6 October 2016
Catherine Chivers – Manager for strategic advice at Perpetual Private.
The 2016 Budget handed down on 3 May, 2016 by Treasurer Scott Morrison foreshadowed the most sweeping changes to the superannuation landscape that the Australian financial services industry has seen in close to a decade.
In recent weeks there has been a flurry of releases from Treasury to give broader effect to the implementation of the Government’s broader reform agenda to improve the sustainability and equity of the superannuation system.
As at 30 September, 2016 there had been two tranches of draft legislation released which provided further detail on how the new rules will operate from 1 July, 2017 and beyond.
At this point, the relevant legislation still needs to pass through Parliament and receive Royal Assent in the normal manner for it to become effective law.
The key elements of the new draft legislation and some of the resulting strategic aspects advisers need to be aware of are outlined below.
The key areas addressed in these twin legislative releases will mean that from 1 July, 2017:
- The “objective of superannuation” has been established;
- A higher spouse income threshold will apply for calculating the spouse contributions tax offsets;
- A Low Income Superannuation Tax Offset (LISTO) will apply;
- A “transfer balance” cap of $1.6 million is in effect;
- The concessional contributions cap (CCs)reduces to $25,000;
- The non-concessional contributions (NCCs) cap reduces to $100,000 per annum (or $300,000 in any three-year period where the “bring-forward” amount is triggered by those able to avail themselves of it);
- There is the ability to “catch up” on concessional contributions (note: applicable from 1 July, 2018);
- Consumers will see broader retirement income product choice available as a result of income stream product innovation; and
- The anti-detriment provision will be abolished.
The objective of superannuation
For the very first time, the objective of the superannuation system is enshrined in legislation covering a “primary” objective and “subsidiary” objectives.
“To provide income in retirement to substitute or supplement the Age Pension.” This is a more expansive purpose than was originally foreshadowed in the 2016 Budget, which merely outlined that the purpose of superannuation was to “supplement” the Age Pension. This primary objective also re-affirms that the purpose of superannuation as “not to allow for tax minimisation or estate planning”.
- Facilitate consumption smoothing over the course of an individual’s life;
- Manage risks in retirement;
- Be invested in the best interests of superannuation fund members;
- Alleviate fiscal pressures on Government from the retirement income system; and
- Be simple, efficient and provide safeguards.
Changes to spouse contribution tax offsets – higher spouse income threshold
From 1 July, 2017, a resident individual will be entitled to a tax offset up to a maximum of $540 in an income year for contributions made to superannuation for their eligible spouse. A spouse will be eligible where the total of the spouse’s assessable income, reportable fringe benefits amounts, and reportable employer superannuation contributions for the income year is less than $40,000 (currently $13,800).
Reduced contributions tax for low income earners – via a new LISTO
From 1 July, 2017, the LISTO seeks to effectively return the tax paid on concessional contributions by a person’s superannuation fund to a person who is a low income earner. Low income earners are defined as individuals with an adjusted taxable income of $37,000 or less. The maximum amount of LISTO payable is $500 per year.
‘Total balance’ cap of $1.6 million
- Represents the maximum amount which can be transferred into a tax-free income stream for use in retirement, based on “retirement phase” assets calculated as of 30 June, 2017
- Will index in $100,000 increments in line with the consumer price index (CPI)
- The transfer balance (TB) cap will be calculated using a “transfer balance” account (TB account) which is similar in concept to an accounting general ledger. Amounts transferred into “retirement phase” (what we presently know as drawing an income stream) give rise to a credit in the account and transfers out (e.g. commutations) give rise to a debit. The TB cap is breached where an individual’s TB account is greater than their relevant TB cap
- There will be no ability to retain funds in retirement phase in excess of this amount, nor the ability to make additional NCCs once this $1.6 million total superannuation balance threshold is breached. Strict penalties apply for breaches of the TB cap, especially where these are repeated
- Instead assets will be required to be transferred back to accumulation phase or withdrawn from the superannuation environment entirely. Where assets are transferred to accumulation phase as of 30 June, 2017, a “cost-base” re-set will alleviate the initial capital gains tax (CGT) impact.
- Complex calculations will apply to the treatment of reversionary income streams for the purposes of the TB cap, however at this stage, reversionary income streams received will also be counted towards the recipients TB cap. Whether this outcome is changed in the final legislation remains to be seen
- Superannuation balances in excess of the TB cap can remain in accumulation phase indefinitely (and with no balance limit) where they will be taxed at a maximum of 15 per cent
- Fluctuations in account balances will not be taken into account when determining the available TB cap “space”. For example, where an individual’s account was valued at $1.6 million as of 1 July, 2017, and the balance subsequently declined to $1.4 million on 1 September 2017, they will not be able to add more money into an income stream (called a “retirement phase account”) as they have already fully used their available cap
- Where an individual only uses part of their TB cap, a “proportionate” approach will apply to assessing eligibility to make further contributions. For example, where an individual transfers $800,000 into a retirement phase account as of 1 July, 2017, they will have used 50 per cent of their available cap. Where the cap is later indexed to $1.8 million they will have 50 per cent of that cap left to use. That is, they will be able to transfer an additional amount of $900,000 into a retirement phase account
- Personal injury payments contributed within the 90-day window will be exempt from the TB cap
- Defined benefit schemes will also be subject to the TB cap, with complex calculations required as a result (especially in cases where an individual receives income streams from both taxed and untaxed sources)
- Modifications to the harsh TB cap are available in cases of a minor child dependant receiving their deceased parent’s benefit
- New estate planning considerations will arise as a result of the TB cap, which may require review and revision of a client’s estate planning strategy
- Will also apply to annuities used for retirement purpose. Currently annuities used for retirement purposes are treated very differently to essentially similar monies formally within the superannuation system
- Importantly, each member of a couple can have a total superannuation balance as of 1 July, 2017 of $1.6 million. There will not be a “shared” $3.2 million cap. That is, there will be zero ability for, say, one party to hold $1 million and the other $2.2 million as of 1 July, 2017 in an attempt to circumvent the new rules
Concessional contributions (CCs) cap changes
- From 1 July, 2017 the annual cap for each financial year will be $25,000 – currently the cap is $30,000/35,000 per annum
- The cap will increase in increments of $2,500 in line with average weekly ordinary time earnings (AWOTE) – currently the $30,000 cap is indexed to AWOTE in $5,000 increments
- Division 293 tax (an extra 15 per cent contributions tax) will apply to an income threshold of $250,000 per annum – currently the threshold is $300,000
- Special new rules will apply to ensure that contributions to constitutionally protected funds (CPFs) and untaxed or unfunded defined benefits count towards the CCs cap. Currently contributions to CPFs do not count towards the CCs cap, and calculating the impact of relevant contributions for those in untaxed or unfunded defined benefit interests can mean that these remain outside of the CCs cap
New annual NCC cap/revised ‘bring-forward’ rule
- Can make NCCs of $100,000 a year from 1 July, 2017, or even $300,000 under the revised “bring-forward” rule, so long as an individual is aged under 65 and their total superannuation balances (at 30 June, 2017) is under $1.6 million
- Where total balances exceed $1.6 million, no NCCs will be permitted. CCs can still be made, in the relevant way
- Where a balance is “close to” $1.6 million, an individual can only use the “bring-forward” rule to the extent that their super balance stays below $1.6 million
- Where an individual has partially used the present NCC “bring-forward” rules allowing a $540,000 NCC, they will not be able to benefit from this from 1 July, 2017. Instead, any use of the ‘bring-forward’ rule from 1 July, 2017 will be based on the new caps applying from that date
- The annual NCC cap and $1.6 million eligibility threshold will be indexed
- These revised rules will broadly apply to defined benefit and constitutionally protected schemes
‘Catch up’ concessional contributions
- This increased flexibility benefits those with varying capacity to save and those with interrupted work patterns, to allow them to provide for their own retirement and benefit from the tax concessions to the same extent as those with regular income
- Individuals aged 65 to 74 who meet the work test will also be able to avail themselves of this proposal
- Any amounts contributed in excess of the cap will be taxed at the individual’s marginal tax rate, less a 15 per cent tax offset
- From 1 July, 2018, individuals can “catch-up” on their CCs where their total superannuation balance was less than $500,000 as of 30 June in the previous financial year. Thus, in effect, the first year that an individual will be able to avail themselves of this new measure is 1 July, 2019
- This measure will mean that additional CCs can be made by using previously unutilised CCs cap amounts from the previous five years
- Unused cap amounts can be carried forward, with unused CCs cap amounts not used after five years lost
Income stream product innovation
- In a major step forward for consumer retirement product choice, the earnings tax exemption will now extend to new lifetime products to be known as “deferred products” and “group self-annuities”. Further annuities issued by life companies that represent superannuation income streams will also receive the earnings tax exemption
- Further, and as previously highlighted, the earnings tax exemption for transition-to-retirement (TTR) income streams will cease from 1 July, 2017. However, TTR income streams will not count for the purposes of the TB cap unless they are considered to be a “standard” account based pension
Farewell to the anti-detriment provision
- From 1 July, 2017 the anti-detriment (AD) benefit will cease to exist. This benefit effectively provided an uplift to any death benefit paid to that deceased member’s spouse, former spouse and children in the form of a return of contributions tax the deceased member paid during their lifetime
- For members who die on or after 1 July, 2017, their loved ones will be unable to receive the benefit. For members who pass away before this date and who were within a fund which paid the AD benefit, so long as the AD benefit is paid by 1 July, 2019, their loved ones can still receive it.
Whether the collective outcome of these measures achieve their stated policy aim of improving the sustainability of the $2.1 trillion Australian sector remains to be seen. It is certainly exciting times to be an advice practitioner helping to guide clients through an ever more-complex maze to achieve their desired retirement lifestyle goals.
Catherine Chivers is the manager for strategic advice at Perpetual Private.