Federal Budget – Super Opportunities

On Tuesday 3rd of May the Treasurer, Scott Morrison, released the Government’s 2016 Budget – an economic plan for Australia’s transition from a mining boom to a more diverse economy.

The budget contained a number of significant changes to the superannuation system, including retirement income streams and other tax changes.

These measures are still proposals only and require passage of legislation to become law.

Notwithstanding this, it’s likely many will pass through as proposed and so it’s worth familiarising with some of the key proposals and associated pitfalls and opportunities.

We believe the areas which will draw most attention are:

We believe the areas which will draw most attention are:

  • Concessional contribution changes and the abolition of the 10% rule and work test
  • The new $500k lifetime non-concessional contributions cap
  • $1.6 mill cap and other exempt pension income deduction changes (including transition to retirement (“TTR”) pensions)

Concessional contribution changes and the abolition of the 10% rule and work test

From 1 July 2017:

  • The concessional contributions cap will reduce to $25,000 per year regardless of age and members with balances of $500,000 or less will be able to carry forward unused amounts for up to 5 years.
  • Additional 15% contributions tax (division 293 tax) income threshold has been reduced to $250,000 per year (from $300,000 per year).
  • Removal of the “work test” and 10% rule for all individuals, effectively opening up personal concessional contributions and receiving spouse contributions for all up to the age of 75.

Example of possible strategic opportunities

CGT minimisation (case study example)

John and Betty (both 74 y.o) have an investment property which they sell on 1 July 2018 – a year which they will have no other income or work. They fetch $820,000 with a cost base of $500,000. After the 50% discount the capital gain is $160,000, they each make a $50,000 concessional contribution ($25k each plus the transfer of unused $25k each from 2017/18). They retain $30,000 in their personal names (broadly within their 18/19 effective tax free threshold as Senior Australians). The $15,000 contributions tax is the only tax payable on a $320,000 capital gain (effective tax rate of 4.7%).

Family trust distributions

With the abolition of the 10% rule from 1/7/17, anyone under 75 can make personal deductible contributions without a work test. This provides more flexibility to make distributions to beneficiaries who can then reduce their taxable income by making personal deductible contributions up to their $25k cap. Together with a proposed low income super tax offset, the effective tax rate on these distributions may be zero. It’s quite possible we could see strategies where high tax paying adult children make distributions to their retired parents.

$500k lifetime non-concessional contributions (NCC) cap

From 7:30pm (AEST) on 3 May 2016, non-concessional contributions will be capped at a lifetime amount of $500,000 (indexed in $100k increments to wages (i.e. AWOTE)) and will include non-concessional contributions made since 1 July 2007. The lifetime cap will replace the existing annual non-concessional contributions caps ($180,000 per annum and the $540,000 ‘bring-forward’ rule).

NCC’s in excess made prior to 7:30pm (AEST) on 3 May 2016 will not be required to be withdrawn from super however will still count towards the lifetime limit for the purposes of assessing future NCC’s.

Example of possible strategic opportunities

There is no doubt this is a restrictive measure on balance and triggers some important planning considerations:

Plan early – The lifetime NCC cap reduces one’s ability to withdraw and re-contribute. Couples now need to plan contributions well before retirement in order to exploit the full cap (i.e. $3.2 million) available to a couple. Strategies such as contribution splitting should be revisited.

LRBA’s gain further momentum – Borrowing via (LRBA’s) to contribute large assets now, and then progressively paying the loan through annual concessional contributions are likely to be popular, particularly for clients with little or no NCC cap left.

$1.6m cap and other exempt pension income deduction changes

Some restrictions on exempt pension income are set to apply from 1 July 2017:

  • The government will limit the amount of superannuation that can be transferred to tax-free retirement income streams to $1.6 million. Individuals with more than $1.6 million in tax-free retirement income streams on 1 July 2017 will be required to either withdraw the excess amount or transfer the excess back to an accumulation account. However, where the retirement income stream exceeds $1.6 million because of future earnings, the excess will not be required to be withdrawn or transferred.
  • Existing and new transition to retirement (TTR) pensions will have investment earnings taxed at up to 15%, in line with superannuation in accumulation accounts.

Example of possible strategic opportunities

Segregation – The $1.6 mill cap will be applied at 1/7/17 however future earnings will be allowed to accrue without the need to rollback any excess to accumulation or place a limit on exempt pension income. On this basis segregation of a fund’s growth assets to back the pension account (or defensive cash assets to accumulation) may have the potential to optimise the outcome.

Sell large unrealised gains in FY16/17 – Some larger funds (SMSFs) will be required to rollback pension monies from 1/7/17 onwards. The FY16/17 year might be the final year these funds could attain 100% tax free status and so where appropriate, consideration could be given to realising assets with large unrealised gains before year end.

TTRs still useful – On balance TTR strategies will look less attractive under the new measures. Salary sacrifice and TTR strategies could still be relevant where both the TTR income is non-taxable and the TTR income is needed to allow clients to maximise their concessional contributions.

Other superannuation measures:

From 1 July 2017:

  • The spouse contribution tax offset of up to $540 will be available to individuals contributing to their spouse’s superannuation fund who can earn up to $37,000 per annum (up from $10,800 per annum).
  • A Low Income Superannuation Tax Offset (LISTO) of up to $500 will be available to those with adjusted taxable income below $37,000 per annum.
  • Superannuation funds will no longer be able to pay an anti-detriment payment to an eligible dependant after the death of a member.
  • The Government will enshrine into legislation the objective of superannuation which is ’to provide income in retirement to substitute or supplement the Age Pension’.
Conclusion

Conclusion

In general the budget super changes had the effect of reducing the attractiveness of super relative to the pre-budget rules – particularly for the perceived wealthy.

Ironically, in the very same budget that the Government will enshrine into legislation, the long term objective of superannuation is ’to provide income in retirement to substitute or supplement the Age Pension’, most measures do appear driven by the short sighted motive of simply increasing the current year’s tax take.

That said, probably only the eternal optimists expected the uncapped, zero tax, super world to last forever. For those who remember the “pre 2006 budget” model (i.e. taxed pensions and lump sums, RBL’s, etc.), these latest changes will still leave us in a more concessional system than we had then. Put simply, super is still far more attractive than investing via corporate and individual tax rates.

One thing we can be sure of is there will be many changes, and with change there has always been strategic opportunities for the vigilant.

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