As older taxpayers are preparing for their post-employment years, retirement and savings becomes a focal point to ensure adequate income to extend into their retirement years.

In recent years, superannuation has become the point of emphasis as the most effective way to save and plan for retirement. In the past more investors used companies, family trusts and their own personal names to invest in retirement assets.

So where is the best place to invest your hard earned income while you prepare for retirement?

For example, Peter aged 40 is earning over $180,000 per annum and being taxed at 46.5% (including Medicare Levy). Peter has $100,000 in his superannuation fund and $100,000 personally invested.

Say if Peter was able to invest $50,000 per annum after tax for his retirement, would he be better putting the funds into his superannuation fund or invest personally?

If Peter invested $50,000 per annum into his superannuation fund after tax, by age 60 he would be about $380,000 better off than if he invested in his personal name. While Peter would be liable to pay income tax on income personally at 46.5%, the same income sourced in his superannuation fund would be taxed at 15%.

While not everyone will be able to receive the same results investing in superannuation over a twenty year timeframe, sometimes superannuation is not the best entity to invest for retirement.

Investment entities include Family Trusts, Companies, Superannuation and investing in your own name. Below is a list of pros and cons for the mentioned entities:

Individual Names

• All income derived by all investments will be assessable at marginal tax rates, up to 46.5% (including Medicare Levy) per annum,
• Capital Gains on the sale of assets will be taxable to the individual at marginal rates, up to 46.5% (including Medicare Levy). There are some concessions available to individuals in these circumstances, such as 50% CGT Discount, when owning an asset for more than 12 months,
• Jointly owning investments enables two individuals to essentially access two marginal tax rates, meaning income up to $72,000 between two individuals will only be taxed at 15%.

Family Trusts

• All income generated within the trust has to be distributed to beneficiaries of the trust in the financial year it was generated.
• Enables trustees to distribute income to low income earning beneficiaries, such as children or grandchildren over 18, enabling access to several marginal tax rates.
• Compliance costs are expensive, as individual income tax returns will still be required by the beneficiaries of the trust distributions.

Companies

• All income derived in a company is taxed at 30%.
• Funds can only be distributed to a shareholder of the company as dividends, which are taxed in the individual’s names at their marginal tax rate. Dividends can include franking credits, which is a refund of 30c in the dollar.
• Asset protection for shareholders, limited to the investments within the company.
• No Capital Gain concessions for gains on sale of investments held in the name of a company, therefore taxed at 30%.
• A company cannot access refunds from excess franking credits from dividend income.

Superannuation Fund

• All investment income is taxed at 15%, when in accumulation phase.
• Capital Gains on gains on the sale of assets will be taxable to the superannuation fund at 15%. A CGT Discount is available to the superannuation fund, if it has held the investment asset for more than 12 months. This results in tax payable on only 10% of the capital gain.
• Income generated when a member is generally over 55 and in pension phase, is tax free to the extent of the pension balance.
• After age 60, all income generated in the superannuation fund and all pension payments are tax free to the member.
• When a member has satisfied a condition of release (reaching age 65, or permanent retirement) they can access both pensions and lump sum tax free.

As you can see, a superannuation fund can be a tax effective entity to use when planning for retirement, in most circumstances. Tax Free income after age 60, tax free earnings when in pension phase and 15% tax rate enables a tax payer to concessional save for their retirement.

1.    The Tax Savings!

Earnings Tax

Investing within superannuation means that any earnings received by the fund are taxed at a concessional rate of 15%.

On the other hand, earnings received from investments held in your personal name are taxed at marginal tax rates that range from 16.5% to 46.5% (including Medicare Levy). 

Therefore the greater your marginal tax rate, the more you can save by investing within superannuation, as can be seen in the table below;

Personal Name				Super
Tax Rate	16.5%	31.5%	45.5%	15%
Investment	100,000.00	100,000.00	100,000.00	100,000.00
Earnings Rate	6%	6%	6%	6%
Gross Earnings	6,000.00	6,000.00	6,000.00	6,000.00
Tax	990.00	1,890.00	2,790.00	900.00
Net Earnings	5,010.00	4,110.00	3,210.00	5,100.00

Furthermore, once a superannuation fund beings to pay a pension, the earnings attributable to that pension account are no longer taxed, further increasing the tax effectiveness of investing within superannuation.

Capital Gains Tax

Capital gains on investments within superannuation are also taxed at the concessional rate of 15%. Furthermore, the fund is entitled to a one-third discount if the investment is held for at least twelve months, bringing the tax rate down even further to 10%; 

Personal Name				Super
Tax Rate	16.5%	31.5%	45.5%	15%
Capital Gain	200,000.00	200,000.00	200,000.00	200,000.00
Discount	50%	50%	50%	33.33%
Taxable Gain	100,000.00	100,000.00	100,000.00	133,333.33
Tax	16,500.00	31,500.00	46,500.00	20,000.00
Net Gain	83,500.00	68,500.00	53,500.00	113,333.33

The exact amount of the tax saving is significantly increased when considering the compound-interest effect, that is, your savings will start to earn their own income over time.

2.    The Advantages of Sacrificing…

Salary sacrificed contributions are those contributions made by an employer on your behalf (in addition to the mandatory 9% Super Guarantee contributions), that are deducted from your before-tax wage.

These contributions are taxed at a rate of 15%, rather than your marginal tax rate. Therefore, like the previous example, the larger your marginal tax rate, the greater the benefit you can receive by making salary sacrificed contributions.

3.    Deductible Personal Contributions for the Self Employed…

If you are self employed, you may be able to claim a tax deduction for personal contributions made into superannuation.

To be classified as self employed, your income from employment (including any salary sacrificed contributions) needs to be less than 10% of your total assessable income.

4.    The Government Co-Contribution…

Low and middle income earners may be eligible for a government co-contribution if they have made non-concessional contributions during the financial year.

For the 2010 financial year, the co-contribution rate and thresholds are as follows;

Lower Income Threshold	Higher Income Threshold	Co-Contribution Entitlement
$31,920.00	$61,920.00	$1 for every $1, up to $1,000 (reduced by $0.033 cents for every dollar over $31,920)

N.B. For income threshold purposes, income is calculated as assessable income + reportable fringe benefits + reportable employer super contributions less business deductions.

5.    Tax Free Withdrawals from Superannuation Post-Age 60…

Upon reaching age 60, all withdrawals from a taxed superannuation account are entirely tax free.

6.    An Increasing Life Expectancy = A Need for More Superannuation…

As of 20 March 2010, the maximum weekly age pension is only $322.10 for single pensioners ($485.60 for a couple).

Therefore, many people will require a healthy superannuation balance in order to fund a comfortable retirement. For more detailed information, see “How much will you need to retire?” on page 2.  

7.    The Protection from Creditors…

Investments held within a superannuation funds may be protected from creditors, should a member become bankrupt. 

However please note, this protection does not apply if investments are purposely moved into superannuation upon a member becoming aware of their impending bankruptcy,

8.    Diversification of Assets & Borrowing Capabilities…

Having a self managed superannuation fund (“SMSF”) allows members to invest in a diverse range of assets such as residential & commercial property, artwork, shares, fixed interest, unit trusts and unlisted private companies.

In addition, SMSF’s can now borrow (via a limited-recourse loan) to invest; further increasing the investment opportunities within an SMSF.

9.    Life & TPD Insurance…

Premiums paid for a life insurance or total permanent disablement policy, held by a superannuation fund on behalf of a member, are able to be claimed as a tax deduction by the fund, further decreasing the effective tax rate paid by the fund. 

10.    The Estate Planning Benefits…

Last, but not least, superannuation provides a fantastic tax effective vehicle for estate planning purposes.

Furthermore, an SMSF can last well into perpetuity (unlike trusts which expire after 80 years) allowing the fund to be utilized by more than just one generation.

What you still need to keep in mind

• Super can not be accessed until a condition of release has been satisfied, for example, when a member has permanently retired post-preservation age. 
• Superannuation cannot be used as security when borrowing money
• There is a legislative risk involved, in that the government may change the rules in relation to superannuation, over time.

As previously mentioned, the current maximum weekly age pension is just $322.10 for single pensioners or $485.60 for a couple.

In addition, with life expectancies increasing, people are looking at a longer retirement, further increasing the need for a substantial super balance.

As a result, many people will be dependent upon their accumulated superannuation, in order to finance a comfortable retirement.

According to the Association of Superannuation Funds of Australia, a couple looking to comfortably retire (comfortable defined as the financial ability to participate in a range of recreational activities, purchase household items and take several holidays) will require $51,727 per year, or $995 per week – a figure well above that of the maximum age pension.

So how much super is enough?

Case Study One

Rob is 50 years old, earning $80,000 per annum, with $350,000 in superannuation. Rob wishes to receive $52,000 per annum upon retirement (at age 65).

In order to achieve this goal, Rob would need to salary sacrifice an extra $665/ month into superannuation, on top of the current $600/month in SG made by his employer. This would give Rob a superannuation balance of $780,000, allowing him to draw a pension of $52,000 per annum.

<see graph 1>

Case Study Two

Penny is 33 years old, earning $65,000 per annum, with $100,000 in superannuation. Penny wishes to receive $60,000 per annum upon retirement (at age 60).

In order to achieve this goal, Penny would need to salary sacrifice an extra $1,420/ month into superannuation, on top of the current $490/month in SG made by her employer. This would give Penny a superannuation balance of $1,011,000, allowing her to draw a pension of $60,000 per annum.

<see graph 2>

N.B. These case studies are for general informational purposes only and are based on several assumptions including taxation rates, life expectancy, inflation rates and rates of return. 

Henry Review

Ken Henry, appointed to review the Australian taxation system, has released his long awaited findings. A few of the Henry Review recommendations were adopted with the May 2010 Budget, with the expectation the government will adopt further recommendations in the near future. 

Superannuation Guarantee increase to 12%

The Henry Review has recommended a rolling increase to employer Superannuation Guarantee Contribution (SGC) over the next seven years. Starting in 2013 financial year, the SGC will increase from 9.25% to 12% by the 2019 financial year. The delay is designed for business to plan ahead and to factor in these increases in their staff salary packages.

Concessional Contribution Cap

The current Concessional Contribution Cap allows contributions up to $50,000 per annum for individuals over 50 years of age, reverting to $25,000 from July 2012, while individuals under 50, only have access to a Concessional Contribution Cap of $25,000.

The Henry Review has recommended to allow individuals over 50 years of age, with a superannuation balance under $500,000, the ability to contribute up to $50,000 per annum after July 2012.

Low Income Earners Government Contribution

From July 2012, the government will make superannuation contributions on behalf of individuals earning less than $37,000 per annum. The maximum contribution allowable will be $500 per year, which equates to the tax on the employer superannuation guarantee contributions. i.e. $37,000 x 9% = $3,330 x 15% = $500.

Raising Superannuation Guarantee Contribution age to 75

For employees over 70 years, employers are not required to pay superannuation guarantee contributions on their behalf, as they are considered exempt under SGC legislation. This recommendation raises the SGC age limit to 75 years from July 2013 as an incentive for mature aged workers to remain in the workforce.

Taxation Rate of Superannuation Funds

The Henry Review has recommended halving the tax rate on earnings for all superannuation funds, including those in accumulation and pension phase. The review recommends decreasing the taxation rate from 15% to 7.5%, including capital gains, while removing the capital gain discounts.

At this stage, the government has not adopted this recommendation put forward by the Henry Review.

This recommendation would benefit smaller and accumulating balances, while disadvantaging the retirement and transitional population by removing their tax free exemption.

Cooper Review

The review into superannuation, headed by Jeremy Cooper, has recently been released, with several significant recommendations for SMSFs.

Borrowing

In 2007 the superannuation legislation was amended to allow SMSF trustees to borrow if they met certain requirements. Commonly known as an ‘instalment warrant’, this allowed SMSFs to borrow to purchase assets to be held in trust for the SMSF.

The Cooper Review has proposed  a ‘wait and see’ approach to these borrowing rules, recommending a review in two years to ensure borrowing does not become a ‘significant focus’ of SMSFs.

SMSFs subject to the Superannuation Complaints Tribunal

The Cooper Review has recommended the Superannuation Complaints Tribunal (SCT), which is considered a cheaper and quicker tribunal for resolving superannuation related issues, to also allow SMSFs disputes to be heard.

Any SMSFs disputes are currently resolved in State Supreme Courts, which can be costly and take time to reach a resolution. With a significant amount of Australians having the bulk of their wealth in SMSFs, this move will allow more disputes resolved in a timely manner, including resolving SMSF death benefits complaints.

In-House Assets

An In-House Asset is a loan to or an investment in a related party of an SMSF. The current legislation allows a SMSF to have a maximum of 5% of the total fund balance invested in in-house assets.

The Cooper Review is recommending to remove this exemption entirely. Any SMSFs currently with an in-house asset investment will be required to resolve within 10 years.

Collectables (including artworks)

Seen as a concern for auditors of SMSF’s in the past, the Cooper Review had initially recommended no new acquisitions and eventual disposal of all collectable assets over the next five years. However the Gillard Government has announced that, if re-elected, they will allow SMSFs to continue investing in collectables including artwork if trustees comply with stringent guidelines.

When considering Estate Planning for your family, how often do you consider the consequences after you pass? Do you want all your assets paid to your estate? Or do you own specific assets you wish to pass onto individual beneficiaries?

Estate Planning is an area of detail which can assist in ensuring your wishes are followed through after your demise.

The process to pass on the assets of your estate begins with your will.

Your will is capable of disbursing personal investments to beneficiaries, such as:

• Cash
• Shares
• Real Property
• Interest in assets held as tenants in common

People are not as aware that superannuation is classified as a ‘non-estate asset’ in which the deceased cannot pass on their instructions via their will.

As more Australians investors are using Self Managed Superannuation Funds as their primary retirement vehicles, estate planning in superannuation funds need to be considered.

The distribution of superannuation assets is at the discretion of the superannuation fund trustees. As a member of the superannuation fund you can make an election, based on the trust deed, called a Binding Death Benefit Nomination (BDBN). This form indicates the members’ wishes as to the distribution of their superannuation interests.

A Binding Death Benefit Nomination can only be made to a member’s:

• Spouse
• Child
• Financial dependants, and/or
• Legal Personal Representatives (the executor of their estate)

A BDBN noted in most trust deeds may be sufficient if passing members’ benefits to their spouse, financially dependant child or to their estate, though they offer limited or no breakup of member components or specific assets.

An SMSF Will is a specially tailored Death Benefit Nomination which provides further scope to estate planning strategies. An SMSF Will can distribute certain assets to specific beneficiaries, allocate taxable and tax-free pensions to beneficiaries, and lump sum or pensions for financially dependant beneficiaries.

Taxable benefits distributed to a tax dependant (spouse or child under the age of 25) are tax-free. Taxable benefits paid to a non-dependant (such as a child over 25) will incur tax to the dependant at a rate of 16.5% on the taxable component.

Tax-free components distributed to dependants and non-dependants will be received in the hands of the beneficiaries tax-free. Therefore, the more tax free component in a members account, the more taxation savings to the beneficiaries of their superannuation interest.

We have included some examples to emphasise the value of strategic estate planning.

Example 1

Joe, aged 60, is a single member and sole director of Joe Smith Superannuation Fund.

Joe has two superannuation interests in his SMSF:

• A taxable pension - $200,000, and
• A tax-free pension - $200,000.

Joe’s wife passed away five years ago and he has two kids, Sally, 24 and Ben, 28.

Ben left home several years ago and has started his own family, while Sally still lives with Joe and is considered a financial dependant of Joe.

Using an SMSF Will, Joe could stream his superannuation benefits to his two kids equally without any taxation consequences.

The taxable pension or lump sum could be paid to Sally, as she is under 25 and as a tax dependant this payment would be tax-free, regardless of the component.

The tax-free pension could be passed to Ben. Ben would pay no tax on the benefits as the entire superannuation interest is tax-free.

Example 2

James and his wife Mary are directors of J C Pty Limited, trustee for JC Superannuation Fund. James, 65 and Mary, 55 have been married for 20 years.

James has two children from a previous marriage, Jason, 30 and Jess, 28.

James’ superannuation interests include:

• A taxable pension - $1,000,000,
• A tax-free pension - $500,000, segregated as listed shares, and
• A tax-free pension - $500,000, segregated to business real property.

James wants to ensure both Mary and his kids are taken care of when he passes away.

James and Jason are in business together, and their business premises is rented and owned by the JC Superannuation Fund. James wishes to pass on the business premises to Jason on his death.

James essentially would like to leave his superannuation benefits to his family as 50% to Mary, 25% to Jess and 25% to Jason.

If James had a Binding Death Benefit Nomination in his SMSF, with the above allocation of his superannuation benefits, his beneficiaries would receive the following:

• Mary – 50% of superannuation benefits - $1,000,000, on a pro rata basis
  • $500,000 from Taxable Pension
  • $250,000 from Tax Free Pension, segregated to Listed Shares
  • $250,000 from Tax Free Pension, segregated to Business Real Property

            As Mary is a tax dependent of James, she would receive the above benefits tax free.

• Jess – 25% of superannuation benefits - $500,000, on a pro rata basis
  • $250,000 from Taxable Pension
  • $125,000 from Tax Free Pension, segregated to Listed Shares
  • $125,000 from Tax Free Pension, segregated to Business Real Property

            Jess would be liable for tax on the Taxable Pension benefits at 16.5%, which would result in a tax bill of $41,250.

• Jason – 25% of superannuation benefits - $500,000, on a pro rata basis
  • $250,000 from Taxable Pension
  • $125,000 from Tax Free Pension, segregated to Listed Shares
  • $125,000 from Tax Free Pension, segregated to Business Real Property

            Jason would be liable for tax on the Taxable Pension benefits at 16.5%, which would result in a tax bill of $41,250. Jason would only receive a cash lump sum from James’ superannuation benefits, as the 
            property would need to be sold to fund the lump sums to the two children.

If James used an SMSF Will, he could request that his superannuation interests be distributed as follows:

• Taxable pension, paid as a reversionary tax-free pension, of $1,000,000 to Mary,
• Lump Sum payment of $500,000, from the tax-free pension, to Jess, and
• Transfer of Business Real Property, from tax-free pension, to James.

The above transactions would mean none of James’ dependants will have to pay tax on their benefits from James’ superannuation interests. Using the SMSF Will also allows James to ensure the Business Real Property is paid to Jason on his passing.