This article appeared in the June 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Consider these strategies to improve your SMSF’s after-tax return
By Grant Abbott, SMSF Strategies
Here are six strategies for trustees of self-managed super funds (SMSFs) to consider:
1. Make the most of annual salary contributions
Salary sacrifice contributions are employer contributions made on behalf of an employee, on which the employer receives a tax deduction and the employee does not pay PAYE tax. This concessional contribution forms part of the superannuation fund's assessable income, which may be taxed at a rate of 15 per cent. For SMSFs, the trustee of the fund may channel these contributions into tax-effective investments to reduce the tax paid.
Key aspects of salary sacrifice contributions are:
- A concessional contribution limit of $25,000 a year per person.
- Contributions up to the age-based limit may be made by more than one employer provided the employers are not associated. A member of an SMSF who works as a director of two non-related companies may have directors fees up to their age-based limit contributed as salary sacrifice into their fund.
- In-specie or asset contributions made into a superannuation fund are not subject to fringe benefits tax.
2. Transferring business assets into an SMSF
The SMSF trustee has a wide range of investments to use with the SMSF Strategies trust deed. There are some in-built legal limitations under the SIS Act 1993, including the sole purpose of the fund must be to provide retirement, death or other allowed benefits to members of the fund.
Some business assets may be currently held by the member of the fund directly or indirectly via a business entity such as a family trust or family company, which under careful consideration may be transferred into an SMSF. Assets include:
- Residential property where the member or entity carries on a business involving the property, such as property development or a motel.
- Genuine farmland or other agricultural land which may include a homestead provided the home is not on land bigger than two hectares in size.
- Commercial and industrial business property provided the property is not used for domestic or private purposes.
The benefits of making such a transfer are threefold:
i) Any future growth and income derived from the property is taxed at a maximum rate of 15 per cent and, if well-structured, free tax to the trustee of the SMSF.
ii) If the asset, such as an office or farm, is leased back to the member's business, the business will receive a tax deduction for the lease payment.
iii) The lease payment made from the business to the SMSF is not a contribution and is not affected by the concessional or the non-concessional contributions caps.
Importantly, the disposal of a business asset may bring into play the capital gains tax (CGT) small-business concessions for the member or entity concerned. Generally, where the member's net assets and those of entities they are connected with are less than $6 million (excluding any superannuation assets), the member may be entitled to transfer the assets tax-free - if they have been held for 15 years or if used as part of the CGT retirement exemption.
It is advised that any would-be member using this strategy check with a specialist SMSF adviser, or accountant or financial planner, on the consequences of the transfer.
3. Personal deductible contributions into an SMSF
Where a person makes a personal contribution into a complying superannuation fund, they can claim a tax deduction provided that during the income year when the contribution is made, they do not have an employer making a contribution on their behalf. This means the following types of members, under age 65 who are not employed, can claim a personal tax deduction:
- Beneficiaries of a trust estate
The deduction is limited to the concessional cap limits. Some interesting features of the personal superannuation contribution are:
- The deduction can be used to offset capital gains, investment income and the like.
- The trustee of the fund must include the deductible amount in the fund's assessable income. This will then be taxed at a rate of 15 per cent.
- The amount of the contribution that does not form part of the fund's assessable income is non-deductible and included in the member's non-concessional contributions cap.
4. Contributions splitting
Concessional contributions may be split to a spouse during the income year following the year in which the contribution is made. The amount of the contribution is 85 per cent of any taxed splittable contribution (such as employer and employee salary sacrifice contributions). The golden rule for splitting contributions is: split contributions to the member spouse who is closer to age 60.
With super benefits tax-free after the age of 60, it makes sense to split to the older member where there is a significant or reasonable age difference between the spouses. This would also apply where it is proposed that a spouse member commence a transition-to-retirement income stream at age 55, their preservation age. The more that can be used as a base for the provision of such an income stream, the better end income benefits provided to the member.
5. A transition-to-retirement income stream to replace salary
The Federal Government has been making some major changes to the superannuation system to encourage fund members to remain in the workforce longer. One of the most important measures, the transition-to-retirement income stream, allows any member of a fund who has reached 55 (older for people born after July 1, 1960), to begin an income stream with the benefits in their superannuation fund - even if they are still in full-time or part-time gainful employment, self-employment or other income-earning position.
(While the member remains in the workforce, the transition-to-retirement income stream is not able to be converted to a lump sum. Additionally, the Simpler Super reforms have placed a 10 per cent maximum limit on the amount of benefits a member may take out of the fund in any one year.)
The two major benefits of beginning a transition-to-retirement income stream for a business owner at age 55 are:
- The income stream can be used as a salary or lifestyle income replacement. For a member between the ages of 55 and 59, the income is assessable but with a 15 per cent tax offset. For those over 60, the transition-to-retirement income stream is tax-free.
- The greater the income stream that can be provided from the fund at age 55, the less need for salary and wages, and therefore more is available for salary sacrifice and personal superannuation contributions, subject to contributions caps.
6. Tax-effective investing
The most effective way for the trustee of an SMSF to run a fund is to split investments in it between those held for member accumulation accounts and member income stream accounts. Any income or discounted capital gains (one-third discount) earned on accumulation account investments is taxable at 15 per cent, less deductions such as life insurance, audit fees and others.
In contrast, income and capital gains generated on the income stream part of the SMSF is tax-free. Contributions included in the fund's assessable income are always allocated to a member's accumulation account within 28 days, thus they are taxed at 15 per cent.
Some of the best forms of tax-effective investing include:
Where a share is held by the trustee of the fund and has imputation credits, these can be used to offset the tax liability on the payment of the grossed-up dividend. With an underlying 30 per cent tax offset on a fully franked dividend, there will be excess tax offsets for dividends received on both member accumulation and income accounts. The most beneficial is for shares paying franked dividends on the income stream side, as no tax is payable on the dividend, but the 30 per cent tax offset can still be claimed by the trustee of the fund. The more tax offsets, the more that can be used by the trustee of the fund to minimise the fund's contributions tax liabilities.
An instalment warrant is simply the investment by the trustee in an Australian share where only 50 per cent of the price of the share is paid upfront and the remainder at some specific time in the future, generally five years for SMSF trustees. In essence, the trustee borrows from the instalment warrant holder. This is legal for the trustee of an SMSF despite superannuation laws stating that a trustee cannot borrow.
The use of leverage, for the most part 50 per cent although in some cases up to 80 per cent of the value of the investment, enables the trustee to:
- Maximise imputation credits and particularly the value of them to a fund receiving large assessable contributions.
- Claim a tax deduction for borrowing expenses to fund the warrant.
(Investing in an SMSF or any superannuation fund needs to look beyond the tax characteristics of an investment. It is incumbent upon the trustee to produce a written investment strategy for the fund and also how specific investments fit within that strategy.)
The changes to superannuation and taxation laws over the past few years have been nothing short of breathtaking. No one would have thought that Australia could have legitimised superannuation as a modern-day tax haven. Members:
- Do not pay tax on super benefits after age 60.
- Imputation credit offsets in the fund, if not used, are refunded to the trustee even though members may not be paying tax on their super benefits.
- The Social Security rules, provided a member is of pension age, enable access the Commonwealth health care card, electricity and phone allowances and, in some cases, the aged pension despite significant assets in the SMSF.
About the author
Grant Abbott is the founder of Super Strategies. To see a video or ask him a question, visit Super Strategies.
The SMSFs page provides useful information about the basics of establishing a fund. The page also features an ASX video on SMSFs, in which the television presenter Anne Fulwood interviews Graham O'Brien of ASX business development.
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