Going small can reap big rewards
With the 2019 Federal Budget leaving superannuation largely untouched (at least in comparison to prior years), it is worth remembering other opportunities that currently exist to give clients a boost to their super. Indeed, the changes announced in this year’s Budget aren’t due to take effect until 1 July 2020, will be reliant on the Coalition being returned to Government and ultimately the successful passage of legislation to give effect to the announcements.
Perhaps the biggest opportunity that has arisen in recent years was announced in the 2017 Budget and took effect from 1 July 2018. If the level of interest from advisers on this opportunity is any gauge, then its potential for application for clients will be significant.
This new initiative, commonly referred to as ‘the downsizer strategy’, was announced by the Government as part of a range of measures in the 2017 Budget to help in opening up the ability for more people to buy a home – in this case by offering some encouragement to those aged 65 and above typically considering selling their property and moving somewhere smaller (hence the term downsizer).
More importantly though, the downsizer strategy is opening up opportunities for clients to top up (or in some cases even commence) their super, and has fast gained traction as one of the most topical strategies seen this financial year.
With average superannuation balances at the time of retirement ($270,710 for men and $157,050 for women) still below the Association of Superannuation Funds of Australia’s (ASFA’s) $640,000 projection for a comfortable retirement for a couple, an opportunity for clients to top up their super is an important consideration, particularly for those approaching retirement.
The downsizer strategy, which took effect from 1 July 2018, means clients now have more opportunity to upsize their retirement nest egg.
Which clients would be interested in this strategy?
To utilise the downsizer strategy, your client needs to be at least 65 years of age. It remains to be seen if the Coalition announcement of extending the pre-age 65 contribution rules to become pre age 67 contribution rules will result in the qualification age for downsizer contributions also rising to age 67. If that is the case, then there is a window of opportunity over the next year and bit for those currently aged (or approaching age) 65 to consider if there is an opportunity now to implement the downsizer strategy.
Despite existing opportunities for super top ups between ages 65 and 74 pending some paid work (or the one-off top up opportunity announced in the 2018 Federal Budget with no work requirement), or waiting for the proposed 2019 Budget announcements (regarding extending the current pre age 65 contribution rules to become pre age 67 contribution rules) to become law from 1 July 2020, these options don’t suit everyone. And it also doesn’t consider the challenges involved in finding a suitable job from someone aged at least 65.
The benefit of the downsizer strategy is that there is no requirement to meet a work test for this contribution. This makes it ideal for clients who are currently aged between 65 and 74. But it is even more appealing for clients aged at least 75 who may still wish to contribute to their super– whether they are still working or not. Remember that the ability to voluntarily contribute to super largely disappears in all respects (both concessional and non-concessional contributions) from age 75.
Not only is this a great advantage of the downsizer strategy, but so is the fact that it doesn’t matter how much a client already has in super. The total superannuation balance threshold of $1.6 million that would normally prevent the ability to make further non-concessional contributions to super doesn’t apply for downsizer contributions.
If your client qualifies as a ‘downsizer’ they can make an additional contribution of up to $300,000 into super. It’s an after tax contribution so no tax is paid on the way in, and because they are over 65, it is returned tax free when they seek to withdraw these funds in the future. And if your client is eligible to make other contributions to super, they can still do this.
The opportunities for couples is even greater. If your client’s spouse also qualifies (based on age), then they can contribute $300,000 each – so $600,000 in total – even if only one member of the couple owned the property. The fact that the ownership of the property can be owned by one of the members of the couple is important, as strategies previously implemented for valid estate planning or asset protection outcomes won’t need to be unwound just to access the downsizer strategy.
Which clients are eligible?
In addition to the current age 65 threshold, there are a number of other important criteria to be met.
First, a client must sell a property that is located in Australia. Second, they must have owned the property for at least 10 years.
When first introduced, the timing of the contract for sale was important as the contract had to be entered into on or after 1 July 2018. This was important as clients who entered the contract for sale pre-1 July 2018, but where settlement occurs after 30 June 2018, were not eligible for this new initiative.
Finally, the property needs to have been your client’s principal place of residence for at least some time during its ownership. Technically the test is whether your client will be eligible for an exemption from capital gains tax (CGT) when it’s sold under the main residence exemption provisions. Where the client had purchased the property pre-CGT (and so no CGT issues arises at all), the test is whether they would have been eligible for an exemption under the main residence provisions if the property had been subject to the CGT provisions (i.e. assume a purchase date of 20 September 1985).
Provided some exemption is available under the main residence provisions, it doesn’t matter whether it’s a full exemption or a partial exemption. This distinction is important as the property being sold could be an investment property today, so long as it was the main residence in the past – which means your client doesn’t have to sell their current main residence. Similarly, if the property your client lives in today was initially an investment property, but they have subsequently moved into it and are now looking to sell, it can also qualify.
When the property is sold, the sale price is key. If the property sells for more than $600,000, for example, then your client could contribute up to $600,000 to super (being $300,000 maximum for each member of a couple, if both eligible). If it’s sold for less than $600,000, it’s up to the client to decide how much to contribute to super, up to the maximum allowed per person. But you can only contribute to the maximum of the sale price.
So how does the downsizer strategy work in practice?
It goes without saying that a client needs to be at least 65 and selling an eligible property. And whilst the sale price of the property will dictate how much can be contributed into super, the physical proceeds from the sale don’t have to be used to make the contribution. Other monies can be used.
Perhaps the most important issue to be aware of is around the timing of the contribution to super under the downsizer strategy. There is a time limit of 90 days from receiving the sale proceeds to putting the money into super. And like contributions made under small business CGT provisions, you need to notify the superannuation fund at the time of the contribution (or earlier) that the contribution is a downsizer contribution.
Any contributions made in error, for example made after the 90-day timeframe has elapsed, or made without the correct notification as a downsizer contribution to the super fund, could be regarded as non-concessional contributions and could possibly result in excess contribution considerations.
Additionally, they could be regarded as having been made in circumstances where the client was not actually able to make that contribution (i.e. made by a person aged 65 or older who hasn’t met the relevant work test requirements).
On this point, it’s also important to remember that provisions that used to compel super funds to reject contributions made in excess of the annual limit have been repealed. Advice around the timing of the contribution and fulfilling all requirements is therefore critical.
Finally, the timing of the contribution can have important implications if the 90-day window for making the contribution straddles 30 June. For clients who have not yet reached a total super balance of $1.6 million and are considering making additional contributions over and above the downsizer contribution, timing is critical.
For example, consider a 66-year-old client (who meets the work test requirements) is selling an eligible property for $500,000. They currently have a super balance of $1.45 million. If they make a $300,000 downsizer contribution prior to 30 June, it will form part of their total super balance at year end (taking it to $1.75 million) and disqualifying them from making further non-concessional contributions the following financial year.
Does the downsizer contribution suit everyone?
Clearly, clients must be in a position where they are thinking about selling their home. For many, the attachment to their principal residence is an important factor which means the downsizer contribution is not an option, even if they qualify in all other respects.
If the client qualifies, or is hoping to qualify for the Age Pension, the impact needs to be considered. Whilst they own their current main residence, its value is excluded from the assets test. However if it is sold, and some of the proceeds added to their super, that value will then be assessed and may reduce their age pension benefits.
And finally, whilst this opportunity is referred to as the ‘downsizer’ strategy, it doesn’t mean that your clients need to look at moving to something smaller or cheaper to access the opportunity. As long as the client (and the property) meets all the relevant requirements, there is no need to move to something smaller or cheaper. If it involves the sale of a previous principal residence (that is now an investment property), there is no need to move at all.
For clients who are eligible for this opportunity, it should certainly be considered, even if they are looking for a new house to buy in the meantime. The contribution is not subject to tax as it enters the super fund, and given they have to be at least 65 in order to qualify, they can withdraw the money at any time.
Given many Australians have their savings invested in their home, this opportunity to upsize super may offer a welcome relief. The extent of how widely this is used is still to be seen, as eligible contributions are only now making their way into the super system. But like all things with super and finance in general, getting it right is important and clients should be seeking professional guidance.
Bryan Ashenden is the head of financial literacy and advocacy at BT Financial Group.
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