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Self Managed Super Fund (SMSF) Article
The $1m contribution limit

By Tony Negline.

This article may be out of date.

11th April 2007

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Water cooler and dinner party conversations are being dominated by getting $1 million into super before 1 July this year.

This limit refers to the maximum amount of personal contributions not claimed as a tax deduction that can be made into super before the end of this financial year.  From 1 July these limits will be restricted even further.

In order to take advantage of this rule some people are borrowing money.  If you are considering using this option it is necessary to do your sums because it is easy to gain nothing from it.

It is important to realize that any interest incurred in making personal contributions to super is not tax deductible.  This by itself can make the transaction uneconomic.  But there are other reasons as to why this strategy may not work.  It is equally important to realise that super fund assets cannot be used to secure a borrowing.  This has to be provided by another personally owned asset.

Take for example Geoff who is over 60 and earns $80,000 salary and has $500,000 in super assets.  Assume he needs $50,000 income for day to day living expenses.  This means he has about $15,000 a year in pre-tax salary that he can use for other purposes.

Like an increasing number of people aged over 60 he intends to work for a few more years.  He decides to borrow $1m to make an undeducted contributions.  Under current law he can convert this contribution into an income stream.  Once the super money moves into pension phase the super fund tax rate reduces from 15% to zero.

Assume that the interest rate on the loan is 8% per annum – that is $80,000 p.a.  The interest is not tax deductible and the loan would have to be secured against something other than his super assets.

Geoff takes the $1m contribution and starts a super pension which pays him $70,000.  From July 2007 this income will be all tax-free because he is over 60.  At the same time assume that the net total return (income and capital growth less expenses) on these pension assets equals 7% p.a.

He decides to use this tax-free pension income as well as the excess salary to pay his annual interest bill on the $1m.  One good question to ask is, how would he pay the interest bill if his super fund asset performed badly and he didn’t have the 7% earnings to pay the interest?  Presumably he would have to eat into his capital.

Whilst this is occurring his current super assets of $500,000 continue to accumulate away.

But what has Geoff gained?  He is using all the income and capital growth from his additional super assets to pay interest.  When he stops work he can take this asset and pay off the debt.  In other words he probably ends up achieving nothing.  Further he is also using his current excess remuneration to pay interest when this could easily be used for another purpose such as salary sacrifice contributions.

If Geoff was under 60 the pension income will be taxed less a 15% rebate.  Effectively this means that he will be even further behind than what he is because he is over 60.

The moral of this example is that borrowing money to make super contributions is not necessarily the best idea.  This is not to say that it never works but it doesn’t take long for it to fall apart.  If you intend to borrow money to make super contributions make sure you check to see if your strategy works if the financial markets drop dramatically and you loose a big proportion of your assets.

Other investors are selling assets that they own in their own name to make the $1m contribution.  But before you rush out and do the same make sure you work out how much it will cost you to sell the asset.  Typical expenses are capital gains tax, stamp duty and so on.

It is common to hear some people wondering if they can take advantage of the $1m opportunity if they don’t have access to that amount of money.  The answer is yes because the $1m is a maximum.  You can contribute any amount up to $1 million.

Many people will only be able to afford a small portion of this amount.  Investors who find themselves in this position should not panic.  A couple who retire on about $250,000 in assets should still be able to generate a retirement income of about $30,000p.a. with about two thirds of this coming from the age pension.  Recent research by the Association of Super Funds of Australia and Westpac estimate that a modest retirement can occur with about $25,000 p.a.

Superannuation is very tax effective for all taxpayers except those who earn very modest incomes.  It also receives social security benefit concessions that other investments do not receive.

This means that no matter what your level of wealth superannuation is an extremely potent tool in helping you prepare for retirement.  

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