SMSF. Okay, so you already have a Self-Managed Super TAX-EFFECTIVE STRATEGIES YOU PROBABLY DON T KNOW (BUT SHOULD!)

Transcription

1 6 TAX-EFFECTIVE SMSF STRATEGIES YOU PROBABLY DON T KNOW (BUT SHOULD!) Okay, so you already have a Self-Managed Super Fund (SMSF), or you ve decided to set one up. It could be because: Of the flexibility an SMSF offers when it comes to managing your family s retirement, You believe establishing an SMSF will be more cost-effective, or It could simply come down to the fact that you want a larger (absolute) say over how your money is invested. Whatever the reasons, you re not alone. According to the Australian Taxation Office (ATO), up to the end of September 2016, there were 581,736 SMSFs in existence, a 23% increase since June Given the increasing number of individuals managing their own superannuation, we believe it s more important than ever to understand how to obtain the maximum benefit from the SMSF structure, and particularly, what you need to do to ensure you re operating your superannuation in the most tax-effective way possible. (Please note, the content herein is intended to be educational, and is not individual tax advice.) Before we delve into these strategies, you need to be cognisant of the tax differences between your SMSF and you. You re wearing two hats When operating an SMSF, you are effectively two people or entities: you re a trustee on one hand, and you re a member beneficiary on the other. That is, the roles are separate and distinct. If you wish to be a trustee of an SMSF, you re making the investment decisions for the fund on behalf of the member/s, and you re responsible for ensuring you re operating the fund within the confines of superannuation and tax laws. So when it comes to discussing tax strategies, we ll emphasise when necessary whether we re talking about tax within the SMSF, or tax as it applies to the member. A couple of caveats before we proceed The discussion below is in the context of recent changes to superannuation where you and your spouse are limited to a total superannuation balance of $1.6 million and a transfer balance cap also of $1.6 million. The ability of members to contribute to super will be limited to those members who haven t yet exceeded their contributions caps and have a total superannuation balance of less than $1.6m. Members who decide to start a pension will also be limited to $1.6 million, and for any members with amounts greater than $1.6 million today there will be a need to reduce the value of their pension to below the cap (however this doesn t mean money needs to be removed from super, it just means excess money may be moved back into the accumulation phase). With that out of the way, here are what we think are the most essential strategies you can follow to maximise tax-effective income from your SMSF. Bottom Line: Super remains a wonderful concessionally-taxed savings vehicle to help fund your retirement. Even if you have a first-class problem of having more than $1.6 million in Super, you re Fool.au 6 tax-effective SMSF strategies 1

2 still sitting pretty but the rest of this report is focussed on Super funds that are in the (very) tax-advantaged pension phase. 1 Maximising the tax-free component of your balance for estate planning purposes What many trustees may not realise is that member superannuation balances, even if they ve been converted to an account-based pension after retirement, have two tax components: Tax-free, and Taxable If a member meets a condition of release (such as retirement), but is also eligible to make contributions to superannuation, the so-called re-contribution strategy could be a useful tool to minimise tax on death benefit payments made to non-dependents (adult kids who have left home, for example). This strategy helps reduce the taxable component and increase the tax-free component of a member s balance, but the benefits of this strategy are being seriously reduced due to the impending changes to the contributions caps on 1 July The current rules surrounding after-tax (non-concessional) contributions up to 30 June 2017 allow individual members to contribute $180,000 per financial year or $540,000 in a bring-forward arrangement over three years for members under the age of 65. From 1 July 2017, however, these contributions caps are being reduced to $100,000 per financial year (or $300,000 over three financial years). The tax-free component will consist of any after-tax payments (and government co-contributions received if applicable) made throughout your working life. The taxable component on the other hand will consist of employer contributions, contributions where a deduction has been claimed, and/or investment earnings. This is significant from an estate-planning pointof-view as any taxable components in a death benefit paid to a non-dependent will be effectively taxed at the beneficiary s marginal rate or 17% (whichever is lower). Here s an example: A retired member, aged 61, with a $1m balance has a tax-free component of $400,000 (40%) and a taxable component of $600,000 (60%). If the member withdraws $540,000, the tax components of the $460,000 left in the member s account will remain in the same 40/60 ratio as above, that being $184,000 as tax-free (40%) and $276,000 taxable (60%). When the member recontributes this money back to super as a tax-free (non-concessional) contribution, the member s balance will again be $1m (assuming no growth in earnings to keep the example simple) and the tax components will appear as follows: Tax-free - $724,000 ($184,000 + $540,000), and Taxable - $276,000 The taxable component, as a proportion of the whole, has been reduced from 60% of the member s balance to 27.6%. 2 6 tax-effective SMSF strategies Fool.au

3 In short, re-contributing money to superannuation on an after-tax basis will mean a more tax-efficient payout to your non-dependents at the time of death but to maximise the benefits of this strategy you should think about doing before 1 July 2017 if you re in a financial position to do so. It s never fun to think about these matters, but it s vital if you wish to ensure the most tax-effective outcome for you and your family after your passing. 2 Salary sacrifice up to your cap Mitigating the above strategy somewhat are the immediate tax benefits of salary sacrificing money into your SMSF. Salary sacrifice is an arrangement between an employer and an employee where the employee has agreed to forgo part of their future entitlement to salary or wages in return for the employer adding the same amount sacrificed being contributed to superannuation. Yes, salary sacrifice amounts are included as assessable (concessional) income of your SMSF, and hence will add to the taxable component of your member benefit, but the immediate benefits are obvious: You, the trustee, have more money working for the members in a concessionally-taxed environment (capped at 15%), and If you re an employee earning more than $18,200 per annum, you ll save on tax. Instead of paying a marginal rate of tax 19%, 32.5%, 37% or 45% (plus 2% Medicare levy), your fund will pay no more than 15% From 1 July 2017, the concessional contributions cap will be $25,000 for everyone (regardless of age) so whilst you ll be adding to your taxable component, it won t be to same degree if you re also able to contribute greater post-tax non-concessional contributions in the same financial year. 3 Claim a deduction from 1 July 2017 (up to your cap) Who would have ever thought the miserable 10% rule would have ever been abolished? Well, it has. Currently, at least until 30 June 2017, only individuals who are substantially self-employed, or not working at all can claim a deduction against their assessable income for contributions made to superannuation. Employees are only able to claim a deduction where they ve earnt less than 10% of the total of their assessable income (assessable income also includes any reportable fringe benefits and reportable employer superannuation contributions). For example, if you earn $100,000 per year from running your own business but also worked in part-time employment with an employer during the year earning $8,000, you d be eligible to claim a deduction (as long as you follow the eligibility criteria as explained here). From 1 July 2017 though, this 10% rule is abolished and anyone who properly notifies the trustee of their fund will be able to claim a deduction to reduce their personal assessable income and hence save on tax as an individual. Fool.au 6 tax-effective SMSF strategies 3

4 4 Spouse contributions From 1 July 2017, the income threshold for a non-working or low-income-earning spouse will increase from $13,800 to $40,000. The offset will gradually reduce after incomes go above $37,000 and are completely phased out at $40,000, but the changes for spouse contributions mean more people will be eligible. The tax offset amount is 18% ($540) capped at contributions of up to $3,000 but your spouse will only be eligible if he or she hasn t yet exceeded their non-concessional contributions cap and has a total superannuation balance of less than $1.6 million in the financial year. Although a small benefit, it s in addition to any pre-tax and post-tax contributions already paid to superannuation and can be a handy way of increasing the proportion of tax-free money within your member s account, not to mention the handy $540 tax offset enjoyed by the contributing spouse. 5 Tax-effective income for the SMSF Franking credits, also known as imputation credits, are a tax credit that is passed on to shareholders after an Australian company has already paid tax at the company level. If your SMSF owns the shares, the dividends and eventual franking credits (30%) will flow through to offset the assessable income of the SMSF (in the accumulation phase where earnings are taxed at 15%) after lodgement of its annual return. This results in a slightly higher benefit for the member (the beneficiary of the fund). Even better is the situation where your fund is in pension phase and owns shares in fully-franked dividend paying companies. Not only is the SMSF s income tax-free in pension phase, all the franking credits the SMSF is entitled to are refunded by the ATO after the SMSF s lodgement of its tax return. 6 Tax-effective income for you, the member a. Ages If you, as a member, are aged between 56 but not older than 60, any income stream you receive in the form of an account-based pension means you may be entitled to a tax offset equal to 15% of the taxable component of your member account. As mentioned above when discussing death benefits, no tax is payable on the tax-free component of the member s balance. When drawing an account-based pension, the member will need to include the taxable component of the income payment in his or her income tax return and is taxed at the member s marginal rate. However, the 15% tax offset will reduce, and in some cases eliminate, any tax paid by the member (depending on what other sources of income the member has received in the relevant financial year). b. Ages 60 and over Income received by a member who is 60 or older will receive their income from the fund tax-free. Not only that, because the income received is not considered assessable income, it doesn t have to be included on the member s individual tax return. 4 6 tax-effective SMSF strategies Fool.au

5 Foolish takeaway Here at The Motley Fool, we re naturally big fans of investing in companies that pay partly- or fully-franked dividends. Conducting such an investment strategy within the confines of an SMSF can therefore be a powerful combination for your eventual retirement (and beyond). What you ll need to do though is be aware of the important tax changes that are happening from 1 July this year, and take advice from your tax agent or advisor before acting on any of the strategies mentioned in this report. We d like to emphasise too that running an SMSF puts you on the pedestal of trustee, with all of the trustee obligations this entails to keep the ATO happy that you re following the rules to the letter. With an engaged approach to running your fund, reading widely on the changes happening to super, and working closely with your advisor or tax agent (who have considered the needs of your SMSF and yourself), we strongly believe that any or all of the strategies above would add meaningfully in the years ahead to tax-efficient income for both you and your SMSF. But remember, some of these doors close on June 30, this year. So re-read this report, call your accountant, tax agent or financial advisor (or all three) and make an appointment as soon as possible. Then take this report along with you, and see what they can do to make your retirement structures as tax-effective as possible, while we work on delivering you an Everlasting Income. Disclosures: Any and all advice contained in the above content is general advice that has not taken into account your personal circumstances and objectives. Before acting on our advice, please consider the appropriateness of that advice in light of your individual and personal circumstances, and if necessary consult with your accountant or tax professional. You should review the product disclosure statement (PDS), prospective or other disclosure documents for any financial product discussed in this report before acquiring that product. Please refer to our Financial Services Guide posted on our web site for more information. All figures are accurate as of March 16, The Motley Fool Australia Pty Ltd. All rights reserved. Fool.au 6 tax-effective SMSF strategies 5