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Self Managed Super Fund (SMSF) Article
Making Large Undeducted Contributions
By Tony Negline.
This article may be out of date.
28th June 2006
Superannuation undeducted contributions are contributions that have not been claimed as a tax deduction. In other words they are made with after tax money by the member.
Until the last Federal Budget an investor could put any amount of undeducted contribution into super they wanted to. Some people were lucky enough to take advantage of this rule and made very large undeducted contributions.
As part of its new super policy the government decided to limit the amount of undeducted contribution that could be made.
At a basic level the contribution rules are as follows:
- An investor is limited to $150,000 of undeducted contributions in a financial year
- An investor can contribute three years of undeducted contributions (that is, $450,000) in one go to accommodate larger one off payments
- If an investor does not make use of this limit during a year it cannot be rolled into future years
These rules mean that an investor could contribute $150,000 between 9 May and 30 June 2006 and then contribute $450,000 during the 2006/07 year. The impact of the $450,000 is that additional undeducted contributions will not be permitted until 1 July 2009. Some couples might find this a useful strategy because it means they could contribute $1.2 million over a relatively short period.
Alternatively a person could contribute $450,000 between 9 May and 30 June 2006. Implementing this strategy would mean that new undeducted contributions could not be made until July 2008.
If these rules are broken then the excess contributions will be returned to the investor and a notional amount of earnings will be taxed in the investor's hands.
Before anyone makes large undeducted contributions it is important that they fully understand the above rules and potential problems with these rules:
- What rule will apply if someone contributed $200,000 during 2006/07? On a strict reading of the government's policy announcement says that because this contribution is more than $150,000 further contributions would not be allowed until July 2009. However some technical experts have been told that contributing $200,000 in a financial year would mean that over the next two financial years you would be limited to $250,000
- The government co-contribution, spouse contributions and other contributions made by non-employers that are not claimed as a tax deduction are all deemed to be undeducted contributions, will these be part of the above restrictions? We do not know an answer to this question. It is reasonable to expect that this will be the case. A follow on question to ask is to whom would these contributions be refunded to if the various caps are breached?
- We understand that from age 65 the government will not allow contributions to be made until a work test is satisfied. The current work test is at least 40 hours work in less than 31 days and presumably this same rule will continue to apply. (No work test applies if a contribution is made under age 65.) However we also understand that if an investor contributes $450,000 in one go then they will be expected to satisfy a work test if those contributions relate to a period of time when the person is over 65. For example suppose Jim is aged 64 and will turn 65 during 2006/07. He decides to contribute $450,000 on 3 July 2006. Under this rule he will be expected to satisfy the work test during 2006/07, 07/08 and 08/09. What will happen if he can't satisfy the rule during 2007/08 but can work in 08/09? We don't know but it is reasonable to assume that the deemed 2007/08 contribution will have to be refunded
- What tax rate will apply if an investor's undeducted contributions are returned because one of the above rules have been breached? We do not know the answer however our best guess is that the highest marginal tax rate plus Medicare Levy will have to be paid – that is, 46.5% from July 2006 onwards. At the same time we do not know if it will be the investor or their super fund who will have to pay the penalty tax
So what should an investor do? One argument says that they should do whatever they like because ultimately the worst penalty they can face that can happen is the refund of the contributions and some penalty tax. This line of reasoning says that political pressure might force the government to amend the above rules and allow some additional flexibility.
But what should an investor do if they do not want the hassle of falling foul of these new rules? They should probably seek very good advice and know that there is some risk that they may have some of their contributions returned to them.
Many people have been asking when can we expect to see the final make-up of these new rules. Unfortunately we do not expect to see final rules until sometime in 2007.
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