Time to look beyond super
May 13, 2009
PORTFOLIO POINT: New restrictions on super will prompt investors to pursue strategies outside superannuation.
Suddenly it is harder than ever to get money into superannuation. While it remains a powerful, tax-effective savings environment, the difficulty of contributing large amounts of money, and the possibility of access to superannuation being restricted until age pension age, means that more people will be forced to turn their investment strategies away from superannuation towards alternatives.
The key changes that investors need to be aware of in the budget include the restriction of tax-deductible contributions to superannuation, the reduced government superannuation co-contributions, the increased pension age (which will affect anyone under 50 years of age) and the increased age pension rates.
From July 1, the maximum tax-deductible contribution to superannuation is $25,000 a year for people under 50, and $50,000 a year for those over 50 up to the 2010-11. (These people previously were allowed to make $100,000 tax deductible contributions).
For an employed person, tax deductible contributions include the compulsory employer contributions that they receive (these are tax-deductible to the employer) and any salary sacrifice contributions.
For the self-employed, tax-deductible contributions refer to the contributions that they make and then claim a tax deduction for.
This limit to the amount of tax-deductible contributions is a significant change, and the most rigorous limitations that have applied to tax-deductible contributions since the era of compulsory superannuation.
So what does this mean in terms of personal finance strategy? Superannuation remains the most tax-effective investment environment available to most Australians. People can direct contributions into superannuation at a tax rate of 15% (a saving of up to 31.5% compared to income tax rates), can have the investment earnings taxed at a maximum of 15% (again a saving of up to 31.5% compared to income tax rates) and can withdraw from superannuation tax-free in retirement.
This change reduces the ability of people to make large, tax-advantaged super contributions close to retirement.
My initial thought is that this will see people put a greater emphasis on making super contributions early in life. It is worth keeping in mind, however, that compulsory superannuation is not yet 20 years old - so naturally we would expect to see people with ever-increasing superannuation balances as they reach age 50 and start to think about making extra contributions leading up to retirement.
Strategy thoughts: In this current financial year, the last with the higher maximum superannuation contributions, people may wish to increase their superannuation salary sacrifice or self-employed superannuation contributions as much as they can in the two months leading up to June 30.
For example, a person earning $100,000 a year might be receiving compulsory 9% superannuation contributions ($9000) while making a further salary sacrifice contribution of $25,000 a year. From July 1 they will be limited to the $9000 employer contributions and $16,000 in salary sacrifice contributions. So, over the past 2 months of this year they might salary sacrifice as much of their income as they can - even more than they are doing now - before the July 1 restriction comes into place.
From July 1, the government co-contribution will be reduced. Currently, if you are earning less than about $60,000 a year you can make a personal contribution to superannuation and receive a co-contribution of $1.50 for every $1 you contribution up to a limit, depending on your income. The maximum co-contribution is $1500 when you make a personal contribution of $1000 if you are earning less than about $29,000. In the budget papers the government has indicated that it will 'temporarily reduce the superannuation co-contribution matching rate from 150% to 100% for contributions made in 2009-10 to 2011-12 and to 125 % for 2013-13 and 2013-14.'
Strategy thought: The period leading up to July 1 is the most powerful time to make a government co-contribution, when the government contributes $1.50 for every $1 that is made as a personal contribution. It is an opportunity that people might pay particular attention to - including the possibility of making contributions on behalf of adult children or grandchildren. Keep in mind that you don't have to make a $1000 contribution; if you put in a smaller amount like $50 it will be matched with a $75 contribution. This is still the most efficient way of turning $50 into $125 that I know of.
Minimum drawdowns reduced
It was announced that there would be a halving the minimum drawdown rate from a superannuation pension for the next financial year, similar to what has been put in place for the current financial year. This effectively gives people more choice if they wish to draw less from their superannuation pension, giving their investments more time to recover.
Strategy thoughts: Some investors will have both an allocated (or account-based) pension and a "term allocated pension". The term allocated pension generally provides people with some Centrelink advantages, with only half of the assets of the term allocated pension counted for the Centrelink assets test. Given the additional Centrelink benefits in a term allocation pension, it would make sense that people halve the withdrawal from this income stream to preserve its value in preference to reducing the withdrawals from their allocated or account based pension.
Has superannuation been made 'worse off'?
My response to people who are cynical about the superannuation system, and its seemingly ongoing rule changes, is that a successful superannuation system is in the best interest of any government because it reduces the need for government age pension payments. I have then been able to point out that the history of superannuation changes has favoured the superannuation investor. Changes such as:
- The initial introduction of a compulsory, tax-advantaged superannuation system.
- The reduction of the superannuation surcharge for high income earners.
- The introduction of new superannuation pension formats.
- The introduction of tax-free superannuation withdrawals after the age of 60.
While this budget puts greater restrictions on superannuation contributions, I can't see that it actually makes anything "worse off" for superannuation investors. Rumours that I heard prior to the budget included that retirement income streams would go back to being taxed and that transition to retirement arrangements would be wound back...or worse still, the dividend imputation system might be scrapped have not come to pass.
Transition to retirement income streams
There was some discussion that the transition to retirement rules may be under some threat. These fears have proved unfounded, and a transition to retirement strategy remains one of the most effective ways to increase the tax-effectiveness of a person's situation.
Strategy thoughts: Of course, the strategy will be somewhat limited by the reduced ability to make salary sacrifice contributions to superannuation. However, the tax benefit of being able to start a transition to retirement while working, having the superannuation fund paying the income stream be taxed at a 0% tax rate and receive tax-free income from the income stream remains.
Age pension rates increases, and long term
The single age pension is increasing by $32.49 a week, with the couple age pension supplement increasing by $10.14 a week.
The age pension provides an effective "safety net" for people in retirement. For example, a home-owning couple can have assets of $870,000 (not including the value of their home) and still receive some part age pension to supplement the income from their superannuation and investment assets.
A stronger age pension provides a better safety net for people in retirement, should they need to access it, which can be generally considered a positive.
Qualifying age for age pension increased to 67
The change to the age pension age doesn't even begin to start for another eight years, so people who are already 55 and retired now will not be greatly impacted but they may be part of further reform that investors should be aware of.
The Pension Review Report, as part of the budget, includes this recommendation:
Finding number 30: The Review finds that there is a case for a phased increase in the age pension age. Any reform would need to be part of a coordinated approach to retirement, including bringing the settings of the superannuation system into line with the age pension age.
Examining that sentence: "Including bringing the settings of the superannuation system into line with the age pension age" might imply a superannuation system where access is limited to people over the age of 67.
This is potentially a major concern for investors, particularly given that the phased increase in the age pension age" recommendation has now been implemented.
Investors need certainty about when they can access their superannuation, to work out how it fits into their overall planning. Put simply, many people want to retire before 67 and need to know whether they can access their superannuation at this time.