as to increase yield and also acquire a place in Noosa through the fund to move into in his retirement. He has found one near Hastings Street that he believes he can get as a bargain for $1.2 million as it is a mortgagee-in-possession situation. Brian’s gross salary (including the superannuation guarantee) is currently $190,000. He would like to retire when he reaches the age of 62 and as such is keen to accumulate and contribute as much as possible into his fund. He has heard about the concept of a transition-to-retirement income stream (TRIS), but he is still unsure about whether he wants to draw any income out of the fund due to his current salary level.
