When super’s not so super

17 September 2019

Australia’s mandatory superannuation system is among the best in the world – and the most tax-effective long-term savings plan for most Australians. But that doesn’t mean it’s the most flexible investment for all Australians. In fact, the rules governing tax, contributions, and thresholds change over time – and rarely become more generous to contributors. 
The 2019 Federal Budget may have left superannuation largely unchanged (compared to previous years in any case), however it is likely that super rules will continue to change.  Having said that, super is still the most tax-effective way of planning for retirement for most Australians. But for those affected by the caps and limits or would like to access long term savings before they are 60 years of age there are other alternatives.
I recently attended an industry conference where the speaker challenged the industry to develop a fund that can travel through life with an investor and meet their changing needs in a tax-effective manner.
Such a structure already exists and has done so for over 50 years. Unfortunately, it needed to be repackaged in a way that meets today’s standards. This structure is commonly referred to as an investment bond and this triggers thoughts such as a limited investment menu, high fees and the one that is most common is that investors think it is a fixed interest investment.
The below benefits of investment bonds have appealed to a number of investors and advisers, particularly those investors on the highest marginal tax rate. 
  • You can accumulate wealth at a maximum tax rate of 30% rather than your marginal tax rate;
  • You can choose from a range of high-quality index and complimentary active specialist low-cost index funds and high quality active investment managers across all major asset classes;
  • You can switch between these funds at any time with no capital gains tax consequences;
  • You don’t have to worry about the tax paperwork as managers like Centuria Life pays tax on the investment earnings attributable to the fund rather than the underlying investor; 
  • After 10 years you can withdraw a monthly tax paid income stream, subject to the 125% contribution rule; and
  • You can access your funds at any time.
At Centuria Life we were challenged with how to deliver a product that can travel with an investor through life but overcomes traditional preconceptions. With feedback from investors and financial advisers we came up with three over-arching mantras which we keep coming back to in everything we do:
  1. Investment choice – provide who we believe are a ‘best of breed’ investment menu; 
  2. Transparent fee structure –unbundled pricing structure with no hidden fees and any fund manager rebates are passed back to investors; and 
  3. Ease of use and education.
The result is a modern product that can travel with an investor through life.
From a tax perspective:
  • When your employer makes a super contribution, you pay 15% tax on the contribution. If your taxable income including super is more than $250,000 per annum there is an additional 15% tax on contributions;
  • You pay 15% tax on the earnings of your super; and
  • Voluntary contributions from your after-tax money or savings are not taxed.
  • There are caps on these contributions however, after which additional tax is payable. 
Another alternative is to create a family trust or company structures in which to hold investments. 
There are no limits to the amount of money that can be held in these structures. Companies are taxed at 30%. Family trusts distribute earnings and these become taxable at the beneficiaries marginal tax rate. 
However, there are downsides to these strategies which some people may be unaware of:
  1. The first and most significant downside is that company and family trust structures are only ever tax-deferral strategies. When distributions occur earnings will be taxed at the personal marginal tax rate of the person receiving it; 
  2. In a family trust structure, all income must be distributed – and once it is distributed it will be taxed at the person’s marginal rate. If this income is distributed to a minor (under 18), then there is no real benefit – as shown in table 2; and
  3. Both company and family trust structures can be costly to set up and maintain. 
Investment bonds, are life insurance policies in structure with a life insured and a nominated beneficiary but have many attributes of a managed fund. The diagram on page 36 summarises the benefits of such a unique structure.
You can access a range of investment options across asset classes. Most providers will offer cash, fixed interest, equities, property, and infrastructure, as well as a range of diversified investment options with a range of risk profiles. The value of the investment rises and falls with the performance of the underlying investments. 
There is a myth that investment bonds need to be held for 10 years. However, if you withdraw money before 10 years you will normally only pay tax on the difference between 30% and any higher marginal tax rate applicable to you in the financial year on your earnings. In years nine and 10 this difference is discounted by one-third and two-thirds respectively. 
There is no limit to the amount you can invest and you can make additional contributions every year, to the value of 125% of the previous year’s contribution. 
If however you do hold it for 10 years, any earnings from the underlying investments as well as the principal will be distributed to you as tax paid. 
The annual earnings of the underlying investment fund pays tax at a maximum rate of 30% – less any applicable tax offsets, such as franking credits from shares and allowable deductions.
Earnings are then re-invested in the bond structure and not distributed to investors. For this reason, investors do not need to declare earnings in their personal tax returns while they remain invested. And unlike shares, term deposits, or managed funds, performance returns for investment bonds are quoted after the payment of taxes and fees by the Centuria Life. 
The investor can also nominate a life insured (usually the investor, but not required to be) and a beneficiary (can be multiple beneficiaries). The investment will mature (become payable) on the death of the life insured or on a nominated date (up to 40 years). 
The investor can nominate one or more persons (nominated beneficiaries) to whom proceeds from the investment are to be paid in the event of the death of the life insured. 
This payment does not form part of the investor’s estate and is paid directly to the beneficiary – by-passing the often complicated and time-consuming probate process. 
It gives an investor control over where his/her money goes.
In addition, there is no tax on death benefit payments. This effectively brings forward the 10-year rule in the event of death of the life insured. Inherited superannuation can be taxed, but investment bonds are not.
Investment bonds compare favourably with superannuation from a tax perspective with respect to estate planning. If superannuation is left to an adult non-dependent child by a single parent, it may incur tax as follows:
A superannuation and taxation dependant will not pay tax on the inherited sum. This includes a spouse (married or de-facto), children under 18, someone financially dependent and/or someone with whom you have an interdependency relationship.
A superannuation dependent, but not a tax dependent, will pay 15% on the taxable component of the super. This includes adult children.
If you are not a superannuation dependent, then you cannot directly inherit super and it must be paid into the estate first. 
Michael Blake is head of Centuria Life.

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Interesting, but more applicable to high income earners, it seems.

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