All about tax. Benefits along the way

In an uncertain world, there are three things investors can count on with certainty.

1. Having a long-term investment plan is good for your wealth.
2. Despite government tinkering, superannuation is the best structure to hold long-term investments because of the tax benefits.
3. And self-managed super funds offer greater control and flexibility over the management of tax.

The upshot is that SMSFs offer investors the greatest potential to maximise their wealth in retirement. While self-managed funds are taxed in the same way as public offer funds, SMSF trustees have a wider range of options and strategies at their disposal to take full advantage of the benefits.

Super provides generous tax concessions every step of the way, from the accumulation phase while you are still working through to retirement and beyond.

Accumulation phase

During the accumulation phase investment earnings inside super are taxed at a maximum rate of 15%.  That means individuals on marginal tax rates of 31.5% (including Medicare levy) and above end up paying less than half the tax they would otherwise pay on investment earnings if they held the same assets outside super.

It also means SMSF trustees can maximise tax credits by holding shares in companies with fully franked dividends. Because of the difference between the company tax rate of 30% and the super tax rate of 15%, you may actually end up with a tax refund.

While some public offer funds do allow members to invest in direct shares, in practice the menu is often limited. And when it comes to investing in direct property, SMSFs have the field to themselves.

SMSFs are the only type of super fund that allows members to invest in direct property and that can have major tax benefits, not only in terms of the concessional taxation of rental income but also capital gains.

Capital gains on the sale of assets inside super during the accumulation phase are taxed at the superannuation rate of 15%. If an investment is sold within 12 months then the entire net capital gain is taxable. However, if the investment is held for at least 12 months the net capital gain is discounted by 33.3% before tax is payable. This results in an effective rate of 10% (15% of 66.6%).

If the same assets are owned outside super you get a bigger discount (50%) for holding them for at least 12 months before selling, but you pay tax on the remainder at your marginal rate. This would result in tax of 23.25% for someone on the top marginal rate (50% of 46.5% including the Medicare levy) and 17% for someone on the 34.0% marginal rate (including Medicare levy). Either way, you are better off holding property and other investments inside super.

Then potential tax benefits are even greater if you hold assets into retirement.

Pension phase

Super offers generous tax concessions in return for ‘preserving’ your nest egg until you reach a minimum age, currently 55. If you reach preservation age, retire and withdraw your super benefits as a lump sum before you turn 60 you may have to pay tax. But once you reach age 60 and retire you can withdraw your super tax-free as a lump sum or an income stream.

Once your fund is in pension phase you pay no tax on investment income or capital gains. This opens up some potentially attractive strategies for SMSF fund trustees.

For example, if you sell an investment property after you retire, when your fund is in pension phase, you pay no capital gains tax. That’s a potential saving of tens of thousands of dollars, perhaps more, especially for small business owners who hold business property inside their own self-managed fund.

Death benefits

If you die before all your super assets have been withdrawn, your fund pays a death benefit to your dependents or your estate. These benefits include the balance of your fund and an insurance payout if you have life cover inside super.

One benefit of SMSFs is that trustees can make binding death benefit nominations that do not lapse. Binding death benefit nominations provide greater certainty that your super benefits will be distributed according to your wishes when you die. Not all public offer funds offer binding nominations and those that do require members to renew them every three years.

Self-managed super funds also have the ability to leave tax-free income streams to dependent beneficiaries and look after child beneficiaries in ways that other types of super fund cannot.

Death benefits paid into your estate may be taxed by up to 31.5%. But if you are receiving an allocated pension at the time of your death, and have nominated your spouse as the reversionary beneficiary, he or she can continue to receive your pension tax-free rather than have it revert to your estate. This has the added benefit of ensuring that your spouse will continue to receive an income stream without interruption.

SMSFs with a corporate trustee can also avoid the need to sell assets on the death of a member. As discussed in Chapter 3, the corporate trustee can continue with new shareholders who have inherited the shares, opening up opportunities for tax-efficient estate planning strategies.

In other words, self-managed super funds not only offer tax advantages to members before and after retirement, but they can also be used as an intergenerational wealth vehicle.