Summary: There are three structures to consider when building wealth over the long term. Super offers low taxes but those born after 1964 can’t access the funds until after they are 60. For trusts, access is less of a problem but beneficiaries must pay full tax on income and capital that is distributed. Holding assets in personal names is easiest but full tax is again payable.
Key take-out: Truly long-term investments should usually be placed inside super, if possible. But more people should consider trusts, from earlier in their lives.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.
There comes a time in many people's lives where the constant struggle to stay afloat is superseded by thoughts of creating real wealth.
There is spare money left over, monthly, after life's expenses are covered. Thoughts turn to how you make the most of it.
At this point, the first consideration is usually what to invest in, followed by in whose name, husband or wife, further investments should be made.
But these aren't the only options and many mistakes with permanent ramifications are often made at this point.
Creating real family wealth should start out with a roadmap that takes in a combination of what you're trying to achieve and when you're hoping to achieve it.
Superannuation and self-managed superannuation funds in particular are an awesomely powerful investment vehicle. But super is, by no means, the only investment vehicle that should be considered.
For younger people, the main drawback of superannuation is access. Super is a "tax versus access" structure for investments. In return for low tax rates, you're not able to access your super until you reach a certain age. (This is currently 55, or 60 if you were born after mid-1964, and this might also be raised by legislation in years to come.)
Putting assets in your own name comes with ultimate flexibility and access, but also with full taxation. This means up to, currently, 49 per cent for income earned, or up to 24.5 per cent for any capital gains on assets held for more than a year.
Super comes with tax rates of 0 per cent or 10 per cent for capital gains, or 0 per cent or 15 per cent for income.
Trusts come with the same tax rates as individual rates, but with the flexibility of determining what income/gains are distributed to whom.
For investors, the two big questions are: What are you trying to achieve? And when will you need the money?
Keep those questions in mind and the decision on structure becomes much easier.
Some investment horizons are short term. We are not going to deal, today, with those that are under, say, five years.
Superannuation: pros and cons
Low taxation. Forever! This is the major benefit of superannuation.
Under current rules (which are increasingly looking like they could be changed), you'll never pay more than 15 per cent tax for anything earned in super.
What isn't properly understood about super's tax rates is the compounding nature of those low tax rates. The extra funds, instead of being taxed, stay in your account and continue to earn money, which is then also taxed at lower rates. On and on this goes, year after year, until you start to access the money.
But it continues on after that. Once you turn on a pension from super, there is no tax paid (currently) and the compounding goes into overdrive. Earning money on which no tax is paid … clearly there are huge benefits to that.
Once you turn on a pension, there is no tax inside the pension fund. And, if you're over 60, there is no tax paid outside the fund for income paid to you either.
The downside? Access. Those born after 1964 can't even begin to access super until after they are 60. And this age might rise in years to come.
Money in super can't be used to educate the kids. It can't be used to replace a clapped out car or to fund an overdue holiday.
Simply, you can't push every spare dollar into super, particularly if you're on the good side of 50, because you might need it before you turn 60 (or 65, if you don't actually retire before then).
Trusts: pros and cons
The main benefit of trusts over super is that access isn't such a problem. Funds can, technically, be distributed to beneficiaries at short notice. But they can stay there protected, for decades, if required.
Trusts allow far greater protection than investments held in personal names. They are often the best investment vehicle for those who need to consider asset protection, such as those in industries who might be might be sued or face personal liability issues (such as those in medical or legal professions, or those who are self-employed).
Income from trusts can be distributed to trustees, according to the trust deed's rules. But trust deeds, at set up, are usually kept reasonably flexible, or as flexible as is required by those setting up the trust (who also might wish to set it up so there is little or no flexibility). So income and gains can usually be passed to those who can benefit from it most.
The downsides of trusts are that they don't allow for negative gearing to be passed through (see individuals in next section), and beneficiaries must pay full tax on income and capital that is distributed.
There is also usually a cost to set up and maintain trusts.
Trusts, whether family or unit, are often the best vehicles for holding family small business interests, or assets that you wish to hand down to future generations.
Individuals: pros and cons
Clearly, the easiest and cheapest way to hold assets is in personal names. There are no set up costs, from a structural perspective.
You can buy and sell at a moment's notice and take gains immediately to make use of as you see fit.
However, full tax must be paid on income and gains, in the name of the person who held the asset.
It can be difficult, even costly, to shift ownership when originally placed in your personal name.
Long- versus short-term investments
Truly long-term financial aims and investments should usually be placed inside superannuation, if possible. If you know that you're not going to need certain portions of your money until retirement, the benefits of low taxation (compounded) of having that money inside super will generally provide the best solution.
The closer you get to retirement, the easier it should be to determine whether sums of money should be placed inside superannuation.
Lower tax, on an ongoing basis, allows you to invest more of your money for longer.
Everything that you need to hold outside of super is, then, a trade off. If you might need access to funds – and inevitably you will need access to funds before retirement – then certain portions of your funds need to be held outside of super.
But in your personal names? Not always. And considering trusts, for holding those assets that you wish to retain some flexibility (and protection) for, should be part of more people's planning, from earlier in their lives.
The closer you are to age 60, the more likely that superannuation is going to be the best investment vehicle for you.
But for those under 40, or potentially even under 50, who might need access early, but need protection for those assets, a family or unit trust might provide the right structural solution to fit between superannuation and holding assets on an individual basis.
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.