In a monthly column to assist trustees, specialist Meg Heffron explores major issues on managing your SMSF.
At the 2023 Federal Budget, the Government recommitted to introducing a new tax on super fund earnings for those with balances above $3 million. While there was a short public consultation period from 31 March to 17 April 2023, I expect the tax will be introduced pretty much as already outlined by Treasury. It will probably include all the contentious aspects, my top three being:
- Applying the tax to unrealised capital gains
- Not giving a tax refund for those whose super assets subsequently fall in value, and
- Not indexing the $3 million threshold.
I suspect any changes will be relatively minor.
Choices for those with a lot in super
Anyone who has retired or made it to 65 has numerous choices where they save, and those impacted by the new tax need to decide whether they take a lot of their wealth out of super.
They could choose to invest in their own names, as a discretionary trust, as a company, or some combination. The right mix will depend on lots of factors, including their existing non-super structures, their plans for the money, estate planning, the amounts involved, etc.
To start, consider the choice of:
- Taking money out of super and putting it in a family trust
- That trust making distributions to individuals where it makes sense from a tax perspective (such as where they have little other income) but paid to a company where it is desirable to cap the tax rate at 30%, and
- A few other nuances to recognise that different types of income are taxed in different ways.
For example, it’s often better for family trusts to pay capital gains (when they sell assets) to a person even if that person pays tax at the top marginal rate of 45% plus Medicare, rather than a company which pays tax at only 30%. This is because individuals don’t have to pay tax on all of the capital gain.
The Stage 3 tax cuts are also relevant as it looks like these will go ahead as planned. If so, individuals and companies will pay virtually the same tax rates up to incomes of $200,000 (the difference is Medicare) so it might not be worthwhile introducing the complexity of a company in the trust structure. In the following, I’ve assumed these tax cuts will happen.
Think differently after 30 June 2025
In that case, should someone with a Total Super Balance (TSB) well over $3 million extract wealth from their SMSF?
It’s not possible to make one statement for all people, so let’s go with … maybe, but maybe not.
For many – particularly funds with assets held for a long time showing substantial unrealised gains already – leaving the money in super might still be best. One of the drivers here is the way the earnings calculation works for the new tax. Remember that the new policy will commence on 1 July 2025 and apply from the 2025-26 financial year onwards for individuals with more than $3 million in super on 30 June 2026.
Consider a single member fund that has a number of different assets but let’s focus on one, a property valued at $4 million at 30 June 2025. The gain in value since it was first purchased is $1 million. When it is sold in August 2027, it is still worth around $4 million. In other words, its value grew a lot initially but then plateaued. When the property is sold, the fund will have a $1 million capital gain in 2027/28 but none of this will impact the earnings calculation for the new tax.
The earnings calculations for 2025/26, 2026/27 and 2027/28 are only concerned with growth in those years specifically, not what has happened in the past.
However, the tax implications would be different if all the growth had occurred after 30 June 2025.
So one important takeaway here is that after 30 June 2025, think differently about assets your SMSF already owns versus purchases in the future, and plan for those changes now.
What about new investments after 30 June 2025?
If this same fund was now considering purchasing a new asset with its $4 million, would the new tax impact the decision? Would it now be more attractive to buy that new asset outside superannuation?
Let’s start with a simple example. If the new $4 million asset simply generates income each year and no growth, even with the new tax, super is probably still better. This is because the new tax is not exactly the same as just applying a 30% tax rate (15% in super plus 15% of the new tax) to this income amount. In fact, the new tax is applied to a lower amount as the fund will have paid the initial 15% tax on those earnings already.
But one of the things everyone hates about the new tax is that it includes tax on unrealised gains. That means each year, there is more tax paid as the assets grow if they are held in super. So surely this simple analysis has to change if the asset is also growing in value?
Let’s use some numbers to explore it further.
Consider an individual with a $7 million super balance ($2 million pension account, $5 million accumulation account). The fund has just sold its $4 million asset and so has cash. This person is weighing up whether they should take this $4 million out of super and invest elsewhere. Let’s assume each investment (whether held in superannuation or outside superannuation) produces income (rent, dividends, interest etc) of 5% pa and capital growth of 3% pa.
After 1 year, the total tax paid from all sources (in the super fund, the new extra tax) would be around $82,000 if all wealth remained in superannuation.
In contrast, the total tax could be as low as $65,000 (approximately) if $4 million was moved outside super and invested via a family trust.
In other words, investing outside superannuation looks far more attractive as it saves $17,000 pa in tax. But the tax equation changes the moment the asset is sold.
For example, if it was sold at the end of the first year, this tax saving evaporates entirely. The ‘remove it from super’ option would actually be worse by around $10,000 than leaving everything in super.
Even if we project this out over several years and assume the asset is not sold for another five years, the “remove it from super” option still looks worse because of the benefits of realising capital gains inside super rather than other structures.
This feels counterintuitive. Even if we take a superficial approach and add the two 15% tax rates, it ‘feels like’ the comparison should be roughly:
- At worst, the super fund will pay an effective rate of tax on capital gains of 10% (15% but applied to a discounted amount) and the new tax more or less taxes gains at 15% as they accrue. These two add up to 25%.
- This is about the same as a discounted gain distributed to an individual taxpayer who – at the very worst – would pay tax at 45% plus Medicare on half the gain (effectively 23.5%).
Given that the first option involves paying tax on some of that gain progressively while the second allows it all to be deferred, it feels like the ‘remove it from super’ option should be better.
But the positive outcome for leaving the money in super reflects the interaction of a number of slightly complex variables and the end result is pretty close, with super winning.
What about death taxes?
The big risk with super is death.
When a super member dies and their money goes to a spouse (either directly or via the estate), it’s not a problem. But if it goes to financially independent adult children, they potentially pay a lot of tax. Not on earnings, but on capital.
This isn’t a new issue or one that’s created by the new tax. But it is a big weakness with leaving money in super for too long.
So perhaps that’s actually the message here. The new 15% tax on earnings won’t necessarily push a lot of money out of super but it will focus attention on the death tax. It’s a reminder that if super is likely to be inherited by someone who is subject to the death tax, it should come out before we die.
Meg Heffron is the Managing Director of Heffron SMSF Solutions, a sponsor of Firstlinks. This is general information only and it does not constitute any recommendation or advice. It does not consider any personal circumstances and is based on an understanding of relevant rules and legislation at the time of writing.
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