How low can you go

Something amazing has happened to taxation.

The succession of personal tax cuts, the revamping of the superannuation system and the introduction of transition-to-retirement superannuation pensions are working together to potentially reduce personal taxes on retirement savings, investments, and salaries to an extraordinary extent.

Just consider that in 2004–05, the top marginal rate began at $70,001*. But from 2008–09 it will cut in at $180,001 - a difference of $110,000. And the fall in personal taxes is truly capped off by the prospect of tax-free superannuation benefits from age 60.

The determination in the community to carry these tax gains even further is illustrated by the growing popularity of taking transition-to-retirement pensions (available from age 55) while simultaneously making higher salary-sacrificed superannuation contributions. This is being advocated by many financial planners, depending upon the circumstances of their clients.

In short, transition-to-retirement pensions receive a tax rebate of up to 15 per cent. Once the recipient turns 60 the income becomes tax-free. And salary-sacrificed contributions provide a widely en-couraged way to minimise tax on salaries and boost superannuation savings for those with marginal tax rates above 15 per cent.

Further, superannuation fund assets that support the payment of a pension, including a transition-to-retirement pension, are not subject to income or capital gains tax (CGT).

Sydney tax and superannuation lawyer Robert Richards says the combination of tax cuts and superannuation reforms means Australia has entered into a new tax and retirement-savings environment that is not yet fully appreciated.

'It almost makes Australia a bit of tax haven for people over 60,' Richards says. 'This is despite blanket publicity in the lead-up to the new superannuation regime.

'The tax and superannuation changes when combined with a little highly legitimate tax planning can produce some very exciting results.'

Perhaps one of the most overlooked advantages of tax-free superannuation benefits from age 60 is its spillover effect on the taxation of non-superannuation investments.

Many retirees will pay much less tax on investments held outside superannuation simply because their super benefits are no longer included in their assessable income.

Tens of thousands of older investors will move into lower tax brackets, and many will become eligible for both the low-income tax offset and the government co-contribution to superannuation. Many will be treated as lower-income earners from a tax perspective regardless of the size of their superannuation pensions.

And a couple who is eligible for the senior Australians tax offset can receive a combined non-superannuation income of up to $43,360 in 2007–08 without having to pay tax.

Alan Freshwater is co-principal of financial planning group RetireInvest in Bondi, NSW. He immediately suggests that his clients gain professional tax advice if he believes the tax position of their non-superannuation assets is likely to significantly change.

Freshwater says numerous investors may not only pay less tax on their investment income but could be subject to lower capital gains tax when assets such as real estate and shares outside superannuation are sold.

Here are six simplified case studies that reflect some of the opportunities. Most concern people nearing or in retirement because they are big beneficiaries of the new tax and superannuation environment.

Case study 1

Scenario: A 55-year-old has a $100,000 salary income plus superannuation guarantee (SG) contributions, and no other income. He has $1m in superannuation. His wife is not in the paid workforce. The couple's estimated living expenses are $60,000 a year.

Strategy: The spouse in the workforce wants to salary sacrifice as much as is tax-effective, and for a transition-to-retirement pension to pay the couple's living expenses in a more tax-efficient way. Crucially, both are determined to build up their retirement savings.

Detail: Andrew Lowe, technical manager for ING Australia, calculates that the working spouse could make salary-sacrifice superannuation contributions of $61,845 a year to super and take a transition-to-retirement pension of $33,155.

His after-tax income would remain almost exactly the same but his superannuation will receive a considerable annual boost - up by more than $32,000 in the first year, and this will magnify in later years.

Case study 2

Scenario: A single 60-year taxpayer has a $100,000 salary (plus SG contributions). She has $600,000 in superannuation, and no investment income or other earnings.

Strategy: She wants to make large salary-sacrificed superannuation contributions and receive a transition-to-retirement pension.

Detail: Superannuation laws limit the amount that she can receive as a transition-to-retirement pension to a maximum of 10 per cent ($60,000 at this stage) a year of her superannuation balance.

Lowe assumes that she salary sacrifices $70,000 into superannuation, adding $59,500 to her superannuation balance after allowing for contributions tax. And she takes a transition-to-retirement pension of $59,500 that more than covers her living expenses. The pension is tax-free at her age.

In summary, Lowe calculates that her net income is up by a little more than $14,000 in the first year without affecting her superannuation balance. She has truly reaped the tax advantages of salary sacrificing super and a tax-free pension.

Lowe says she can push her tax benefits further by making a non-concessional or personal contribution to superannuation.
This would make her eligible for a government co-contribution to superannuation of $1449 because the large salary-sacrificed contributions have reduced her taxable income to $30,000.

Case study 3

Scenario: A retired couple, both aged 65, has combined superannuation savings of $2m ($1m in the account of each spouse). There are no non-superannuation assets or investments. The couple's estimated living expenses are $70,000 a year, and they have already begun to draw a superannuation pension.

Strategy: The couple obviously wants to pay all living expenses through superannuation but are seeking guidance about what to do with pension income in excess of their needs.

Detail: The superannuation pension is tax-free given their age. Under superannuation law, each spouse must draw a pension of at least 5 per cent a year of their account balances (this applies to those aged 65–74) - a combined amount of $100,000 in this case. This is $30,000 in excess of the couple's needs.

Fund members aged 65–75 must pass certain work tests in order to make superannuation contributions. Work tests do not apply in this case because both have retired.

However, Lowe points out that the investment of the $30,000 of unused pension income can still produce excellent tax results if invested in non-superannuation assets. No tax would be payable on their non-superannuation income until it reached a combined amount of $43,360 because each spouse is eligible for the senior Australians tax offset.

Case study 4

Scenario: A 60-year-old retired couple jointly owns a $1m share portfolio held outside superannuation (producing a 3.3 per cent fully franked yield) plus $1m in superannuation. (Each spouse's superannuation and non-superannuation investments are equal.) The couple's living expenses are $70,000 a year.

Strategy: The couple wants to receive income from their superannuation and shares in a highly tax-efficient way to meet their living expenses.

Details: Lowe says the couple could take tax-free superannuation pensions of $40,000 in total. (Under the superannuation rules, they must draw down at least 4 per cent a year of their superannuation balance because they are under 65.)

Their share portfolio will produce combined dividends of $35,000 in the first year plus imputation credits of $15,000.

Lowe suggests the couple could use some of their imputation credits to pay their combined tax liability of $1826 in the first year, reducing the refund for excess imputation credits to $13,174.

After paying Medicare, the couple could contribute $17,424 - the income unused for living expenses - back into superannuation as a non-concessional contribution (previously known as an undeducted contribution).

Case study 5

Scenario: Each spouse in this couple earns an $80,000 salary (plus SG contributions). Both are 40.

Strategy: Each spouse intends to make salary-sacrificed contributions of $10,000 a year into superannuation.

Detail: Lowe calculates that the couple's salary-sacrifice strategy will provide a combined tax benefit of $4300 in the first year, taking into account income tax, Medicare and contributions tax. And their concessionally taxed superannuation savings will receive a big boost.

Case study 6

Scenario: A recently retired 60-year-old couple jointly owns a $4.7m share portfolio (producing a 3.5 per cent fully franked yield) held outside superannuation. Their living expenses are $70,000 a year.

The example of this high-asset couple is included to illustrate how the recent tax cuts and imputation system can produce excellent results - even if very valuable assets are owned outside superannuation.

Strategy: This couple wants to use the income from their shares to pay their living expenses, and wants to reinvest the remainder.

Detail: Lowe says their share portfolio will produce combined fully franked dividends of $164,500 in the first year - well above their living expenses.

Their imputation credits of $70,500 will completely eliminate all additional tax payable (excluding Medicare).

Lowe says the couple could contribute the amount of income above their needs into superannuation until they reach 65, as allowed under superannuation law.

'Because of their level of assets and knowing that any growth in dividends over time will result in a future income-tax liability, the couple may want to transfer some of their shares into superannuation as non-concessional contributions,' he says.

If the couple establishes a self-managed superannuation fund, they could transfer some of their shares into the fund but should be aware of likely CGT.

And there is an added tax bonus. Lowe says the couple would generally be eligible for a tax deduction on personal contributions up to $100,000 a year because they do not receive superannuation support from an employer. The deduction could offset the CGT that might be payable on transferring some shares into a self-managed fund.

This article is of a general nature only. Readers should consider their personal needs, circumstances and objectives, and any professional advice received.

*All amounts listed in Australian dollars.

Reference: October 2007, volume 77:09, p. 46

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