Michael Hutton sifts the new superannuation rules and finds a lot of good news for business owners. But for some, retirement plans will need urgent attention
Following the additional benefits and enhancements announced in the Federal Budget in May this year, superannuation is now the prime tax-advantaged, long-term investment vehicle, particularly for business owners.
The changes, on top of other significant modifications to superannuation in recent years, means superannuation is now arguably the best way for business owners to take excess wealth out of their business. Not having all their wealth locked into their business and subject to business risks should always be one of their objectives.
The government’s aim was to simplify Australia’s superannuation system, making it easier for people to understand. In doing so, superannuation has become more attractive by reducing or eliminating taxes and levies and simplifying rules, encouraging Australians to fund their own retirement. However, the different opportunities accessible with superannuation must be understood, decisions made and action taken, in order to take advantage of all the benefits.
For business owners, it’s particularly important to understand the way super works, its options as well as the changes, both to maximise the amount they can take out of the business to ensure their own comfortable retirement, and also to comply with government requirements when paying superannuation contributions for employees.
The introduction of Super Choice last year allowed most Australians to pick, for the first time, the superannuation fund that manages their money. This gave them more control over how their retirement income is managed.
When Super Choice was introduced, many business owners feared that they could be overwhelmed by the administration required to comply with the legislation. But in the twelve months since its introduction it seems that many fears of the impact administration would have on businesses, particularly smaller businesses, were unfounded.
Research shows less than five percent of employees have actively changed superannuation funds. Most ‘switching’ occurs when employees choose to stay in their old fund when changing jobs.
Businesses have responded well to their responsibilities, ensuring employees have nominated a complying fund, and making contributions to these funds. Whether employees have responded well by making an informed decision about who manages their super is another question.
In July last year, the unpopular superannuation surcharge was abolished. This 12.5 percent surcharge (originally 15 percent) applied to all tax-deductible contributions made to super, based on age and income. It phased in for those with salaries plus benefits (including superannuation) of greater than $99,710, and reached the maximum rate when income and benefits exceeded $121,075 (for the 2005 financial year).
The surcharge not only applied to deductible super contributions, but also to employer eligible termination payments (ETPs), so any ‘golden handshakes’ could be taxed.
Its removal was key to improving the attractiveness of superannuation for all Australians, and particularly for business owners. Business owners who were liable for both the 15 percent superannuation tax and the 12.5 percent surcharge on their superannuation contributions understandably felt there was little incentive to make additional super contributions and many instead left their profits in the company to be taxed at 30 percent.
The introduction of measures that allow people to transition into retirement, rather than earning an income one day and drawing a pension the next, have been very popular. People can now reduce the hours they spend at work as they approach retirement, or reduce their earnings by salary-sacrificing into super, while drawing part of their super as a pension. This is a particularly attractive strategy for business owners who have started to hand over their business to others as part of their succession planning, but don’t want to completely stop working and remove themselves from the business, or have contractual obligations that keep them involved.
Since January 2006, people can split superannuation contributions with their spouse (provided their fund allows it). Therefore, a couple with one person earning less than the other, or not working at all, can equalise their superannuation balances. However, this strategy has become less relevant since the Budget in May announced that reasonable benefit limits (RBLs) will be removed from July 1, 2007 (see below).
Work test is another super change in recent years. From July 1, 2004 people under the age of 65 no longer need to work in order to contribute to superannuation. This is useful for retirees with investment portfolios, as deductible contributions can still be made and claimed as a deduction against investment income.
As well as these recent amendments, the May Budget contained several significant changes to superannuation. Some of these will be of particular benefit to business owners, giving them much more flexibility in structuring their affairs.
In early September, some of these changes were further defined and adjusted by the government, to ensure people who were in the middle of a retirement strategy at the time of the Budget weren’t disadvantaged by the new rules.
The changes which will apply from July 1, 2007 include:
• For those aged 60 and over, all lump sums and pension payments from a superannuation fund will be tax-free. This is particularly beneficial for those receiving regular pensions as the fund itself will not be taxed. It will also make pension accounts more transferable as there will be no tax considerations, therefore making retirement income more flexible and easier to manage.
• Reasonable Benefit Limits (RBLs), which placed a limit on how much could be withdrawn from a superannuation fund in a concessionally taxed manner, will be abolished. As a result, people no longer need to consider whether it is a good idea to put large sums of money into super and whether they will be able to access all of it tax-effectively when they retire.
• People who don’t want to start receiving pension payments when they stop working, or reach a certain age, will no longer be required to do so, thus leaving their superannuation savings in a fund for longer and ensuring it lasts them longer. Therefore, those who can live off an income from other investments—for example, a business owner who is still involved in the business after ‘retirement age’—don’t need to touch their superannuation savings until they need to.
• Tax-deductible contributions can continue to be made to a fund up to the age of 75 if the work test is satisfied. Again, for business owners who are keen to stay involved in the business for as long as possible, this is very beneficial as they can still make tax-deductible contributions to their superannuation, taking advantage of its low tax rate.
• All personal deductible contributions will be 100 percent tax deductible (previously, this was limited to a full tax deduction for the first $5,000 only, with 75 percent of the balance deductible).
• Business owners who meet certain requirements and have owned their business for more than 15 years can now roll over up to $1 million of the profit made on the sale of the business into their superannuation fund. This is up from $500,000, and is a significant benefit for business owners. For a husband and wife team, for example, this can be an effective way of getting $2 million into super where income earned is tax advantaged.
These changes are very positive for most Australians. However, other changes announced in the Budget may cause difficulties for some. These include age limits and a contribu
Age-based limits on contributions (which allowed those closer to retirement to make bigger contributions) are to be abolished, and a single annual limit of $50,000 will be introduced. This will be indexed each year but will only increase in $5,000 increments. A transition period is in place for those aged over 50, with contributions of $100,000 allowed up to the year 2012.
For a husband and wife over the age of 50, working in their own business, up to $200,000 a year of business profits can therefore be transferred to super as deductible contributions.
This could prove very beneficial to some business owners in their cash flow budgeting, and allow the regular transfer of wealth from their business to their super savings in a tax-advantaged way.
For others, it places an unwelcome limit on how much they will be able to contribute to super during their earning life.
From Budget night, un-deducted contributions were capped at $150,000 per person per year. The Government has since agreed to extend this to $1 million per person until June 30, 2007 to allow those who were in the middle of a retirement strategy to complete it. For many people this is a useful benefit. However, there may still be pre-retirees who had planned to make particularly large lump sum contributions—for example, when selling the family home and other assets at retirement—who may now not be able to add this sum to their superannuation.
Overall, the total effect of these changes further enhances superannuation as the most tax-effective way to accumulate investment wealth for retirement. Having no limit on how much can be withdrawn from super tax-effectively will be a tremendous advantage for many business owners.
However, the limit on contributions may create difficulties in getting enough money into super by retirement age, especially for those already approaching retirement. Business owners should therefore start their retirement planning earlier to make sure they don’t run out of time, and make use of strategies such as getting the profit on the sale of the business into super.
* Michael Hutton is a partner with accountants and business and financial advisers,
HLB Mann Judd, Sydney.
Super Jargon Explained
Work test: Must work at least 40 hours over a consecutive 30-day period during the financial year. This now only applies to those over 65 years.
Reasonable Benefit Limits (RBLs): The amount that can be withdrawn from super (or received as an eligible termination payment) before higher non-concessional tax rates apply. For the financial year ending June 2007, the limits are: Lump Sum RBL—$678,149; and Pension RBL—$1,136,291. After that date, RBLs will no longer apply.
Tax deductible contributions: Amounts contributed to a super fund, which are tax deductible to the contributor and are taxable (at 15 percent) within the super fund. It is currently based on the age of the fund member.
Un-deducted contributions: Amounts contributed personally to superannuation for which a tax deduction cannot be claimed. These amounts are not taxed within the fund and are not taxable when paid back to the member.
Salary-sacrifice: Forgoing salary income in order to make additional super contributions. The contributed income is taxed at 15 percent instead of marginal tax rates but cannot be accessed until retirement.