Budget: Time to reconsider wealth building plans

The game has been radically changed – now is the time to consider alternatives and plan for the years ahead.

Summary: The federal budget’s superannuation policy suite will require super savers and retirees to reconsider the tools at their disposal to maximise wealth creation – with the lifetime cap on post-tax contributions to cut in at $500,000, and balances over $1.6 million in pension mode to be taxed, now is the time to think about the role of negative gearing in an investment portfolio, whether contributions can be split with a spouse, and consider investing in a larger family home that can be used for retirement savings when downsized.

Key take out: Budget 2016 presents two major changes – super policy means you must go back to the drawing board to establish how best to build wealth for retirement, and the new ‘innovation’ focus encourages younger Australians to focus on start-ups rather than conventional employment. Think about these two game changers when planning your investments.

Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

In the budget Scott Morrison’s attack on superannuation went much further than Bill Shorten had proposed. It means all those who have saved for retirement via superannuation will need to re-look at their strategies and those looking to assemble savings must drastically revise their options.

And so today I am going to explore some of the alternatives that are available.

Changing the super game

But first I want to share with you my personal experiences. Along the way in my journalistic career I concluded that there were four ways of saving in a tax efficient way that were legal – superannuation, negative gearing, and a large family home. There were also tax schemes.

I chose superannuation over negative gearing and building or buying a mansion to live in. At the time tax schemes were very prevalent and were backed by excellent legal opinions... I was tempted, but did not yield to temptation. 

For me, my self-managed superannuation fund proved to be marvelous, but negative gearing and overinvesting in the family home would also have been very successful. 

At the time superannuation in pension mode was taxed at 15 per cent. I have always regarded the tax-free status of pension mode superannuation as a bonus that Peter Costello handed to us. One day it might be taken back. I fully realise that many people with superannuation savings will be hit hard particularly as interest rates are now so low. But at least there is certainty because the effect of the Morrison policy is not that different to the Chris Bowen plan. 

What really changes the game are the restrictions on superannuation contributions. There is a lifetime cap of $500,000 on tax paid funds (non-concessional contributions) that can be invested in superannuation and that cap cut in at 7.30 pm on May 3. Those who were waiting until just before June 30 to inject large sums missed out.

There will be some very sad stories.

Those who already have larger sums in superannuation have a $1.6 million capital limit on the money that can be earned tax-free. I assume that if you have $1.6m in your funds, then all the earnings will be tax-free. If you have $3.2m in superannuation funds (twice $1.6m) fund, then half those earnings will be tax-free and the rest taxed at 15 per cent.

While that may be the practical outcome, in fact the money will need to go in what appears to be a tax-free account, or it can be withdrawn.

This will need clarity and I am sure there will be more information. In addition tax-deductible contributions are limited to $25,000 per annum. The contributions tax of 30 per cent, which previously cut in at $300,00 income, will now cut in at $250,000. Superannuation as we know it for higher income earners has been savaged.

If you want to try and accumulate a worthwhile sum in superannuation then my advice is that if you possibly can take up your contribution entitlement each year, do so. I realise this is not always easy to do because of the need to pay off mortgages, health costs, school fees etc, etc. 

If your spouse has an income (more on that later) then make sure that they take up their superannuation contribution entitlement. 

But the bottom line is that my children and grand children will not be able to save the amounts I achieved via superannuation. Like so many other Australians, they will now have to look at other alternatives to assemble their retirement savings. They will need in the first instance to go back to my original choices: a larger family home and negative gearing.

If you are going to negative gear, look around for properties where you understand the market. And, of course, if you are a very brave soul you can negatively gear parts of the share market. I have never felt comfortable doing that given the big fluctuations but perhaps I am too cautious. 

Another strategy that you must consider is building up the assets of your spouse so that income and capital gains are earned away from the main income earner and therefore carry a lower tax. At this stage, gifting is not taxed. As part of this process you will need to look at discretionary trusts. Many people have been able to use them so that they are just as tax efficient as superannuation. You need top advice. 

And don’t forget the larger family home. Increasingly children are staying home and you can downsize when you need money for retirement.

After the budget lock up I was driven to Sydney where I addressed a lot of executives and small business operators. Later in the month I will be addressing students. On both occasions my aim is to alert them to a fundamental cultural change that the budget heralds.

The innovation shift

For most of the last century a big proportion of the population has aspired to conventional employment.

The government is now telling up and coming Australians to aspire to start their own businesses including hi-technology start-ups. Frankly, being an executive is starting to stink. You work long hours and are taxed at 50 per cent. You can't easily split income with your spouse. It makes much more financial sense to have a business, including contracting to large enterprises. 

Once you are in your own business space you can split incomes (as long as you don’t go too far). And that not only lowers your tax, but also gives you two superannuation entitlements. You might even get a capital gain on the sale of the business. 

Clearly there are risks that don’t go with conventional employment, including sometimes putting the family house on the line.

Large companies who signed up contractors often treated them like dirt, handing them standard contracts that were all weighted towards the large organisation. But now the unfair contracts legislation will mean that if the contract is under $300,000 for one year (or $1m for longer periods) and it is not negotiated, then the unfair contracts provisions make it void.

A whole revolution in contracting is about to open up with hundreds of thousands of contracts to be renegotiated. This all cuts in in November, at the same time as Scott Morrison’s decision to take $1.8bn from superannuation funds over four years – and give almost the same amount to up and coming businesses – gets underway.

Large companies are going to have to re-think their business model if they want to keep talent. Alternatively they will have to pay executives greater sums to compensate and keep them working for the enterprise. 

In your share investments, look for companies that are thinking of these things as well as the implications of new technology. 

Smaller mid cap enterprises may do a lot better than the very large enterprises, who may find it difficult to adapt.

At an NAB breakfast I attended this morning a few items became clear: 

1 It seems the $500,000 small business capital injection on sale is still available - we will have to check.

2. Accountants at the breakfast plan to increase clients' gearing in superannuation to increase asset exposure. Of course new funds must be established for each property.

3 A number of funds bought property on vendor terms to be paid for by non-confessionals contributions - the $500,000 lifetime limits means these are now severely limited and many will not be able to make the payments.

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