Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 198

Catch-up contributions are a tax planning opportunity

As part of the latest superannuation reforms, from 1 July 2018 individuals with a total superannuation balance of less than $500,000 before the beginning of the financial year will be able to make ‘catch-up’ concessional superannuation contributions.

These individuals will be able to access their unused prior years’ concessional contributions cap (that is, the amount by which those contributions are less than $25,000) on a rolling basis for five years and claim a tax deduction for those contributions in the year in which they are made. Any unused concessional contributions cap for the year will expire after five years.

The aim of the measure is to make it easier for people with interrupted work patterns, and with varying capacity to save over periods of time, to accumulate wealth in superannuation and gain access to the same tax concessions as those people who have regular and steady work patterns and income.

Reform offers planning opportunity

It also provides a planning opportunity. By deferring concessional contributions to a year in which an individual’s taxable income is higher, and making them as ‘catch-up’ contributions in the year when they are in the higher tax bracket, they will be able to create a larger tax arbitrage between tax at the super fund level and tax at the personal level. An example illustrates the point.

Dennis is a consultant operating as a sole practitioner. It is June 2019 and his taxable income for the 2019 year will be $80,000. He has not made any superannuation contributions for the year and has a superannuation balance of $300,000. Dennis expects that his taxable income in 2020 will be $165,000 higher because of a net capital gain that he is likely to crystallise due to the disposal of an investment property that he has just put on the market. That is, his taxable income in 2020 will be $245,000.

If Dennis makes a concessional contribution of $25,000 to his super fund in June 2019 and then another $25,000 in 2020 he will create a total tax arbitrage of $12,375. This could be considered a ‘standard’ contribution pattern.

In 2019, his personal taxable income will go from $80,000 to $55,000 and his tax will reduce from $17,547 (not including Medicare levy or small business tax discounts to which he might be entitled) to $9,422. A saving of $8,125 in personal income tax.

His super fund will pay tax of $3,750.

In 2020, his personal taxable income will go from $245,000 to $220,000 and his tax will reduce from $84,782 (not including Medicare levy or small business tax discounts to which he might be entitled) to $73,032. A saving of $11,750 in personal income tax.

His super fund will again pay tax of $3,750.

$8,125 + $11,750 - $3,750 - $3,750 = a $12,375 tax arbitrage.

How catch-ups will work

If Dennis defers the 2019 concessional contribution and makes a catch-up contribution in 2020 (along with the $25,000 allowed for that year) then Dennis will create a tax arbitrage of $16,000.

There is no personal tax saving in 2019. And no tax at the super fund level.

However, in 2020, his taxable income will go from $245,000 to $195,000 and his tax will reduce from $84,782 (not including Medicare levy or small business tax discounts to which he might be entitled) to $61,282. A saving of $23,500 in personal income tax.

His super fund will pay tax of $7,500.

$23,500 – $7,500 = a $16,000 tax arbitrage. $3,625 more than the standard approach of making the maximum $25,000 in each year.

By deferring the superannuation contribution from 2019 until 2020, the tax rate arbitrage goes from 17.5% (32.5% – 15%) to 32% (47% – 15%). The extra 14.5% arbitrage on the $25,000 catch-up concessional contribution amounts to $3,625.

Same amount in super with less tax

Under a 'standard' contribution pattern, over the three years, Dennis will get $75,000 into super with $16,750 in total tax arbitrage.

Under a 'catch-up and reserve' strategy, over two years Dennis will get $75,000 into super with $23,000 in total tax arbitrage.

Denis has created a 30% return, in two years, on his $75,000 contribution.

The strategy will work best where there is a large jump in taxable income from one year to the next resulting in changing tax brackets. Taxpayers would need to know that their taxable income in subsequent years is going to be (much?) higher than the current year.

And, of course, there is the risk that waiting to make catch-up contributions could back-fire if the taxable income drops or the catch-up contributions bring the taxpayer into a lower tax bracket in the catch-up year than they were in in the previous year. Or, indeed, if future government generosity leads to the lowering of the marginal tax rates or expanding of the lower tax brackets or the rules change.

But circumstances could arise where taxpayers will know with a degree of certainty that their taxable income will jump up in a particular year (and then maybe fall again). For example, as in the above scenario where a property is being prepared for sale which will finalise in a later year. Or where a person is party to an option contract which, upon exercise, will result in the disposal of a CGT asset at a price which the person knows will result in a taxable capital gain. Or large dividends might be paid from private companies.

In such circumstances, a person might wish to consider deferring concessional contributions and make them as catch-up contributions in the year when the taxable income increases to maximise the total tax arbitrage. Don’t forget, though, the savings are tied up in super.

 

Stephen Lawrence is a Lecturer, Taxation and Business Law School, UNSW, Chartered Accountant and Member of the International Tax Planning Association. These views are considered an accurate interpretation of regulations at the time of writing but are not made in the context of any investor’s personal circumstances.


 

Leave a Comment:

     

RELATED ARTICLES

Super changes, the Budget and 2021 versus 2022

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

Where is superannuation research heading?

banner

Most viewed in recent weeks

10 little-known pension traps prove the value of advice

Most people entering retirement do not see a financial adviser, mainly due to cost. It's a major problem because there are small mistakes a retiree can make which are expensive and avoidable if a few tips were known.

Check eligibility for the Commonwealth Seniors Health Card

Eligibility for the Commonwealth Seniors Health Card has no asset test and a relatively high income test. It's worth checking eligibility and the benefits of qualifying to save on the cost of medications.

Hamish Douglass on why the movie hasn’t ended yet

The focus is on Magellan for its investment performance and departure of the CEO, but Douglass says the pandemic, inflation, rising rates and Middle East tensions have not played out. Vindication is always long term.

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Latest Updates

Investment strategies

Gullible travels, or are Aussies more sceptical?

Businesses exploit the psychological processes that people go through when they decide to buy something, but does the US research work when faced with "traditional hard-bitten, no-bullshit Australian scepticism"?

Retirement

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

Retirement

Global survey shows Australians least confident about retiring

Australians are generally optimistic about retiring comfortably but their confidence lags retirement savers in other countries. They are also the most unsure about future returns and withdrawal rates in retirement.

Financial planning

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Investment strategies

Morningstar asset class performance, 2021 and historical

As we enter a new year, we dive into the Morningstar database to see which asset classes have performed well over various time periods, with the related risks and largest historical drawdowns.

Investment strategies

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Using past performance is a risky way to invest

We often assign quality in investment choice by historical returns, backed up when we see fund flows directed towards such historically well-performing funds. This is a mistake made by investors and regulators.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.