Automating the process
Chapter 6 - Self - employment and super
If you are self-employed you should take special care with your superannuation. You should also read this piece of research produced by the Australian Super Funds Association (‘ASFA’). (Clicking this link will cause an article to download).
In 2012, ASFA found that 25% of self-employed people had no super at all!
For self-employed people, super is simply too easy to overlook. Superannuation is not compulsory for self-employed people (it is compulsory that they pay it on behalf of their employees – but not themselves), which means that many businesses prefer instead to use all cash generated from their business to meet the expenses of the business and their day-to-day financial needs. Superannuation becomes something they will attend to ‘next year.’
Too many small business owners consider the business itself to be ‘our super.’ This is a mistake and can seriously compromise wealth creation and the retirement lifestyle of these business owners.
Superannuation can be especially useful for self-employed people. There are various reasons for this, and some of the more substantial reasons are discussed below.
The tax advantaged nature of superannuation is not unique to self-employed people. But it is something that all self-employed people should be aware of. Basically, taxable income that is contributed into superannuation typically reduces the amount of wealth lost to tax on that income.
For example, a self-employed person any business profits of $80,000 a year faces a marginal income tax rate of 30%, and a Medicare levy of 2%. If a self-employed person decides to contribute $10,000 into superannuation, then her after-tax income falls by just $6800 ($10,000 -32%). Within a superannuation fund, the $10,000 is taxed at just 15%, leaving her with benefits worth $8500. So, the member gives up $6800 worth of immediate spending power but acquires an asset worth $8500. That is the equivalent of an immediate investment return of 25% on the $6800.
If the individual’s marginal tax rate is higher, then the equivalent investment return is also a higher.
Benefits held within superannuation fund are often beyond the reach of creditors in the event that the self-employed person becomes unable to pay their business debts. If there is any threat of litigation against a business owner, this can be a real benefit to the member.
There are some caveats here. Superannuation is not allowed to be misused as a way of simply avoiding liabilities. The courts can ‘undo’ amounts that have been transferred into superannuation with the specific intention of avoiding a liability to repay debts. This is why a regular, systematic use of superannuation as a means of accumulating wealth makes even more sense – rather than making a huge contribution just before your business goes bust.
Often, superannuation benefits can be managed as a way of complementing other parts of a financial plan. There are various ways in which this can happen.
One way is for a self managed superannuation fund to be used to purchase business premises from which a business is run. Generally, assets held within superannuation cannot be used for personal purposes. However, if a self managed superannuation fund purchases premises and then leases those premises to the business for an arm’s-length rent, this is generally okay.
There are a number of benefits here. One is that the business owner can take effective control of both sides of the tenancy: their superannuation fund is the landlord and their business is the tenant. The second is a business premises can often be wonderful investments in their own right, and this can be especially the case where there is a long term secure and profitable tenant in place.
Thirdly, given that the amount of concessional contributions that can be made into superannuation are limited each year, paying rent to a self managed super fund is another way of increasing the income of that fund. That said, business owners need to take care that the amount of rent paid to a self managed superannuation fund as a landlord is no more than would be paid to any other landlord who owned a similar building. You simply cannot use the investment as a way of getting extra money into super.
Fourthly, while the rent is deductible to the business at the effective marginal income tax rate of the business owner, the rent is only taxable in the hands of the superannuation fund at the superannuation tax rate of 15%. Usually, this results in a net tax saving.
AUTOMATING THE PROCESS
Over the years, we have learned that human nature tends to put things off until tomorrow – and it does this every day! For that reason, many business owners find themselves in late June, scratching around to find some cash to deposit into a superannuation fund before 30 June. This is not the best way to go.
A much better way to go is to automate a process by which one 12th your budgeted annual contributions are paid into your superannuation fund each month. This can often be done using a simple direct debit mechanism, and allows you ‘to set and forget’ your superannuation contributions.
Setting and forgetting is much better than the alternative: simply forgetting! If you think this would suit you, then get in touch and we will show you how.