Federal Budget Super Changes: Impacts, Opportunities & Actions

On 3 May 2016, the Government handed down what is arguably the most significant Federal Budget since 2007 for our clients. If implemented, the proposals are far reaching in their potential impact on the retirement and planning strategies of many Australians.

We are finding that of most concern at this point in time is the:

• the retrospective nature of the proposed lifetime NCC cap,
• the retrospective nature of the proposed $1.6 million cap on how much individuals can transfer into retirement accounts ,and
• the many ‘unknowns’ in relation to the finer details of each proposal, in particular the way in which the penalty regimes will be administered.

Given the level of uncertainty and the potential consequences where mistakes are made, all investors need to be particularly careful with advice awaiting implementation, as well as any future strategies being considered.

It’s worth re-iterating that these changes are proposals only and may or may not be made law. We would therefore caution against doing anything impulsive or fundamentally shifting strategies.

Despite the changes super will still be the best place to save for retirement for the majority of Australians and there will still be scope to accumulate large balances in their superannuation funds

From Calibre Private Wealth Advisers’ perspective, the recent announcements have created some clear opportunities for clients and/or others who may be seeking advice

Opportunities between now and 1 July 2017 include:

• maximising concessional contributions ($30,000/$35,000 depending on age)
• revisiting and re-evaluating existing transition to retirement (TTR) strategies
• reviewing existing Account Based Pension balances and appropriateness of the fund and product.

Opportunities from 1 July 2017 (assuming passage of legislation) include:

• the ability for clients aged 65-74 who do not meet the work test, to make non-concessional contributions (NCCs)
• the potential broader ability to contribute to super utilising the Small Business CGT concessions and associated CGT cap
• connecting with clients to reinforce the fact that for most people, superannuation remains to be a tax-effective savings vehicle when compared to investing outside super
• considering the appropriateness of, and ability to implement contributions splitting
• the ability to potentially plan a ‘concessional contributions’ schedule, to maximise the benefit of the ‘catch up’ CC regime, and to manage tax in an effective manner.

Concessional Contributions

The concessional contribution (CC) cap will be reduced to $25,000 pa regardless of age. The higher cap that currently applies to individuals aged 49 or over on 30 June of the previous financial year, will no longer apply.

The drop in the cap to $25,000 will limit the contributions that attract concessional tax treatment and may limit the amount of additional voluntary employer contributions, personal deductible contributions and salary sacrifice.

The existing CC caps for 2015/16 are:

Opportunities, impacts and actions

Clients who have the capacity to fully utilise the current CC cap for 2015/16 and 2016/17 may wish to consider doing so before the CC cap reduces.

There may be a need to reconsider a client’s existing TTR strategy to avoid breaching the CC cap.

Clients currently maximising the higher cap will need to reconsider their contribution strategy, including the need to revisit salary sacrifice arrangements, and may need to provide updated contribution information to employer

The introduction of a ‘catch up’ regime may, however, provide an increased capacity for some to make additional CCs above the annual $25,000 limit in future financial years. This measure is limited to individuals with aggregated super balances of less than $500,000

These changes will allow individuals to make additional or ‘catch-up’ contributions, assuming they have financial capacity.

These opportunities may arise due to broken work patterns as a result of maternity or paternity leave, or a focus on other financial priorities in earlier years, which result in unused cap amounts.

When considered in light of the proposals that allow individuals aged under 75 to claim deductions for personal contributions regardless of employment status (see below), this new measure may also provide a timing and forward planning strategic advantage.

The timing of contributions can be planned, allowing for larger deductible contributions to be made in years of higher income (e.g. when capital gains are realisation, or higher income from distributions from trusts or other passively earned income is received).

Extra 15% contributions tax (Division 293)

The income threshold above which an additional 15% tax is payable on CCs will be reduced from $300,000 to $250,000.

The lower threshold will also apply to members of defined benefit schemes and constitutionally protected funds covered by the tax. Existing exemptions that currently apply (in respect of Judges and certain State office holders) will be maintained.

CCs made within the caps, such as employer contributions, salary sacrifice contributions or personal contributions for which a personal tax deduction is claimed, are ordinarily taxed at 15% in superannuation.

However, since 1 July 2012, certain high income earners have also incurred an additional 15% tax on CCs. This is commonly referred to as ‘Division 293 tax’.

The additional tax is levied on the individual personally. It can be paid out of the client’s cash reserves or by completing a release authority to have an amount released from their super fund.

Work test abolished

What do we know?

Currently an individual who is aged 65 or over at the time a contribution is made, must have satisfied a work test in that financial year, for a fund to be able to accept a contribution. This work test will be abolished.

The ability to make spouse contributions will also be extended to age 74. Again, no work test will be required to be satisfied by the receiving spouse. Currently, spouse contributions cannot be made for individuals aged 70 or over and the work test must be satisfied from age 65 to 69.

What don’t we know?

It’s unclear whether this measure will impact ‘contributions splitting’ arrangements between spouses, specifically where the receiving spouse has reached preservation age and has retired.

Currently, these individuals cannot receive contribution splits. Legislation requires that such individuals have not ‘retired’ rather than requiring them to have met a ‘work test’, so it may be the case that current rules relating to these arrangements will be unchanged.

Opportunities, impacts and actions

This change obviously provides greater opportunities to make super contributions for older clients.

For example (subject to the lifetime NCC cap), it may now provide older clients who are downsizing or disposing of assets, the ability to contribute sale proceeds in to super.

It will also provide individuals aged over 65 the ability to make contributions to super under the CGT Cap.Currently they would be unable to do so if a work test had not been met.

This may be of particular benefit when sale proceeds are lagged.

The changes may also enable a person who is 65 or over, and eligible to make a contribution to super under the Personal Injury Payment or structured settlement provisions, to make a contribution.

Personal deductible contributions

What do we know?

All individuals under age 75 will be able to claim a tax deduction for personal superannuation contributions, regardless of employment status.

Currently, only self-employed individuals (e.g. sole traders) or those who derive less than 10% of total income from employment sources, are eligible to claim a tax deduction.

There was no indication that the steps to claiming a deduction would change, such as the rules that relate to the lodging the Notice of Intent form.

Opportunities, impacts and actions

Care should be taken to avoid breaching the CC cap which will be lowered to $25,000.

On the other hand, there may be an opportunity for certain individuals who do not utilise their annual CC cap in full from 1 July 2017 to make additional ‘catch-up’ contributions.

This may provide a planning advantage whereby larger deductible contributions may be made in years of higher income, by making a conscious decision to hold off on making concessional contributions in an earlier financial year (if possible), and carrying forward unused CC cap amounts under the catch up provisions.

Pension “transfer balance cap “

A $1.6 million lifetime ‘transfer cap balance’ will be introduced for superannuation pensions. The cap will limit the total amount that a person can use to start pensions in their lifetime.

While the measure is called the ‘transfer balance cap’ it is important to understand that the $1.6m cap relates to the total value of the amount of transfers of accumulation interests to a ‘retirement phase account’ over a person’s lifetime. It is not a ‘cap’ on pension account balances at a given point in time (see ‘What don’t we know’ below for further considerations on this point).

Earnings on the amount in pension phase within the cap will not be constrained by the cap, however, and will continue to be taxed at 0%.

This means that if a person exhausts their transfer balance cap, but their ‘retirement phase’ account balance subsequently grows due to earnings on investments, and the balance is taken over the cap, the person will be able to retain their interest.

Amounts accumulated in super in excess of $1.6 million will need to remain in the accumulation phase (or may be withdrawn subject to meeting a full condition of release) and will continue to have earnings taxed at the concessional rate 0f 15%.

The cap will index in $100,000 increments in line with the Consumer Price Index.

What if a client is already in pension phase?

Individuals already in pension phase with balances above $1.6 million will be required to reduce their aggregate ‘retirement phase’ balances to no more than $1.6 million by 1 July 2017. That is, there is no grandfathering of existing pensions.

Tax penalties will apply if subsequent amounts are transferred in excess of the $1.6 million cap (including penalty tax to earnings on the excess transferred – see ‘What don’t we know’ below for more information).

What if a person’s pension balance falls below $1.6m at some point in the future?

If a person has not previously maximised the cap, they may be able to make additional transfers into pension phase. In the event that the cap is indexed, a person’s remaining ‘cap space’ will be determined proportionately. This is best demonstrated with an example.

Example:

Mary transfers $1.6m from her accumulation account in to an account based pension. At that time, the transfer cap is $1.6m. She maintains additional amounts in her accumulation account.

Mary has used 100% of her available transfer cap and, even if her account balance subsequently decreases, she is unable to make additional transfers to pension.

Clare, on the other hand, transfers $800,000 into a retirement phase account. Clare has therefore used 50% of her existing balance transfer cap.

If the cap is subsequently indexed to $1.7m, the way in which her ‘remaining balance transfer cap’ will be determined is as follows:

$1.6m – previous transfers + [Percentage of previous cap used to date x dollar uplift in cap (indexation)]

That is, for the purpose of the example:

$1.6m – $800,000 + [50% x $100,000]

=$850,000.

What if a person makes excess transfers post 1 July 2017?

Both the Superannuation Q&A Factsheet and the Superannuation Fact Sheet 02 provide commentary on what the outcome will be for people that breach the transfer cap.

The excess must be removed from the account, which may be via a partial commutation back to accumulation phase. It has been noted that individuals will be subject to tax on both the transfers in excess of the cap, and the earnings on excess amounts (see ‘What don’t we know’ below for more information).

What don’t we know?

Amounts which are counted towards the cap are those which have been transferred to ‘retirement phase’.

It is unclear exactly what types of income streams and retirement products this measure will capture. Obviously there are additional complexities which may arise if a person has a product which has restrictions in relation to commutations, such as a DB pension, or other non-commutable income streams.

The penalty regime

While the exact nature of the penalty tax regime is unclear, it is proposed to be similar to the tax that applies when there is a breach of the NCC cap under the current rules.

We cannot be sure exactly what this means at the current time, given the suggestion was the both the excess amount transferred and associated earnings may be subject to tax.

Currently, if an election is made to withdraw the excess NCC and associated earnings, the associated earnings are included in a person’s assessable income and taxed at the person’s marginal tax rate. If this election is not made, the entire excess NCC is subject to tax at the top MTR (currently 49%).

Opportunities, impacts and actions

It is important not to lose sight of the fact that super continues to be a tax effective structure as earnings that must remain in accumulation are taxed at up to15% compared to a client’s MTR, which may be greater.

Clients are still able to make lump sum withdrawals when required.

For client’s with existing account based pensions in SMSF’s with pension account balances in excess of $1.6m, there may be a requirement for these client’s to seek tax advice from their registered tax agent; specifically those clients who have segregated pension assets (particularly those with large assets in pension phase).

Broadly, this is because a segregated asset cannot exceed the value of the pension account balance (that is, a segregated asset cannot partially support both a pension and accumulation interest).

Transition to retirement

What do we know?

Once an individual reaches their preservation age, they are able to access their preserved superannuation as a ‘non-commutable income stream’, known as a transition to retirement (TTR) pension. Currently earnings on any amounts in pension phase are taxed at 0%.

From 1 July 2017, the tax on earnings will increase to a maximum of 15% while the income stream is deemed to be a TTR pension. There will be no grandfathering provisions, which means that tax will apply regardless of when the TTR pension was commenced.

Further to this measure, the ability for individuals to treat certain pension payments as a lump sum will be abolished. This follows recent industry discussion and ATO commentary that indicates an ability to elect for pension payments to be taxed as lump sums and access the $195,000 ‘low rate cap’.

What don’t we know?

It’s unclear whether the 0% tax on earnings will apply once a full condition of release has been satisfied or the pension must stop and a new pension be commenced (subject to the transfer cap balance).

Although it was not explicitly addressed, it is also expected that in line with the proposed changes, this would mean that Capital Gains Tax would also apply to gains within pension phase, at up to 15%

Opportunities, impacts and actions

Investors will need to revisit TTR strategies in light of the:

• taxation of earnings
• introduction of the transfer balance cap
• reduction in the CC cap, and
• introduction of the ‘catch up’ cc regime

The measures may reduce the future opportunity set for this strategy. We will explore these issues further and provide additional insights shortly.

Further, there may be an opportunity to review a client’s circumstances, to confirm whether since their existing TTR pension was commenced, whether a full condition of release has subsequently been met (for example, after turning age 60, an employment arrangement has ceased).

In this case, you may wish to communicate this to the client’s superannuation fund, which may provide favourable tax outcomes.

NCC changes

What do we know?

A lifetime non-concessional contribution (NCC) cap of $500,000 will apply to Australians up to age 74 from 7.30pm, 3 May 2016.

All NCCs made on or after 1 July 2007 will count towards a person’s lifetime NCC cap. This effectively means that for many clients they may not be able to make further NCCs after the Budget announcement.

Any contributions above the $500,000 cap made after commencement will be subject to penalty tax if they are not withdrawn.

NCCs made prior to commencement cannot result in an excess and can remain in the fund. However, a person who has already contributed greater than their lifetime cap will not be able to make subsequent NCCs without attracting penalty tax.

These measures will replace the annual NCC cap, which is currently $180,000, as well as the ‘bring-forward’ rule, which allows individuals aged under 65 on 1 July of a financial year to potentially contribute up to $540,000.

These measures will decouple the NCC cap from being a multiple of the CC cap.This lifetime NCC cap will be indexed to AWOTE.

Any contributions above the $500,000 cap made after commencement, as well as ‘associated earnings’ on these amounts, may be withdrawn. If these amounts are withdrawn, the associated earnings will be taxed at the MTR.

If excess contributions and associated earnings are not withdrawn, that will subject to penalty tax. Superannuation Fact Sheet 4 indicates that these arrangements would mirror the existing regime (i.e. if not withdrawn, tax will apply at the top MTR).

The lifetime cap will include NCCs made into defined benefit accounts and constitutionally protected funds.

What we don’t know? Tracking lifetime contributions

If these changes are legislated, it will obviously be of significant importance to know exactly what NCC’s a person has made to super from 1 July 2007, prior to making any future contributions.

The way in which a person or adviser can ‘track’ a person’s remaining lifetime NCC cap is another issue that will need to be worked through.

It has been announced that the ATO will be updating the online display of superannuation accounts through the MyGov website to include an individual’s lifetime NCC balance.

There is no indication that this system is readily available, nor is there any understanding of the frequency with which the information displayed will be updated. There may be a lag in updating information due to the timing of fund reporting.

Opportunities, impacts and actions

As the lifetime NCC cap includes NCCs made since 1 July 2007, it may prevent some clients from making additional contributions. This would include clients who have undertaken the recontribution strategy.

This also means that any future recontribution strategy must be carefully considered before implementation.

Any unimplemented advice to undertake a recontribution strategy will need to be reviewed and revisited, to ensure that advice is not implemented that would cause a client to breach their lifetime NCC cap.

In the absence of any existing and available ‘NCC register’, obtaining an accurate indication of a client’s total NCC’s since 1 July 2007 may be problematic.

Contacting existing and previous funds, reviewing historical statements, and having discussions with clients may all be options.

Problems may arise however where accounts have been closed, pensions have been started, funds no longer have contributions history readily available, or client’s only recall large contributions.

It is important to identify all NCCs, regardless of size, such as:

• spouse contributions
• excess concessional contributions that remain in super, and
• the $1,000 NCC made to trigger payment of the Government co-contribution.

Disclaimer

Any advice in this article is of a general nature only and has not been tailored to your personal circumstances.  Accordingly, reliance should not be placed by anyone on this information as the basis for making any investment, financial or other decision. Investors should, before acting on this information, consider the appropriateness of this information having regard to their personal objectives, financial situation or needs. We recommend investors obtain financial advice specific to their situation before making any financial, investment or insurance decision.

Information in this Federal Budget Super Changes extract is current as at 11^th May 2016 and is based on information received in good faith from third party sources, and on our understanding of legislation and Government press releases at the date of publication. While it is believed the information is accurate and reliable, the accuracy and completeness of that information is not guaranteed in any way. Opinions constitute our judgement at the time of issue and are subject to change. Neither Calibre Private Wealth Advisers or their employees or directors give any warranty of accuracy, nor accept any responsibility for errors or omissions in this Federal Budget Analysis extract.

Any general tax information provided in this Federal Budget Super Changes extract is intended as a guide only and is based on our general understanding of taxation laws. It is not intended to be a substitute for specialised taxation advice or an assessment of your liabilities, obligations or claim entitlements that arise, or could arise, under taxation law, and we recommend you consult with a registered tax agent.