Technical Q&As

Under the proposed changes to superannuation outlined in the 2006/07, there will be a cap on undeducted contributions of $150,000 per financial year, applying from 9 May 2006.

The Government has announced an 'averaging' over three years, whereby if the $150,000 limit is exceeded, the surplus amount can be carried forward over the next two financial years, so long as the $150,000 cap is not breached in those years.

Where carrying forward undeducted contributions to future years, any contribution work-test requirements must be satisfied for the year in which the contribution will apply.

Where under age 65 no work test needs to be satisfied to contribute to superannuation. For those aged 65 to 74, at least 40 hours must be worked during a consecutive 30-day period during that financial year. Once a person reaches age 75, they cannot contribute to super, unless specified under an industrial award.

Donna is currently 64 and does not need to satisfy the work test for 2006/07. In 2007/08 Donna will be turning 65 and will need to satisfy the work-test for that year. However, as Donna is retiring in October, she will satisfy the 40 hours during a consecutive 30-day period work test. This means that Donna can make a maximum undeducted contribution to superannuation of $300,000 in 2006/07 ($150,000 of which will apply to 2007/08).

Roger does not need to satisfy the work test until he turns 65. This means Roger can make an undeducted contribution of $450,000 for 2006/07 ($150,000 applying to both 2007/08 and 2008/09). Under the super contribution splitting between spouses, Roger is able to split 100% of undeducted contributions to Donna in the next financial year (we already know that Donna will satisfy the work-test for 2007/08).

This means that by 2007/08, the $750,000 net proceeds of the investment property will have been contributed to Donna's superannuation, and able to be accessed tax-free without restriction.

In order to make a personal deductible contribution to super less than 10% of total assessable income plus reportable fringe benefits must come from employment as per the eligible person formula below:

If Ronaldinho sells his share portfolio he increases his assessable income by $50,000 - half capital gain after applying the 50% discount for individuals as the asset has been held for longer than 1 year. In this case it's not enough to pass the 10% test, since:

However, by withdrawing $146,000 from super the full amount is added to assessable income, Ronaldinho pays $711 in ETP tax because we have withdrawn more than the tax-free low post threshold (assumed to be $141,692 for 2007/08). Ronaldinho will therefore meet the 10% test, since:

Results

Assumptions

Case study calculations

Harry decides to roll his superannuation into a non-commutable allocated pension and in the first year draws $43,478 in pension income. In order to maintain his desired net income of $45,750, Harry salary sacrifices $53,129, which reduces his assessable income to $50,349, and in order to achieve his maximum Government Co-contributions entitlement, makes an undeducted contribution of $256.

The following table compares Harry's current situation and the proposed situation:

By drawing $43,478 from his NCAP, Harry is able to contribute $50,389 to his super, including $639 in undeducted contributions!

To be eligible for MATO, the individual taxpayer must:

• Be an Australian resident for tax purposes
• Be aged 55 years or more at the end of the income year, and
• Have received net income from working (within certain limits).

MATO cannot reduce an individual's tax liability below nil. In other words, any excess cannot be refunded or transferred to another person, such as a spouse.

MATO is based on the taxpayer's net income from working, which is defined as income from working less work-related deductions. Income from working includes:

• salary and wages (and like payments such as allowances and commissions)
• regular payments under sickness or accident insurance policies or compensation schemes
• business income from a business that you carry on
• personal services income
• foreign employment income
• assessable farm management deposit withdrawal amounts
• reportable fringe benefits
• professional income of sportspeople, entertainers or consultants

Income from working excludes income not related to the individual's work. For example, unless the person is a professional investor, investment income is excluded. Kevin's net income from working is $150,000. Britney's net income from working is $50,000.

Kevin would not be entitled to any MATO, whereas Britney would be entitled to the maximum MATO of $500. This means that Britney increases her take-home income by $500 (MATO is calculated from the information included in the individual's tax return and taken into account when working out the individual's tax refund or liability.)

Rather than the couple's taking this money in the hand, Kevin could make an extra gross salary sacrifice contribution of
$885 in year 1.

A better strategy than merely salary sacrificing would be for Kevin and Britney to implement a transition to retirement (TTR) and contribution splitting strategy. The transition to retirement arrangement would increase Kevin's MATO entitlement.

• Kevin would use his super to commence a term allocated pension (term 45 years with the maximum payment)
• regular payments under sickness or accident insurance policies or compensation schemes
• Britney would use her super to commence a term allocated pension (term 45 years with the maximum payment)
• Income and salary sacrifice are indexed at 4.5% pa
• Inflation rate is 2.5% pa
• The tax scale is indexed at 2.5% pa
• The maximum deductible contribution is indexed at 4.5% pa
• Reasonable benefit limits are indexed at 4.5% pa
• Nominal rate of return is 8% (5.5% unrealised growth and 3% income) pa
• 50% Australian equity component
• 75% franking level on Australian equity component
• 58% of Kevin's Superannuation Guarantee and salary sacrifice contributions are rolled over to Britney's super

The following table contrasts the couple's accumulated retirement benefits (at age 65) - in today's dollars - with and without the combined transition to retirement and super splitting strategy:

Under the TTR/splitting option, the couple have greater combined benefits, less excessive benefits, a more tax effective split of benefits (as the couple can now take advantage of income splitting in retirement) and more MATO (which reflects in the higher level of combined benefits).

The TTR/splitting strategy enables Kevin to salary sacrifice an additional $32,000 per annum. In year 1, Britney still receives the maximum MATO of $500, however because Kevin’s employment income has been reduced by a further $32,000 he will now be entitled to a MATO of $250. Kevin’s MATO increases the couple’s after-tax income by $250. The increase in combined after-tax income from Britney and Kevin’s MATO’s is $750. As a result, Kevin is able to salary sacrifice an additional gross amount $1,327 (i.e., $750/0.565) to super. As a result of their MATO entitlements, however Kevin is able to make a further additional salary sacrifice contribution, which in turn increases his MATO entitlement.

As a result of Britney’s and Kevin’s MATO entitlement (which after Kevin’s further additional salary sacrifice turns out to be $591), in year 1 Kevin is now able to make an additional salary sacrifice contribution of $1,476 p.a. (including the $885 resulting from Britney’s MATO), which is an increase of $591 on the strategy of salary sacrificing without implementing transition to retirement planning.

Although the increase in retirement income resulting from the increase in Kevin’s MATO (resulting from the transition to retirement arrangement) is small by comparison to the increase in retirement income resulting from the transition to retirement arrangement combined with superannuation contributions splitting, an increase is better than no increase and reinforces the claim that there are peripheral benefits associated with the transition to retirement strategy.

Division 6.7 of the Superannuation Industry (Supervision) Regulations 1994 sets out standards for splitting contributions with a spouse. The Regulations allow up to 85% of deductible contributions and 100% of undeducted contributions to be split with a spouse.

Under the splitting rules the receiving spouse must be under age 65 and where aged between 55 and 64 must not have satisfied a retirement condition of release (see Quick Reference Guide section)

Only contributions made on or after 1 January 2006 are splittable, and the splitting application can be submitted to the superannuation fund trustee anytime in the financial year after the financial year in which contribution is made (the exception is where an entire benefit is to be rolled over, in which case the contribution must be split in the financial year in which the contribution is made.)

As Katie is less than age 55, Tom can split his previous year's superannuation contributions to Katie.

In order to minimise the tax Tom and Katie are paying on their net income, Katie can cease her salary sacrifice arrangement (SSA) and Tom can increase his SSA to $25,000 p.a. The benefit of this is that the couple's individual assessable incomes are more closely equated - that is, Katie is receiving more after-tax income than Tom would have received had he taken the same amount of income as salary.

In the following financial year, Tom can split up to $28,135 to Katie - i.e. 85% of 9% SG and SSA. Tom's assessable income is now $65,000 and Katie's is $50,000. This means they are able to make the same level of contributions to super, BUT reduce their annual tax liability by $1,200 from $29,385 to $28,185.

Tom could instead increase the couple's combined salary sacrifice arrangement by an extra $2,100 and their take-home income would be the same as when Tom was salary sacrificing $15,000 and Katie was salary sacrificing $10,000.

Under the transition to retirement condition of release a non-commutable income stream is defined as either a non-commutable allocated pension or annuity or a non-commutable pension or annuity.

A non-commutable allocated pension or annuity (NCAP) is effectively a traditional allocated pension or annuity described under SIS Regulation 1.06(4) and 1.05(4)), which cannot be commuted to cash except in certain circumstances. These circumstances are:

• to cash an unrestricted non-preserved benefit
• to pay a superannuation contributions surcharge
• to give effect to an entitlement of a non-member spouse under a payment split (i.e. under Family Law by Court order or binding financial agreement); or
• if a condition of release with a nil cashing restriction has been satisfied (e.g. retirement and age 65).

A NCP is a pension or annuity that meets the pension and annuity standards (described under 1.06(2), (7) or (8) (annuity) and 1.05(2), (9) or (10) (pension)) and include:

• lifetime pensions and annuities
• life expectancy based pensions and annuities; and
• term allocated pensions and annuities.

Under the transition to retirement condition of release, an additional commutation restriction exists for NCP's in that even within six months of commencement they cannot be commuted to cash except:

• to cash an unrestricted non-preserved benefit; or
• if a condition of release with a nil cashing restriction has been satisfied (e.g. retirement and age 65).

NCAP's can be rolled back to the accumulation phase of superannuation at any time. By contrast, NCP's can only be rolled back to the accumulation phase of superannuation within the first six months of commencement and are not funded from the commutation of another complying income stream.

Judging by the information contained on various super fund manager websites (some actually say no employer contributions after age 70!) there is little wonder there is confusion amongst financial advisers on this point. The answer is yes - but only if where certain conditions are satisfied and there is an administration process involved - albeit likely to be lessened when the Government's new IR changes are introduced.

1. the contributions are mandated employer contributions; or
2. the contributions are made by the member in respect of the member and the member has been gainfully employed on at least a part-time basis during the financial year in which the contributions are made.

Under SIS Regulations, mandated employer contributions include contributions made under an agreement certified, or an award made, on or after 1 July 1986 by an industrial authority. An industrial authority is broadly defined as a court, or a tribunal or other body or person, constituted under a law of the Commonwealth, a State or a Territory with power of conciliation or arbitration in relation to industrial disputes.

SG contributions must cease upon the member reaching age 70 and Peter is not covered under an award. However, Peter and his employer are able to draw up an agreement mandating a certain level of employer superannuation contributions, which can be certified by an industrial authority - namely the Office of the Employment Advocate (OEA).

• The agreement must receive pre-approval from the OEA
• The employee then has two weeks to sign the pre-approved agreement; and
• Then the agreement must go back to the OEA for final sign-off before it is deemed to be certified.

The industrial relations reforms proposed to commence in March 2006 will streamline this process such that the OEA will simply sign off on an agreement. If this is workplace agreement, the only tests it must pass in relation to content will be to meet the Australian Fair Pay and Conditions Standard.

Commencing a pension before retirement allows current benefits to be 'locked in' as reasonable benefit limit (RBL) amounts, meaning growth over and above average weekly ordinary time earnings (AWOTE - the indexation rate used for RBLs), that could reasonably be expected during the accumulation phase of superannuation, are potentially not counted towards the lump sum or pension RBL at retirement.

By commencing a non-commutable allocated pension $500,000 will be counted toward Gerard's RBL at 10 August 2005. At retirement at age 65 Gerard will commence another income stream with the benefits accrued in the accumulation phase of superannuation over the 10-year period. By implementing the Advance transition to retirement strategy Gerard will accrue $806,961 in superannuation at age 65 (and yet maintain his current net income from a salary of $75,000 indexed to today's dollars by 2.5%).

In order to determine whether the new income stream is non-excessive (i.e. entitled to the pension and annuity tax offset of up to 15%) the $500,000 NCAP must be indexed by AWOTE. At age 65 the RBL amount of the NCAP is $760,143 ($500,000 x 992.9/653.1). This amount is added to the new benefit of $806,961 to determine whether the new pension is entitled to a rebate/offset. The current lump sum and pension RBLs for 2005/06 are $648,946 and $1,297,886 respectively. At retirement the lump sum and pension RBLs for Gerard will be approximately $964,395 and $1,928,782 respectively (indexed by 4.5% each year - the same rate AWOTE increased on average over the past 10 years).

Had the strategy not been implemented the $500,000 benefit in superannuation would have grown to $914,141 without any additional contributions. This means that by commencing the pension early $153,998 of benefits - on the original capital value amount only - will not count towards Gerard's RBL.

From 1 January 2006, an excess RBL position may be avoided or allieviated further by splitting the large deductible (and eventually reportable) contributions made back to super under the Advance transition to retirement strategy with a spouse.

Assumptions

• Nominal return rate of 10% p.a.
• Indexation rate of 2.5% p.a.
• Tax scales for 2005/06 used for Year 1
• Tax scales for 2006/07 used for Year 2 and beyond
• Remunerated as a packaged employees and where salary sacrificing to super an effective arrangement has been established, such that SG is paid on the full salary and is not reduced by salary sacrifice amount.

A death benefit may be payable to either Josh or Claudia's dependants in the form of a pension. However, the pension recipient must be included as a member of the fund (and therefore the trustee) before the pension can be paid. Section 10(3) of the Superannuation Industry (Supervision) Act 1993 specifies that a member of a SMSF will include any person who receives a pension from the fund irrespective of whether it is a retirement or death benefit. The trust deed will also need to be amended after death by the Executor of the estate, if there are no provisions to pay the benefit as a pension.

Commencing a pension before retirement allows current benefits to be 'locked in' as reasonable benefit limit (RBL) amounts, meaning growth over and above average weekly ordinary time earnings (AWOTE - the indexation rate used for RBLs), that could reasonably be expected during the accumulation phase of superannuation, are potentially not counted towards the lump sum or pension RBL at retirement.

By commencing a non-commutable allocated pension $500,000 will be counted toward Gerard's RBL at 10 August 2005. At retirement at age 65 Gerard will commence another income stream with the benefits accrued in the accumulation phase of superannuation over the 10-year period. By implementing the Advance transition to retirement strategy Gerard will accrue $806,961 in superannuation at age 65 (and yet maintain his current net income from a salary of $75,000 indexed to today's dollars by 2.5%).

In order to determine whether the new income stream is non-excessive (i.e. entitled to the pension and annuity tax offset of up to 15%) the $500,000 NCAP must be indexed by AWOTE. At age 65 the RBL amount of the NCAP is $760,143 ($500,000 x 992.9/653.1). This amount is added to the new benefit of $806,961 to determine whether the new pension is entitled to a rebate/offset. The current lump sum and pension RBLs for 2005/06 are $648,946 and $1,297,886 respectively. At retirement the lump sum and pension RBLs for Gerard will be approximately $964,395 and $1,928,782 respectively (indexed by 4.5% each year - the same rate AWOTE increased on average over the past 10 years).

Had the strategy not been implemented the $500,000 benefit in superannuation would have grown to $914,141 without any additional contributions. This means that by commencing the pension early $153,998 of benefits - on the original capital value amount only - will not count towards Gerard's RBL.

From 1 January 2006, an excess RBL position may be avoided or allieviated further by splitting the large deductible (and eventually reportable) contributions made back to super under the Advance transition to retirement strategy with a spouse.

Assumptions

• Nominal return rate of 10% p.a.
• Indexation rate of 2.5% p.a.
• Tax scales for 2005/06 used for Year 1
• Tax scales for 2006/07 used for Year 2 and beyond
• Remunerated as a packaged employees and where salary sacrificing to super an effective arrangement has been established, such that SG is paid on the full salary and is not reduced by salary sacrifice amount.

If the bona fide redundancy payment is for $120K the first $58,427 will be tax-free. This is based on an initial tax-free amount of $6,491 plus $3,246 for each year of completed service for 2005/05. This amount will not be treated as an ETP. The remaining $61,573 (based on $120K redundancy) is treated as an employer ETP and can be cashed out or rolled over.

Tax on the employer ETP above the tax-free amount will depend on whether the person is under or over 55 years of age and whether they cash or rollover. As Todd is under 46 he will pay $19,395 tax where cashing out. Table 1 below compares the different effective tax rates where cashing an employer ETP or rolling over to superannuation then cashing out.

Note: Employer ETPs rolled into superannuation on or after 1 July 2004 are treated as preserved benefits.

Todd's $30,000 long service leave payment will be included in his assessable income and taxed at 31.5%, giving a net payment of $20,550. This is because Todd's service is post 15 August 1978. For pre 16 August 1978 service 5% is included in assessable income and taxed at marginal tax rates.

• A payment split in an unfunded defined benefit fund triggers a surcharge deduction and payment must be made within one month after the day on which the lump sum, or the first instalment of pension, becomes payable in satisfaction of the debt. For constitutionally protected funds, payment must be made within 3 months of notice.
• Under the FL valuation provisions (compulsory for Court orders), step 3 of the valuation process deducts any surcharge debt from the gross value of the payment split (refer FLSR 28). The surcharge debt is calculated as:
  • For unfunded defined benefit funds - the amount recorded in the most recent member information statement provided by the fund to the member before the relevant date.
  • For constitutionally protected funds (ie. State Government funds exempt from tax) - the amount stated in the surcharge debt account maintained for the member spouse by the Commissioner of Taxation at the relevant date.

Note: Assumptions may need to be made as to the estimated surcharge liability at the actual time of the split as it may not be same amount as that recorded on member statement.

• To pay a beneficiary if:

- the payment is required to be made by law or by the governing rules of the fund
- apart from the borrowing, the trustee would not be able to make the payment
- the period of the borrowing does not exceed 90 days; and
- the total amount borrowed does not exceed 10% of the value of the assets of the fund.
• To pay a surcharge liability if:

- apart from the borrowing, the trustee would not be able to make the payment
- the period of the borrowing does not exceed 90 days; and
- the total amount borrowed does not exceed 10% of the value of the assets of the fund.
• To cover settlement of security transactions if:

- at the time the investment decision was made, it was likely that the borrowing would not be needed
- the period of borrowing does not exceed 7 days; and
- the total amount borrowed does not exceed 10% of the value of the assets of the fund.

From 1 July 2004 the work test has been removed for those under age 65 making a contribution to superannuation. This means that anyone under age 65 can contribute to superannuation without being gainfully employed for more than 10 hours per week (as was required prior to 1 July 2004). As Tom is aged 64, he is able to contribute to superannuation.

An 'eligible person' is able to claim a tax deduction for personal contributions made to superannuation. Eligible persons include those who are not employed, cannot reasonably expect superannuation support from an employer, and have assessable income greater than zero; or those who are employed, but their assessable income, exempt income and reportable fringe benefits from employment represents less than 10% of their total assessable income and reportable fringe benefits.

Tom's is employed but only 9.8% of his total assessable income comes from employment (i.e. $5,000/[$40,000 + $6,000 + $5,000]). This means Tom is able to claim a deduction for the first $5,000 of personal contributions plus 75% of the remainder up to his age-based maximum deductible limit ($95,980 for people aged 50 or over for 2004/05).

The in-specie transfer of property to a member in satisfaction of the member's benefit is not prohibited under the SIS Act. The Australian Prudential Regulation Authority issued Superannuation Circular No I.C.2, which partly addresses this issue. Paragraph 9 of the circular provides that if the governing rules of a fund so provide, a member's benefits, are permitted to be paid in-specie or in cash. However, the trustees must be able to substantiate the value of the relevant asset for the purposes of the SIS Act and taxation purposes.

Subsection 27A(8) of the ITAA 1936 provides that where a transfer of property has been made to a person for the purposes of making an eligible termination payment, the transfer is deemed to be payment of an amount equal to the value of the property immediately before the transfer.