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Self Managed Super Fund (SMSF) Article
Big Tax Deductions Under "Better Super"
By Tony Negline.
This article may be out of date.
1st November 2006
Under the government’s proposed super rules it will be possible to contribute large amounts to super. As we shall see the downside with these contributions is that penalty taxes may be payable when the contribution is made.
There will be three ways to make these large contributions – via employer contributions, via personal deductible super contributions and via undeducted contributions.
Any employer contributions or deductible personal super contributions above $50,000 during a financial year will be taxed at 46.5%. A special transitional rule will apply for five years, between 2007/08 and 2011/12, for those over 50. This transitional rules means that personal deductible contributions or employer above $100,000 will be taxed at 46.5%.
A different set of rules will apply to undeducted contributions. Undeducted contributions above $1 million between 10 May 2006 and 30 June 2007 will be taxed at 46.5%.
From July 2007 onwards undeducted contributions above $150,000 will have a similar tax rate. From this date investors under 65 will be allowed to contribute three years of undeducted contributions – that is, $450,000 – in advance. If they breach this rule the penalty tax rate will apply.
The penalty tax will have to be paid by the super fund member. This means that if an employer makes a super contribution above the thresholds then the employee will be liable for this debt. However the super fund member will be allowed to pass this liability onto a super fund. (It remains to be seen if a super fund will be required by law to pay this debt on a member’s behalf. It will be unfair on investors if this would not be the case. It will be unfair on super funds if they won’t be allowed to charge an administration fee for this service.)
If the 46.5 percent tax rate doesn’t apply then the contributions will be taxed at 15%. This tax will continue to be a liability of the super fund.
Now what should you do if you want to make super contributions above the various thresholds – should an employer make these contributions or should you make undeducted contributions?
Lets look at an example; Jim Jones is a highly paid executive. In July 2007 he is deciding how he will use $300,000 of his remuneration to make super contributions. For the sake of our example we will assume that these additional contributions will be taxed at 46.5%. Whilst this tax rate seems high it needs to be remembered that this money may well have ended up in super anyway because of the tax concessions attached to this benefit once it is inside the super environment.
If his employer makes the contribution then the net of tax contribution will be $160,500.
On the other hand assume that he wants to take this remuneration as salary so that he can make an undeducted contribution. After he has paid marginal tax, he will receive $160,500 into his hands. If he uses this to make an ‘excessive’ undeducted contribution (that is above whatever threshold applies to him), this too will be taxed at 46.5%. This means his net contribution will be $85,867.
On the other hand if the maximum undeducted contribution threshold were $150,000 then his next contribution would be $155,617.
There would be different variations in the net contribution if Jim’s maximum undeducted contribution thresholds were $450,000 or $1 million.
Clearly careful planning is required. Jim will need to weigh up how to maximise his contributions made – that is minimise the amount of tax he pays – many years in advance.
Before a contribution is made it is important to understand how a contribution might be taxed when it is paid from the super fund. Under current rules, any contribution claimed as a tax deduction – and the earnings on those contributions – are counted towards an investor’s Reasonable Benefit Limit. Undeducted contributions are not counted against a person’s RBL. (Any earnings on an undeducted contribution do count towards an RBL.)
As benefits greater than a RBL face penalty taxes finding ways to limit this is important. As a result under current rules, Jim Jones might be attracted to making his undeducted contributions are as large a possible.
However the new super rules do away with RBLs. Once a person turns 60 all super benefits will be paid tax-free. In this case it might not matter how a contribution is made – maximising the contribution could be the biggest issue.
Benefits taken before age 60 will be taxed. Undeducted contributions will be paid tax-free. Deductible contributions and super fund earnings will be tax-free under $140,000 if paid between age 55 and 60. Amounts above this threshold will be taxed at 16.5%. A slightly different set of rules will apply if an investor is under 55.If you do not intend to receive your super before age 60, then you might think that the tax rates that apply before that age are not important. This is fair enough. However no one can predict the future and it may be that you need access to the funds before age 60. With this in mind it may be better to weigh up all your options.
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