For many years, superannuation has provided significant tax benefits for retirees. However, recent changes in legislation limit the amount that can be placed into super, and investment returns may not be as good as in the past. As a result, future generations are likely to pay more tax in retirement as they will hold more of their wealth outside super.
This problem can only be minimised with long-term planning.
What is the problem the next generation is likely to face?
So, while the $1.6 million TSB may be a concern of many retirees of the current generation, it will not be a concern for the next as many will not get even close to this level.
Helping a child make a concessional (tax-deductible) contribution
There are many different views on whether parents who have excess money available to help their children should do so – this is a very personal family decision. If the parents decide they would like to help their children in this way, the children’s tax position needs to be considered and as such, superannuation should be a factor.
The major benefit received from making tax deductible superannuation contributions is the compounding effect of paying a lower tax rate. This can be shown by a simple example.
Bryce is 40 years old and earns $100,000 a year. His employer contributes the minimum required superannuation guarantee (SGC) of 9.5% or $9,500. Including the SGC, he is entitled to make a deductible contribution of $25,000 but does not have the financial resources to use his full limit.
He expects to retire at age 65. His mother would like to help Bryce build some wealth in a tax-effective way. Note that:
So, there is a 24% tax saving by Bryce’s mother adding funds to his super. As shown in the graph below, the long-term effect of this tax saving is substantial. Assuming future earnings are taxed at 15% inside super, compared to 39% outside and the investment return is 7%, the net value of this $10,000 will be worth over double if held inside super compared with outside. Bryce will also have a lot more money in his super at 65 resulting in a more tax-effective retirement.
Helping a child to make non-concessional (after-tax) contributions
Given that there is no initial tax deduction, lending money to a child to make a non-concessional contribution is not as beneficial in the short term. However, in our experience, it is still worth considering by individuals or families with significant wealth. For example, an individual who is Age 75 with children who are Age 50 may take the opportunity to add to their child’s super progressively knowing that they may otherwise be left with considerable funds outside superannuation when they receive an inheritance.
It is becoming increasingly difficult to maximise the benefits of superannuation. More thought needs to be put into not only how much wealth is transferred to the next generation but also how it is transferred.
A strategy like this may have significant tax, family and estate planning consequences. As a result, it should not be entered into without first receiving both financial and legal advice.
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