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Big super changes on the way

MML

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Hold on to your collective superannuation and pensions hats, because the winds of political change have once again swept across Australia’s $2 trillion superannuation industry.

Some, arguably those that are less focused on maximising the opportunities available to save for retirement, may barely feel them. But others, including many already reaping the rewards of the large retirement nest egg they have managed to accumulate over time, could get blown away.

They have the most to lose, as do individuals and couples still working who have the ability to contribute pre-tax and after-tax income into their superannuation up to the full limits allowed under law.

The problem is, the laws are changing yet again. If you don’t know what’s happening, you could easily get caught out. And with most of the changes coming into effect from July 1, 2017, the window to take action is rapidly closing.

Passed in Federal Parliament in late November 2016, the impending changes amount to the biggest single overhaul of existing superannuation and pension rules in 30 years.

In essence, they will effectively prevent individuals from amassing large fortunes inside their super fund while still employed, which under the current rules can generate an unlimited stream of tax-free pension income in retirement.

The measures being introduced lower the amount of funds that individuals can put into superannuation from their income or other sources, and also reduce what can be held in pension mode. Yet, while some of the changes are relatively straightforward, others are highly confusing, even to licensed financial advisors and superannuation professionals.

So here is a detailed run-through of all the new changes on the way, when they will take effect, and what they mean for both those still saving for retirement in accumulation phase, others who are transitioning to retirement, and those who are fully retired.

In the following article, we explain the changes to the Age Pension framework that came into effect on January 1, 207, which will make it even more difficult for individuals or couples to build up a retirement nest egg and still claim a full or part government age pension contribution.

According to Federal Treasurer Scott Morrison, the intent of the latest rule changes is “to improve the fairness, sustainability, flexibility and integrity of the superannuation system” as part of a broader objective to provide income in retirement to substitute or supplement the Age Pension.

Ironically, in some cases, there will be people who do not qualify for the Age Pension that actually earn less from their retirement interests – due to factors such as low-interest rates – than those receiving the full pension.

Lowering the concessional contributions cap

This change has the potential to affect every working Australian making personal superannuation contributions beyond those made by their employer.

The annual maximum level for individuals to make concessionally-taxed contributions into their superannuation at the lower 15 percent tax rate has been progressively falling for some time, and now that level is being cut even further for everyone.

From July 1, 2017, the annual cap on concessional (before-tax) superannuation contributions will be reduced to $25,000 (currently $30,000 for those aged 49 and under at the end of the previous financial year, and $35,000 for those aged over 50).

A lower concessional contributions rate, of course, is bad news for everyone saving for retirement, especially those in the latter years of their working life who often have the ability to ramp up their contributions before hitting retirement.

The other side of the coin is that most individuals do not take advantage of the full concessional contributions allowance each year anyway.

Those in a position to do so can still contribute up to the current higher concessional levels before June 30, 2017.

Those aged 49 and under can contribute up to $30,000 in the current financial year at the 15 percent tax rate.

Those aged between 50 and 65 can contribute up to $35,000 in the current financial year at the 15 percent tax rate.

Increasing the tax rate for higher income earners

Those earning more than $300,000 currently already pay an additional 15 percent tax on their concessional superannuation contributions, bringing their rate to 30 per cent.

From July 1, 2017, the higher tax threshold will be lowered to $250,000. Any contributions in excess of the new annual $25,000 concessional contributions cap will be treated as income and taxed at their full marginal tax rate.

Lowering the annual non-concessional superannuation cap

Just like the ever-shrinking annual concessional contributions cap, so to is the Government taking the knife to allowable non-concessional (tax-paid) contributions into super.

From July 1, 2017, the annual non-concessional contributions cap will be cut to $100,000 from the current $180,000.

Individuals under age 65 will still be eligible to bring forward up to three years of non-concessional contributions ($300,000), down from the current allowance of $540,000.

Transitional arrangements will apply. If an individual has not fully used their non-concessional bring forward allowance before July 1, 2017, the remaining amount will be reassessed on July 1, 2017, to reflect the new annual caps.

Individuals aged between 65 and 74 will be eligible to make annual non-concessional contributions of $100,000 if they meet the work test (that is, if they work 40 hours within a 30-day period each income year). As per current arrangements, they will not be able to access the three-year bring forward of contributions.

But there is a new major restriction. The Government has now mandated that individuals with a total superannuation balance of $1.6 million or more as at June 30, 2017, will no longer be eligible to make any non-concessional contributions.

Individuals with balances close to $1.6 million will only be able to access the number of years of bringing forward to take their balance up to $1.6 million.

As these changes don’t come into effect until next financial year, those able to do so should take advantage of the current $540,000 higher limit under the three-year pull-forward rule, or the $180,000 annual after-tax contributions limit before June 30 next year.

Changes to the transfer balance cap

The magic $1.6 million figure is central to the new superannuation changes, and from July 1, 2017, this will be the maximum level that individuals can have in a pension account earning tax-free income.

Any funds above $1.6 million will either have to be transferred back into a superannuation accumulation account and pay 15 per cent tax on any earnings, or be taken outside of the retirement system altogether.

As an example, for someone with a $1.8 million balance, $200,000 will have to be transferred back into an accumulation account. Any earnings on the $200,000 would be taxed at 15 percent. On a 5 per cent annual return on $200,000 ($10,000), the earnings would attract taxation of $1500 (currently zero).

The good news is that subsequent earnings on the pension account balances in the retirement phase will not be capped or restricted. But the minimum annual pension drawdown conditions will still apply, starting at 4 percent of the fund balance.

Transitional arrangements will apply. People already retired with balances above $1.6 million on June 30, 2017, will have six months from July 1, 2017 to bring their retirement phase balances under $1.6 million. The transfer balance cap will be indexed and will grow in line with the Consumer Price Index measure of inflation, meaning the cap will be around $1.7 million in 2020-21.

We discuss this key change in more detail in a separate article, including what steps may need to be taken well before July 1, 2017, to restructure retirement assets currently being held in a tax-free pension account.

Changes to transition to retirement income streams

In a move aimed at closing off a tax loophole, the Government will remove the tax-exempt status of income from assets supporting transition to retirement income streams (TRIS), also known as transition to retirement (TTR).

These earnings will now be taxed concessionally at 15 per cent. Individuals will also no longer be allowed to treat certain superannuation income stream payments as a lump sum for tax purposes.

This will help ensure that TRIS are fit for purpose and not used as a tax minimisation strategy.

The tax treatment of income streams in the hands of the individual will not be changed. For most individuals, this will mean they are tax-free, or taxed at the individual’s marginal tax rate less a 15 per cent offset.

Abolishing the anti-detriment rule

From July 1, 2017, the Government will remove the anti-detriment provision which has allowed superannuation funds to claim a refund of the 15 per cent contributions tax paid during a fund member’s lifetime after their death.

An anti-detriment payment is an amount that can be included when a lump sum death benefit is paid to a dependant, such as a spouse or child under the age of 18.

Superannuation funds will no longer be able to claim a tax deduction for anti-detriment payments made to eligible dependants. This change will provide consistent treatment of death benefits across all superannuation funds.

However, lump sum death benefits paid to eligible dependants will continue to be tax-free.

Improving access to concessional contributions

There are also major positives from the latest set of superannuation changes, and this change will be a huge positive for self-employed earners who have been to date severely restricted if they receive more than 10 per cent of their total income from one client.

From July 1, 2017, the Government will allow all individuals under the age of 65, and those aged 65 to 74 who meet the work test, to claim a tax deduction for their personal contributions to eligible superannuation funds up to the standard concessional contributions cap.

Currently, an income tax deduction for personal superannuation contributions is only available to people who earn less than 10 per cent of their income from salary or wages.

This limits the ability for people in certain work arrangements to benefit from concessional contributions to their superannuation. Under the new arrangements, more individuals will be able to make concessional personal contributions up to the annual cap.

Widening the tax exemption net

Also, another positive change is that from July 1, 2017, the Government will extend the tax exemption on earnings in the retirement phase to products such as deferred lifetime annuities and group self-annuitisation products.

Extending the tax exemption to deferred or pooled income stream products will encourage providers to offer a wider range of products.

This will provide more flexibility and choice for retirees and help them to manage consumption and risk in retirement better – particularly longevity risk, to avoid people outliving their savings.

Conclusion

The superannuation changes coming into effect from mid-2017 are likely to affect most working and retired Australians as the Government seeks to reduce what some regard as overly generous tax concessions, especially for those in retirement.

Yet even with further changes giving individuals with balances below $500,000 the ability to make catch-up concessional contributions of up to five years at once coming into effect in 2018, lower annual concessional and non-concessional limits mean many will struggle to build a sizeable superannuation next egg at retirement.

Combined with the low superannuation returns currently being achieved by many, the overall attraction of holding all of one’s investment assets inside of super is likely to diminish over time.

That all depends on the extent of further changes to the superannuation landscape over time. For all Australians, it is definitely a case of watch this space.

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