Make the most of what you’ve got

Between May 9, 2006, and July 1, 2007, the proposed rules allow a person to contribute up to $1 million to superannuation from after-tax contributions, referred to as non-concessional contributions.

However, from July 1, 2007, a proposed cap of $150,000 will be placed on after-tax contributions. For those younger than 65 it is possible to contribute $450,000 over a three-year period without penalty.

Personal tax deductions for superannuation contributions may be available if less than 10 per cent of a person’s income and reportable fringe benefits come from employment sources.

It is therefore available for those who are self-employed, or receiving income mainly from investments or pensions.

For the 2006-07 financial year the maximum tax deduction is determined on a contributor by contributor basis and linked to the age-based limits.

From July 1, 2007, the proposed changes mean that the first $50,000, as indexed, or $100,000 until 2012 for those older than 50, of tax deductible contributions for a person will receive concessional tax status in the superannuation fund.

In other words, the test is on the individual rather than the contributor.

You may ask, what has making contributions to superannuation have to do with moving investments into a self-managed superannuation fund (SMSF)?

In fact, the combination of contributions and investments has a great deal to do with increasing our superannuation savings for us to live more comfortably.

Let’s look at a few case studies to see what can be done to transfer investments or money we receive from the sale of those investments to superannuation under the Simplified Superannuation rules.

Case study one: Rochelle

Rochelle, 62, lives off a small public service pension and income she receives from a rental property.

She purchased the rental property in 1984 and as it is a ‘pre-capital gains tax’ investment she will not be liable for capital gains tax if it is sold.

When Rochelle bought the property in an inner city suburb, it cost her about $36,000.

With the increase in property prices and changes to zoning rules, particularly over the past few years, it is now worth just over $1.25 million.

If she decides to sell the property she expects to receive about $1.2 million.

Let’s assume that Rochelle decides to sell the property in May 2007.

Under the proposed superannuation rules it is possible for Rochelle to contribute nearly all of the proceeds from her property to superannuation this financial year, that is, before July 1, 2007.

However, she will need to make sure that contributions are made in the right way to take advantage of the new rules.

This case study examines one option for Rochelle. However, there may be a range of possibilities available to her.

Because Rochelle is under 65 there are no work tests that need to be met if she wishes to contribute to superannuation.

This means she can contribute at any time over the next three years without having to work.

After she reaches age 65 she will need to work at least 40 hours in 30 consecutive days if she is to contribute to superannuation.

Now let’s look at what Rochelle can contribute to superannuation under the proposed rules.

As there is a $1 million limit to the amount of after-tax contributions she can make to a fund between May 9, 2006, and July 1, 2007, she may wish to contribute the bulk of money received from the sale of the property before July 1, 2007.

She is also eligible for a tax-deductible contribution for superannuation contributions of up to $105,113 as she receives no income from employment sources.

Her income is earned from the public service pension she receives and the rent from the property.

If she chooses this route then she can contribute up to $1,105,113 to her fund.

However, this may not be the best option as her income is likely to be less than $105,113 or the point at which she may pay a marginal tax rate of 15 per cent or less.

Let’s assume Rochelle earns $80,000 per annum consisting of rent from the property of $50,000 and a rebatable pension of $30,000. The tax payable on the $80,000 is $21,050 and the pension rebate is $4,500.

If she was to contribute the maximum aged-based contribution then she would pay no tax and maximise the amount paid to superannuation.

However, this would not be the best result as she would not gain the most efficient result because the aged-based contribution she makes would be taxed at 15 per cent.

A better way to make the tax-deductible contribution would be for Rochelle to claim a deduction to the amount at which her tax was 15 per cent.

For Rochelle, this would occur at a taxable income of $55,000, as the maximum tax rate up to $25,000 is 15 per cent and up to $75,000 the tax rate is 30 per cent. Because her pension is eligible for a 15 per cent tax rebate, she can earn $55,000 and pay no more than 15 per cent tax plus Medicare.

This means that before July 1, 2007, it would be better for Rochelle to contribute $1,025,000 to superannuation.

The contribution would consist of the $1 million in after-tax contributions and $25,000 in tax-deductible contributions.

She would have no tax to pay for this financial year and in future years could make either an after-tax contribution of an average of $150,000 per annum until she is 65 or a tax-deductible contribution of up to $100,000 if required.

If we consider that from July 1, 2007, the proposed rules will treat Rochelle’s public service pension as tax free and that all her retirement savings are now in superannuation rather than receiving rent from the property she may end up not paying tax again.

Therefore, there may be no need to claim the tax deduction for any superannuation contributions she makes.

You may ask, why didn’t Rochelle just transfer the rental property to the superannuation fund as an in specie contribution, that is, contributions otherwise than in cash?

Under the Superannuation Industry (Supervision) Act 1993 there are strict limits to what a person can transfer to a superannuation fund, including a SMSF.

It is permissible to transfer commercial property, listed shares and other securities, some insurance policies and some other non-arm’s length investments to the fund.

However, it is not possible to transfer a rental property used for domestic purposes to a fund.

Case study two: Austin

Our second case study is Austin, who is 60 and works two days a week as a casual music tutor.

This financial year he expects to earn about $15,000 per annum from teaching and about $43,300 as dividends from his share portfolio.

During the past four years, Austin’s share portfolio has increased in value from $85,000 to nearly $635,000 and has a potential capital gain of $550,000.

Austin has read about the proposed changes to superannuation in this year’s Budget and that listed share investments can be transferred to superannuation without having to sell them.

In view of this he decides to make some contributions to the fund.

However, his accountant/financial planner has said that he needs to take into account the potential taxable capital gains if he was to transfer the shares to his superannuation fund. It is estimated that the taxable capital gain will be in the vicinity of $275,000.

While Austin has been correctly advised by his accountant about the taxable capital gain, with careful planning the tax on the capital gain may be reduced or even eliminated. It all has to do with the timing.

As we have seen previously, it is possible to obtain a tax deduction for personal superannuation contributions, provided less than 10 per cent of a person’s total income and reportable fringe benefits is earned from employment sources.

As Austin will earn $15,000 from teaching as a music tutor, he will need to earn at least $150,000 in total to be eligible for a personal tax deductible superannuation contribution.

In other words, he will need to have a taxable capital gain of more than $135,000 from the transfer of his investments to his SMSF so that his total income is more than $150,000 for the financial year.

Let’s suppose that Austin transfers one-third of the shares he owns to his SMSF. The value of these shares is about $211,000. The estimated purchase price of the shares was about $28,000 resulting in a capital gain of $183,000. As Austin has held the shares for longer than 12 months, only 50 per cent of the capital gain, that is, $91,500, is taxable.

As you can see, Austin’s total income for this financial year consists of $15,000 from music tutoring and $91,500 from taxable capital gains ($106,500 in total).

As the income from tutoring is greater than 10 per cent of Austin’s total income, he would not be eligible for a personal tax-deductible superannuation contribution.

However, it may be possible for Austin to have a break from the tutoring for a period so that his income remains less than 10 per cent of his total income.

This will allow him to gain a valuable personal tax deduction for superannuation and save him approximately $29,100 in tax if he decides to transfer one-third of his shares to his SMSF.

Of course, there are a number of other options that are available to Austin to transfer his shares to superannuation.

This could include transferring all of his shares to superannuation prior to July 1, 2007, without claiming a tax deduction and paying tax on any capital gains.

In these cases, you would need to see what benefit could be gained if he was to commence a tax-free transition to retirement pension under the proposed rules from July 1, 2007.

If Austin were to do this, he could still continue tutoring and reduce the amount of taxable income as his investments would have been transferred to superannuation.

Any income and capital gains used to pay the pension assets are tax free in the fund and tax free when paid to Austin. This could mean he may not pay tax again.

The case studies of Rochelle and Austin show some of the flexibility of the proposed superannuation rules to provide a range of tax-efficient solutions for wealth creation in retirement.

Graeme Colley is technical manager at SuperConcepts .