Forget concessions, the reality may be a 93% tax

Thanks to cuts in the last federal budget, many investors could unknowingly be heading for a big tax shock when they look at next year's super statement.

Most investors will be aware that the Government cracked down on so-called high income earners rorting the system by more than halving the amount you can contribute to super on a concessionally taxed basis.

The limits were cut from $100,000 for those aged 50 and above to $50,000 and from $50,000 to $25,000 for the under-50s. On the face of it, that halved the amounts allowed in reality the cut was even more savage as those original limits had been due to be indexed this financial year.

Theoretically, the under-50s should have been able to squirrel away up to $55,000 this year  so the cut was more in the order of 55 per cent.

But all that is history. The new limits came in and apply for the first time this financial year. We're stuck with them.

But super experts are warning that not everyone understands how they work and could find they have unintentionally breached the new limits come next July.

That's because the new caps apply to all concessional (or pre-tax) contributions made on your behalf. So it's not just the voluntary contributions you elect to make through a salary sacrifice arrangement or by making tax-deductible contributions yourself, if you're eligible.

It also includes any compulsory super payments your employer makes on your behalf, plus any additional employer payments such as higher contributions and  wait for it  any costs of the fund subsidised by your employer.

Some employers, for example, choose to pay some or all of the administration or insurance costs of their corporate fund.

Employees are unlikely to take account of, or even be aware of this when deciding how much extra they should contribute.

But intentional or not, the penalties for making excess contributions are hefty. Any contributions above the limit are taxed at 31.5 per cent. That's on top of the normal 15 per cent contributions tax, so you're automatically being hit with the top tax rate of 46.5 per cent  regardless of your income or marginal tax rate.

Arguably, that should be penalty enough. But the excess is also counted towards your non-concessional cap  the amount that you can contribute after-tax.

If you're nearing retirement and have taken the opportunity to make a big after-tax contribution (maybe you've sold an investment or received a divorce settlement), you could find that excess contribution has tipped you over this cap as well. In that case more penalty tax will apply  another 46.5 per cent  taking the total tax hit to an incredible 93 per cent. If you are over the limit by $10,000, that's $9300 to the government and just $700 to you. It's hard to think of a more punitive tax rate.

The stiffness of these penalties is not accidental. They were introduced to limit the extent to which investors could benefit from the abolition of all taxes on super benefits taken after age 60. Limiting contributions was intended to be simpler and less costly than the convoluted old system of reasonable benefit limits.

But the lower contribution caps have made more people vulnerable to excess benefits, and super experts are warning of the need to review your contribution levels before it is too late.

The consulting company Mercer says a red flag should automatically be raised for anyone under 50 and earning more than $277,000 (or over 50 and earning more than $553,000  though that's less common).

On this salary, if you are receiving your full compulsory super entitlement, that alone will amount to $24,930 (or $49,770) and even a small pay rise could tip you over the limit. Fortunately, there is a provision to stop you automatically being pushed into excess contributions. Your employer is only required to pay the Super Guarantee on the first $40,170 of ordinary time earnings per quarter  which equates to annual earnings of $160,680 a year. So you can talk to your employer about trading off some of those super contributions for other benefits, though they may not attract the same tax concessions. Mercer says one option is to keep the money going into super and have it counted as a non-concessional contribution.

You'll still pay the same 46.5 per cent you would have paid if you had taken the salary, and you'll be building up your super  so long as you take care not to exceed the non-concessional limit as well.

Other options include tax-effective investments like insurance bonds, borrowing to invest, paying off debt and managed funds.

But it is not just the super high earners who need to review their contribution levels. Compulsory super on a $150,000 salary is $13,500, so a modest contribution of $250 a week would push an investor over the new cap if they're under 50.

And someone earning less than this could run into problems if they are maximising their super contributions but don't reduce them after receiving a pay rise  and the corresponding lift in compulsory super.

The new limits have increased the importance of reviewing your super strategies early in the year, rather than the usual last-minute rush in June. It can be difficult to turn off arrangements at short notice and once contributed, you can't just ask for your money back.