Most of the major changes to super announced in last year’s federal budget have come into effect since 1 July 2017, prompting questions around whether super is still the most tax-effective saving mechanism for all clients.
According to the Australian Tax Office website, changes to super are designed to “improve the sustainability, flexibility and integrity of Australia’s super system”.
The Treasurer tells us that super is designed to help Australians save for their retirement, and not for the purposes of amassing wealth in a tax-advantaged environment. Whether that be for retirement, or the purposes of inter-generational wealth transfer.
As a result, the most fundamental changes to the super system in a decade were announced last year, and most have come into effect on 1 July 2017. And while the number of Australians directly affected by the most substantial of the changes is relatively small, the number likely to be affected in the future may be much larger.
Looking ahead and planning now is crucial, even though super remains one of the most tax-effective ways to save for retirement – if you are able to stay within the contribution limits and caps. If you can’t or don’t want to, it’s worth considering other tax-effective options available.
Your clients might be asking some of the questions below, we have outlined three options when it comes to re-structuring portfolios to minimise tax.
Transfer balance cap of $1.6 million
“I have more than $1.6 million in a retirement phase account. What should I do with the excess, which I now need to move out?”
There is now a limit on the amount of super you can transfer and hold in tax-free ‘retirement phase accounts’. This cap is set at $1.6 million for an individual, so $3.2 million for a couple. If you receive a pension or annuity valued at over $1.6 million you may need to pay an excess transfer balance tax and will be required to reduce your balance. You will have six months from 1 July 2017 to do this.
Reduced concessional contributions cap
“I have been contributing more than $25,000 in concessional contributions to my super fund to try to increase my savings for retirement. Would I be better to put $25,000 only into my super, and invest any extra elsewhere?”
Regardless of age, all Australians will be now only be able to contribute $25,000 per annum in pre-tax contributions to super. If you exceed the cap, the excess will be included in your assessable income and taxed at your marginal tax rate.
Reduction in the non-concessional contributions cap
“I have been contributing extra after-tax payments to super because of the favourable tax treatment on returns from super. With the new limits, however, and given my balance is approaching $1.6 million, should I be looking at other options outside of super?”
Non-concessional, or after-tax contributions to super will now be limited to $100,000 per annum, reduced from $180,000. And if your superannuation balance is $1.6 million or more, you are no longer allowed to make any non-concessional contributions at all.
Transition to retirement streams no longer tax free
“With the removal of the tax-free status of transition-to-retirement income streams, is there a way for me to receive a tax-free or tax-advantaged income stream anymore?”
Transition to retirement income streams allows Australians to move to retirement by accessing a limited amount of super. At the moment, the super funds that pay the transition to retirement income stream receives tax-free earnings on the super assets that support it. From 1 July, this tax-exempt status will be lifted and earnings will be taxed at 15 per cent.
Who will be most affected by the changes to super?
Firstly, it’s important to stress that regardless of what are quite fundamental changes, super remains the most tax-effective saving vehicle for most people.
Wealthier Australians are likely to be most affected, as are investors still in the accumulation phase but who earn a high income – because they may now be penalised for contributing too much to super. The same may also apply for Australians who had been hoping to accumulate wealth in super, in order to benefit from the favourable tax treatment and then to pass the wealth onto their children.
SMSFs may also be disproportionately affected, particularly those with larger balances.
Are there other tax effective investment structures to consider outside of super?
There are tax effective investing options outside of super, all of which have been used by investors for many years.
Let’s take a look at three tax effective investing structures, each with its own characteristics that may be suitable for particular clients, depending on their circumstances.
- Creating a company structure to hold investments
It is possible to create a company that then holds investments on behalf of an investor. Because company earnings are taxed at 30 per cent, all earnings on the investments held in the company are taxed at 30 per cent, not at the investor’s marginal rate.
However, when returns are distributed as dividends, recipients must pay the difference between the company tax rate of 30 per cent and their marginal tax rate.
It’s important to be aware of the costs in setting up, maintaining and running a company.
- Creating a family (discretionary) trust to hold investments
A family trust, like a company, can hold investments on behalf of beneficiaries. There is no real tax benefit to the family trust structure, because the trust must distribute all earnings, but there is some flexibility in distributions. It is possible to distribute to low income family members and also to change to whom you distribute every year. In some family situations, these may offer flexibility to vary who is the beneficiary of distributions each year. If the family includes low-income earners, this may provide taxation advantages, however it is important to note that, legally, all distributions are at the complete discretion of the trustee. This means that a potential beneficiary of a discretionary trust only has a right to be considered for distributions.
- Investment bond
An investment bond is an insurance policy with a life insured and a nominated beneficiary; it is a tax-paid managed fund. Investors can choose to invest in a range of investment options depending on their risk profile, ranging from Australian shares to cash.
All earnings from the underlying portfolio are taxed at 30 per cent, and tax is paid by the bond issuer. Earnings are then re-invested in the bond and are not distributed. For this reason, the investor does not need to include earnings from the bond in his/her tax return.
There is no limit on an initial investment into an investment bond and an investor can make additional contributions into the bond of up to 125 per cent of the previous year’s contributions.
If the bond is held for 10 years or more, the earnings and principal can be accessed by the investor tax paid.
Every client’s situation is different of course, so it’s important to look carefully at desired outcomes and different options before making any decisions.
Neil Rogan, general manager, investment bonds, Centuria
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