The new age of simpler super

Now that the new superannuation rules are in full swing, it’s time to see whether they are truly ‘simpler’ or are just another way of describing the previous complex web of intrigue.

In most cases they do provide an easier to understand set of rules for contributions and taxing of the fund.

However, expert knowledge is still required to untangle what some of the rules are trying to achieve.

Consider the words used to describe the different types of pensions, splitting of contributions and transfers of different amounts to a member’s account. Even the contribution provisions are peppered with quirky rules.

Despite what was said last year, the new rules will require a greater need for clients to seek planning advice.

This is because, initially, people will wish to understand the new jargon, the impact on their retirement savings and then find out whether there are any new opportunities that could be to their advantage. Three areas to consider are contributions, pension payments and estate planning.

While the rules for contributing to superannuation are relatively easy to understand, there are some areas where greater knowledge of some of the rules will reap rewards.

These relate to the work tests, the contribution rules just prior to a person reaching age 65 and making contributions other than in cash, such as in specie contributions to self-managed superannuation funds.

Work tests

For most clients, satisfaction of the work tests is mainly irrelevant, as clients who wish to contribute to super are usually under age 65 and there is no requirement to satisfy the test.

However, for those 65 or older meeting the work test becomes an essential part of retirement planning. In most cases it is relatively easy to satisfy the tests that a person is gainfully employed and has worked the required number of hours.

Whether a person is gainfully employed depends on the activity they undertake and the income they receive or are likely to receive.

For example, a person who undertakes voluntary work would not be considered gainfully employed because they are not paid for the work they do. Reimbursement of expenses or the provision of meals by a charity to a voluntary worker does not amount to ‘gainful’.

However, on the other hand, an author may be gainfully employed even though the receipt of income may not occur until publication.

In contrast, a person who is in prison would not be gainfully employed even though they receive a nominal payment for any work they may undertake. The payments for the work a prisoner undertakes are merely allowances and the working arrangement is not considered employment.

Often some clients may feel they are in a difficult position to substantiate the time they have devoted to meet the 40 hours in 30 consecutive days work test.

This occurs in the case of self-employed people and those who work on an ad hoc basis. In these cases it may be difficult for some clients to match the time they spend working with the income received.

In situations where clients may feel uncertain about the hours worked, keeping a diary may be worthwhile and provide peace of mind for the client.

The rules for making concessional and non-concessional contributions are relatively easy to understand. These contributions depend primarily on the age of the person and whether they meet the work tests when they are 65 or older.

Reaching 65

Despite their relative simplicity, as a person moves towards age 65 the operation of the legislation should be clearly understood.

There may be situations where a person older than age 65 is able to have non-concessional contributions of more than $150,000 made to the fund.

However, this is only for a limited period and the person will need to trigger the two year bring forward rule before they reach age 65.

As an example, let us assume a person turns 65 in this financial year and prior to their 65th birthday makes a contribution of more than $150,000.

This will trigger the bring forward rule of the next two years contributions and permit a non-concessional contribution of up to $450,000.

If we assume the person is only able to contribute $160,000 in this financial year, they are able to contribute up to $290,000 during the next two financial years without breaching the non-concessional contributions cap. This means they could contribute $290,000 in the financial year in which they turn 66.

However, it should be remembered that after age 65 it is necessary for the work tests to be met in order to make the additional contribution. While this rule is of limited use, it may be worthwhile for those who receive the proceeds from the sale of an asset over an extended period that straddles a number of financial years.

Most concessional and non-concessional contributions to superannuation are made in cash.

In specie contributions

However, for some funds contributions can be made by the transfer of assets. These contributions are referred to as transfers in specie contributions and are a common way of making contributions to a self-managed superannuation fund.

The superannuation rules restrict the transfer of particular types of investments that can be transferred to the fund.

However, it is quite permissible to transfer investments listed on a stock exchange, public unit trust investments and business property over which there is no mortgage or other charge.

The main issue that arises with the transfer of investments as an in specie contribution is the impact of the set limits for concessional and non-concessional contributions.

For example, a person may wish to make an in specie contribution of a property to the fund.

If the value of the potential contribution exceeds the relevant contribution limits then the client and their adviser need to determine how the transfer can take place without the transaction resulting in the contribution being taxed at penalty rates.

This may mean only part of the value of the property or other investment can be transferred to the fund, or it could mean that if the fund has sufficient liquidity that it purchase part of the property, with the remainder being treated as a contribution.

Other considerations in this case would be the impact of capital gains tax and, in some states, potential stamp duty issues.

Income drawdown

There is no question that going forward the new account-based pensions, which are permitted from July 1, 2007, will make life easier for many.

The great benefit of these pensions is their simplicity in calculation and flexibility to draw amounts above the minimum as required.

While these are favourable and necessary features of a simplified system for superannuation, clients and their advisers may need to take into account a greater level of planning of income drawdowns.

The reason for a greater level of planning with account-based pensions is that up until June 30, this year, all types of pensions provided a broad framework within which payments were required to be made.

For example, allocated pensions required that the relevant payment fell within the minimum and maximum levels. These levels were designed to provide a pension that would last for a person’s life expectancy if the maximum was taken or longer if taken as a minimum.

Other types of pensions, such as term allocated pensions and the range of complying pensions provided a set amount, within limits, to be paid to the pensioner.

The same does not necessarily occur with the new type of account-based pensions.

These pensions merely require a minimum to be withdrawn, with a maximum limit set only for the period when the amount drawn is taken as a transition to retirement pension.

The issue for clients who wish to take an account-based pension is whether the amount drawn down has been done in the most effective way. The general idea is to ensure that the pension will last until the pensioner or their spouse both pass away.

A person who merely draws down the minimum amount of the account-based pension may find that at a reasonable earnings rate there continues to be a substantial amount of money left in superannuation by the time they reach age 100 and beyond.

While this may seem attractive to those who survive the pensioner, it does nothing to ensure that the amount in superannuation has been used as effectively as possible during a person’s lifetime.

A reasonable plan for the payment of an account-based pension would seem to be for a client to draw down more than the minimum pension in the earlier years, when a person would be expected to have relatively higher living expenses.

As the pensioner gets older the cost of living in relative terms would be expected to reduce and, therefore, their pension should reduce accordingly.

The skill of a good planner is therefore required to get the balance right in determining the pattern of expenditure of the client, with as few adjustments as possible.

Estate planning

One other aspect of the new superannuation system is estate planning considerations. This has taken on a greater level of importance than under the previous rules.

The main aim of clients and their advisers under the new arrangements is to ensure that on the client’s death any amounts paid to non-dependants for tax purposes includes the largest tax-free component.

Prior to July 1, this year, it was possible to split benefits payable on a person’s death into the tax free and taxable components and through careful streaming.

The effect of streaming was to reduce the tax payable to dependants of the deceased to a minimum. Under the ‘simpler super’ rules it is not possible to split the ‘superannuation interest’ of a person into its taxable and tax-free components.

However, there are a number of strategies that can be used to change the proportion of taxable and tax-free components.

Two strategies that are able to achieve the change in the proportions are the re-contributions strategy and the two-fund strategy. The efficiency of either of these strategies depends on the individual client’s circumstances and the overall costs and savings associated with the implementation of either arrangement.

One concern of many advisers is the application of the tax avoidance provisions to some of the strategies, particularly for those clients who are over age 60.

The main reason put forward by some commentators is that the only purpose for entering into these arrangements is to provide a non-dependant with a greater tax-free payment.

Recent indications from the Australian Taxation Office suggest that use of the re-contributions strategy would be unlikely to be considered as tax avoidance.

The main reason seems to be that the increased tax-free death benefit obtained by the non-dependant will only occur if a number of other possible events take place.

Those events rely on the death of the pensioner, possibly their surviving spouse, and the likelihood there will be something left over to be paid to the non-dependant.

The simpler superannuation rules provide a great range of planning opportunities for advisers and clients.

While some strategies may be familiar to many who have used them in the past, it is their application under the new rules that needs to be understood. Some will work for one client and not for another.

Graeme Colley is the technical manager at Super Concepts.