Year end tax strategies - Getting more bang for your buck

Each financial year there is a window of opportunity to implement strategies to manage that year’s tax and superannuation matters. It is crucial that clients start planning now, if they haven’t already done so, to ensure they avail themselves of all the appropriate opportunities before the window closes for this financial year.

Capital Gains Tax (CGT)

There are a number of concessions that apply to capital gains, such as the 50 per cent individual discount and small business concessions for eligible taxpayers.

Any residual capital gain after the application of all concessions utilised can be further reduced by allowable deductions (eg, personal deductible superannuation contributions) or effectively reduced by utilising a salary sacrifice strategy.

Example

A 45-year-old client sells some shares this financial year. She has three children, all in private schools, has paid off her mortgage and has no other debt. She earns a salary of $190,000 per annum and expects to spend all her net income (ignoring the capital gain) for the year. The net gain on the sale is $25,000 (after applying the 50 per cent individual discount as the shares were held for longer than 12 months).

This client’s tax liability would therefore be expected to increase from $65,350 to $76,975 in that year due to the part of the capital gain that is added to her assessable income.

To minimise the tax payable in that year, the client’s adviser recommends the client salary sacrifices $36,255 (maximising contributions within her concessional contributions cap once her Superannuation Guarantee [SG] is taken into account) in the financial year and live off the proceeds from the sale.

As the strategy is implemented in April, there are sufficient future earnings to allow this amount to be salary sacrificed. The client’s taxable income will reduce to $178,745. In addition to paying tax of $60,179 on her income, the client’s super fund will pay tax of $5,438 on the salary sacrifice amount.

As a result of this strategy, the total tax payable will reduce from $76,975 to $65,617. In other words, the tax on the capital gain is almost completely offset by the strategy.

In the following financial year, the client can use the remaining after-tax proceeds towards her living expenses and, in turn, start to make salary sacrifice contributions, or increase the level of salary sacrifice she would otherwise have made for that year.

Concessional contributions include the SG, and personal deductible and salary sacrificed contributions; they and are counted towards the concessional contributions cap. For the 2008-09 financial year, the concessional contributions cap is $50,000 for those under age 50 on June 30, 2009.

People who are 50 or older on June 30, 2009, have a concessional contributions cap of $100,000 under transitional provisions. The amount (if any) by which a taxpayer’s concessional contributions for the year exceeds their cap is taxed at an effective rate of 46.5 per cent and counts towards the taxpayer’s non-concessional contributions cap. This means that such contributions are generally not tax effective.

It is also important to take into account that contributions to superannuation are preserved until a condition of release (eg, retirement) is met.

Government super co-contribution

The government co-contribution helps low to middle income earners save for their retirement. The Government will make a co-contribution (up to $1,500) in respect of personal after-tax contributions made to superannuation by eligible taxpayers, including self-employed individuals.

The maximum co-contribution of $1,500 is reduced by 5 cents for every dollar over the lower income threshold ($30,342 for 2008-09), with the co-contribution phasing out completely at the upper income threshold ($60,342 for 2008-09).

The taxpayer must make a personal after-tax contribution by June 30, 2009, to be eligible for the co-contribution this financial year. The co-contribution can be claimed when the taxpayer lodges their tax return for the 2008-09 financial year.

In the 2008-09 financial year, certain taxpayers can maximise their co-contribution by implementing a strategy combining salary sacrifice contributions and after-tax contributions.

Example

Rob earns $50,000 per year. His living expenses (plus a buffer for emergencies) amount to $40,000 per year. Rob could do the following:

• strategy 1 — salary sacrifice all his surplus gross income to super;
• strategy 2 — contribute all his surplus net income to super and receive the government co-contribution; or
• strategy 3 — salary sacrifice some of his surplus gross income and contribute his remaining after-tax income to super, so as to optimise the total amount of his contributions (including co-contribution).

The results are shown in the table.

From July 1, 2009, strategy 3 will cease to be effective for increasing a person’s co-contribution entitlement due to proposed changes to the definition of ‘income’ for the purposes of calculating the co-contribution entitlement. Legislation has been introduced into Parliament, however, at the time of writing, this legislation has not passed.

Pension drawdown relief for retirees

As a result of the recent major downturn in global financial markets, which has significantly decreased many retirees’ superannuation savings, the Government has announced it will suspend the minimum pension payment requirement for certain income streams for the 2008-09 financial year. At the time of writing, this measure is yet to be reflected in the regulations.

This proposed measure applies to the following types of income stream (including transition to retirement income streams):

• account-based annuities and pensions;
• allocated annuities and pensions; and
• market-linked (term allocated) annuities and pensions.

Retirees who have already received half of their minimum payment (as per current standards) for the 2008-09 financial year will be able to elect to not receive any further income payments for this financial year.

This measure is useful for clients who do not need the full minimum payment (as per current standards) from their pension as such clients, who may not be able to recontribute their surplus income to super, are not forced to sell income stream assets at low prices to fund surplus payment amounts.

Example

A 60-year—old retiree client with an account balance of $500,000 must, under the current rules, receive $20,000 per annum. Under the proposal, if the client has already received at least $10,000 this financial year, a request can be made to stop further income payments for the rest of the financial year.

If the client has not already received at least that amount, they can elect to reduce their remaining payments such that their total payments for the year are no more than $10,000.

By planning well in advance of the end of this financial year, clients are well placed to take full advantage of the opportunities available.

Dimitri Diamantes is technical services manager at Zurich Financial Services.