Over the past couple of weeks – Tealey and I have had the opportunity to speak at a number of events hosted by financial advisers for their clients and friends.
One of the things we enjoy about these functions is the opportunity to meet with ‘real people’. These are the individuals who are concerned, and sometimes confused, about their journey towards retirement.
A recurring question often asked by many is ‘how do the announcements made in the May 2016 Budget impact on our retirement plans’.
Superannuation (super), is the building block of retirement planning. It is complex in terms of the way the system works and perhaps – more importantly – the way it is taxed.
The confusion is not limited to members of the public. Even some politicians seem to have a clear lack of understanding about the taxation of super!
In this article, I will attempt to provide a very quick and simple overview about the taxation of super.
Contributions:
Money paid into super by fund members and their employers is a contribution. There are two types:
- Non-concessional contributions: these are made a person for them self or for their spouse. A tax deduction is not claimed for these contributions.
- Concessional contributions: These are contributions made by an employer on behalf of their employees, and contributions made by individuals who are eligible to claim a tax deduction for their contributions (i.e. a self-employed person).
Provided non-concessional contributions fall within prescribe limits – they are not taxable when paid into a super fund.
However, concessional contributions are treated as taxable income of the super fund to which they are made. The super fund pays tax at a rate of 15 per cent on concessional contributions they receive. This tax is deducted from the member’s accounts and is referred to as ‘contributions tax’.
High-income earners (with a taxable income in excess of $300,000) pay an additional 15 per cent tax on their concessional contributions; making their effective tax rate 30 per cent.
Investment earnings
Super funds invest member’s contributions in a range of investments that may include cash, fixed interest deposits, shares, and property. Investments may be made in Australia or overseas. The nature of the investments held will vary from fund to fund.
The return on investments made by a super fund is taxable income of the fund.
The rate of tax paid by a super fund depends on whether a member’s account is in the ‘accumulation phase’ or ‘pension phase’. A member’s account that is in pension phase is one that is paying a super pension (or income stream) to the member.
The investment income earnt by accumulation accounts is subject to a tax rate of 15 per cent. This is paid by the super fund. Capital gains are taxed at a lower rate of 10 per cent.
Where a super fund earns income on member’s accounts that are in the pension phase, the income, including capital gains, is tax free to the super fund. Because a super fund is not required to pay tax on these investment earnings, pension members should generally receive a higher rate of return on their account.
Benefit payments
A super fund may pay member’s benefits as a lump sum, and regular income payments (a pension), or a combination of both.
Lump sum and pension benefits may be taxable in the hands of the fund member, however for members aged 60 and older, there is generally no tax payable on benefits the member receives. Having said that, in some cases where a person is a member of an ‘unfunded super scheme (generally older style public sector funds), some tax may be payable, even if aged 60 or older.
When benefits are paid to members under the age of 60, the tax payable will depend on the age of the member, and the components that make up their superannuation benefit.
How does the budget affect this?
- Contributions: the budget did not propose any negative changes in respect of the taxation of contributions, except for higher income earners.
The current $300,000 income threshold before the additional 15 per cent tax is paid on concessional contributions will be reduced to $250,000.
There is also a proposal to reduce the amount that can be contributed as
non-concessional and concessional contributions.
- Investment earnings: the taxation of investment earnings remains untouched with one exception.
Currently in the instance where a member is drawing an income from a ‘transition to retirement’ pension, the investment earnings are tax-free to the super fund.
The budget included a proposal to tax these investment earnings at 15 per cent instead of the current 0 per cent.
For super fund members have retired and are receiving a super pension, the tax rate of 0 per cent will continue to apply to investment earnings.
- Benefit payments: the budget did not contain any changes to the way in which super benefits paid to a member are taxed. Importantly – for people aged 60 and over, their benefits[1] will continue to be tax-free.
The budget included a number of key announcements in relation to super. Most importantly – none to the changes announced have been passed into law yet.
Most Australians will be unaffected, at least in a negative way, by the budget announcements.
Superannuation continues to deliver very favourable tax outcomes to those saving for; or already in retirement.
In fact – a number of the budget announcements may make super more accessible to older Australians.
Mainstream media has often ‘conveniently’ chosen to ignore the positive announcements. Bring on the good news stories!
[1] Except for members of unfunded superannuation funds who have benefits that include an untaxed element of their taxable component.
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