Door is open for tax effective superannuation contribution strategies
Resulting from the 2021 Federal budget, from July 1 2022, anyone under the age of 75 can make and receive personal or salary sacrifice super contributions without having to satisfy a work test. Annual contribution limits still apply and personal contributions for which you claim a tax deduction are still restricted to those who meet the work test (for those aged between 67 and 74 inclusive).
Previously, people aged 67 to 74 were required to work for at least 40 hours in a consecutive 30-day period in a financial year or be eligible for the work test exemption.
This means you can potentially top up your super account until you turn 75 (or no later than 28 days after the end of the month you turn 75). It also opens up potential new strategies for making a big last-minute contribution, using the bring-forward rule.
The bring-forward rule allows eligible people to ‘’bring forward” up to two years’ worth of non-concessional (after tax) super contributions. The current annual non-concessional contributions cap is $110,000, which means you can potentially contribute up to $330,000.
When combined with the removal of the work test for people aged 67-75, this opens a 10-year window of opportunity for older Australians to boost their super even as they draw down retirement income.
Some potential strategies you might consider are:
- Transferring wealth you hold outside super - such as shares, investment property or an inheritance – into super to take advantage of the tax-free environment of super in retirement phase
- Withdrawing a lump sum from your super and recontributing it to your spouse’s super, to make the most of your combined super under the existing limits
- Using the bring-forward rule in conjunction with downsizer contributions when you sell your family home.
Case Study – Bill and Jane
Bill and Jane, both age 70, and are husband and wife.
Jane retired from the workforce aged 65, and commenced a pension on 1 July 2017 for her full superannuation member balance within her SMSF for $1,270,000. At 1 July 2017, the Transfer Balance Cap (TBC) limited the amount a member can have in a tax-free pension to $1,600,000. At the time of her pension commencement, Jane had not reached the upper limit of her TBC, but utilised 79.375% ($1.27m of $1.6m available).
After pension withdrawals and factoring in investment growth and earnings, Jane’s member balance was $1,470,000 as at 30 June 2022.
Bill continued working until recently, and having contributed into their SMSF up until retirement, his member balance at 30 June 2021 was $2,030,000.
On 1 July 2021, as Bill has satisfied a condition of release, can request to commence a pension with this SMSF, which he enters into on 1 July 2021 with his member balance still at $2,030,000. At 1 July 2021, the TBC is $1,700,000 (having been indexed from $1.6m). Given this, Bill’s tax-free pension account is limited to $1,700,000, and the remaining $330,000 of SMSF assets remains in accumulation phase, and its taxable earnings on this $330,000 is taxed at 15%.
After pension withdrawals and factoring in investment growth and earnings, Bill’s member balance remained at $2,030,000 as at 30 June 2022.
To summarise, at this stage, the fund member accounts are as follows:
- Jane $1,470,000 (100% tax free pension phase)
- Bill $2,030,000 (83.7% tax free pension phase)
With the abolishment of the work test in relation to non-concessional contributions into super from 1 July 2022, Jane is now eligible to make non-concessional contributions into her super fund where she was previously unable to since retiring .
To maximise the tax effectiveness of their superannuation investments, Bill, in addition to his minimum pension requirements, takes $330,000 as a lump sum withdrawal from his accumulation account. This leaves him with a balance of $1,700,000 ($2.03m less $330k) to which his member balance is 100% in tax-free pension phase.
Jane then re-contributes this same $330k (utilising her bring forward rule of 3 years worth of non-concessional contributions) back into the SMSF, bringing her total member balance to $1,800,000. As Jane has previously only used $1.27m of her $1.6m TBC prior to this, Jane is eligible to request a pension be commenced for the $330,000 that has recently come into her member account as an accumulation balance. Jane has a $1.6m TBC rather than a $1.7m TBC because the TBC at the time the original pension commenced was $1.6m. Notwithstanding her pension balance prior to the contribution was $1.47m, her capacity to have an amount in pension is defined by the gap in her original TBC to the amount originally placed in pension phase. As her TBC is $1.6m, the original $1.27m pension can be increased by $330k to $1.6m.
Once Jane’s non-concessional contribution amount is transferred into pension phase, the fund member accounts are as follows:
- Jane $1,800,000 (100% tax free pension phase)
- Bill $1,700,000 (100% tax free pension phase)
Assuming the previous $330k taxable surplus in Bill’s member account was deriving a 7% income growth, the $23,100 income would attract tax at 15%, or $3,465 per year. This tax saving year on year, for say 20 years (ignoring all other effects) would be $69,300 of tax that has been saved by withdrawing excess accumulation balances from the higher balance spouse (Bill) and being able to re-contribute it via a Non-Concessional Contribution to the lower balance spouse (Jane).
The window of opportunity presented by the recent changes to the work-test rule can allow retirees to re-structure their pension balances and create genuine tax savings and efficiencies, not just for one year, but for many, many years to come.
Our King & Whittle advisers are skilled to deliver outstanding results for our clients. Should you wish to speak to one of our advisers, please don’t hesitate to contact us.