A new client couple have recently sought advice on structuring their investment and superannuation portfolios. They were able to make a lump sum contribution into super and then roll this over into their pension portfolio. The common instinctive response would be to agree with this approach as you would be moving assets from an environment where you would be taxed at marginal tax rates into an environment where all income earned by those assets would be received tax free.
This is particularly pertinent for some as they hold shares and / or managed funds which are sitting on capital losses. To transfer assets from your own name into a superannuation / pension account is deemed to be a change of ownership and thus a capital gains event. Transferring these assets into superannuation and then pension mode whle they are sitting on capital losses may therefore be be a worthwhile move.
However, there are also higher levels of fees payable once in super pension mode so there are extra costs that need to be weighed up and if there are no tax benefits from making this move you might actually be worse off.
A key in making the decison is the Senior Australians Tax Offset (SATO).
How does SATO work?
The government provides senior Australians with a tax rebate. For the 2008-09 year it is $1,602 for each member of a couple.
Seniors are also eligible for the Low Income Tax Offset (LITO) of $1,200.
So basically what this means is that seniors can each earn up to $24,680 per annum (2008-09) each and not pay any tax or lose any franking credit benefits. (For a single the amount would be $28,867)
The Low Income Tax Offset is rising to $1,350 for the current year (2009-10) and $1,500 for 2010-11. If SATO remains at $1,602 then the maximum amount of taxable income you can each earn before paying any tax will be:
2009-10 - $25,680
2010-11 - $26,680
Implications of SATO
The implication of this is that seniors relying on their assets to produce their retirement income can earn up to $25,680 of income in the current financial year before paying any tax. Therefore you can hold assets outside of a superannuation pension that earn this level of income before you would lose anything from not transferring these assets into super and then pension mode.
If we estimated that the average income being produced by a portfolio was 5% this could see you holding up to as much as $500,000 of assets per person before having any tax to pay.
What about franking credits?
The couple I spoke to thought they were not paying any tax as they always received a tax refund from the government. However, care needs to be taken that you are not losing some of the benefits of the franking credits that are receivable from owning shares.
Let's use an example. Say you were paid dividend income of $25,000 in a financial year and all of those dividends were fully franked. When it came time to declaring your income you would actually have $25,000 of income plus $12,700 of franking credits. Your taxable income would be $37,700. What would happen is that you would lose some of those franking credits in tax. So rather than receiving the full $12,700 of franking credits as a refund from the ATO you would lose around $1,900 in tax.
If held within a superannuation pension you would receive back all of the franking credits in full.
Capital Gains Tax
This simple explanation does not factor in capital gains tax implications. If you thought you would sell some of your investments before they were passed on to your estate, and through doing so realise a capital gain then you would need to leave some room to move to allow you to have some capital gains each year and still not pay any tax.
The exact breakdown of how much you could ideally hold in investments outside of super is particular to each individual or couple and should take into account likely income to be produced by these assets and investment philosophy, in particular whether you think you will be realising capital gains through retirement years.