Superannuation continues to be one of the most tax effective ways for managing your annual tax liability. It provides:
- Tax deductions for contributions up to $50,000 per annum (or $100,000 for those over 50). To obtain the deduction you must ensure that the deduction is claimed in the correct entity, i.e. either your employer or as a member contribution, provided you meet the eligibility criteria (refer below regarding the 10% rule);
- Earnings in your superannuation fund are only taxed at 15% (or 0% in pension phase);
- One-third of capital gains are tax free when the asset is held for more than 12 months with two-thirds being taxed at 15% (or 0% in pension phase);
- Once you attain your preservation age (between 55 and 60 depending on the year you were born), you can withdraw your benefits. Between age 55-59 all pensions withdrawn are taxed at your marginal rates but receive a 15% tax rebate. Over age 60, your pension payments and lump sum withdrawals are tax free.
Whilst the values of superannuation benefits have significantly reduced over the past 18 months, the tax benefits have not changed. The investment markets will bounce back, and as superannuation is a long term investment vehicle, you will generally have time on your side to ride the market cycle. It will go up again and it will go down again. But from a tax perspective, if you can achieve tax savings from contributing to super and due to a greater amount of after tax cash being invested in a low tax environment, you have a much better chance for wealth accretion, than by not contributing.
Let me explain:
Max is taxed at the highest marginal rate on $50,000 of his income. After tax, he will be left with $26,750. If this was invested and earned 4% income in year 1, and Max was taxed on that income at 46.5%, he would be left with after tax income of $572, bringing his total value to $27,322. Please note I am ignoring any capital growth.
If the same $50,000 was able to be contributed to super as a tax deductible contribution, Max would not pay any tax on this income in his name. Instead, the super fund would pay tax at 15%, leaving him with $42,500 to invest. If this was invested and earned 4% income in year 1, and the fund was taxed on that income at 15%, Max would be left with after tax income of $1,445, bringing his total value to $43,945.
In this simple scenario, by contributing to super in a tax deductible way, Max will retain 31.5% of his original $50,000 to invest and after tax would have earned and retained after tax income in super of 153% more than outside of super (that’s about 2 1⁄2 times more).
So, you can see from the simple example above that the benefits of contributing to super and obtaining a tax deduction can easily produce a better after tax position for your income and ultimately your capital.
Proposed Changes to the 10% Rule Legislation has been introduced to Parliament which will have broader reaching impacts than was originally envisaged by the Bill, particularly in relation to the application of the 10% rule.
Currently, where a taxpayer receives superannuation support from an employer (i.e. superannuation guarantee “SG”) they will be entitled to a tax deduction for personal super contributions up to their contribution cap of $50,000 (or $100,000 for those over 50) provided they meet the 10% rule. The contribution cap will include any employer contributions made, so it is only the net amount of the cap that can be claimed personally. The 10% rule will be met if the taxpayer’s assessable income from the SG activity (e.g. wages) plus any reportable fringe benefits does not exceed 10% of their total assessable income plus reportable fringe benefits.
Take the example of Wendy, a 45 year old doctor who has $500,000 of patient fees, earns wages from the hospital of $40,000, has reportable fringe benefits of $10,000 and has salary sacrificed $15,000 of wages to super. The hospital has also paid $3,600 of superannuation guarantee payments.
Under this scenario, Wendy could claim a tax deduction for an additional contribution to super of $31,400 as she has met the 10% rule. Her wages and reportable fringe benefits totalled $50,000 which represents 9.1% of her total assessable income plus reportable fringe benefits.
The proposed legislation now looks to include salary sacrificed contributions in to the calculation for the 10% rule from 1 July 2009. So the wages plus reportable fringe benefits plus salary sacrificed amounts total $65,000 and represents 11.5% of the total assessable income plus reportable fringe benefits plus salary sacrificed amounts. From 1 July 2009, Wendy would lose her eligibility to claim a tax deduction for super in her name, if the Bill is passed.
For those people who rely on salary sacrifice to meet the 10% rule so that they can claim deductions in their own name for super contributions, you should consider your arrangements before 30 June 2009 to assess the impact these changes may have on your eligibility to do so.
In addition, these changes will impact on the eligibility for Government Co-contributions and Spouse Contribution Rebates due to the inclusion of the salary sacrificing component.
If you are interested in obtaining more detail on the issues discussed above, please contact us on 07 3833 3999.