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Self Managed Super Fund (SMSF) Article
Aged Care and Superannuation

By Tony Negline.

This article may be out of date.

2nd May 2007

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In early April 2007 the then Treasurer released the second edition of the Intergenerational Report or IGR in shorthand.  The report notes that the mix of lower birth rates and longer lives is expected to cause a budgetary problem over the next forty years.

In his speech launching this report Mr Costello said that this problem is the biggest economic challenge facing Australia in the medium to longer term.

The IGR shows us that the number of people aged over 80 will grow dramatically in the near future principally because we already have very high life expectancies which are expected to increase over the next 40 years because of technological advances in health care and the cost of pharmaceuticals.  The economic downside to living longer is that more is spent on health care costs for those over 75 age than all younger ages.  This is an extremely important issue for government as most of our health costs are publicly funded.

The Federal Treasury believes that most of the budgetary black hole which will begin to emerge in about 2025 and progressively will become unsustainably worse, unless some form of corrective action is taken, will primarily emerge because of increases in health and aged care costs.

The government has initiated a number of solutions to help solve these impending problems.  One major current strategy seems to be to encourage us to work for longer.  The current government accepts that it currently has no complete solution for this large impending predicament.

One area that the government does not seem to have formally looked at is encouragement or compulsion to save from our longer term aged care and health care costs.

Unwittingly however the government has given us a structure whereby we can tax effectively save for these costs over a very long period of time.  This informal system will exist because of the July ’07 super changes.

Under this new system it will be possible to put money into super and leave it there indefinitely.  Once a person hits 60 any withdrawals on this money can be taken out tax-free whilst the person is alive.  If this money is never used to pay a pension then its income and realized capital gains will be taxed at 15%.

This system could be used to fund for long term care in the following way.  A person is currently 40 and wants to retire at 65.  The person currently earns $60,000 per annum.  Via compulsory super and voluntary after tax contributions they have started saving for their retirement income needs.

They decide to set up a second interest in their super fund (their existing super interest is used for their retirement funding).  Salary sacrifice contributions of 1% of salary will be placed into this second interest each year to fund their long term health care.  The idea is that the funds will not need to be accessed until age 80 at the earliest.  That is the funding period is at least 40 years.  As the funds will not be needed for such a long period of time, it may be possible to accept a greater investment risk.

If we assume the person initiates this strategy and contributes these additional contributions until retirement then the person could receive over $220,000 assuming modest salary increases and an average pre-tax return of 9% on investments for the 40 years.  In today’s dollars this is equivalent to $70,000 assuming inflation averages 3% over the intervening period.

This would provide a major dent in increased health care costs for quite a few years based on Treasury’s current expectations for these costs.

It is highly likely that some large super funds will begin marketing this type of arrangement in the very near future.

Anyone who sees the benefit of providing this funding for themselves needs to be aware that running two member benefits in the same super fund will probably incur greater administrative expense.

Further it is probably the case that most super fund trust deeds would not cater for this type of funding arrangement.  One very important issue which needs to be considered before implementing this is the sole purpose test.  This super law test says that to receive tax concessions a super fund has to exist to either provide retirement benefits for members or death benefits to those members’ dependants.

In order to implement this strategy one would need to argue that funding for a member’s old age health care costs is funding for that member’s retirement.  As the government now has formal rules in place that allows us to keep money in super indefinitely it would seem that they have accepted this argument.

One potential big downside with initiating this strategy is that an investor would be assuming that the current super laws would remain suitable for a very long period of time.  Anyone with even a passing interest in the super and tax regimes will know how often the rules change.  As always legislative risk is something that must be taken into account with any commercial activity.

Is it likely that the government will make funding for long term aged care compulsory?  Although it does not seem likely, in the realm of political policy making anything is possible.

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