With the Government set to change the superannuation contribution caps rules from 1 July, 2012, Troy Smith outlines the strategies available to financial advisers.
Treasury recently released an options paper on the proposal to retain a higher concessional contribution cap of $50,000 for those 50 and above with less than $500,000 in superannuation.
The financial planning community has welcomed the proposal in the belief it will help people to save for retirement.
As usual, the proposal has resulted in a flurry of questions. Will the cap be indexed? Are pension payments or withdrawals included? When are assets valued?
At this stage, the proposals are not law and any legislation is planned to commence from 1 July, 2012.
Eligibility for drawdowns
There are three different options to determine eligibility to access the higher concessional cap, including whether drawdowns are included in the cap:
- Include withdrawal amounts in the account balance: Those who have commenced drawing down from their superannuation could retain the higher contribution cap, subject to meeting the ordinary criteria. All pension payments and withdrawals would be recorded as drawdowns, and included in the calculation of the total superannuation balance. Under this option, a record of all drawdowns would need to be maintained and indexed to average weekly ordinary time earnings;
- Extend eligibility to those who have commenced withdrawals, but exclude withdrawn amounts from the account balance: To reduce the complexity with maintaining annual records, this option would allow individuals with account balances of $500,000 or more to withdraw amounts prior to assessment and retain eligibility for the higher cap; and
- Exclude eligibility for those who have commenced withdrawals: Anyone who has commenced drawing down from their superannuation, such as lump sum withdrawals, commencing a pension (including transitions-to-retirement) would be excluded from accessing the higher concessional cap.
Account balance assessment
There are two options to determine the date to calculate an account balance:
- 30 June in the financial year preceding the year in which the contributions are made: Many superannuation funds do not provide final account balance information until mid-way through the financial year. This gives the individual little time to make financial decisions, and may result in contribution cap breaches; and
- 30 June two years prior to the financial year in which the contributions are made: This option provides greater certainty for fund members as they would know whether they are eligible for the higher caps before the start of the financial year and can plan accordingly.
Calculating the balance
Two options have been put forward to calculate an account balance:
- Withdrawal benefit: Under this model (the current and most simple), an individual’s superannuation account balance is the total amount of benefits payable should a person voluntarily cease to be a member of the fund. Defined benefit interests would be calculated using the family law methodology as outlined below; and
- Family Law methodology: Account balances would be based on an actuarial assessment of an individual’s accrued benefit at a particular point in time. This is consistent with current valuations used in family law situations.
Eligibility for the higher cap
There are two options to assess whether or not a person meets the superannuation account balance criteria:
- Self-assessment: A self-assessment model, which is consistent with the existing system, whereby the onus is placed on the individuals to assess whether they meet the relevant criteria; and
- ATO assessment: Under this model the Australian Taxation Office would provide an online facility that records individual account balance information (including drawdowns, if they are included in the balance).
Tips and traps
With the potential re-jig of the law surrounding contribution caps, new advice opportunities arise which require advisers to re-think their strategy. On the flipside, a few new pitfalls have been created.
Tip: Spouse splitting superannuation
Splitting superannuation contributions between spouse has been available for years.
However, since the abolition of reasonable benefits limits and the introduction of tax-free pensions, spouse splitting fell out of favour. Perhaps it’s time to re-consider?
Spouse splitting permits a superannuation fund member to split up to 85 per cent of their concessional contributions to their spouse, provided the receiving spouse doesn’t satisfy a condition of release.
Utilising this as a planning strategy may permit clients to keep their superannuation under the $500,000 cap by splitting their concessional contributions to their spouse.
Tip: Insurance in superannuation
Life, total and permanent disability, income protection or trauma insurance can be held inside superannuation. Advisers weighing up recommending insurance in superannuation consider the implications from a taxation perspective, a cash flow perspective and whether a condition of release could be satisfied.
Subject to the proposal being legislated, advisers should consider that insurance premiums paid from superannuation will reduce the superannuation account balance. This may prove to be an effective long-term strategy to keep clients under the $500,000 cap.
Tip: Delaying large contributions
Delaying large contributions until after retirement, when clients won’t require the higher concessional contribution cap, can be another strategy to consider.
The difficulty will be managing this strategy in light of an individual’s eligibility to contribute to superannuation, if they are above 65 and no longer working.
Also, advisers need to take into account the tax and estate planning implications if amounts are invested outside of superannuation.
Trap: Recontribution strategy
A withdrawal and recontribution strategy has the potential to be counted twice, depending on the final decision. In the event that withdrawals are counted, making a withdrawal and recontributing the amount back to superannuation would result in both the withdrawal and the amount contributed being counted against the cap.
Trap: Death benefit pension
Death benefit pensions are available to certain dependants of the deceased. In the most extreme example, consider the example of a 16-year-old child who receives a death benefit pension from a deceased parent.
Under one option of the proposal, pension payments, and withdrawals are recorded and indexed.
Fast forward to when the beneficiary is 50 years of age.
Indexation of pension payments and withdrawals may be sufficiently large enough to preclude the person from being eligible for a higher concessional contribution amount.
Subject to the proposals, advisers may need to consider if receiving a death benefit pension will exclude an individual from accessing the higher cap once age 50 has been reached.
Special rules for SMSFs
The proposal requires self-managed superannuation funds (SMSFs) to include their share of unallocated fund reserves and report assets at net market value.
However, obtaining net market values may be complicated for certain assets.
Case study: James and Melissa are trustees for the Jamel SMSF. The SMSF owns all units in a unit trust. The assets of the unit trust include a bank account with a negligible balance and a commercial property acquired by the unit trust for $1,000,000.
Investment into the unit trust doesn’t fall foul of the in-house asset test as it meets the strict criteria of a related non-geared trust.
Based upon the proposals, trustees are required to obtain updated unit prices.
However there is no obligation for the unit trust to revalue the underlying assets, hence the unit trust can continue to report unit prices based upon the acquisition price of the commercial property.
The result is that the value of the units is reported at levels based upon the acquisition price, rather than a higher (or lower) price based upon a current market value.
This may enable James and Melissa to stay under the $500,000 cap for longer, as the value of investments held by their superannuation fund continue to be reported at a lower level.
Summary
The draft consultation paper has given us an insight into how the cap may operate. Once the proposals have been legislated, advisers will have a clearer picture of which strategies will work, which ones won’t, and which strategies need to be amended.
Troy Smith is a technical specialist at OnePath.
