Superannuation may still be the best total tax deal in town, but some of the advantage has been stripped away by the reintroduction of the surcharge.
Recent legislation introduced Version 2 of the surcharge that was abolished eight years ago. The Tax and Superannuation Laws Amendment (Increased Concessional Contributions Cap and Other Measures) Act 2013 (the Act) introduces Div 293 into the Income Tax Assessment Act 1997 (ITAA 1997). Div 293 reduces the concessional tax treatment of super contributions for individuals who have a high income threshold of $300,000.
The law provides two new defined classes of taxable contributions:
- Div 293 taxable contributions that arise if your low tax contributions and adjusted income exceeds $300,000 in any year from 1 July 2012. The contributions that are counted for Division 293 tax purposes generally include: employer-contributed amounts; other family and friend contributions; assessable foreign fund amounts; assessable amounts transferred from reserves; and defined benefit contributions (funded and unfunded).
- Low tax contributions, defined as taxable super contributions and roll-overs less excess concessional contributions.
A separate new law, Superannuation (Sustaining the Superannuation Contribution Concession) Imposition Act 2013 imposes an additional 15 percent tax on the taxable contributions.
Note: The taxed element of the taxable component of a super lump sum (other than a death benefit) up to the low rate cap is excluded from the definition of income for surcharge purposes.
To understand how the law operates, you must understand the new low tax contributions. These are concessional contributions that are within your contributions cap. Any amount above $25,000 if you are younger than 60 years old or $35,000 if you are older than 60, are excess concessional contributions.
These contributions are specifically excluded from the Div 293 tax. Keep in mind that excess concessional contributions are included in the calculation of income for the purposes of determining whether there are Div 293 taxable contributions. In addition, excess concessional contributions count toward the nonconcessional contribution cap.
To Super or Not to Super
High wealth individuals have typically included superannuation contributions as a part of their tax management strategies. That easy to understand when you consider the benefits of diverting income to an investment vehicle at a tax cost of 15 percent compared with the marginal tax rates of as high as 46.5 percent (47 percent from 1 July 2014).
However, when that margin or arbitrage is reduced to 30 percent compared to 46.5 percent, you may want to consider alternative strategies for wealth creation and retirement planning.
Apart from superannuation, gearing into income producing assets can be a tax-effective wealth creation strategy. Interest on loans used to acquire income generating assets can generally be deducted from the borrower’s assessable income. However, you should not let taxes drive this strategy. Instead, adopt the tactic to expand a balance sheet capability to build wealth.
The following provides a simple illustration of a debt funded share portfolio compared with maximising super:
Debt funded share portfolio
|add: franking credits||2,143|
|less: interest expense||5,500|
|less: salary sacrifice super||8,350|
|Tax & Medicare||58,011||54,032|
|After tax income||123,632||117,618|
Scenario 1: $100,000 borrowed at 5.5 percent annually invested in a portfolio of Australian shares (assumes the taxpayer has a reasonable risk profile).
Scenario 2: Super salary sacrifice above 9.25 percent SGC
In this example, after-tax income is $6,000 a year more that under scenario 1 compared with scenario 2, the superannuation salary sacrifice. If you factor in the 15 percent contributions tax paid on the salary sacrificed contributions the (tax) difference increases to $7,266.
One of the best advantages that superannuation can offer over other investment vehicles is that once a contribution is made, it is off limits until there is a trigger event. Typically that event occurs once you reach your “preservation age” which starts at 55 if you were born before July 1960 and age 60 if you were born after June 1964. Superannuating a part of your remuneration helps to build a retirement nest egg and doesn’t permit a change of plans.
If you are employed you don’t have a choice. The superannuation guarantee charge (SGC) ensures that 9.25 percent a year from 1 July 2013 (rising to 12 percent by the 2021-22 financial year, subject to legislative changes), is a part of your remuneration package. There is however a cap on the maximum SGC. For the 2013-14 income year, the maximum salary level is $192,160 a year and the SGC tops out at $17,775. An employee can elect whether to salary sacrifice the reminder of the concessional contribution cap of $25,000 (or $35,000 from 2013-14 for those 60 or over).
As an employee your choice is limited to the gap between your SGC and the concessional contribution cap.
If you have an adjusted income of $318,000 or more, the surcharge will mean that an additional $2,666 is paid in annual tax on the compulsory SGC. In other words, 15 percent of the $17,775. The surcharge is charged to you, although you have the options of having the tax withdrawn from super.
Self-employed individuals do have a choice and may use other investment vehicles in an attempt to manage tax. If, for example, the company tax rate for smaller companies reduces to 28.5 percent, companies will represent a better (entry) tax deal than super if you would otherwise have Div 293 taxable contributions.
If the company has a discretionary trust as the shareholder, there may be scope to distribute income to tax advantaged entities (such as non-working adult children) and access a partial or full franking credit refund.
Although the new surcharge has stripped some of the tax advantages of superannuation, it has at the very least sealed the end to the Simpler Super regime just six years in and muddied the water for pre-retirees looking to build up their super in the run down to retirement.
Consult with your adviser for more details and help with your investment decisions.