Tax with Max: The 10% rule explained

Understanding how the 10% rule works, gifting property and CGT, and more.

Summary: This article provides answers on the 10% income rule and self-employed workers, gifting a property and Centrelink benefits, seeking advice on recontribution strategies, and the future of the proposed changes to pensions by the former government.
Key take-out: The 10% rule means a worker cannot contribute extra self-employed income into their super fund if they are employed on a salary full-time.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

The 10% income rule and self-employed workers

I wonder if you can give me any justification for the 10% rule for super? For example, if you earn $10,000 from an employer and $80,000 self-employed you can’t contribute any of the $80,000 to super. This means the max you can put in is the $10,000 as salary sacrifice. How can the ATO think this fair? Why can’t such a person put in $35,000 as a concessional payment like salaried workers?

Answer: The ATO is not to blame for this policy. It is the politicians that have been in charge of formulating and legislating superannuation policy. One of the only reasons that this policy is in place is to protect the tax revenue collections that the government is always trying to maximise.

The current system with regard to self-employed super contributions is an improvement on what the old policy was. Originally the self-employed could only gain a full tax deduction for the first $5,000 of a superannuation contribution and then they received a deduction for 75% of the balance.

The tax deductibility of super contributions is not the only area where the self-employed are disadvantaged. A person’s eligibility for the age pension is based on them passing an assets and income test. Currently under the income test there is a work bonus that effectively means the first $250 that a person earns is not counted as income. The problem is only employment income is counted in this work bonus. Someone who earns business income has all of it counted and does not get the work bonus.

Gifting a property and Centrelink benefits

I wish to gift a flat owned for 25 years to my son who is on a disability pension. What is the most efficient method, considering CGT and effect on Centrelink benefits, of bequeathing this unit with a high capital gain to a Centrelink disability pension recipient? Do I transfer now and pay high CGT, leave it in a will where the recipient pays CGT on disposal, or have it go into a testamentary trust?

Answer: The liability to pay the capital gains tax on the unit would not be your son’s but yours as you are the current owner of it, and therefore it will not have an effect on his pension. You could gift the flat to your son now and the capital gains tax would be payable by you and, as he would be living in the flat, there would be no capital gains tax payable by him should he sell it in the future.

Another option could be to have him live in the flat and pay rent to you, which could result in an increase in the disability pension he receives, and then the ownership of the flat would pass to him upon your death. For as long as he lived in the flat there would be no capital gains tax payable by him after he inherited it.

If you are worried about transferring ownership of the flat to your son now you could have a testamentary trust set up as a part of your will. The flat would pass to the testamentary trust upon your death and it would be controlled by the trustee nominated by you. Due to the complexities associated with your son and transferring ownership of the flat to him, you should seek professional advice.

Seeking advice on recontribution strategies

In a recent edition you said: “Once he does retire you could also consider adopting a re-contribution strategy that involves your husband taking a lump sum tax-free superannuation payout that is then contributed by you as a non-concessional contribution. Due to the complexities involved you should not take any action until getting professional advice.”

I think I understand the process but this comment about the complexities made me wonder if I’ve missed something. Isn’t it a straightforward step that just requires you to stay under the $150,000 and $450,000 limits and consider the work test if you are 65 or older?

Answer: The reason I stated that the person should be getting professional advice is because of the complexities that you noted. Someone should not embark on this strategy unless they are sure that they are not going to breach any of the contribution limits and, depending on their age, whether they are eligible to make a super contribution.

The other important thing to consider before implementing the strategy is whether it is worthwhile. This is because the people who use a re-contribution strategy do not get the benefit. By converting taxable super to tax-free super the amount of tax paid by non-dependent beneficiaries decreases. Taxable super passing to non-dependents is taxed at 16.5%.

In some cases, where it can be reasonably estimated that a couple’s super will either run out or have a very low value in the future, the time and effort involved in the re-contribution strategy is not warranted.

Proposed changes to pensions by former government

I am 65 next June and getting ready to start a pension from my SMSF, however I wonder if you could answer this question please. [Former Treasurer] Wayne Swan in the last budget changed the asset or income test for the age pension. I think if you commenced a pension before January 2015 the current rules concerning your assets applied, but if you started after that date you would lose an extra $26 in each $100 after that date. Could you explain that please, as I saw it on TV and have not been able to find an answer anywhere else?

Answer: The policy you are referring to was a change in the way that pension income from a superannuation fund is assessed under the income test for age pension eligibility. Thankfully, like many other super policies that were put forward by Wayne Swan, they had not been passed as legislation before the election was called.

Currently when a person receives a pension from a superannuation fund the actual amount received is reduced by the purchase price of the pension. This purchase price is calculated by dividing the value of the person’s superannuation account at the time they start the pension by their life expectancy at that date.

The ability to deduct the purchase price from a superannuation pension has been the most fair and equitable way of assessing the income for Centrelink purposes. This is because the way superannuation pensions are designed, where the minimum pension required to be taken increases as the member gets older, means there will come a time when the capital of the superannuation account will be paid to the member.

Under the proposed change, superannuation pensions would have been treated like all other financial investments. This would have meant that the value of a pension account each year had the deeming rate of income applied to it. As a result the income counted under the income test would have been greater than the current value counted by Centrelink. As to whether the Coalition will take up this unfair and in equitable policy will be anyone’s guess.

Max Newnham is a partner with TaxBiz Australia, a chartered accounting firm specialising in small businesses and SMSFs.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

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