Busting the super reforms myths

The federal government's proposed superannuation changes are definitely retrospective, and will also affect individuals with lower account balances than $2 million.

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Summary: The federal government’s official line is that only a relatively small percentage of individuals – those with high super account balances – will be affected by the increased income tax to be imposed from the latest round of superannuation changes. The reality is quite different.

Key take-out: A super fund with an account balance well below $1 million could easily breach the new $100,000 tax-free earnings cap if it achieves a high return on investment assets.
Key beneficiaries: SMSF trustees and superannuation members. Category: Superannuation.

The new changes to superannuation have surprised many investors, shocked quite a few and puzzled nearly all.

Already, it’s clear there are four myths forming on what the changes may mean to investors; they need to be busted wide open. I hope to do that today.

But another thing is also clear. We probably have to assume that it’s going to go ahead. For all the lip we heard from some Labor MPs who threatened to cross the floor, including Simon Crean and Senator Kim Carr, it seems likely the changes will pass.

Crean said he would consider crossing the floor for any legislation that taxed super funds retrospectively. This is retrospective taxation, make no doubt about it. But Crean has already given his seal of approval. So we need to assume that it will become law.

(In this opinion I disagree with my colleague Max Newnham, who is sceptical the laws will ever come to pass. Max will devote his ‘Ask Max’ column to the super changes later in the week, and he is also featuring in a special webcast at Eureka Report tomorrow (Thursday April 11 at 12.30pm) with Managing Editor James Kirby, which will examine the changes. To register for the webcast tomorrow, click here.

For 30 or more years, people have been able to put money into superannuation with the understanding that their pension fund account would not be taxed. People have made decisions based on that understanding.

The new laws – which will tax individual super pension accounts that earn more than $100,000 a year in income – mean that some decisions that were made 30 years ago, or as little as one week ago, were made based on that assumption.

Importantly, we should also note that the Opposition hasn’t said they will dismantle these rules. They’re sticking to their previous policy of “no new negative changes to super in the first year or term”. That doesn’t mean dismantling anything.

As I will explain below, my main concern about the new tax is who it will punish. (I will return to measures including the new concessional contribution limits of $35,000 in future columns.)

When the Eurozone handed down the sentence on Cyprus – that bank depositors were going to be “taxed” on their savings – I was actually shocked.

Not because of the punishment, but because of who was being punished. Some of those people who had their money in banks – traditionally the lowest-risk asset class – were going to cop one in the neck for the country.

Investors in high-risk assets were, by default, being rewarded. Particularly if they had been lucky enough to pull their money out of the bank and punt on the stock exchange.

Risk and reward are related. You want higher rewards, you chase the higher risks. If you’re interested in safety, you accept the lower risk that comes with investments such as bank deposits. But then the Cyprus government comes in and taxes 10% of your savings. (You literally would have been better off putting it under the mattress.)

It’s not dissimilar to the risk versus reward conundrum that has just corrupted our super in Australia, with the new tax on super pension funds announced last week.

The first thing that needs to be understood by the SMSF community is that the rules apply to each member, not to a fund. If you have two members of your SMSF, then each member gets the income limit of $100,000. A fund with four members could, therefore, have $400,000 worth of tax being earned before it is taxed at 15% on the excess, though distribution of income in a SMSF is never likely to be that even.

Also, don’t for a minute believe this line pushed out that “it’s really only those with $2 million or more in super that are going to be affected”. That’s simply not right. It’s a broad brush figure, a throwaway line for a press release, that seriously obfuscates who is going to get hit.

There will be thousands of SMSF pension fund members who have closer to $1.2 million that are going to be hit by the new tax. Further down, I’ll show you how SMSFs with just $500,000 could be hit.

And, conversely, there will be plenty of people sitting on funds of more than $3 million who won’t pay the tax at all. This will impact on the way SMSFs invest.

Let’s debunk some myths.

Myth #1 – that only funds with more than $2 million will be affected

Rubbish. There will be plenty of Eureka Report readers with less than $1.5 million in super who get slugged.

Why? Because the new tax on earnings of more than $100,000 is an income tax.

If you have super fund assets worth $1.5 million on which you’ve managed to receive a 7% return, then your super fund has earned $105,000 for the year. And you’re paying the new tax.

Please remember that it is per member, not per fund.

If you have $1.3 million in super and you’ve managed to earn an 8% income return for your super fund, the income is $104,000. And you’re paying the tax also.

Who gets returns like these?

Investors in the major banks and Telstra, on average, earn grossed up dividends of about 8%. Have a look at the following table, which takes the dividends of the four major banks and grosses them up to reflect the tax credits in the dividends. The final column then shows – if your super fund were made up entirely of that one stock – how little you would need to have of that stock in order to be impacted by the new tax.

All are below $1.34 million.

(Obviously, not for a second, do I suggest that SMSFs hold one stock as their portfolio.)

Table 1: SMSF favourites and income generation

Fully franked dividend %

Grossed up %

Need to earn $100k

ANZ

5.23

7.471429

$1,338,432

CBA

5.39

7.7

$1,298,701

NAB

5.89

8.414286

$1,188,455

Telstra

6.18

8.828571

$1,132,686

Westpac

5.49

7.842857

$1,275,046

But it’s not just high-yielding shares. There are thousands of SMSFs who switched to cash in early 2008, as the GFC was unfolding, and locked in long-term deposits north of 8%.

Term deposits like that aren’t available now. You’ll struggle to get 4.5% today. But less than two years ago, it wasn’t difficult to put together a fixed interest portfolio that yielded more than 8% income.

The 10-year average income distribution from the Vanguard Property Securities Index Fund is 7.81%. (There has been negative growth in that time.)

Myth #2 – that if you have $2 million in super, you definitely will be affected

Not necessarily. It will be quite manageable – depending on your attitude to taking a risk within your super – to have a super fund that is worth $3 million or more and not be hit by this new tax.

Investment returns are made up of income and growth. If you are more interested in chasing growth than income, you can potentially have a much greater amount of money in your super. There are plenty of small cap companies who pay no dividends, but who hold out the prospect of capital growth.

Take, for example, a super fund that is yielding just 3%. Arguably they are taking higher risk in their portfolio than someone who is taking a higher income portfolio. But that fund could be worth $3.33 million before it will be paying the new tax.

Myth #3: Capital gains are not income

Um, yes they are. Capital gains are income – they’re just taxed a different way.

There is still too much detail that is yet to be finalised, but let’s say your SMSF makes a profit of $50,000 on the sale of an asset. (Sometimes you have to take a profit.)

Presumably the one-third discount applies (for owning the asset for longer than one year) and you’ve got a gain of $33,333.

Now your super fund can only earn $66,667 from other assets before being hit by the tax. If they were getting an average return on their assets of 7%, then our super fund could be just $953,000 big before being hit by the new tax.

As super fund members get old, selling down assets becomes more and more likely. If you have to take profits, then you will be generating capital gains income that becomes, potentially, taxable.

Myth #4: Gloss comes off geared property investment. Or does it?

Property poses an even bigger problem. Take this to a not-ridiculous extreme and you could have a $500,000 SMSF being hit by the new tax.

Any property that is sold for a $150,000 gain looks likely to become subject to the new tax. Super funds get a one-third discount for capital gains. Apply that discount to a $150,000 capital gain and you’ve got $100,000 income (there are ‘grandfathering’ provisions introduced here which I will explain in the coming weeks, but the new tax is applicable).

Then, if your super fund pension account is earning anything else from the other assets it holds, that pushes its income over $100,000. It will be paying tax at 15% on any extra income.

A super fund could be, literally, worth $500,000 to $700,000 and get stung.

There will be a couple of consequences for geared property investment.

For some, it will become less appealing. For others, it will become more attractive. If either is taken it up, it will distort the market.

Less appealing? The previous rules said that you could gear a property during your accumulation phase, then sell the property tax-free when you moved to a pension.

Not anymore. You might get away with it tax-free, but given the values of property and the profits they tend to generate, that’s highly unlikely.

But it also has the potential to distort on the other side of the ledger. If you have $200,000 worth of income in your super fund, then under the new rules, you would be up for $15,000 on the second $100,000.

However, what if your SMSF also had four investment properties, all negatively geared to an average of $25,000 per annum each? All of a sudden your $200,000 income has been reduced to $100,000. And the size of your super fund may well have doubled from $2 million to $4 million.

Strategies to come

The new rules will throw up dozens of new strategies over the next few years.

Probably the most crucial will be splitting super with your spouse. There will be absolutely no point having one spouse with a $4 million balance and the other with nil.

As your fund approaches a combined income of $200,000 – even half-way to that figure, it will require some super contribution management.

I’ll cover more on this in the coming weeks.


The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.
Graph for Busting the super reforms myths

  • The SMSF Professional’s Association of Australia (SPAA) believes the federal government’s superannuation reforms are beneficial because they create long-term certainty within super without unfairly disadvantaging self-managed super funds (SMSFs).  “[We] welcome the announced increase in the concessional cap for over 60s… which will assist Australians close to retirement, particularly women and those with broken work patterns,” chief executive Andrea Slattery said.  SPAA thinks the Council of Superannuation Custodians will help “depoliticise” super and will provide bipartisan support. The reforms, which allow people to refund unlimited excess concessional contributions, were also welcomed. But the association believes a similar option should apply to non-concessional contributions because it usually attracts the most tax and has the most inadequate measures to deal with it.
  • The federal government is wrong about how many people will be affected by its superannuation reforms, according to Combined Pensioners and Superannuants Association (CPSA). “The Government’s estimate of only 16,000 people being affected by this measure is unrealistic, as the estimate is based on a 5% annual return, when annual returns of double or more are typical,” policy coordinator Paul Versteege warned. However, he said that the CPSA welcomes the reforms despite the lack of thoroughness in the federal government’s approach. The CPSA supports the increase in the concessional contributions cap to $35,000, the taxation of super earnings above $100,000 in pension phase, and the reform of the excess annual contributions cap – which currently charge at the top marginal tax rate regardless of someone’s annual income. Meanwhile, a Super Review roundtable discussion by top industry executives has found that people with high super balances are likely to remove a significant portion of their funds from super as a result of Friday’s reforms. “More people will change their affairs to negatively gear and go into property,” Energy Industries Super chief executive Alex Hutchison said.
  • Applications for SMSF auditor registrations are lifting but are still well below the numbers reached in 2007, according to the Australian Securities Investment Commission (ASIC). “We have now received over 3,381 SMSF registration applications from the commencement of registration, 31 January 2013,” the regulator said in its April SMSF newsletter. While this is a big boost from the 1,300 received in February, the ASIC’s expectation at that time was for full-year applications to be 6,000 – well short of the 11,500 submitted in 2007. ASIC also advises SMSF trustees to submit their applications by April 30 to give ASIC enough time to assess them because they can’t be audited if they aren’t finalised.

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