Super tinkering: how it will affect your clients

1. How will the proposed reduction in the concessional contribution cap affect my clients’ superannuation contribution arrangements?

This Year

The reduction of the concessional contribution cap to $25,000 ($50,000 transitional to June 30, 2012) does not apply until July 1, 2009, so clients will not be penalised for contributing within the current concessional contribution cap ($50,000 or $100,000 transitional) this financial year.

Importantly, the $100,000 transitional concessional cap is available to anyone aged 50 or over at any time during this financial year. For example, a client turning 50 on June 30, 2009, can make concessional contributions of up to $100,000 during 2008-09 without incurring excess concessional contributions tax.

Employees may need to review their existing prospective salary sacrifice arrangements if their retirement plans are adversely affected by the cap reduction. This effectively means some employees will need to top up their salary sacrifice contributions by drawing, where possible, a much lower salary for the month of June. The self-employed may also need to consider making a larger personal deductible super contribution this financial year.

Next Year

The Australian Taxation Office (ATO) has recently contacted approximately 25,000 individuals who have been assessed as exceeding one or both of their contribution caps in 2007-08.

The reduction of the concessional contribution cap from next year is likely to result in more clients incurring an excessive concessional contribution tax liability due to:

n a lack of understanding of the cap amount;

n failing to take into account certain contributions that count toward the cap such as Superannuation Guarantee (SG) payments, salary sacrificed bonuses and certain reserve allocations; and/or

n failing to monitor salary sacrifice or deductible contribution levels.

Remember, the tax commissioner will not disregard or reallocate a client’s excessive contributions to another financial year unless there are special circumstances (refer Practice Statement Law Administration PS LA 2008/1).

For those in the top tax bracket who will access their super tax-free from age 60, there is no tax difference between paying excess concessional contributions tax and making an after-tax non-concessional contribution (assuming the excessive concessional contribution does not also create an excessive non-concessional contribution).

Earnings on the excessive concessional contribution accrue on 85 per cent of the contribution rather than 53.5 per cent of the after tax non-concessional contribution. However, clients who make excess concessional contributions, that would have otherwise made a non-concessional contribution, need to consider other issues such as legislative risk, excess non-concessional contributions, taxable super benefits and estate planning issues before making the contribution.

The reduced cap may also encourage the practice of streaming larger super contributions to a spouse where couples carry on a business together, such as a personal services business, or via certain service arrangements. Importantly, Ryan’s case and Taxation Determination TD 2005/29 are still relevant in determining whether Part IVA may apply to arrangements where the size of the super contribution is disproportionate to the value of the service being provided.

2. What is the status of the transition to retirement (TTR) strategy?

The TTR strategy remains unaffected from July 1, 2009, other than the amount that can be salary sacrificed into super in a tax-effective manner.

The reduction of the concessional cap means the TTR strategy may be less tax effective for some high-net-worth clients.

For example, a client aged 55 on a salary of $150,000 and with a super balance of $800,000 could see the benefits of a salary sacrifice and TTR strategy reduce by $57,000 (from $148,000 to $91,000) over 10 years due to limiting their total concessional contributions to the relevant cap.

This example assumes the client draws a pension payment to maintain their original net income; investment returns are 7 per cent per annum after fees but before tax and inflation is 3 per cent per annum.

3. How will the 50 per cent reduction in minimum pension drawdowns affect my TTR and retiree clients next year?

Existing pension clients and clients commencing an account-based pension from July 1, 2009, (including those who commence in June this year but elect no minimum) can effectively defer their 2009-10 minimum pension payment (equal to 50 per cent of the legislated minimum) to June 30, 2010. The next pension payment is not required to be drawn until June 30, 2011. This enables the client to maximise their tax-free earnings in the pension by limiting and deferring pension payments where possible.

If a client commences an account-based pension part way through 2009-10, they will need to draw down 50 per cent of the pro-rated minimum amount by June 30, 2010.

If a client wishes to fully commute their pension in 2009-10, they will still need to draw down 50 per cent of the pro-rated minimum amount of the pension prior to commutation.

In addition, if the commuted amount is rolled over to a new pension, the client will need to draw down 50 per cent of the pro-rated minimum in the new pension.

Clients may need to confirm with pension product providers the administration of the reduced minimum payment for 2009-10 — that is, whether it will be applied automatically or whether a client will need to elect the reduced minimum payment.

Clients should check whether taking a lower pension payment in 2009-10 may result in a higher Centrelink entitlement, although this may only be the case if the original pension payment was much greater than the client’s non-assessable amount of their pension.

4. What are some of the issues my clients need to consider in accessing the Government co-contribution from next financial year?

The Government will temporarily reduce the 150 per cent matching rate and maximum $1,500 co-contribution that is payable on an individual’s eligible personal non-concessional superannuation contributions to 100 per cent with a maximum co-contribution of $1,000, with effect from July 1, 2009.

The co-contribution is still an extremely attractive scheme despite the reduction of the multiplier.

For example, a client whose income is $40,000 with $1,000 of pre-tax income ($685 post-tax at a marginal tax rate of 31.5 per cent) to contribute to super would be eligible for a co-contribution of $678, providing them with total net super contributions of $1,363.

If the same $1,000 was salary sacrificed to super, their net super contributions would be $850.

Note that the income test for co-contribution eligibility is based on ‘total income’ and from July 1, 2009, this will include reportable employer super contributions (ie, generally amounts above SG). This means clients cannot improve their co-contribution entitlement by entering into a salary sacrifice arrangement.

5. Are there any other superannuation-related Budget measures that may affect my clients?

Increasing the super preservation age to 67 to align with the increased age pension age

The Government’s tax review panel recently released a draft Retirement Income Report.

The report recommends aligning the super preservation age with the increased age pension age. The final report is to be delivered to the Treasurer in December 2009 (go to www.taxreview.treasury.gov.au).

It is unknown at present whether an increase in the preservation age would also result in an increase in the age at which super is tax free (currently age 60) or if an earlier transition to retirement age will be introduced.

Introducing an Australia and New Zealand retirement savings portability scheme

The Government has agreed in principle to the signing of a memorandum of understanding with New Zealand to establish a trans-Tasman retirement savings portability scheme. This scheme will permit transfers of superannuation savings between certain Australian superannuation funds and New Zealand KiwiSaver funds.

Commonwealth seniors health card (CSHC)

The Government will remove the inclusion of gross tax-free superannuation pension income in the proposed amendment to the definition of income used for determining eligibility for the CSHC.

This means a client, aged 65, may draw a pension payment of, say, $165,000 per year and still retain eligibility to the CSHC.

Managed investment trust (MIT) taxation

Australian MITs (except those taxed as companies) will be able to make an irrevocable election to apply the capital gains tax (CGT) regime to disposals of assets. This provides increased certainty and reduced compliance costs with respect to the industry’s current application of CGT discounts in MITs and super funds.

Super Guarantee and paid parental leave

Superannuation Guarantee Ruling SGR 2009/2 issued May 13, 2009, looks at the meaning of ‘ordinary time earnings’. The ruling specifically does not deal with employees who are on parental leave.

The ATO has advised the Government it considers salary paid while on parental leave and other ancillary leave payments as ordinary time earnings for SG purposes.

However, the Government will clarify that SG contributions will not apply to voluntary paid parental leave payments, and the Government will review this position when it reviews the treatment of superannuation under the paid parental leave scheme in 2013.

Increase to Medicare Levy surcharge

From July 1, 2010, a Medicare Levy surcharge of up to 1.5 per cent may apply to those who do not have qualifying private health insurance and whose income exceeds $120,000 (singles) or $240,000 (couples and families). Currently, the maximum Medicare Levy surcharge is 1 per cent.

Note that clients may inadvertently exceed the relevant surcharge threshold because of receipt of taxable superannuation benefits, receipt of taxable death benefits by non-dependants and/or receipt of taxable employment termination payments.

Sam Wall is head of FirstTech Technical Services at Colonial First State.