Understanding the changes to the superannuation contributions cap

Bryan Ashenden explains the significance of last year's changes to superannuation's concessional contributions cap.

In the 2009 Federal Budget, the Government announced that the concessional contribution caps would be halved. It also indicated that the non-concessional contributions cap would remain unchanged.

Effective from the July 1, 2009, the concessional cap was halved from $50,000 to $25,000 per financial year. The transitional cap has also halved from $100,000 to $50,000 for those over 50 at any time during a transitional financial year. The transitional period finishes on June 30, 2012.

Analysis of the changes

Some of the relevant considerations when managing the concessional contributions cap include:

1. salary sacrifice arrangements;
2. superannuation guarantee contributions;
3. transition to retirement strategies; and
4. funding insurance through superannuation.

Salary sacrifice arrangements

Clients who had salary sacrifice arrangements in place should revise their arrangements to ensure they do not exceed the concessional contributions limits. Particularly at risk are those who are salary sacrificing and under 50.

Table 1 shows the maximum amounts a person who is under 50 can salary sacrifice without breaching the concessional contributions cap.

The proposed transitional concessional contributions cap allows greater flexibility for those individuals who are over 50 during the transitional period until June 30, 2012.

The maximum salary sacrifice percentage for those people who are over 50 at any time during the financial year and are able to use the transitional cap is as shown in Table 2.

The halving of the caps has had an immediate impact on people who have been (or had planned to) contribute at levels above the new cap limits.

For example, if a client had been planning to salary sacrifice up to $50,000 to super this year (including super guarantee contributions) and they are under the age of 50, they will need to reconsider these plans or they will be up for an additional $7,875 tax on the now excess contribution of $25,000.

But does the halving of the contribution caps mean super is only half as effective as it used to be? Many think so, particularly if they had planned to contribute more to make up for some of the lost savings from recent market performance.

But this is not necessarily true. It’s important to think about what clients were planning to do, the impact of the new laws, and what can be done to make a difference.

Superannuation guarantee arrangements

In most circumstances, individuals who are only relying on the superannuation guarantee arrangements will not breach the concessional contributions cap.

This is due to the maximum contributions base, which limits the extent of superannuation guarantee to a base of $40,170 per quarter or $160,680 per year. The maximum superannuation guarantee payable on behalf of these employees is $14,461.

Superannuation guarantee arrangements would only cause a breach of the concessional contributions cap for a person who is under age 50 in the 2009-10 financial year where:

• The individual has ordinary times earnings of at least $277,777 and the employer does not cap the contribution amount at the maximum contributions base; or
• The employee is employed by more than one employer and each employer’s contribution is within the maximum contributions base.

Transition to retirement strategies

The reduction in the concessional contributions cap could have a significant effect on individuals who have or are seeking to adopt a transition to retirement (TTR) strategy.

The new contribution caps will compress the amount that can be salary sacrificed to superannuation. Individuals adopting a TTR strategy will be limited to salary sacrificing $50,000, and this will be reduced further when the transitional limits finish on June 30, 2012.

Case study 1

For example, Gus turned 60 on July 1, 2008, and is earning $100,000 per year. He adopted a TTR strategy from his 60th birthday by salary sacrificing $70,000 to superannuation and taking an after-tax equivalent from a TTR income stream.

Gus will need to revise his salary sacrifice arrangements, as shown in Table 3.

The ability for Gus to access concessionally taxed income and elicit a tax saving from the TTR strategy has reduced since the contribution cap reduced from July 1, 2009.

There is a further reduction in the tax saving once the transitional rules are no longer available from July 1, 2012 and his concessional cap reduces to $25,000 (indexed).

However, this does not detract from the long-term benefits that a TTR strategy can provide to clients.

Funding insurance through superannuation

With the reduction in the contribution caps, the net amount being put into the superannuation system that will be allocated towards the provision of retirement benefits becomes more important.

In particular, where clients have excess capacity to fund contributions, consideration should be given to the effect on the net amount allocated to the client’s account.

There are a number of options available, including:

• Making non-concessional contributions (NCC) with the surplus amount;
• Transferring insurance outside of superannuation; and
• Fund contributions in excess of the concessional contribution cap.

Case study 2 — 46.5 per cent marginal tax rate

Samuel is under the age of 50 and has been contributing $30,000 to superannuation each year. He has structured his life and total and permanent disability (TPD) insurance through his superannuation fund, the premiums for which are $5,000 per annum.

He is on a marginal tax rate (MTR) of 46.5 per cent (including the Medicare levy) for the 2009-10 financial year.

Making a non-concessional contribution with surplus

Under the revised contribution limits, Samuel would need to reduce his concessional contributions to $25,000 — leaving him with surplus cash of $5,000.

He would pay tax of $2,325 on this amount, leaving him with $2,675 that he could contribute as a non-concessional contribution.

Without the non-concessional contribution, he would only have $17,000 ($25,000 less $5,000 premium, less $3,000 tax on contribution) allocated towards his retirement benefit.

Making non-concessional contributions with the surplus income produces a superior result to transferring the insurance outside of superannuation.

It also produces an equivalent result to making contributions in excess of the cap at the top marginal tax rate.

At lower marginal tax rates it produces a superior result to both scenarios (see Table 5 for a comparison) and as a result it tends to be the preferred solution in most cases.

Transfer insurance outside of superannuation

A second option would be to transfer the life and TPD insurance outside of superannuation. However, in most cases this would produce a substandard result.

In Samuel’s case, he would need to allocate $9,346 (being $9,346 — ($9,345 x 46.5 per cent) = $5,000) to fund the premium. This would leave only $20,654 to be contributed to superannuation. After contributions tax is deducted, the net benefit allocated to his account would only be $17,556.

Income protection insurance on the other hand produces a much better result by being funded outside of superannuation, largely due to the ability to claim it as a deduction in one’s personal name.

As a result, only $5,000 would be required from pre-tax income and the full $25,000 would be contributed to superannuation, leaving $21,250 after tax.

Funding contributions in excess of the concessional contributions cap

A seemingly extreme measure would be to look at continuing to salary sacrifice in excess of the contribution caps as contributions made in excess of the caps are taxed at the maximum rate of 46.5 per cent.

The deductibility of insurance within the superannuation system would work to Samuel’s advantage when making a comparison to funding the insurance outside of super where no deduction would be available.

In fact, contributing in excess of the cap to fund an insurance premium works out equally as efficient as making non-concessional contribution provided the person is on the top marginal rate.

However, looking at a lower marginal tax rate you can see from the revised numbers, that making a non-concessional contribution is more efficient once the marginal tax rate drops below the 46.5 per cent marginal tax rate.

As shown, funding contributions in excess of the contributions caps is only comparable at best for those individuals on the top marginal tax rate, and as a result it should generally be discouraged.

Funding in excess of the concessional caps also raises other issues that need to be reviewed and discussed with clients in light of their personal circumstances:

• An excess concessional contribution will give rise to an excess contributions tax liability equal to 31.5 per cent of the excess. This liability goes to the client directly, although they can have the liability paid out of their super monies.
• Any excess concessional contribution will count towards the client’s non-concessional cap. Depending on the level of non-concessional contributions, this could cause the bring-forward provisions (three year averaging rules) to be invoked or could give rise to an excess non-concessional contributions tax of 46.5 per cent.
• The excess contributions will form part of the taxable component in the fund and may affect the tax consequences of future death benefit payments or withdrawals by the client before age 60.
• If the option to move existing insurance arrangements from inside super to outside super (or vice versa) were adopted, it would also be important to ensure that this is done in consultation with the insurer to ensure the client did not have a lack of cover at any time.

Conclusion

The changes to the concessional contribution caps (and flow-on effects to non-concessional contributions) have resulted in a number of opportunities for you to speak with your clients, not only about the effects the changes have, but also to further demonstrate the value of the advice that you provide them on an ongoing basis.

Bryan Ashenden is senior manager, technical and advocacy at BT Financial Group.