Strategies to maximise access to the higher concessional contributions caps from 2012
Dealing with the reduced concessional contributions caps from 1 July 2012
For the current (2011) and next financial year (2012) the maximum amount of concessional (deductible) superannuation contributions allowable is $50,000 per annum for those over the age of 50.
From the financial year starting 1 July 2012 – which is just over 18 months away – this cap will be reduced to a miserable $25,000 per annum.
But there is a lifeline however: The government has announced changes that, if passed by parliament, will permanently increase the concessional contributions cap to $50,000 for individuals who have total super balances below $500,000 and are 50 years old or over.
This article reviews strategies available that SMSF members and their advisers must utilise now to ensure that they can access the higher $50,000 cap.
Superannuation Contributions Splitting
In general where a husband and wife are members of a SMSF, the husband often has significantly more in his member account than his wife. The major problem that this can create is that from 1 July 2012 if his benefit is over $500,000, then he will be limited to making concessional contributions of only $25,000 in anyone financial year.
Using the above, if Mr Bird makes concessional contributions of $50,000 for the 2011 financial year, chances are that once the contributions (less tax) and the earnings of the fund are allocated to to his account, his balance will exceed $500,000 and come the financial year starting 1 July 2012 he will be limited to making only $25,000 concessional contributions.
If a contributions splitting application is made, it enables the contributions from the spouse with the higher members benefit (in this case the husband) to be transferred to the spouse with the lower account balance.
The maximum amount of concessional contributions that can be split from one spouse to another is $50,000 x 85% = $42,500. If less than $50,000 in concessional contributions is made, then the maximum amount that can be split is 85% of the concessional contributions.
A contributions splitting application can be downloaded from the ATO website. You do not need a SMSF to put in a contributions splitting application, however you need to ensure that your SMSF trust deed allows the splitting of contributions.
Control who the contributions go in for
Now – this strategy is only available where the members of the SMSF receive their superannuation contribution from an entity which they control – such as a family company or trust.
If there is a situation where one SMSF member is close to the $500,000 figure as their member balance, if contributions are made then only the minimum should be taken as being contributed for that member (need to ensure that 9% SGC requirements are met) with the rest being taken as being contributed for the SMSF member with the lower balance.
With this strategy you need to be careful to ensure that the contributions caps are not exceeded for the relevant members – especially if one is over age 50 and one is under age 50.
Allocation of profits
One of the fantastic aspects of a SMSF is the discretion the trustees have to allocate the earnings of the fund in a disproportionate way – provided the trust deed allows it.
I will tell you a secret: When most accountants prepare SMSF accounts, they simply allow the software to automatically allocate the profits on a proportionate basis – which is not necessarily in the best interests of the members.
Using the above example with Mr and Mrs Big Bird, if the fund had (after tax) income of $60,000 for the year and it was allocated proportionately, about $46,000 profit would be allocated to Mr Bird and put his member balance over $500,000 – and he would not be able to contribute $50,000 for the financial years commencing 1 July 2012.
Now – it is important that you don’t get too carried away with this strategy. If the SMSF has income for the year, you can’t allocate more than 100% to one member, and allocate a loss to another member as this would breach the minimum benefit standards which ensure that a members benefit will always be made up of their total contributions, plus (or minus) the profit (or loss) allocated to each member over the years. You also can’t dip in and ‘move’ some benefits directly from one members account to another.
Once again key thing you need to use this strategy is a good quality, up to date and strategically written trust deed.
Use an investment reserve
A modification of the strategy of allocating the profits of the SMSF disproportionately is to allocate some of the profit into an investment reserve.
A reserve account within a SMSF is an account which is not specifically allocated or ‘belong’ to a specific member. Many industry super funds use reserves where they allocate a percentage of profits in years with very strong earnings, and they then draw down from these reserves in years of lower returns to give a ‘boost’ to member accounts.
If there are two members who are both close to the $500,000 account balance, and the SMSF was to revalue a major asset such as a commercial property, then the increase in value (which could potentially be hundreds of thousands of dollars) could be allocated to a reserve and the two members would stay under the $500,000 member account balance and still be able to contribute $50,000 each in concessional contributions for the years after 1 July 2012.
Now – the use of reserves within a SMSF is a complex matter and should be only be approached with the assistance of an appropriately qualified SMSF professional.
Take a pension
Every SMSF member over the age of 55 should have commenced a transition to retirement pension (a.k.a. TRIS / TRIP / TRAP). A pension will reduce the members account balance by a maximum of 10% per year (assuming they are still working).
Even if a member is still making concessional contributions by drawing down the maximum of 10% under a transition to retirement pension, their member account will not grow excessively and will stay under the $500,000 figure for a longer period.
Taking a transition to retirement pension also has many taxation advantages as only the taxable portion of the pension (made up of concessional contributions and profits) is taxable, with the tax free portion (made up of non-concessional contributions) – you guessed it – tax free. In addition the taxable portion comes with a 15% offset – meaning there is always going to be a tax saving opportunity by using a TRIS.
Now, because a TRIS is limited to 10% of the members balance, the higher their balance, the more tax savings can be obtained. This needs to be taken into consideration when the spouse of a SMSF member who is over age 55 is significant younger – especially if contributions and income are being allocated to the younger member.
Take a lump sum
Sometimes, a member may have a portion of their member account which is ‘unrestricted non-preserved’ – meaning they can withdrawal that amount out of super without any restriction.
If the member is under 60, then the taxable portion of the amount drawn out will be taxable – however with a lump sum there is a lifetime limit (currently $160,000 for the current year) which can be drawn out with no tax paid.
It does seem counter intuitive to draw out a large amount of from super at a time when the members are focussed on getting as much into their SMSF as possible – but it is one strategy to keep the members balance under $500,000 and allow the higher $50,000 amount of concessional (tax deductible) contributions to be made.
If a lump sum does come out, there is nothing preventing it from being re-contributed into the account of another member with a lower account balance, or even used to fund a member-financed SMSF limited recourse loan.
In review, this article is a little strange because we are looking at ways to reduce or restrict a members account within a SMSF so they can get more into their members account.
If you are a member of a SMSF and you account balance is getting close to $500,000 then you need to work with your accountant or adviser to ensure that you will be able to continue making tax deductible concessional contributions of $50,000 from 1 July 2012.
Are the above strategies worthwhile?
If you have a marginal tax rate of 31.5% (including the Medicare levy) and are able to obtain an extra $25,000 of tax deductible concessional contributions, then even taking into account the 15% tax on those contributions, you will be better off from a tax perspective by $4,125 per year – which is nothing to be sneezed at.
Obviously, the higher your income, the more valuable the the higher concessional cap will be.
If you are an accountant or adviser and you are currently preparing the 2010 SMSF accounts and annual return for your clients, then you need to review their situation, look into your crystal ball, and decide whether you need to use any of the above strategies to ensure that your SMSF clients will have access to the valuable higher contributions caps from 1 July 2012.
If you have any questions or comments please feel free to post a comment below or contact me.