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And we’re off: super tax risks post 1 July

We had about eight months to prepare for the most significant tax changes to superannuation in a decade. While the major amendments reduce concessional contributions for some people and increase them for others, the two most important changes reduce the tax shelter of superannuation for the wealthy.

It is easy to see why these were needed. Under the pre-2007 tax system, the rules provided incentives to put as much post-tax wealth into a super fund as possible. There were tax penalties for taking out more than was considered reasonable. Yet, when they transitioned to the post-2007 system of exempting from tax all benefits from age 60, they ignored how much was accumulated under those old rules.

Now there are limits on tax-exempt pensions with a $1.6 million starting amount, and the same $1.6 million in superannuation is an eligibility condition for non-concessional contributions.

The practical consequences of the super changes

There are now two main risks for both investors and their advisers:

First, for exempt pension income in accounts, other than in a SMSF, that exceed the $1.6 million cap, anyone affected will now have to decide which assets should receive the tax exemption and which should be taxed at 15% on their income. Broadly, it should be decided on whether the assets are tax sheltered anyway, such as imputation credits on dividends or the one-third discount on capital gains.

Also, if there is more in super than the tax-exempt limit, decisions must be made whether to hold the excess assets inside a superannuation fund or outside. Issues include whether the income from assets transferred outside can be sheltered using the progressive personal tax rates rather than the fixed 15% rate applicable in a fund will be important. There is also the potential for income splitting between partners to further use the progressive tax rate shelter. Remember that the tax-free threshold for individuals is $18,200, and then the marginal tax rate is 19% up to $37,000.

Second, the new eligibility conditions throw up contribution timing and even due diligence risks for financial planners and other professionals who are advising their clients.

A couple of examples will demonstrate the point. Eligibility to contribute non-concessional contributions and some concessional contributions now depends on the member’s account balance on the prior 30 June. While that looks straightforward, the issue of valuing illiquid assets in SMSFs could prove problematic. What if the only assets are real estate? Will a drive-by valuation suffice?

And what about transitional arrangements for balances that are close to but less than the $1.6 million cap? For example, someone with more than $1.5 million but less than $1.6 million at 30 June 2017 is entitled to the $100,000 non-concessional cap in 2017/2018, but not the bring forward ability. For balances between $1.4 million and $1.5 million, the non-concessional cap in 2017/2018 is $200,000 and the bring forward period is only two years. There are rules about bring forwards triggered as far back as 2014/2015, and the impact on co-contributions, tax offsets for spouse contributions and the role of segregated assets.

As ever in super, the devil is in the detail.

Even in the non-SMSF world, it will be risky when advising on contributions for members early in a financial year. The ATO has advised that, with the fund reporting systems currently in place, the ATO will not be certain of the member’s prior 30 June account balance until November of the following financial year.

And then there are ‘legacy’ pension problems. Some people commenced their working life in jobs that traditionally gave them a deferred pension payable at, say 55 or 60 years of age. This was common in the public sector or large corporates. That deferred pension picked up in those early career choices a long time ago is probably worth ‘two and sixpence’ in the scheme of things. They sit in the bottom drawer and simply don’t factor into real retirement planning. Now, unfortunately, they do factor, as the value of those deferred pensions is included in the ability to make contributions where their total superannuation balance is a factor. That, obviously, creates due diligence issues and, indeed, risks.

Welcome to the new world of tax planning around the pension income exemption and risky advice about non-concessional contributions.

 

Gordon Mackenzie is a Senior Lecturer in taxation and superannuation law at the Australian School of Business, University of New South Wales. This article summarises the major points, it does not consider the needs of any individual and does not summarise all aspects of the legislation.

7 Comments
Graham Hand
July 21, 2017

Hi Rob and others, Gordon has written a detailed explanation which we will post as an article so it is not lost in the comments. Thanks, Graha

Rob
July 21, 2017

I refer to Gordon Mackenzie’s article and wish to get some clarification.

He discusses Risks,and the First risk deals with deciding which assets should receive the tax exemption and which should be taxed at 15%.

His premise is that the Fund member has in excess of $1.6 million in his account – so there is a pension account with $1.6 million which will be tax exempt,and an Accumulation account with the balance taxed at 15%

My query relates to his suggestion of segregation of assets. My understanding is that for “tax “ purposes there is now no such concept as “segregation” -tax will simply be determined on a “proportional” basis.

So,is Gordon suggesting there will still be segregation for tax purposes??,or is he alluding to some other strategy that is applied purely for accounting purposes and how this might affect the growth of the two account balances moving forward??

I am a little confused and would appreciate some feedback

Bruce
July 20, 2017

I agree with Gordon’s comments on the ‘legacy’ pension problems. Those of us who accepted lower remuneration during our working lives in return for a defined benefit pension are caught between a rock and a hard place. Unlike members with funds in SMSFs, a portion of the notional value of the pension (say $400k) cannot be withdrawn and transferred to a spouse’s fund; the notional value cannot be reduced thereby preventing a defined benefit pensioner couple with a notional value of say $850k from claiming a pension card; and unlike members of SMSFs, the income is taxed at marginal rates (less 10%).

Graham Hand
July 20, 2017

Gordon has clarified that the sentence was supposed to apply to funds other than an SMSF, so we have added this qualification. The inability to calculate the exempt income with segregation is restricted to SMSFs where a member has >$1.6M in their Total Superannuation Balance.

damon carter
July 20, 2017

Bob is spot on. For balance over $1.6 million my understanding is you cannot segregate the assets, so in the future the assets will be assigned using the proportional method! Can Mr Mackenzie clarify this for our enlightenment?

Bob
July 20, 2017

You say: "for accounts that exceed the $1.6 million cap, anyone affected will now have to decide which assets should receive the tax exemption and which should be taxed at 15% on their income."

This implies segregation of assets can be used to decide which assets can be used to support the pension from the $1.6m transfer balance cap, with the balance of assets rolled back into the accumulation phase. This is not right, is it? Or am I missing something?

Greg
July 20, 2017

Crazy complex this stuff. What about 'Events-Based Reporting'? All superannuation funds, including SMSFs, will be required to report transfer balance cap debits and credits to the ATO on an events basis. Yeh, over one million SMSF trustees know that.

 

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