Time is money

The turmoil on world equity markets has shaken the faith of investors.

Figures released by the Australian Bureau of Statistics show that Australians have lost 36 per cent of their household wealth in cash, bank deposits, shares and bonds in the 18 months from September 2007 to March 2009.

While these figures exclude superannuation and real estate, they underline the effect of the equity market falls on wealth since the market peak in November 2007.

In a recent survey we found many Australians were worried they did not have enough superannuation to retire on and felt the current financial crisis had affected their superannuation balance.

The major stake for most Australians in the equity markets is their superannuation account, and as it has fallen they have blamed superannuation for their losses. This mistakes the symptom for the cause. Superannuation is merely a holding vehicle for assets.

After such savage falls in returns many investors are feeling the pain of loss. Instead of being trapped by the past we should be asking what superannuation strategies are suitable in the current environment?

Committing more funds to superannuation when equity prices are low makes sense, but it is contrary to intuition. Objectively, however, this might be the ‘best of times’ to make salary sacrifice, personal deductible and non-concessional contributions into superannuation and take advantage of the market slump.

It has been stated many times that dollar cost averaging works because an investor buys more units when prices are low and less when they are high. With share prices down about 40 per cent from their highs, now might be an opportune time to implement this strategy. Many fund members via regular employer superannuation contributions already do this. As in many endeavours, the benefit will be seen in the future when markets recover and units are worth more than their current value.

For investors in funds that can accept an in-specie contribution, now might be a great time to make those transfers. With share prices down from their earlier levels, the capital gains assessable to the individual will likely be low or nil. If the member meets the qualifying criteria, any capital gains could be offset by a personal concessional contribution. An in-specie transfer allows for future capital growth in an asset to benefit from the tax concessions within superannuation and for franking credits on share dividends to offset tax within the fund.

Of course, advisers need to consider their clients’ personal circumstances and other needs whenever considering superannuation contributions. They should also be mindful of the new concessional contribution limits applying from July 1, 2009.

As member balances have fallen in value, it is now possible to undertake a withdrawal and re-contribution strategy covering a significant percentage of a member’s account, particularly if the re-contribution is undertaken using the two-year bring forward non-concessional contribution of up to $450,000.

This strategy is particularly applicable for those over 60 who have met a condition of release, as they are able to make tax-free withdrawals from a taxed fund.

In addition, no work test is applied to individuals under the age of 65 making contributions. For those between 55 and 60 who have met a condition of release, the first $150,000 (in 2009-10) of a taxable component in a lump sum withdrawal is tax free.

Advisers should bear in mind that the increased tax-free component in a fund resulting from a withdrawal and re-contribution strategy may affect potential anti-detriment payments, as these are usually calculated on the taxable component remaining in the fund.

If your client’s fund takes investment losses against the taxable component, the result is to decrease any taxable component and alter the tax-free and taxable proportions within the member’s account. Any resulting increased tax-free proportion can be ‘locked in’ by the commencement of a pension from the account.

The strategy has three effects. A greater proportion of a pension paid to a member between the ages of 55 and 59 will be tax-free.

Additionally, increases in investment values will be applied in the proportions ‘locked in’ at the commencement of the pension.

Lastly, as the taxable component has been reduced, a death benefit paid to a non-tax dependant will bear less tax.

The Government announced in the Budget that the 50 per cent reduction in minimum pensions previously due to expire on June 30, 2009, will be extended to June 30, 2010. This measure will benefit members who wish to continue a superannuation pension but take less from their account.

Members of pension age might also benefit by qualifying for the age pension, as in many instances those taking 50 per cent of the minimum pension might have little or no assessable income, calculated after taking the deductible amount from their superannuation pension, for the income test.

Additionally, for those under 60 years of age, taking 50 per cent of the minimum pension will reduce the amount assessable for income tax.

Members whose funds are expected to report considerable taxable income in the 2009-10 financial year, say from the disposal of appreciating assets, might consider starting a pension taking 50 per cent of the minimum drawdown so that their fund earnings are tax free in the year.

If tax is incurred in their own names from the receipt of a superannuation pension, it may well be more than offset by the elimination of tax on earnings from assets supporting the pension.

A popular strategy has been to use salary sacrifice and a transition to retirement pension to maintain after-tax income while increasing a superannuation balance. This is still a viable strategy despite the reduction in concessional contributions limits announced in the Budget.

The new limits on concessional contributions will, in some cases, reduce the benefits of the strategy. Nevertheless, the strategy is still effective in increasing the superannuation balance above what it would have been without salary sacrifice and a transition to retirement pension.

A combination of the strategies including contributions, withdrawals and re-contributions, utilising a higher tax-free component in a fund and starting a transition to retirement pension might be appropriate to your clients’ current circumstances.

Advisers can reassure clients that despite the swings in financial markets, superannuation remains the leading investment structure to provide for their retirement.

Stephen Kunz is a technical services consultant at Suncorp Life.