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The $1.6 million cap … an unlucky break for the lucky few

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The Government’s proposal to introduce a $1.6 million cap on the total amount of superannuation benefits in pension phase limits the amount a person can accumulate in a tax-free environment. Whilst the average Australian could only dream of building a $1.6 million retirement fund, those that do will be required to move the excess funds out of pension phase. This overflow could be invested in a number of ways, and now would be a good time to talk to your financial adviser about the alternatives.

But let’s face it – super is still likely to be the best place to park large swathes of wealth, with generally considerable advantages to retaining excess funds in this environment. Concessional tax on earnings may not be better than no tax, but it sure is better than the marginal rate at the heavy end of the wealth spectrum.

Rolling the funds out of pension phase to an accumulation fund will generally not have any tax consequences on the withdrawal, and future earnings of the accumulation fund would be taxed at the concessional 15% rate. However, the tax consequences of subsequently withdrawing the excess out of super depends on factors such as age, condition of release and the underlying tax components of the benefits.

If you are retired and over the age of 60, withdrawing your benefits would be tax-free (unless you have an untaxed element in your taxable components, which would be taxed at 15% up to the untaxed plan cap of $1.395 million … but now we’re getting technical). If you are retired and under 60, you may consider sitting the fund in accumulation phase until you reach that magic age, as a lump sum withdrawal above $195,000 could see 15% of your taxable components going to the Tax Man. Declaring it as an income stream payment would not be any better while you are under the age of 60.

Example of past and possible future

DC-table1Tom is 56, retired and currently drawing $120,000 per annum as his minimum pension requirements from his $3 million fund. Half of his benefits consists of taxable components so Tom happily pays $3,247 in income tax on his pension payments knowing that this tax impost will only be for another four years.

Let’s say Mr Turnbull wins the election and all of Sco-Mo’s budget dreams come true.

Tom still wants to live comfortably on $120,000 per annum post- 1 July 2017. He rolls out $1.4 million from his pension account and parks it in an accumulation fund after seeking advice. Being fully retired, he could nominate to take all of his income needs from his $1.6 million pension account, or he could continue drawing the minimum and augment his income with lump sum withdrawals from the accumulation fund (let’s keep it interesting and assume that he has fully utilised his low cap rates in the past).

Interestingly, Tom would pay less personal income tax under this strategy but the earnings in his $1.4 million accumulation fund are now subject to 15% tax. If the income generated in his accumulation account is 5%, the fund now pays $10,500 in tax on the investment earnings.

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Should Tom roll back more into accumulation phase or perhaps pull it out from superannuation altogether? If he does, should he be planning for any future capital gains derived from the accumulation assets now while everything remains in pension phase and tax exempt? Asset transfers between pension and accumulation phase would generally keep the purchase cost information … food for thought.

And he could hold a significant sum (say $400,000 earning 5% income) in his personal name and pay little or no tax due to the tax-free threshold outside super, and any capital which would derive income above the tax-free threshold could remain concessionally-taxed in superannuation.

DC-cartoon2But what about the anti-detriment changes?

Tom has had a happy life and his adult daughter, Jessie, stands to inherit his wealth. Superannuation was taken into consideration as part of his wealth distribution and estate plan. Scott Morrison’s proposal to remove anti-detriment payments now means that Jessie’s inheritance would be heavily impacted.

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Tom’s adviser shows him that superannuation may no longer be appropriate if his wealth distribution goal for Jessie remains a top priority. Given this significant impact, Tom could potentially look into holding some of his capital in his own name. With careful planning, his adviser can help him minimise the income tax payable over his lifetime.

Some other consequences to consider

There are several questions for the consultation papers when (and if) the budget proposals go through to legislation. Obviously the mechanics and administration changes would need to be carefully planned before 1 July 2017.

Many people will now need to park the plan for additional non-concessional contributions due to the proposed $500,000 life time cap, especially those who have made strong contributions from July 2007.

If you are not part of the $1.6 million club and have under $500,000 in super, there are a few options to consider.

If an impending bonus is going to tip you into the next tax bracket, or you’re planning to sell an investment property at retirement, it may be wise to hold back from further contributions (yes, stop that salary sacrificing arrangement) and subsequently make use of the catch-up concessional contributions provisions. This could serve to keep you in the lower tax bracket, and swell your fund balance considerably. And what if you make your large concessional contribution in June? You could then defer claiming the contribution until the following financial year, which effectively gives you up to six years of concessional caps to play with. Of course, you’d need over $150,000 in capital gains or other assessable income to make it worthwhile, but it’s a win nonetheless if you have the cash.

What other things should your adviser be considering in the next 13 months? Balance equalisation would be important; making use of the ability to split contributions with a spouse (beyond the age of 65), as well as making use of the spouse tax offset for partners earning under $37,000 (a proposed increase from $10,800). Of course, you would need to leave a buffer under the proposed non-concessional lifetime cap of $500,000 to make this worthwhile and trigger the $540 tax offset.

To summarise, there are a raft of strategic options to consider with the 2016 Budget proposals. The evolution of wealth creation will continue unabated, albeit in a new guise and with vastly different focus areas. Contribution splitting with a spouse will become the norm, whilst salary sacrificing and transition to retirements will be locked up in dusty museums for future generations to laugh and point at. Remember these are just proposals at this stage, and we are far from seeing the changes in their final form. Haste and complacency are your enemies in equal measure, but patience in planning your financial future will always be your friend.

The unintended consequence of Scott Morrison’s super 'reforms' is to make the provision of quality financial advice essential once again. Surely, Scott, this wasn't your intention?

 

Diana Chan is Head of Compliance at Stanford Brown. This article is general information and does not address the circumstances of any individual.

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14 Comments

Mike Van Leeuwen

October 04, 2016

Hi Diana.

My wife and I are both over 60 and have individual balances above 1.6 M each in a SMSF.
We are currently in pension mode receiving the minimum 4% draw down.
With the new rules we need to set up two pension accounts of 1.6 M each and two accumulation accounts for the remainder.
All our investments in our SMSF are either in syndicate investments or shares in private companies.
How do we determine what is going into each account and how is this valued?
Is it determined at the buy in price or the current valuation price?
Also if an investment in the pension 1.6m account is written off, so the balance is now say $800,000 can the account be topped up with an investment from the accumulation account to make the balance back up to 1.6 Million?

Trevor Long

September 25, 2016

I am one of the far seeing individuals who was in a long term Super scheme which netted less than $1.6m when I retired in 2011 however my financial advisors have managed to grow that amount whilst I withdraw the minimum. The result is that my super is now in excess of the $1.6m however that amount supports my wife and I. As I understand it the $1.6m limit is on a per person basis so how does the Govt recognise that my Super supports two persons or am I expected to start a new Super scheme for my wife from the excess in my fund?

David McGrath

September 04, 2016

Please leave superannuation as per previous Governments.( Thus reducing a drain on Government revenues through pensions ). Increase the GST by 2% and reduce the deficit remarkably quickly - a no brainier. Economics 101

Ramani

June 19, 2016

A rather subtle feature of our super and tax regime in assessing the difficulty of reaching the $1.6 million cap (if legislated) s that unrealised gains are not included in taxable income, though they are (and logically must be) included in calculating crediting rates (or underlying unit pricing). Given super's long term horizon (decades of accumulation followed by decades of longevity-fueled withdrawal phase), with liabilities being better matched to longer term assets such as equities, property, infrastructure, most investment strategies would anticipate a growth element in addition to income (namely: current yield).

This allows balances to be compounded free of tax to the extent unrealised gains are embedded in the portfolio, and they do not prove transitory (ie., do not vanish while cashing out). This could be managed through diversification or defensive derivatives exposure, subject to risk appetite.

Capital losses when not realised are the opposite; but it is to be hoped that the total portfolio of a member does not get into this state frequently, where choice of fund / portability should act as a check on manager performance and competitiveness.

Graeme

June 17, 2016

Why would salary sacrificing be “locked up in dusty museums”? I think it is great that my wife can still salary sacrifice (15% tax) $35k pa for two years then $25k pa until she turns 60. The alternative is paying tax at her marginal rate of 32.5%.

Actually the whole thing will is still be very generous. My wife’s grossed up income this year comprises part time $34k wages and grossed up $37k in mostly franked dividends. She salary sacrificed all the wages, only pays 10.7% tax on the rest, then will get back $10k in franking credits as well.

I’m retired, so my only income is a grossed up is $55k, which is also mostly franked dividends. I make a concessional contribution of $35k (15% tax) into a wrap super scheme to get access to fund managers I can’t personally invest with and pay no tax on the rest. I also get back $10k in franking credits.

And in a month’s time when I’m 60 I can convert my older super to pension phase and get withdrawals and earnings tax free from that as well. Like I said, very generous.

Diana Chan

June 20, 2016

Hi Graeme,

The super reforms also include proposals to allow all Australians under the age of 75 years to be able to claim a tax deduction for super contributions regardless of their employment circumstances from 1 July 2017. This means no more work tests if you are over 65 and no need to show that you are substantially self-employed.

So potentially instead of salary sacrificing, you could review your employer SG payments received over the financial year and make your pre-tax contribution before the end of the financial year up to the concessional caps (which are proposed to be reduced to $25k). Be mindful of employer-sponsored insurances in super.

If legislated and until then, maximising your concessional contributions to the current caps ($30k if you are under 50 and $35k if above) by salary sacrificing or claiming personal tax deductions if you are eligible remains a valid strategy to improve your tax position.

Kind regards

Malcolm W

June 17, 2016

Sounds like a great strategy for the person wanting to make a larger concessional contribution if the rules do change - stop your salary sacrifice and save up that balance.

Just need to hope the rules don't change again in the meantime !

Given recent events it would be hard to have that confidence.

Happy Self Managed retiree

June 17, 2016

I am a little confused. As I understand it, the $1.6 mil is the most an individual can transfer / put into a pension super fund account; it is not the balance at any given time as this will obviously vary quite dramatically and may often total much more than this cap. Please enlighten me if I am wrong as I often read conflicting views.

Diana Chan

June 20, 2016

Yes, the proposed $1.6m pension transfer cap is a lifetime limit and indexed in $100k increments.

If you already have more than $1.6m in pension then you are considered to have used 100% of your pension transfer cap and will not be able to transfer any more funds into pension even after the cap is indexed to $1.7m.

But indexation is a fickle thing, it will take years to increment and it easy for governments to stop/pause/defer whenever it suits them ... it's like imposing a tax hike without physically applying a tax hike.

Regards,

Gary M

June 16, 2016

Good to acknowledge that TTR paper shuffling belongs in a museum.

Stephen Chan

June 16, 2016

Diana,

Very well written and explained. Tom and many of us will be worse off had Turnbull and Scott Morrison have their ways. Superannuation rules are already complicated and the new proposal would make them incomprehensive to most people except for the financial professionals.

Thanks for the article.

Regards,
Stephen chan

Robert Northcoat

June 16, 2016

Good article Diana,

I just cant work out how my clients are going to get $1.6mil into their super funds, given the proposed $25k cc and $500k ncc.

Beyond the absurd, are there any strategies that look reasonable?
Any ideas...

Diana Chan

June 16, 2016

Hi Robert,

Unless you already have a decent sum in super and many years to contribute, it seems that the $1.6m balance in super could be a stretch goal with the proposed limitations on contributions.

Larger contributions which are not included in the NCC caps may be possible if your clients have capital proceeds from the sale of a small business asset and are eligible to apply the 15 year or retirement CGT concessions, or receive a contribution from personal injury settlement ... although clients should never bank on the latter for their retirement plan.

Regards

Hex

June 16, 2016

I think that is a brilliant point.


 

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