SELF-MANAGED SUPER FUND GUIDE 2017
Tax on concessional contributions
The concessional contribution cap
Chapter 4: Using a SMSF: Contributions
Money that is transferred into superannuation on behalf of a member is known as a ‘contribution.’ There are two types of contribution: ‘concessional’ and ‘non-concessional.’ Making a contribution into a self managed superannuation fund is generally quite simple.
Most SMSF’s make use of some form of bank account (which may be a cash management account or similar) and a deposit into this account is all that is required for a contribution to have taken place. The fund then needs to retain a record of what the contribution was and to whom it related.
The remainder of this section has been reproduced from our previous e-book on superannuation generally.
Concessional contributions are ‘before tax’ contributions. This means that they are made using income that is yet to be taxed. They include employer contributions (also known as ‘super guarantee contributions’ or SGC), salary sacrifice contributions and any other contributions which a member has effectively claimed a tax deduction for.
The term ‘before-tax’ means that the member does not pay tax on the contributions before they are sent to the super fund. Once contributions arrive in a fund, they are generally taxed at 15%. The fund pays this tax, and the member’s balance within the fund is reduced accordingly. Contributions on behalf of high income earners who have an adjusted taxable income in excess of $250,000 per annum are taxed at a higher rate of 30%. This limit fell from $300,000 to $250,000 on 1 July 2017.
TAX ON CONCESSIONAL CONTRIBUTIONS
As stated above, concessional contributions are taxed at 15% in the hands of the superannuation fund. The fund pays this tax directly to the Australian Tax Office (‘ATO’).
To illustrate how this all works, think of an employee earning $70,000 a year. Under the superannuation guarantee rules, her employer must make a contribution worth 9.5% of her salary into super. 9.5% of $70,000 is $6,650. The employer pays this full amount directly into the employee’s super fund.
Superannuation is treated differently to the $70,000 of salary paid to the employee. For the employee’s salary, the employer must deduct the employee’s tax payments from the gross salary and send it to the ATO. The employer only gives the employee the after-tax amount. So, for salary, the employer pays the money to 2 places: the employee and the ATO.
The standard tax paid on $70,000 per year is approximately $14,300 before personal deductions. This means that the employee receives $55,700 and the ATO receives $14,300.
For superannuation contributions, the employer does not withhold tax. Instead, the employer pays the full amount of the contribution into the superannuation fund and the superannuation fund pays tax to the government. The employer only pays money to one place: the superannuation fund.
In the case of an employee on a salary of $70,000, the employer must contribute $6650 directly to the fund. Having received the money, the fund must then pay tax of 15% ($998) directly to the ATO. This leaves $5652 in the employee’s superannuation account.
Concessional contributions are taxed at a flat rate of 15%. This is less than the amount of tax that the employee on $70,000 a year would have paid had she received the extra $6,650 as salary. On a salary of $70,000, an employee’s personal marginal tax rate is 32%. So, had an employee received $6650 a salary, she would have paid $2,128 in tax. So, she would only have received $4,522 after tax.
Of the $6,650, the super fund is left with $5,652 after tax. The employee would only have been left with $4,522 after tax had she received the money as taxable income. So, in return for the money being locked up within superannuation until later in her life, the employee gets an additional $1,130.
The employer claims a tax deduction for both the $70,000 of salary paid and the $6,650 of super contributions paid.
Once an Australian tax payer has taxable income above $20,000, their marginal income tax rate is at least 19%. This means that the tax rate applicable within superannuation is less than a person’s marginal income tax rate in most cases. This in turn means that most people end up with a larger amount in super than they would have if they received the amount as taxable income.
The lower tax rate within super is designed to do two things. Firstly, it encourages people to use superannuation – they end up with more money if they do so. Secondly, as we will discuss below, investment earnings within super are also taxed at a lower rate. This means that people start with more in super and then get to keep more of the investment earnings that their super creates.
The superannuation guarantee rules oblige most employers to contribute an amount equal to 9.5% of an employee’s wages or salary into superannuation. Usually, an employee can choose to direct that some more of their salary or wages be contributed into super as an extra contribution on their behalf. This is known as a ‘salary sacrifice.’
The logic of salary sacrifice is simple. If a person has taxable income greater than $20,000, their marginal income tax rate will be at least 19%. That means that for every dollar of salary or wages that they earn, they receive no more than $.81. If, instead of receiving that dollar as wages or salary, the employee receives the dollar into their superannuation fund, the fund and the pays tax of 15%. This means that the employee is left with $.85 within the superannuation fund.
Personal marginal income tax rates increase as income increases. For example, once a person’s taxable income has reached $37,000, their marginal income tax rate becomes 32%. This means they only get to keep $.68 for each dollar that they earn above $37,000. Once taxable income goes over $87,000, the marginal tax rate increases to 37%, meaning people only get to keep $.63 of every dollar they earn, etc. The full list of rates for the 2017-2018 tax year are as follows:
As can be seen, the financial benefit of salary sacrifice increases as taxable income increases.
As discussed below, the total concessional contributions that a person can have in a given year is capped at $25,000. Therefore, the amount that can be salary sacrificed is limited to $25,000 less any amount being paid into super as a superannuation guarantee. A person who receives a superannuation guarantee contribution of $10,000, for example, can only sacrifice an additional $15,000 of income into superannuation.
As of 1 July 2017, members of super funds can claim a tax deduction for contributions that they pay directly into a superannuation fund, provided they flag their intention to do so with the recipient fund. Contributions made by the member himself or herself are known as ‘personal contributions.’ Personal contributions can be made up to the age of 74.
As discussed in the next section, a person can only make personal contributions such that their total concessional contributions do not exceed $25,000 in a given year.
THE CONCESSIONAL CONTRIBUTIONS CAP
The tax advantage for concessional contributions is a ‘limited offer.’ As of 1 July 2017, concessional contributions are subject to an annual cap of $25,000. This is a reduction from the annual cap that applied prior to that date ($35,000 per year for members aged 50 or older, and $30,000 per year for members aged under 50).
Contributions in excess of these caps will be taxed at the member’s marginal tax rate and included in the member’s non-concessional cap (see below), unless the member elects to withdraw the excess funds. The member can elect to withdraw up to 85% of the excess funds.
People with superannuation balances below $500,000 will effectively be able to average this annual contribution out over a five year period. This means that if a member makes a contribution in one year of, say, $10,000, then he or she can make a concessional contribution in the second year of $40,000, such that the average across the two years is $25,000 per year.
Basically, the cap becomes $125,000 over five years, but the average level of contribution cannot exceed $25,000 during the five year period. (That is, you can ‘catch up’ in later years but you cannot ‘pay more in advance’ in the earlier years).
You may have heard the term ‘contribution splitting.’ A member is permitted to split certain contributions between themselves and their spouse. They do this by transferring the contributions they have made from their super account to their spouse’s account. This rule recognises that (generally) female spouses have restricted work patterns compared to male spouses. Women often take time off work to have children and raise their family, which prevents them from accumulating significant funds in their super account. This concession is designed to recognise and address this imbalance.
The rules allow for up to 85% of a concessional contribution (that is, the amount that is left after tax) made in the previous financial year to be transferred to the spouse’s account. The funds that are transferred to the spouse are treated as a ‘rollover’ and not as a contribution, and so they do not get taxed again in the hands of the recipient.
As the funds were initially a concessional contribution, the funds will be an entirely taxable component and form a part of the recipient spouse’s taxed element in their fund.
While splitting was first introduced to allow for a non or low-earning spouse to effectively be superannuated, it is often used for more pragmatic reasons. There is no rule that benefits need to flow in a particular way (for example, from the member with a higher balance to a member with a lower balance). So, one common strategy is for a younger partner to split his or her contributions to an older spouse. The benefit here is that the money will generally become available sooner by doing this.
An alternative is to split contributions in such a way as to maximise Centrelink entitlements. This might mean deliberately minimising the super balance of one or the other spouse – usually the older spouse who is likely to seek Centrelink benefits sooner.
NON - CONCESSIONAL CONTRIBUTIONS
Non-concessional contributions are ‘after-tax’ contributions which a member can elect to pay into their superannuation fund. These contributions are not taxed going into the super fund, and they form part of what is known as the ‘tax free element’ within the fund. Members do not receive a tax deduction for making these contributions.
The idea is that the money used to make the contribution has either already been taxed or would not be subject to tax outside of super, and that it would therefore be unfair to impose a tax within the super fund.
For example, a person may receive a lump sum as an inheritance. That lump sum is ‘after tax’ as any tax was paid by the estate. They wish to invest that money in the most tax effective manner, and so they contribute the lump sum into their superannuation fund as a non-concessional contribution. Once the monies are within superannuation, earnings are taxed at no more than 15% (falling to 10% on capital gains for assets held for longer than 12 months).
The existence of non-concessional contributions encourages people to put money into super. This is seen as good social policy, as the greater a person’s personal wealth, the less likely they are to rely on Social Security payments in their old age.
The amount that people can contribute as a non-concessional contribution is capped. Post 1 July 2017, the annual cap is $100,000 per year. Because concessional contributions are often made using lump sums, the rules actually allow people to bring forward the next two years, such that $300,000 can be contributed at any time in a given three-year period.
Non-concessional contributions can be made up to the age of 75. After the age of 65, a person must meet the work test. A person aged 65-74 cannot access the bring forward facility.
Non-concessional contributions cannot be made where total superannuation benefits exceed $1.6 million. This means that people with balances close to $1.6 million need to take care that making a non-concessional contribution will not cause their benefits to exceed $1.6 million.
Contributions that exceed the allowable cap will be taxed at the current highest marginal tax rate of 49%, and earnings on the excess contributions will be taxed at the member’s marginal tax rate. The trustee of the fund is required to return the excess contributions to the member.
In the 2017 budget, Treasurer Scott Morrison announced a change to the non-concessional contribution rules to take effect from 1 July 2018. This change will allow people aged over 65 who sell their family home to make an additional non-concessional contribution worth up to $300,000 per person (meaning $600,000 per couple if there is a couple). This measure is aimed at encouraging people to downsize the family home. It is hoped that this will improve supply conditions in the housing market, which should reduce upward pressure on house prices.
This measure effectively allows older Australians to swap part of the tax-free investment that their house represents for a tax-free investment within their superannuation. The measure will only benefit people in very limited circumstances, so we encourage you to contact us if you are contemplating downsizing the family home.