How to avoid the pitfalls of superannuation contribution caps

Deborah Wixted explains how to make the most of superannuation funds and outlines the best way to avoid the contribution cap traps.

There is no doubt that when it comes to excess contributions, prevention is much better than cure. With the super contributions season upon us, it is important for advisers to ensure they are checking their clients’ superannuation contributions against their relevant cap.

The Australian Taxation Office (ATO) has issued approximately 40,000 excess contributions tax assessments (ECTA) for 2007-08 and has estimated the same number will be issued for 2008-09.

As we move in to the super contributions season, many of your clients will be keen to maximise the amount they can contribute and it is important that you are prepared so your clients do not receive an ECTA in the future.

The super contribution caps for 2009-10 are outlined in Table 1.

The ATO has identified a number of key areas for improvement that advisers should note. These include:

• lack of communication between the adviser and the client;
• failure to understand the contribution cap rules and how they interact with strategies such as transition to retirement and re-contributions;
• failure to obtain information and keep proper records; and
• lack of awareness around the duty to monitor contribution levels, which lies with super fund members and not the trustee. Subsequently, these members rely on their advisers to monitor contribution levels.

Here are five common examples of where one or all of the above factors have led to an ECTA:

1. Failure to ask the client for information about contributions made to all of their superannuation funds

In many instances advisers are not undergoing proper checks of their clients’ contributions history or clients fail to inform their adviser when they make a contribution.

A case in point is where an adviser instructs his 67-year-old client to make a $150,000 non-concessional contribution (NCC) in August 2009.

Subsequently, without notifying the adviser, the client withdraws the total amount in September 2009 and then makes another $150,000 NCC in December 2009. This lack of communication will result in an excess contribution of $150,000 and an ECTA of $69,750 (ie, 46.5 per cent x $150,000).

2. Lack of understanding of how the superannuation contribution caps work

Another common misconception is around how the ‘bring forward’ rules operate. Those who are under 65 years of age in the financial year are entitled to use the higher $450,000 NCC (over three years).

However, if the client is not under 65 years of age in the financial year, the contribution is subject to the lower NCC cap of $150,000 per annum.

If there is no prior ‘bring forward’ rule in operation, the incorrect cap of $450,000 may mistakenly be used.

3. Transition to retirement and salary sacrifice strategies

This is a common tax effective strategy used by advisers where the types and levels of contributions being made and to what cap they are counted against can be overlooked by advisers.

A case in point is where a client aged 52, on an annual salary of $100,000, has a salary sacrifice arrangement in place up to his or her concessional cap of $50,000 (2009-10).

The adviser, however, may not be aware that any super guarantee contributions (if the 9 per cent is based on gross salary) and a bonus of $40,000 that is salary sacrificed will also count towards the client’s concessional cap.

Lack of communication in this situation will result in an ECTA of $15,435 (ie, [$9,000 + $40,000] x 31.5 per cent).

4. Re-contribution strategies

This strategy is commonly used for estate planning purposes, however, if contribution amounts are not monitored carefully, the following scenario may eventuate. In July 2008 a client aged 62 is advised to cash out and recontribute $450,000 into his or her super fund.

Then in June 2009 the client is advised to contribute $375,000 under the two-year ‘bring forward’ rule. Both of these contributions are deemed non-concessional and have been made in the same financial year.

Failure to take into account the previous advice in this situation will result in an ECTA of $174,375 (ie, $375,000 x 46.5 per cent).

5. Failure of personal deduction notices

The following are examples of problems that can occur in this area:

1. A client makes a NCC up to the cap of $450,000 and then makes a personal deductible contribution of $50,000, which is a concessional contribution. Unfortunately, the accountant fails to include the deduction in the client’s tax return. As a result, the deduction will be disallowed and the $50,000 concessional contribution will be classified as a non-concessional contribution that exceeds the NCC cap. This scenario will result in an ECTA of $23,250 (ie, $50,000 x 46.5 per cent).
2. Clients may be eligible to make personal deductible contributions if they are substantially self-employed and satisfy the 10 per cent test. If clients fail this test (which may not become apparent until after the conclusion of the financial year) and the client has maximised the use of their non-concessional cap, the disallowed contribution amount will now be classified as a NCC and the same result will eventuate as above.
3. The deduction actually claimed in the tax return does not equal the amount claimed in the deduction notice submitted to the super fund. Once again, this may lead to the same problem mentioned above.

6. Bonuses

A number of your clients may receive bonus payments that they opt to have salary sacrificed to their super fund.

This may sound harmless enough on its own, but if other contributions are made in the same financial year and have not been accounted for, it may prove to be costly.

A case in point is where Jim aged 48 has made the following contributions in 2008-09: a $50,000 concessional contribution (his cap for 2008-09), a NCC of $150,000 and a $5,000 bonus that he salary sacrifices to his super fund. In 2009-10, Jim makes a NCC of $450,000 under the bring forward rule.

Consequently, Jim will receive two ECTAs of $1,575 ([$55,000 — $50,000] x 31.5 per cent) and $72,075 ([$605,000 — $450,000] x 46.5 per cent).

This excess amount arises because the $5,000 counts towards Jim’s NCC cap on 2008-09 and invokes the bring forward rule a year earlier than anticipated.

Had Jim informed his adviser about the bonus he could have taken it as salary and paid much less tax in comparison.

Deborah Wixted is head of technical services at Colonial First State.