MLC’s Gemma Dale outlines the issues financial advisers need to consider before and after 30 June to help clients maximise opportunities and avoid costly mistakes.
For many people, the end of the financial year has traditionally been a reactive time when they realise they face a tax bill and consider what they can do in the remaining time to reduce their liability.
One of the keys to long-term financial planning is to proactively implement strategies that build and protect wealth throughout the entire year, so there is no need for the mad 30 June tax scramble.
A good example is salary sacrifice. Employees can only sacrifice remuneration into super for which they don’t have a pre-existing entitlement. The practical offshoot of this is they can’t put salary directly into superannuation on a pre-tax basis once they have earned it.
So implementing a salary sacrifice strategy at the start of May means they only get to utilise two-twelfth’s of their opportunity in that financial year.
Also, there is often little point waiting until June to see how an employee’s concessional contributions are tracking against the concessional contributions cap.
But this financial year is a little different to the last couple. Some significant changes are about to take place that warrant specific attention.
Collectively, these changes make this 30 June potentially the most financially significant since the Simpler Super changes were introduced in 2007.
The means-testing of the concessional contributions cap for those aged 50 and over, the ending of the transitional eligible termination payments (ETP) rules and the flood levy, and the changes to the co-contribution and private health insurance rules make this 30 June more of a transition point than a line in the sand.
Concessional contributions cap will become means-tested
While we are still waiting on legislation, the Government appears committed to reducing the concessional contributions cap effective 1 July from $50,000 per annum to $25,000 per annum for people aged 50 or over with more than $500,000 in superannuation.
Those people who are impacted by the cap reduction should consider taking full advantage of the current limit of $50,000 if their cashflow allows. But even those with less than $500,000 in superannuation should probably try to ‘max their cap’ as well.
Clients aged 50 or over are likely to be no more than 10 to 15 years away from retiring (often less) and they can’t use this year’s cap next year. So with the retirement clock ticking quickly, under-utilising this year’s cap means they will have less money to generate a tax-free income at 60 and over.
Come 1 July, clients impacted by the cap reduction will also need to review their concessional contributions and adjust them accordingly. Where surplus investible funds become available, it may be worthwhile making additional non-concessional contributions.
TTR strategies could need an overhaul
Clients using the ‘transition to retirement’ (TTR) strategy will need to review their concessional contributions post 1 July to ensure they don’t exceed the cap.
Those TTR clients who want to ‘match cashflows’ may also need to reduce their TTR income payments. If they don’t, they could receive surplus income which would be taxable under age 60.
Some TTR clients may even want to commute and repurchase a pension with a lower account balance.
This is because even if they dial back their TTR income payments to the 3 per cent minimum in 2012/13, the income they receive could still be surplus to their needs, given the extent of the proposed concessional contributions cap reduction.
Cap breaches are still common
While the reduction in the concessional contributions cap is likely to catch out some unwary investors in 2012/13, it’s important to be aware of the many other reasons why people have exceeded their caps. These include, but are not limited to:
- Not accounting for contributions already made into all superannuation funds in a financial year;
- Forgetting that superannuation guarantee contributions are included in the concessional contributions cap;
- Failing to aggregate contributions from all employers, where there is more than one;
- Not taking into account that deductible superannuation insurance premiums or administration costs being paid by an employer count towards the concessional contributions cap;
- Rolling over benefits to another fund or commencing a pension before lodging a notice of intent to claim a deduction;
- Not realising that excess concessional contributions count towards the non-concessional contributions cap;
- Not being aware that the three-year non-concessional contributions bring-forward rule has been triggered in a prior year;
- Not understanding that amounts put back into superannuation when using the ‘re-contribution’ strategy count towards the non- concessional contributions cap.
Transitional ETP rules are ending
This financial year will be the last opportunity that ‘transitional’ ETPs can be paid directly into super where substantial tax savings could be made.
Alternatively, less tax could be payable on transitional ETPs of $165,000 or more if taken as a lump sum in 2011/12, as higher ETP tax rates will apply from 1 July 2012.
Financial advisers should make sure clients who are eligible for the transitional rules are aware of the potential tax savings available if they receive an ETP before 30 June this year in the event they are contemplating resigning or retiring, or are faced with a redundancy.
To be eligible for the transitional rules, the payment amount or a formula for determining the payment must have been specified in the client’s employment contract or workplace agreement on 9 May 2006.
It’s also essential that the employment contract or workplace agreement in force at 9 May 2006 remains unchanged at the time employment is terminated. If not, the transitional rules will not apply, as the Australian Taxation Office points out in ID 2007/163.
But this doesn’t necessarily mean we will see a mass employee exodus before this 30 June. Not a lot of people have been with their employers since May 2006 when the employer had the right arrangements in place at that time, and no changes have been made since then.
For those people not eligible for the transitional rules, the ‘defer the payment until the new financial year’ rule of thumb generally still holds. This is because:
- Less tax may be paid on amounts that are taxable at marginal rates (such as accrued annual or long service leave) if income from other sources is lower next financial year;
- New taxable income thresholds and marginal tax rates that particularly benefit lower income earners will come into effect on 1 July 2012;
- The ETP cap that applies to the taxable component when taken as a lump sum increases from $165,000 to $175,000; and
- The flood levy currently payable by people with incomes over $50,000 p.a. will no longer apply.
Getting the payment timing right can make a big difference to a client’s financial wellbeing.
Co-contribution changes
Currently, clients who earn less than $61,920 p.a. and make a personal superannuation contribution could receive a government co-contribution of up to $1,000.
From 1 July 2012, the maximum co-contribution will reduce from $1,000 to $500 and the income threshold at which a co-contribution is not available will reduce from $61,920 to $46,920.
Also, people earning up to $37,000 p.a. will qualify for a low income superannuation contribution of $500, regardless of whether or not they make a personal super contribution.
Table 1 shows the impact of these rule changes for people with a range of lower incomes.
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There are also other issues to consider when deciding whether to retain or cancel private health insurance. These include the client’s current and potential health, likely claim needs, and healthcare preferences.
Furthermore, it may be possible to reduce the hip pocket impact of the rebate reductions by taking out a higher policy excess.
The bottom line
The end of this financial year is fast approaching. So make sure you don’t leave it to the last minute to contact clients who could benefit from proactive and tax-effective advice before and after this 30 June.
Gemma Dale is head of technical services at MLC.
