In the lead-up to June 30, it is important for investors to remain focused on their long term financial goals and not invest for short-term taxation purposes.
Salary sacrifice
For those paying tax at a marginal rate of over 15 per cent, salary sacrificing into superannuation can be tax effective.
Salary-sacrificed contributions into super are taxed at 15 per cent, compared to income which is taxed at a person's marginal tax rate. Investors save on income tax while boosting their retirement savings.
Transition to retirement
An effective strategy, for those aged 55 years or over, combines salary sacrificing into super with drawing an income from a super benefit in the form of a transition-to-retirement (TTR) pension.
By replacing salary income with pension income and redirecting salary to super, individuals can take advantage of tax concessions provided on super contributions which are taxed at 15 per cent, pension payments which will either be tax free or subject to a 15 per cent tax offset on the taxable portion for under 60s and tax-free earnings in pension phase.
Super tax breaks
There are other super tax breaks available. For couples, if one spouse earns less than $10,800, the other spouse can make a $3000 non-concessional contribution to super for them and qualify for a $540 tax offset (an effective return of 18 per cent). A partial offset is payable for incomes up to $13,800.
Another attractive super tax break is the government co-contribution applying to those with total income less than $61,920 a year. It matches dollar for dollar non-concessional contributions made by qualifying people, up to a maximum of $1000.
Within a family, it is possible to access both the co-contribution (of $1000) and the spouse tax offset ($540) as long as the low-income-earning spouse has total income less than $10,800.
Avoid excess tax penalties
While contributing extra to super is usually viewed as a tax-effective way to provide for retirement income, the restrictive caps on concessional and non-concessional contributions limit the amount that can be contributed to super annually.
Amounts above the concessional contribution cap of $25,000 each year or $50,000 for people aged 50 or over are subject to penalty tax of 31.5 per cent (in addition to the 15 per cent contributions tax). A further sting in the tail means that excess concessional contributions also count towards the non-concessional contribution cap.
Amounts above the non-concessional contribution cap of $150,000 a year or $450,000 for people aged under 65 under the bring-forward provision are taxed at 46.5 per cent.
In situations where there is surplus money to invest, the super borrowing provisions provide an opportunity for individuals, family trusts or companies to lend money to a related self-managed superannuation fund (SMSF) in order to fund the acquisition of an asset. This enables individuals to increase the level of personal funds invested in super without breaching the contributions caps.
Timing is crucial
The proportioning rule ensures the tax-free and taxable components are withdrawn in the same proportion they comprise a super benefit. Planning for these components to be isolated as separate super interests within a fund can ensure an optimal estate planning outcome for beneficiaries.
The timing of contributions and the timing of pension commencement is important for this strategy to be effective. Similarly, there are tax advantages to be gained by timing the commencement of a pension to use a full financial year of tax-free earnings and timing the withdrawal of pension payments to occur after a person's 60th birthday. Poor planning can have a significantly detrimental impact on the end benefit received by individuals and beneficiaries and could cost them thousands of dollars of taxation.
Segregating current pension assets
Most SMSFs retain assets unsegregated, that is, single assets are not allocated to a specific member or account within the fund. The costs to segregate pension assets in an SMSF are generally higher, but if a fund is planning on selling an asset with a large capital gains tax (CGT) liability attached, it is worthwhile running the numbers to determine whether segregating assets produces the most tax-effective outcome.
In pension phase, income and capital gains of the fund are exempt from taxation. Conversely, while in pension phase, with segregated assets, capital losses are disregarded and are unable to be carried forward to be used in years in which the fund experiences capital gains in the accumulation phase.
Investing outside super
In a time of super contribution caps, it is important to know there are other ways to invest tax effectively, especially when franking credits and CGT discounts are considered.
The removal of all tax on super lump sums and pension income for people receiving these benefits over 60 years has beneficial flow-on effects for individuals receiving income from investments outside of super. It potentially lowers the tax paid on non-super income and may increase access to other benefits such as personal income tax offsets (for example the low income and senior Australians tax offsets).
Although many investors may believe a portfolio needs to be totally invested in super pensions to be tax free, in reality, substantial sums can be invested outside super with similar results. In this way, diversification across tax structures can be achieved without compromising the tax position.
Small business CGT concessions
Generous taxation concessions exist for those who make a capital gain on the sale of a qualifying small business. These concessions range from having no CGT payable where the business has been owned for more than 15 years to having a 50 per cent reduction in the capital gain applied. This concession is in addition to the general 50 per cent reduction that applies to businesses owned by such entities as partnerships, trusts and individuals.
In some cases, the proceeds from the sale of a small business can be rolled over to super (subject to certain limits) and not count towards the non-concessional or concessional contributions caps.
Borrowing to invest
The taxation benefits of gearing are often overemphasised. Tax effectiveness can sometimes be achieved as interest payments on the loan used to purchase the investment portfolio can be tax deductible. However, if the portfolio is negatively geared (where loan interest exceeds investment income), additional cash flow is required to fund the interest repayments.
In most circumstances, a high-income-earning employee pays substantial tax on their salary and has few avenues available for reducing this liability. When a strategy involves negative gearing, an individual's assessable income will be reduced by the tax deductibility of the shortfall between interest paid and income received.
Charitable giving
There are a number of reasons why people give and one benefit sought is the availability of a tax deduction. To be tax deductible a gift must be made voluntarily to a deductible gift recipient (DGR). A tax deduction can be claimed for gifts of money, property (land, buildings, artwork, collectibles), trading stock and property gifted under certain Commonwealth initiatives.
For gifts of money, the deductible amount is the amount of the gift (which must be $2 or more). For gifts of property, there are various valuation rules. Although a deduction for a gift cannot add to or create a tax loss for the donor, donors can elect to spread deductions for gifts of cash and property (valued over $5000) over a period of up to five years. The ability to carry forward tax deductions can be a significant benefit.
When looking at charitable giving, other tax-effective alternatives to direct donations include bequests through a will, using private or family foundations, private ancillary funds and community or corporate foundations.
Top 5 tax tips
- Take advantage of concessions offered through super by looking to make salary-sacrifice contributions or by commencing a transition-to-retirement pension.
- Watch out for restrictive contributions caps that could result in expensive tax strategies.
- Compare the tax outcome of segregating assets with leaving them unsegregated in a year when a pension is commenced within an SMSF.
- Diversify investments inside and outside super and receive a tax-effective retirement income stream.
- Look at spreading deductions for large charitable donations or gifts over a five-year period.
