The new SG opt-out rules for high earners

There is one budget announcement that has received very little publicity – probably because it’s not controversial and is, in fact, just good old common sense. The budget measure in question will allow people whose compulsory superannuation guarantee (SG) contributions cause them to exceed the $25,000 concessional contributions cap to opt out of their compulsory contributions from 1 July 2018.

You may be wondering why this doesn’t happen more often – working backwards, 9.5 per cent of earnings will be more than $25,000 for anyone earning more than $263,158 (9.5% x $263,158 = $25,000.01).

But remember the SG legislation has a built-in protection for cases where an individual has only one employer. This is because the SG is only payable (by the employer) on earnings up to the maximum contribution base. This is currently $52,760 per quarter ($211,040 a year). The maximum compulsory contribution from a single employer would therefore be just over $20,000 (although even this would exceed $25,000 if the SG rate is increased to 12 per cent as planned – hence it is not entirely surprising a solution is being considered).

The problem arises for those with more than one employer. Consider someone who is a director of three companies, each of which pays directors’ fees of $100,000 a year (giving the individual total earnings of $300,000 a year). Each employer would currently contribute 9.5 per cent of $100,000 ($9500) and the total amount contributed each year would be $28,500.

In the case of the example above, the government’s proposed change would allow the individual to opt out of the compulsory contributions for one or more of those employers on the basis that they will exceed the concessional contributions cap if they don’t.

Ever since excess concessional contributions became refundable and ultimately taxed at personal income tax rates rather than penal rates, it has actually been possible to ensure an excess does not represent a substantial tax cost. But it has nonetheless locked funds into the crazy cycle of:

  • accepting contributions the members and trustees know will exceed the cap, and
  • watching out for ATO notifications of the excess so they can remove the excess from the fund to avoid having the excess treated as a non-concessional contribution.

This is particularly relevant for SMSFs because many higher earners have SMSFs and hence their funds face this more frequently than other funds. And it is not just highly paid directors who face this issue. Other SMSF clients are likely to include:

  • doctors with a private medical practice who also work in the public hospital system, and
  • dentists or vets carrying out locum work at multiple practices where they are paid personally for the work they perform (rather than via a company that in turn pays them their superannuation).

It is strange in some ways that it has taken over 10 years to solve this problem. Before 1 July 2007, when superannuation concessions were limited via reasonable benefit limits (RBL), there were specific provisions that allowed individuals already in excess of their RBL to opt out of compulsory superannuation entirely. The fact the same option did not exist after 1 July 2007 probably reflects the fact that at the time:

  • contribution limits were higher (remember the days of $50,000 for those under 50 and $100,000 for those over 50?), and
  • the maximum contribution base was lower ($36,470 per quarter in 2007/08).

Together, these factors meant that even someone under 50 (with the lowest possible contribution limit) would actually need more than four separate employers to have a problem.

The change makes sense, but is there anything that remains unknown at this stage?

Draft legislation released in May has indicated that the process will operate via a system of “shortfall exemption certificates” issued by the ATO for one or more quarters. Individuals will apply for these directly with the ATO and then provide them to the relevant employer. (The Commissioner won’t provide the certificate unless the ATO is satisfied that the member would have excess concessional contributions if the certificate was not issued.)

This is important as employers need to have the comfort of knowing they have done the right paperwork and won’t get caught with an unexpected bill. (Remember, it is employers who bear the risk when SG contributions are underpaid – they become liable for the SG charge, including associated penalties and administration loadings.)

One risk facing those eligible to opt out is they will obviously wish to ensure they still receive their full remuneration somehow. They will need to negotiate with the relevant employers to have the forgone contributions paid as additional salary. This may not be possible in all cases.

Returning to the medical specialist who works in the public hospital system as well as their own practice, we expect some may find it difficult to convince a very large bureaucracy to make system and rule changes for a small group.

All in all, it will be a welcome (and overdue) change, but not without its complexities.

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