The Australian Financial Review
9 December 2016
The biggest changes in superannuation in nearly a decade affect all super savers – whether you’re just starting out or you’ve amassed big balances over time and are worried about the $1.6 million cap on tax-free pensions.
There is huge confusion about the impact of the super changes, First floated in the May Federal budget, they were finally passed by Parliament in late November. That means you’ve got until June 30 next year to get your super house in order.
The implications are huge. If you’ve got more than $1.6 million in pension phase, have you worked out which assets it’s smart to transfer back to accumulation phase? And if you’ve got a defined benefit scheme, do you know the calculations you’ll have to use to work out whether you’re close to the $1.6 million cap? What about after-tax contributions – do you know there is a limited time in which you can get more into super?
So many questions and a limited time in which you’ll need to answer them. We asked for your questions and have had an overwhelming response. For space reasons we can’t answer all of them but will address them in future articles.
Q: I understand that the cost base of equities will be reset to their market value on June 30, 2017. Does that mean that where the market value of the shares is less than the original cost, the unrealised loss will be wiped off?
A: Resetting the cost base of equities is not an automatic event that occurs on a particular date. It is only available where your super fund is in pension mode and you have more than $1.6 million that must be divided between a pension account and an accumulation account. Or you could be in a transition to retirement (TTR) pension.
You must also own any investments before the reset date – which could be June 30 but could also be an earlier date when you restructure your $1.6 million-plus pension account balance into pension and accumulation accounts. A stricter requirement is that the investment must have been owned between November 9 (when the super legislation was introduced) and June 30.
Resetting entitles you to CGT relief on individual investments. When assessing which investments to reset, you need to analyse their prospects for staging a recovery and the potential capital gain that you will pay tax on.
What about resetting an investment that has experienced a loss? The legislation, says Nerida Cole from Dixon Advisory, specifically states that the CGT relief provisions can only be applied to an investment the super fund has made a capital gain on.
Not being able to apply the reset to an investment with a market value less than its cost should not disadvantage a fund as it is not a particularly attractive strategy anyway. That’s because it would lock in a lower cost base for future capital gains on which tax must be paid.
There is one point worth highlighting if you do choose to access the CGT relief provisions, says lawyer Robert O’Donohue of HWL Ebsworth. That’s the 12-month period that assets are required to be held to access the discount that reduces the tax payable on capital gains from 15 to 10 per cent. Accordingly if you do choose the CGT you should also ensure the investments are held for at least another 12 months after the restructure to access the 10 per cent CGT. JW
Q: I expect that on June 30, 2017 I will have more than $1.6 million in superannuation. I wish to maximise my non-concessional contributions this financial year. I understand that if I haven’t yet triggered the “bring forward” rule, I can make a $540,000 contribution before June 30, 2017 under current rules. If I make after-tax contributions into a defined benefit superannuation scheme next financial year (either because such contributions are a condition of scheme membership or because employer contributions require matching employee contributions), how do I avoid a penalty for making excess non-concessional super contributions under the new rules?
A: First, you are correct in assuming that you may be eligible to contribute up to $540,000 into super as a non-concessional contribution if you have not made any non-concessional contributions this year or you have not previously triggered the bring-forward rules in the past two years by making contributions over $180,000.
If you make contributions and you have over $1.6 million in super, you will be issued with a notice of determination and you’ll be required to remove the excess contributions with interest from the fund. You will be required to do this within 60 days or the ATO will do it for you if you do not respond. A notional earnings rate of around 9 per cent will apply to excess funds and your marginal tax rate will apply to this amount to provide a disincentive to people exceeding the barrier.
The treatment of defined benefits will take a little education. If you have a lump sum defined benefit, the outcome will be fairly simple with respect to the computation and tax on excess super balances above $1.6 million. The situation is a little different for defined benefit income streams depending upon whether it’s from a taxed or untaxed source – although a multiple of 16 will be used to equate the total lump value. Excesses over the $1.6 million cap equivalent will be taxed differently depending on whether it’s from a taxed or untaxed source. It’s best to discuss your situation with your fund. SH
Q: I have an SMSF and also a Commonwealth Public Service (CSS) pension. I am 80. At present when I submit my tax return I include the CSS pension in my taxable income. If needed, I am eligible for a tax offset of 10 per cent of that pension. My SMSF is well in excess of $1.6 million. If I have to include 16 times my Commonwealth pension in my total super assets, this will lift these assets to well in excess of $1.6 million and hence have a big impact on the total tax I must pay. It seems most unfair that I must include my CSS pension in my taxable income and will also pay extra tax on any super in excess of $1.6 million. My wife is older than 75 so I cannot split my “excess” with her. What can I do?
A: Your question explains the headache that has been created for retirees in your situation by the super reforms, says financial planner Nerida Cole of Dixon Advisory. Under these reforms how much of your CSS pension gets tax-concessional treatment is determined by multiplying the annual pension amount by a factor of 16. So a gross annual pension of $40,000 will have a value of $640,000 assigned against your allowable $1.6 million pension balance. This leaves $960,000 able to be held in other retirement pension accounts, like the one from your SMSF which you describe as having well in excess of $1.6 million.
Unlike super pensions funded from personal savings (like an SMSF) which are tax-free for retirees 60 and over, pensions from a source like the CSS (which comes from government funding) are not tax- free. Instead, they are taxed from age 60 right throughout retirement at marginal tax rates with a 10 per cent tax offset. You mention you are eligible for this offset if it is needed which suggests it may not be required, especially if you are entitled to other tax breaks like the seniors Australian pensioners tax offset (SAPTO).
Your comment implies the tax on your CSS pension likely falls within your tax-free threshold entitlements, reducing your need for the 10 per cent tax offset. The offset is a right to reduce your tax by 10 per cent of your pension amount. A $40,000 pension, for instance, comes with a $4000 tax offset.
One point worth reminding holders of larger defined benefit pensions is that this offset will be capped at $10,000 from July 1, 2017.
So the July 1 reforms – which treat a tax-paying retirement pension like one from CSS and a tax-free retirement pension from an SMSF as having the same value – is creating some waves. It is doing so by reducing the amounts in SMSFs that pay tax-free pensions. The reduction means a greater proportion of SMSF savings is relegated to an accumulation account where the investment earnings are taxed.
This question also highlights a lost opportunity to share some of the SMSF savings with your wife. Because she is over 75. it is not possible to withdraw and re-contribute some of your money into her super. That said, what you have to settle for is that super in the SMSF in excess of the $1.6 million limit does not have to leave the super system. In the accumulation phase of super, income is taxed at 15 per cent and capital gains at 10 per cent where the investment is held for 12 months or more. This is still attractive compared to many marginal tax rates – particularly if calls to reduce SAPTO get further support. JW
Q: Is the $1.6 million cap a gross cap or after netting off any non-recourse debt?
A: The $1.6 million cap is based on net assets in pension phase. Net assets equals assets less liabilities including limited recourse borrowing arrangements (LRBAs). So if you have a property worth $2 million with debt of $500,000, then your net assets would be $1.5 million. That said, I’d hope you have some further diversity in your fund in the form of cash, shares or other liquid assets to meet your pension obligations and the requirements of your written investment strategy – hopefully you have one of those too! SH
Q: My SMSF, now in pension phase, holds a tax-free component. How is this treated under the new legislation?
A: Under the new legislation there won’t be any difference in the treatment of a tax-free component in a pension account. Your fund will still be required to record the taxable component of a pension account, which in turn will give you the tax-free component.
The different components are only relevant when any super passes from the pension phase to an adult beneficiary as it will determine the death benefits tax that is payable on the super. Keeping tabs on a fund’s taxable and tax-free components is not as relevant while you are in the pension phase as all payments are tax-free. JW
Q: Has the government made it easier to commute a TTR pension to an accumulation account now that the tax-free status of TTR income streams is to change?
A: A TTR pension can be put back into accumulation mode fairly simply. From July 1, 2017 TTRs will not receive tax-free earnings or capital gains status. Nor will they be classified as retirement income streams and thus the $1.6 million cap will not apply. Instead, TTRs will attract the same tax that superannuation in accumulation phase pays – losing much of its allure, but not all. TTRs can still be an effective strategy to reduce debt in the approach to retirement, rebalance partner accounts or simply to subsidise your income if you’re working part-time.
One of the “new” key benefits from having a TTR in place before June 30, 2017 (even if you set one up for just a few months) will be the ability to reset your cost base for CGT purposes on June 30, 2017. This significant opportunity is designed to utilise the opportunity that exists within TTRs and account-based pensions without encouraging people to churn assets or create a selling spree on assets between now and the end of the financial year. Essentially, the government recognises the CGT-free status of both pensions and will allow the CGT relief to occur. SH
Q: We are 75 and retired. We currently must withdraw 6 per cent of the value of our SMSF each year. Will such minimum withdrawals apply to both the $1.6 million cap and any accumulation account in the future?
A: The simple answer is that the minimum withdrawal requirement will only apply to the $1.6 million pension account balance. With accumulation accounts, there is no compulsion to withdraw any amounts. But withdrawing money from an accumulation account is available to you as you wish.
Because you’re 75, even though investment earnings on such accounts will be taxable, any withdrawals can be taken as tax-free lump sums.
According to Godfrey Pembroke financial planner Matthew Scholten, a strategy you may consider is withdrawing some of the capital from the accumulation account and investing this in shares, for instance, where you are entitled to dividend imputation tax credits that can result in a lower overall tax rate than the 15 per cent super tax. Given that super tax concessions are unlikely to be better in the future, people should be prepared to explore alternatives to super wherever they are identified. JW
Q: My spouse and I have two SMSFs. She is 57 and I am 60. We are both on TTR pensions from one SMSF with $2.5 million value. The other SMSF with $2 million value is in accumulation phase. Our pension interests on both SMSFs are almost equally divided. If we stay on TTR pensions from the first SMSF and start a new pension from the second SMSF this year, how will the $1.6 million limit on both SMSFs be determined? I understand once the pension starts on June 30, 2017, the balance stays regardless of the changes in pension asset value. Does this rule apply to TTR pensions? We might roll over assets from one SMSF to the other to segregate pension assets to make two lots of $1.6 million and leave the excess in accumulation phase. Would this strategy work?
A: There are always a number of combinations and permutations to suit different needs. TTRs are not included in the $1.6 million cap. The term “pension” refers only to retirement pensions for those who have attained a condition of release. If you are in this situation, you may be well served to change your TTR to a full account-based pension. If not, your $1.6 million cap will apply when you start a retirement income stream and not before. This may bring some people to retire earlier than expected. If you’re over 60, a condition of release also includes ceasing gainful employment so those people with two jobs may also benefit from resetting the CGT and playing around with the conditions of release that may be available to them – of course, advice is needed for this.
Here’s what I’d do if I were in your situation if you haven’t attained a full condition of release; first, I’d start a second TTR pension from the second SMSF before June 30, 2017 to allow me to reset the cost base for CGT purposes on that date. CGT relief is being offered to pensioners in both TTR phase and account-based pension phase. This may save you many thousands of dollars in CGT, if not tens of thousands – this applies to property too! You will also receive zero earnings tax and a CGT benefit for this financial year for having the TTR in place. SH
Q: Is a UK defined benefit pension caught in the new super rules?
A: No it isn’t. You needn’t think it will somehow be assessed under the new legislation. Because it is a foreign-sourced pension, it is not taxed like an Australian superannuation pension. Any UK pension income is added to your ordinary income and taxed at your personal tax rate. JW
Q: Is the $1.6 million limit on transfers into tax-free super pensions reset if the pension capital drops? Say I transfer $1.6 million into pension mode. Some years later the account balance drops to $1.2 million due to pension payments and a fall in equities value. Am I able to then contribute another $400,000 to bring it back to the $1.6 milion balance? It’s very important for people wanting to use the re-contribution strategy to get rid of the tax liability of super accounts on death.
A: The $1.6 million cap will not be able to be reset once it’s set. So any rises or falls in value will not effect the cap amount – although the government has left the opportunity to reassess pending any significant global upsets such as the financial crisis of 2008-9. There will always be potential government intervention and if there is one thing we can guarantee with superannuation, its change!
You may see this as a major disadvantage but the likelihood of a rise well above the $1.6 million is more probable given the average move on share and property prices is around 6-8 per cent a year over a 10- or 20-year period (despite the last two years being flatish on the ASX All Ords).
With respect to the recontributing strategy, I’d suggest you utilise the opportunity of the $540,000 or $1,080,000 non-concessional contribution caps for a couple before June 30 if you have the funds.
For the uninitiated, the re-contribution strategy allows you to pull money out of super in a proportional fashion between your taxable and non-taxable amounts (check your super statement or member statement in your SMSF returns for these amounts), assuming you’ve attained a condition of release and are thus eligible to withdraw money from super, and then re-contribute the funds as non- concessional contribution. This raises your non-tax taxable component within the fund to reduce or eliminate the 15 per cent tax when your super is inherited by your adult children or non-dependents. Dependents still receive the super tax-free.
There’s a free e-book download on my website at www.hendersonmaxwell.com.au on this re- contribution strategy if you’re interested. SH
Q: How will existing tax losses in an SMSF be treated in the future when the fund has assets greater than $1.6 million? Can all the tax losses be transferred to the taxable accumulation account or is it proportioned?
A: Essentially what happens to an SMSF’s investments where there are pensions and accumulation accounts is that all gains and losses are offset against one another. You then apply the percentage of the total net balance attributable to the pension which has been calculated by an actuary to determine how much of any net result will be exempt from tax.
Where a fund has losses, they are used up even if only part of the total investment pool is exempt from tax. You can’t pick and choose whether losses will be offset against taxable earnings only. It must all happen proportionally. JW
Q: Suppose you have two pension accounts, each with $1 million where one consists entirely of taxed funds and the other entirely of untaxed funds? From which fund would it be most advantageous to transfer the required $400,000 into an accumulation account?
A: For the benefit of other readers, some superannuants took advantage of making significant lump sum non-concessional contributions and quarantining those funds into a separate SMSF to take advantage of super laws that enabled those funds to forever remain tax-free. The key benefit was to avoid paying the so-called superannuation death tax when assets are passed on to non-dependent beneficiaries. This tax equates to 15 per cent (plus surcharges of all taxable components of your superannuation.
For practical estate planning purposes and to keep the non-taxable pension forever tax-free, I would not touch the non-taxable pension so it remains the basis of the $1.6 million cap. As your question sounds a little “theoretical”, I may even consider starting a new SMSF with the taxable portions and have a pension account up to the $1.6 million cap (ie, $600,000) and another accumulation account with the $400,000 balance.
Super laws have a habit of changing so I’d try to leave the non-taxable pension untouched forever – if nothing else, for simplicity and estate planning. So long as you’re over 60, the pension created from the taxable component of your super fund will still be tax-free so the benefits are really for your beneficiaries.
You may also have an opportunity to do a withdrawal and re-contribution of the $540,000 to create a higher tax-free amount in your superannuation before June 30 by utilising the higher non-concessional cap and creating an even higher tax-free amount for estate planning purposes.
Caution needs to be advised as to the use of partners with reversionary pensions as they have the potential to supersede existing account-based pensions when inherited. SH
Q: I started a TTR pension in 2015-16 as I am over 60 and still working part-time. My financial advisor suggested I deposit the TTR amount received back into my super account. I believe that the new rules make it no longer beneficial for this strategy. What should I do from July 2017? Can the TTR account be cancelled and rolled back into my super account?
A: Even though the investment earnings will be taxable from next July, a TTR pension can still be an effective way to access your super tax-free if you are working part-time and likely to need some money from your super, says financial planner Matthew Scholten. It is also very flexible and can be stopped and rolled back into an accumulation account.
As someone who is over 60 one thing to watch out for is that if you started your TTR pension because you quit a job, it is possible you may have retired under rules that entitle you to start a full pension from a super payout. In that case not only the pension payments will be tax-free but the investment earnings will also be exempt from tax. So your pension may not need to be a TTR.
Another thing to remember about taxable TTR pensions from next July, says Meg Heffron of Heffron SMSF Solutions, is that because they don’t count towards the $1.6 million cap there is no limit on the savings they can accumulate
Where someone is looking to accumulate a multi-million-dollar super balance and also needs some cash from their super fund, they could start the TTR pension. While their immediate thought might be that they could only withdraw up to 10 per cent of a $1.6 million account balance, that is actually not the case.
Although the $1.6 million cap will need to be considered when you start a full pension, there is no limit on how much super can be saved in a TTR account. You could have a $5 million TTR account from which you can withdraw $500,000 of income under the 10 per cent entitlement.
Of course the TTR’s investment earnings will be taxable. But at the 15 per cent super fund rate. Heffron says this could make some sense for someone over 60 looking to use super as a flexible investment account from which they could take money out. A TTR pension is the only way this is possible from super if you haven’t retired. JW
Q: I wish to know what type of assets (growth or high dividend) I should transfer into the accumulation account because I will exceed the $1.6 million cap but still prepared to cop the 15 per cent tax.
A: This is the $1.6 million question on the lips of everyone who exceeds the cap. Interestingly, if you’re already in pension phase and have an SMSF, you won’t get a chance to choose which assets can be split off from a tax perspective because your fund will be assessed on a proportional basis and will not be allowed to be assessed on a segregated basis for tax purposes. But you will get a choice for CGT purposes.
Strategically, if I had a material amount over the $1.6 million cap, I’d be setting up a second SMSF (or a retail or industry fund) before June 30, 2017 and rolling over the excess into that fund. I’d have my growth assets in the “tax-free $1.6 million cap fund” because they will be allowed to grow to any number once the cap has been set. And I’d have the fully franked “boring shares” like Telstra or cash in the accumulation account assuming you’re confident enough about your growth portfolio.
This will create a situation whereby your growth assets will be allowed to grow happily in a tax-free environment (with the $1.6 million cap having been set on July 1, 2017) and the accumulation assets will enjoy the benefits of franking credits. If we assume 100 per cent franking then you’ll not only pay no tax, but you’ll still receive a 15 per cent rebate (assuming a 30 per cent company tax rate on your shares).
You’ll still pay CGT but the cost base can be reset on June 30, 2017. And since you’re not really planning on selling these very often, CGT won’t be a huge issue. In any case, CGT is only 10 per cent in accumulation mode assuming you hold the assets for 12 months or more and receive the 33 per cent discount. You will need to hold the assets for at least 12 months after the CGT relief is enacted to receive the discount otherwise the original cost base will apply. As you can see, some serious planning and preparation may be required to establish these structures and planning should begin immediately. SH
Q: I am a public servant member of the Public Sector Super (PSS) hybrid taxed/untaxed defined benefit scheme and I also have a SMSF. I understand after July 1, 2017 I will no longer be able to salary-sacrifice concessional contributions into my SMSF. How will my PSS balance on June 30, 2017 be treated to determine whether I’ve exceeded the $1.6 million total super limit beyond which further non-concessional super contributions are not permitted? If I have more than $1.6 million in super, what is the mechanism I use to withdraw funds from my SMSF to offset excess non-concessional contributions made to the PSS scheme? If I am forced to reduce my after-tax PSS contributions to zero, I miss out on notional employer contributions amounting to 10 per cent of salary.
A: The point you make about missing out on potential employer contributions amounting to 10 per cent of salary is an important aspect of your question, says financial planner Nerida Cole.
It highlights that you should make every effort to continue member contributions to the PSS that will entitle you to the maximum annual accrual multiple despite the fact that it may result in you being penalised for making them.
Continuing to maximise PSS member contributions (which are considered non-concessional contributions) will be doubly important because changes to the concessional contributions regime will significantly reduce the ability of PSS members to salary-sacrifice contributions.
Higher earners may not be able to salary sacrifice at all, making it very difficult to build a supplementary pool of funds for retirement.
Without knowing more details of your situation, it is impossible to say if you will exceed the $1.6 million balance limit that will prevent you from making non-concessional contributions after July 1, 2017. But even where making contributions to the PSS results in an excess non-concessional contribution, it is one of the rare circumstances where it will be worthwhile incurring a penalty to do this.
This is because, as you note, for PSS members to stop their post-tax member contributions (generally 10 per cent), this will reduce the level of matching employer contributions and have significant detrimental consequences on the calculation of the final defined benefit payable at retirement.
So how might your PSS balance on June 30, 2017 be treated to determine whether you have exceeded the $1.6 million limit, beyond which further non-concessional super contributions are not permitted? The ATO is expected to perform this assessment role by counting the value of all accounts, including pension accounts, accumulation accounts and all types of defined benefit funds. For defined benefit accounts still in the accumulation (or contributory) phase, this will generally be the withdrawal value.
So what happens if you are assessed as breaching the excess contribution entitlement? You will receive a notice to this effect from the ATO asking you to rectify the excess contribution of, say, $20,000 plus a notional earnings figure over the year.
For someone with a defined benefit fund, like a PSS, fortunately the government has recognised you can’t take the $20,000 out of a defined scheme. What is acceptable is to make a rectification payment from another fund, say the SMSF, with the tax adjustment on punitive earnings going to the ATO. JW
Q: What are the tax implications and penalties if I contribute more than $25,000 (salary sacrifice + employer contributions) into my superannuation fund (not self-managed) from July 1, 2017? Are there any tax benefits in continuing to contribute over the allowed amount?
A: Concessional contribution limits drop from $35,000 a year for those over 50 and $30,000 a year for those under 50 to just $25,000 for everyone from July 1, 2017. Excess concessional contributions will be treated differently after July 1, 2017. Rather than be penalised at 49 per cent, they will attract concessional contribution charges of around 5 per cent (it can change each quarter but approximates to 5 per cent) as well as your normal marginal tax rate.
Overall, there may be some benefit in leaving the money in superannuation owning to the potentially lower earnings tax and CGT that is applied to super. But you may as well just make non-concessional contributions to avoid the 5 per cent penalty tax and avoid being behind the eight ball from the outset.
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