14 February 2017
The sweeping changes to superannuation put through late last year are likely to result in thousands of out-of-date SMSF trust deeds from the July 1 start date.
Though the changes have had wide coverage and many investors know they need to update their understanding of the system, the impact on SMSF trust deeds has not yet been made plain to the wider public.
But changes to super may alter previous advice on how to operate a super fund and should be a catalyst for all SMSF trustees to review their trust deeds.
In fact, all SMSF operators should review their superannuation arrangements anyway.
Indeed many are now questioning whether previous advice on superannuation is still valid in regards to it being the preferred asset structure when planning for retirement.
Here’s what you need to know when reviewing this issue. The alternatives
Timothy Ricardo, small business and SMSF specialist from Ricardo Accounting on the NSW Central Coast has recently experienced a spike in inquiries on SMSF alternative structures.
“The government’s ongoing changes to superannuation had the unintended side effect of undermining confidence in the system,” he says.
“When you keep changing the goalposts, people eventually lose trust and start reviewing their options.”
The main alternatives to SMSFs are trusts and companies. Sydney financial adviser Xavier Lo says, “unfortunately there is no one-size-fits-all option when it comes to choosing between a company or trust”. People are drawn to these structures because, unlike superannuation, funds can be accessed at any age.
But there’s a catch: “The downside is these structures pay a higher level of tax than a superannuation fund,” Lo says.
Investment companies are set up for individuals to build wealth outside their personal name. The company is taxed at 30 per cent on income and gains. There is no capital gains tax discount, however land tax thresholds can be used. Ricardo says: “In retirement, a self-managed investment company can pay out franked dividends to investors, potentially refunding tax paid on earnings throughout the investment period.
“For people who do not need money now, and are on a high individual tax rate, this can present a benefit both in the short term and throughout retirement that could see a low-as-zero tax rate for investment earnings from the self-managed investment company.”
An addition to the company option is to create a hybrid structure where a trust owns shares in the company. This allows profits to be taken out before retirement and distributed to lower-income beneficiaries such as a non-working spouse or children.
The alternative to a company is a discretionary or “family” trust. They enjoy access to the 50 per cent capital gains tax discount but gains must be distributed proportionately to beneficiaries.
One of the key complications in family trusts law is state-based land tax treatment. For example, NSW has no land tax threshold whereas land tax is levied in Queensland after a $350,000 exemption. The major disadvantage of a trust is that it cannot retain profits without paying the highest marginal tax rate, currently 49 per cent.
Weighing the choices
According to Ricardo: “As a tax structure, trusts are good for low-income producing investments such as gold and high-growth companies (with no dividends), this keeps taxable income low and defers tax on capital gains until they are realised, which could be in retirement when personal incomes are lower.”
When property makes up a large portion of the assets, the pendulum usually swings in favour of companies. “Companies benefit from land tax thresholds, they can negatively gear property, retain tax losses and capital gains tax is capped at 30 per cent within the company,” says Ricardo.
But in thinking about a company and trust as an alternative to a SMSF, do not forget the obvious choice, holding assets in your personal name. Ricardo says: “The individual set up is easier and with less costs, but does have limitations such as low asset protection and the inability to split income.
“Still, many accountants make extra money by unnecessarily setting up trust and company structures, which cost thousands of dollars in fees each year. Cheaper options should always be considered on balance.”
Of the major changes coming to super from July 1, including the $1.6 million cap on account-based pensions, the reduction in contribution caps and the removal of the tax-free status of transition-to-retirement pension earnings and gains, perhaps the imposition of the $1.6m cap is the most pressing issue.
One example of the benefit of an updated trust deed is where a SMSF member has a pension balance of more than $1.6m in a mix of term-allocated pension and account- based pension balances. The incoming super changes allow the term-allocated pension to be commuted back to accumulation phase to remove the excess amount above $1.6m. This may be valuable for some trustees who have money locked in the old term-allocated pension, but can only be actioned with an updated SMSF trust deed.
Government changes have no doubt damaged the confidence in Australia’s superannuation system as the premier retirement vehicle. But the truth is that there is no obvious alternative that suits everyone. Expert taxation and financial advice is required to ensure the right structure is matched to individual circumstances. And for those with a SMSF, do not forget to review the trust deed before July 1.
James Gerrard is the principal of independently owned Sydney financial planning firm financialadvisor.com.au