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Look at super with different eyes

Too often I hear from people that the only important thing about super is ‘the return on my investment’. When you have a better understanding of superannuation regulations, you quickly find out super returns are far from the most important thing.

The purpose of this article is to encourage people to think differently about super, not to provide the only answer to a problem. The only golden rule of super is that there are no golden rules. Everyone’s situation is different. It is important to make your fund work for you, not you for it.

Thinking differently starts with the terms we use. Most people think of super as that thing we do for when we are old. Pensions are things we only use when ultimately we stop work, again about being old. Not so. Super is simply a trust structure, and pensions are just distributions from a trust. They are actually called income streams not pensions. In the same way, a distribution from a company is called a dividend and a distribution from a family trust is a trust distribution. The real driver is the tax benefits that the super environment provides everyone. Anyone who is paying tax on their investments should be asking the question, how can I do this better?

Let’s take it away from super for a moment. Here is a simple example of how to think differently:

  • person aged 55 with small business
  • expects to work for another 15 years then retire with children taking over the business
  • trustee of an SMSF with $200,000, all concessional amounts in accumulation
  • wants to acquire the business premises valued at $1 million
  • has $400,000 cash outside super.

What would normally happen?

  • continue to work and pay the base super guarantee amount to the fund, but no additional amount because borrowing money so will want to pay loan off quickly
  • head off to the accountant who will set up a Family Trust to buy the property
  • contribute or lend the $400,000 cash to the Family Trust and then go to the bank and borrow the remaining $600,000, giving bank security over the property in the Family Trust. This will ensure the asset is there for the family and a few tax benefits of distributing the earnings and capital gains around the family via the Trust.

Sound familiar? There is nothing wrong with this strategy, but there may be a better way to do it that ensures the whole family ends up better off with debt paid off faster. I suggest a rethink.

Starting with the existing SMSF, the first step is to commence a pension. This is where most people fall down – they don’t want a pension because they are not old.

By commencing the pension, there will be no income tax or capital gains tax in the fund on the income generated from the assets in the fund. I do note, however, being 55 and with the SMSF money coming from a concessional source, there will be some tax on the pension paid as outlined later. If the pension money is not needed, put it back into the SMSF. This is also a start of estate planning. It changes assets that would be taxed against the children into assets that won’t be taxed against the children. If the asset were in a Family Trust, the income every year would be distributed and tax would be paid.

Next, contribute the $400,000 cash to the SMSF and start a second pension with it. There are tax and estate planning benefits here as this is all a Non Concessional Contribution(NCC) therefore not taxed as it goes in and not taxed as it comes out, regardless of who it is paid to.

The client then buys the property through a holding trust entity within the SMSF, following the superannuation rules for borrowing money and buying property. Follow the rules when considering borrowing within your fund as getting it wrong can have adverse consequences. Don’t rush out and do this without getting proper advice. The bank is given the security. Strangely, this sounds exactly like the first scenario. The key benefit is that the asset in the fund is not subject to income tax or capital gains tax. If it were in a Family Trust, they would be. Which one do you want?

So what are the benefits of all this?

  • pension from the $200,000 @ 4% is $8,000 and is taxable at marginal tax rates less 15% (from age 55 to age 60)
  • commence a separate pension for $400,000 with all NCC tax free money (need to ensure the property is segregated to this account and the rent will cover the loan interest payments)
  • pensions are paid on net pension amount ie $400,000 not $1 million as the debt is taken off the calculation and 100% tax free even at age 55 ie 4% of $400,000 is $16,000 tax-free.
  • capital gains tax on the property if sold is nil under current legislation
  • net rent received is taxed at nil, yet fully deductible to the small company
  • in retirement 100% of income to client is not taxable
  • on death asset passes from NCC account to children tax free (no capital gains tax or ETP tax)
  • more effective loan payment (rent received is tax free so more money to pay off loan more quickly).

I do stress, this is not the only answer. This example was put together to illustrate my point. We don’t think enough about how to get the best out of superannuation. Take some time to talk through the options and design it for yourself. Get some advice, super is designed for your benefit, use it if it helps but if nothing else start the thinking process. And go and see a professional.

 

Andrew Bloore is Chief Executive Officer of SMSF administrator, SuperIQ.


 

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