Tuesday 26 September 2017
The long term impact of Super Reform 2017
The introduction of the $1.6 million transfer balance cap has significantly disrupted many financial services professionals’ workflow arrangements this calendar year. And there’s more to come for many advisers, with transitional capital gains tax (CGT) elections for self managed superannuation funds required by the fund’s 2016/17 tax return lodgement date, as well as the tidying up of some clients’ transfer balance account excesses once the larger super funds have reported 30 June 2017 balances to the Australian Taxation Office.
It is arguable, however, that the super reform contribution cap changes will have a greater long-term impact on the advice provided to clients than the transfer balance cap measures.
Lower super contribution caps
A long-term trend towards lower contribution caps is apparent – see Charts 1 and 2 below.
The maximum amount of pre-tax contributions has decreased from a peak of $105,113 in 2006/07 for those over age 50 to the current concessional contribution cap of $25,000 across all age groups. Pre-tax super contributions were referred to as maximum deductible contributions prior to 1 July 2007 and are now referred to as concessional contributions (CCs).
*Age determined at the date of last contribution in the income year prior to 1 July 2007. From 1 July 2007 to 30 June 2012 the higher threshold applied if age 50 or over on 30 June in the relevant income year. In 2013/14 the higher threshold applied only if age 59 or over on 30 June 2013. From 1 July 2014, the higher threshold applied if age 49 or over on 30 June of the preceding income year.
There was no restriction on the level of after-tax contributions prior to 10 May 2006. The after-tax contribution limit today is generally $100,000 per annum, or $300,000 over a three year period. After-tax contributions were referred to as undeducted contributions prior to 1 July 2007 and are now referred to as non-concessional contributions (NCCs).
Furthermore, the Australian Labor Party has proposed reducing the annual NCC cap to $75,000, so a change of Government could result in a further reduction.
Given the apparent trend towards lower contribution caps, if clients wish to maximise the opportunity to build a significant account balance by retirement, they may need to contribute to super sooner and over a longer period than was required in the past.
Determining a client’s NCC capacity
A more significant change for certain clients is the complete removal from 1 July 2017 of any NCC capacity when their total superannuation balance (TSB) reaches $1.6 million. And those with a TSB of $1.4 million or more will have a reduced NCC capacity.
A client’s TSB is determined annually based on the value of their superannuation interests on the previous 30 June. It is the sum of:
- the value of all accumulation phase superannuation interests (including non-retirement phase transition to retirement income streams)
- the transfer balance account balance, modified to reflect the 30 June value of any account-based interests in retirement phase income streams
- any rolled over superannuation benefits not reflected in accumulation phase values or the transfer balance account
- less the sum of any structured settlement contributions.
In addition, when determining a client’s NCC capacity, the transitional NCC rules which apply in 2017/18 (and 2018/19) and the age-based NCC restrictions must be considered. So there’s a high degree of complexity in determining the NCC capacity of a client, and as a result, a relatively higher chance of inadvertently exceeding the NCC cap than was the case prior to 1 July 2017.
The following flow chart summarises the process for determining a client’s NCC cap in 2017/18.
2017/18 Non-concessional contribution (NCC) cap
Paul turned 64 on 18 June 2017. He hasn’t triggered the NCC bring-forward rule in 2015/16 or 2016/17.
Paul has an accumulation phase super account which was valued at $950,000 on 30 June 2017. He also has a defined benefit pension which caused a credit to his transfer balance account of $480,000 on 1 July 2017. So Paul’s TSB on 30 June 2017 was $1.43 million.
2017/18 income year
Paul hasn’t triggered the bring-forward rule in the last two income years, is age 64 or younger on 1 July 2017, and has a TSB of $1.43 million, so his NCC cap in 2017/18 is $200,000.
He may make a NCC prior to his 65th birthday on 18 June 2018, but otherwise Paul must meet the work test (40 hours in 30 consecutive days) prior to making the contribution.
2018/19 income year
Paul’s NCC cap in 2018/19 will be $100,000 if his TSB on 30 June 2018 is less than $1.6 million. Otherwise his NCC cap will be nil. Paul will need to meet the work test in 2018/19 before making any NCCs.
It’s possible that the 2017/18 income year may be Paul’s last opportunity to make any NCCs.
The impact of reduced super contribution caps
Although it will be important for clients to start making super contributions earlier and over a longer period, there will be circumstances where that opportunity hasn’t arisen.
Some clients seek financial advice for the first time when receipt of a large windfall is imminent. A sum of money may be forthcoming from, for example, an inheritance, a property sale, sale of a business or a compensation payment.
Taking full advantage of superannuation’s 15 per cent taxation environment is generally the first priority for most advisers.
If the small business concession contribution (SBCC) rules can be met, a lifetime contribution limit of $1.445 million may apply, allowing a relatively large amount of funds to be transferred into superannuation. There is speculation that the SBCC cap may be reduced also, given that it wasn’t reduced in the 2017 super reform program, and there is now a large divergence between the NCC cap and SBCC cap. However, there has been no indication of an intention to reduce the SBCC cap by the government.
Ignoring the transitional NCC rules, the maximum amount of NCCs from 1 July 2017 is generally $300,000, or potentially less depending on previous NCCs, TSB and age. So the capacity to invest a windfall into superannuation may be limited.
In a couple situation, both spouses could utilise their NCC capacity, so up to $600,000 could be contributed to superannuation. In addition, concessional contributions of up to $25,000 each may be made.
But when a client’s or couple’s capacity to contribute to superannuation is exhausted, where to next?
The corporate tax rate
With personal income tax rates as high as 47 per cent (including Medicare levy), structures utilising the corporate tax rate at 30 per cent look attractive. Even more so if the corporate tax rate for all corporate entities is progressively reduced (as proposed in a bill currently before Parliament) to 25 per cent by 1 July 2026. For larger entities with aggregate turnover of more than $1 billion, the reduction from 30 per cent will begin to occur from 1 July 2023, if the proposed legislation becomes law.
Note that on 18 September 2017 the Government released an exposure draft of legislation that will exclude corporate entities from qualifying for the lower small business tax rate (27.5 per cent) if 80 per cent or more of the entity’s assessable income is passive income such as rent, dividends, interest and capital gains. These entities will not be able to access the lower tax rate before the 2023/24 income year.
It’s likely that advisers’ focus will move to investment structures such as discretionary/family trusts with corporate beneficiaries and investment bonds. The latter are offered by some life offices and friendly societies, and earnings are taxed within the product at the corporate tax rate.
There’s an interesting parallel between the pros and cons of SMSFs versus platform-style larger super funds and the use of family trusts with corporate beneficiaries versus investment bonds. We’ll explore the use of family trusts and investment bond tax aspects and strategies in a future edition.
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