Although the recently announced budget is currently just a proposal, if the changes are passed they have far reaching planning implications. Most established financial plans will need to be revised to adapt to the changes and new thinking will be needed to prosper from them.
A key building block of most people’s retirement plan is their superannuation. Whether by design or simply through the contributions employers pay on their behalf, superannuation becomes a significant retirement asset. The beauty of superannuation is its tax status. At the moment, when your super is converted to a pension all investment earnings are tax free and if you are over 60, withdrawals are received tax free also, making it a legal tax haven for your retirement savings.
When you overlay this with the fact that it’s possible to invest in almost anything we can as individuals, it’s easy to see why superannuation is usually a key building block of a financial plan.
Negatives the budget presents for a financial plan
The biggest issue I can see that this budget presents for retirement is that it has increased the limitations considerably on how much we can get into super, therefore making the planning and timing of how we confront retirement planning even more important to address early.
The options that exist to contribute are both pre-tax through salary sacrifice or post-tax as an after tax contribution. The proposed changes impose a lifetime limit on how much we can contribute post-tax of $500,000 per person and a pre-tax limit, regardless of age, of $25,000 p.a. per person.
A new $1.6 million limit on how much an individual can have in super invested in a tax free pension, means for people who risk breaching this figure, forward planning could yield significantly better financial outcomes for a family unit.
In addition to this, a commonly used strategy known as ‘Transition to Retirement’ is having its wings clipped considerably. Currently, earnings beyond 60 years of age attract 0% tax for working Australians who have their super invested as a pension. The proposal will only allow people who have met a full condition of release and in pension to be eligible to 0% tax on earnings. I think this change will have a far-reaching impact on the suitability of the strategy ongoing for people who currently use and enjoy the benefits as well as new people considering the benefit.
While these are significant reductions on the current legislation, there are some real positives, which will go some way to offsetting the negatives.
For a start the proposal includes a simplification for how pre-tax super contributions can be paid. Whereas currently there is a complicated ‘10% rule’ that determines whether you can contribute personally and claim it as a tax deduction or if you are an employee and are therefore only able to contribute via salary sacrifice. The proposal is to simplify the rule to allow anyone to contribute to super up to the maximum $25,000 limit and claim a tax deduction. Not only is this simpler for people working, but it allows those who are not working to contribute pre-tax when it makes sense to do so. I think this rule change will result in more people maximising what they are allowed to contribute, because it offers greater individual control.
There is also a proposal to allow catch up payments, up to a maximum of 5 years’ worth of contributions when an individual’s balance is lower than $500,000. This potentially opens great planning options, when for example, income increases following periods of lower income, like mothers having young children and having a career break, or promotions, which result in higher income. It could also work well when a capital gain arises.
Another good change proposed is to abolish the work test. Currently, this test prevents anyone over age 65 from contributing to super unless they work 40 hours in a 30-day period during a financial year. The change proposes to abolish this, allowing anyone, working or not, to contribute to super up to age 75.
I think it’s likely that super splitting will become more commonplace in future, given several of the previously described proposed changes. Super splitting allows one spouse to split up to 85% of their contributions in a financial year to the other. This could allow a younger spouse to effectively ‘transfer’ funds into the older spouse’s name, who might be eligible to start a full pension, where earnings are tax free. Alternatively, this could assist with keeping one spouse’s balance under the $1.6 million pension balance limit while still taking advantage of the tax effectiveness of superannuation.
And the other issue of note here is the spouse contribution. It is also proposed to receive a makeover and will be more favourable for a lower income-earning spouse. Currently, the opportunity only applies if one spouse is earning under $13,800, however this is proposed to change to increase the cut-off point to $40,000. The benefit is up to $540 per annum.
Given the changes to superannuation and the fact that the budget will make it more difficult to get money into the superannuation environment, it stands to reason that for some of us we’ll have more money held personally for investment in our retirement.
I believe that this fact, coupled with reductions in the company tax rate in the short term to 27.5%, with a long-term reduction to 25% intended, will see companies used more regularly as an investment-planning tool. The concessional tax rates compare very favourably to what higher income earners pay and with the benefit of franking credits, will provide a tax effective way of releasing funds in retirement.
"GOOD FORTUNE NEEDS GREAT PLANNING"
The content of this presentation is intended to be general information only and has been prepared without taking into account any person’s objectives, financial situation or needs. Each person should consider its appropriateness having regard to these matters or obtain relevant professional financial advice before making any financial decisions. Examples are illustrative only. Each person should obtain any relevant professional financial, taxation and social security advice before making any financial decisions.