Using concessional contributions to boost superannuation and reduce tax

David O'Connell examines how personal concessional contributions made by the self-employed from pre-tax income can increase their superannuation benefits and potentially reduce their income tax liability.

Concessional contributions are contributions made into a fund on behalf of a member that are included as assessable income for the fund, with some exceptions, such as:

• transfers from a foreign superannuation fund
•  a rollover of an untaxed element
• a contribution into a constitutionally protected fund.

Concessional contributions are taxed within the fund at 15 per cent and form part of the member’s taxable component. Some characteristics of the taxable component within a taxed fund are:

• generally taxable when withdrawn as a lump sum or as a pension before age 60
• tax-free when withdrawn from age 60
• taxed at 15 per cent plus Medicare levy when paid to a non death benefits dependant
• may attract an anti-detriment payment when paid as a death benefit to an eligible dependant.

Limits

The annual cap for concessional contributions is $25,000 with transitional arrangements allowing a person aged 50 or over on the last day of the financial year to make concessional contributions of up to $50,000 per annum until 30 June, 2012.

The Federal Government proposed in its budget before the election that after these transitional rules come to an end, the concessional contribution limit for those over 50 years of age would continue to be $50,000 per annum, but be restricted to those with total superannuation balances below $500,000.

Contributions that exceed the concessional contributions cap are taxed a further 31.5 per cent, effectively taxing the contribution at the top marginal tax rate including the Medicare levy.

If the member has exceeded the concessional contributions cap, the Australian Taxation Office (ATO) provides the member with a voluntary release authority for excess contributions tax, which expires 90 days after the issue date on the form.

To withdraw funds from their superannuation benefits to fund their excess contributions tax liability, the member needs to fill this form and send it to the trustee of their superannuation fund.

Otherwise, they can disregard the form and fund the tax liability from non-superannuation sources.

The member also has the option of using a combination of sources by nominating to release benefits less than the tax liability and fund the shortfall from their non-superannuation funds.

An important point to remember is excess concessional contributions will also count towards the member’s non-concessional contribution cap for the year.

If the member has already reached their non-concessional contributions cap for the financial year, the excess concessional contributions will be taxed a further 46.5 per cent as excess non-concessional contributions.

This equates to an effective tax rate of 93 per cent.

There is a situation where breaching the concessional contributions cap is unavoidable.

An employer is obligated to make superannuation guarantee (SG) contributions of 9 per cent of each employee’s ordinary time earnings up to $42,220 per quarter.

As SG contributions are concessional contributions, where a person has a number of high paying jobs, they may breach the cap before making any voluntary contributions.

For example, a person under 50 years of age who holds two jobs, each paying $140,000 per annum would exceed the concessional contributions cap and be obligated to pay the excess concessional contributions tax.

Who can make personal concessional contributions?

To make a personal concessional contribution, less than 10 per cent of the person’s assessable income, reportable fringe benefits and reportable employer superannuation contributions must come from being an employee.

There is an additional test for those under 18 at the end of the financial year in which they made the contribution. They must also have derived some income from employment or running a business in that year.

This does not apply to people over the age of 18, as they can claim a deduction for a personal contribution even if all their assessable income was passive.

A point for people intending to claim a deduction to remember is that superannuation payments, which are not assessable income, are not counted towards the 10 per cent rule test.

These payments include lump sum withdrawals and pension payments to those over 60 as well as the tax-free components of lump sum withdrawals and pension payments to those under 60.

A further point is that the test is based on assessable income and therefore, a sole trader is tested on their revenue before associated deductions and consequently is more likely to satisfy the 10 per cent rule.

Notice of intent to claim a deduction

For a person seeking to claim a tax deduction on their personal contributions, they must complete a notice of intent to claim a deduction for personal super contributions form and return it to the trustee of their superannuation fund.

This must be completed before they lodge their tax return or at the end of the financial year following the contribution, whichever is earlier.

Additionally, the notice can only be lodged with the fund that accepted the contribution and the member’s benefits must still be in the accumulation phase.

The member must receive an acceptance of the notice from the trustee for the deduction to be valid and to be able to complete their tax return.

Where all or part of the relevant superannuation benefits, after the contribution was received have been used to commence an income stream or been subject to contributions-splitting, the notice is invalid and no deduction is allowed.

In addition, where a portion of the superannuation benefits has been rolled over, a deduction is allowed only on a portion of the contribution.

In certain circumstances a member may alter the amount they wish to claim as a deduction by completing a new notice and lodging it with the trustee.

However, the amount may only be reduced down, to nil if required. Importantly, once a valid notice has been accepted by a trustee:

• • the notice cannot be revoked
• • the amount claimed cannot be increased
• • a second notice cannot be lodged.

An exception to this is where the ATO declines the initial amount claimed. In this situation, the member has the option to reduce the amount to the allowable amount.

However, where all or a portion of the relevant benefits have been rolled over or used to commence an income stream, some or all of the contributions tax paid may be irrecoverable.

Summary

Personal concessional contributions can provide significant benefits and are an integral part of many financial planning strategies.

As a result, it is important to consider any potential issues at the time of contribution, as generally, there are few options available to make adjustments after the end of the financial year of the contribution.

David O’Connell is head of technical services at Fiducian Portfolio Services.