Issue 09 - SMSF Wealth Newsletter - August 2017
The irony of superannuation is that by the time the average person can afford to make significant additional contributions into their superannuation, they will likely be too old to reap the benefits of compounding returns to achieve substantial value.
Individuals between 30 to 45 years of age, on the other hand, are able to generate up to 30 years worth of compound returns on any additional superannuation contributions, assuming a condition of release is still available at age 60 (as under current law).
Whist this makes good financial sense, life between 30 to 45 years of age is known for a multitude of other financial pressures. Getting married, managing mortgage repayments and providing for children can make controlling the weekly cash flow difficult. Diverting precious funds into a tax-effective haven that will remain out of reach for up to three decades sounds impractical for most.
For 30 to 45 year olds, common superannuation decisions relate to:
- Making additional superannuation contributions vs mortgage repayments
- Boosting superannuation on a low income
- Assigning superannuation assets to growth or conservative asset classes
- Taking up insurance inside or outside superannuation
- Making spouse contributions
- Dividing up superannuation assets in the event of a divorce
To Pay Down The Mortgage Or Boost Superannuation?
Balancing additional mortgage repayments against boosting superannuation is a common challenge. Often 30 to 45 year olds will want to know if it is more advantageous to direct additional funds towards their owner-occupied mortgage or into the concessionally taxed superannuation environment.
The answer depends on your personal circumstances, your marginal tax rate, the interest rate on your mortgage, the return on investment being achieved by your superannuation fund, whether or not the contribution is concessional (one that you have claimed as a tax deduction and therefore taxed within your superannuation fund) or non-concessional (one that you have not claimed as a tax deduction and therefore not taxed within your superannuation fund).
Usually you would focus on paying down non-deductible debt (home mortgage and credit card debt) that is not working for you from a tax efficiency point of view. You are not really getting any tax benefit, other than moving money into a concessional tax environment, when making after-tax non-concessional superannuation contributions. Therefore, with non-concessional contributions, if you are comparing those to paying down the mortgage, you may be better off paying down the mortgage in some circumstances.
The decision may be different when considering concessional contributions which are only taxed at 15% when entering the superannuation environment, assuming your adjusted taxable income is less than $250,000. If you are on the highest tax bracket of 45% plus 2% Medicare levy, you will have 53 cents in the dollar after-tax. If you made a concessional superannuation contribution instead, you will have 85 cents in the dollar after-tax.
While the strategy does have merit and is worth considering, cash flow will always have the final say on whether or not it is feasible in your particular circumstances.
We can model your individual circumstances if you would like advice on this strategy.
Strategies For Those With Low Incomes And / Or Superannuation Balances
Superannuation contributions can be a sensitive issue for individuals who have low incomes, low superannuation balances, or both. Contributing to superannuation throughout your working life is important to create a reasonable nest egg for retirement. It is suggested that individuals should be contributing around 15% of their salary over 40 year working life.
For individuals with low superannuation balances but increasing incomes, there is now legislation coming in that will provide catch-up contributions for those able to save more in the future. If you do not contribute your full $25,000 per year concessional entitlement from 1 July 2018, you will be able to carry forward the unused portion for up to five years provided your superannuation balance is less than $500,000.
For individuals struggling to make additional contributions to superannuation due to low income, there is very little that can be done beyond closely examining your budget and reining in your cash flow. If you really want to put more into superannuation, you need to critically analyse your expenses to free up some cash flow. If you're overcommitted and not able to meet your day-to-day expenses, credit card debt can build up and you could end up going backwards. If you do not have the cash flow then you should not be putting any extra money into superannuation.
The Low Income Superannuation Tax Offset (LISTO), which came into effect on 1 July 2017, was introduced to ensure that people earning $37,000 or less do not pay higher tax on their superannuation contributions than on their wage income. It is a Government contribution to refund tax paid by the fund on contributions that would not have been taxed if received as wages by the taxpayer. The maximum LISTO that can be received is $500.
Investing Your Superannuation: Upping The Risk?
Apart from how much you are able to contribute towards your superannuation balance, another important consideration is the risk profile you are willing to adopt. If you are unfamiliar with the turbulence of the markets you may be less inclined to invest in growth asset classes of domestic and international shares and property. Instead, you may prefer a more balanced option which incorporates a mix of other conservative asset classes, such as Government bonds and cash.
Individuals aged 30 to 45 years are able to take on more risk than those individuals about to retire. The long time frame will allow the smoothing effects of time to potentially smooth out volatility and provide an attractive return on capital. Nevertheless, individuals who adopt this approach must be prepared to brace themselves throughout the periods of uncertainty and market fluctuations as there is always going to be volatility in investment markets.
As they are riskier investments, there will be periods of poor performance, even negative performance but when you are looking at many investment cycles before retirement, you have the capacity to deal with the ups and downs of market fluctuations.
Insurance: In Or Out Of Superannuation?
Insurance cover is extremely important for those individuals within the 30 to 45 year old age bracket. These individuals usually have a number of financial dependants, mainly their spouse and children, in addition to mortgage commitments. The ability for an individual or their family to access insurance in the event of an injury or death is vital.
Life insurance cover can be purchased outside of superannuation or there is an option to purchase a number of life insurance policies within the superannuation environment.
If purchased through superannuation, the premiums are deducted from the individual's superannuation account balance rather than requiring payment by the insured from funds outside of the superannuation system.
Funding these premiums from an existing superannuation balance has benefits and drawbacks. There is a significant cash flow benefit when you do not need to come up with the funds to cover your premium. For younger individuals, who have other pressures on their finances, holding insurance in superannuation can be tax effective because if you are getting a tax deduction for your superannuation contribution going into your superannuation fund, then effectively you're getting a tax deduction for your insurance premium.
However, there is a drawback to paying insurance directly out of your superannuation balance. The problem is that the contributions that your employer would otherwise be making towards boosting your superannuation account balance are going to be eroded by having to pay the premiums.
A solution to this issue is to make additional superannuation contributions to cover the premiums. The tax advantages still stand provided the additional contributions are made as concessional contributions within the $25,000 per annum limit.
It is important to note that the policies offered through superannuation can be more restrictive than those offered directly by insurers. Speak to your Brentnalls SA advisor before changing insurances.
Increasing The Balance Of A Low Earning Spouse
It is common for one partner in a couple to take time away from full-time work after having children. Not only can this income reduction make the costs of living more difficult but the partner who stays home is likely to see no material increase to their superannuation balance while out of work.
One option to keep both partners' superannuation balances rising beyond the earnings generated is to make spouse superannuation contributions. These are non-concessional contributions from the full-time working spouse into their partner's superannuation account.
An individual can claim an 18% tax offset on non-concessional superannuation contributions deposited into a low income spouse's superannuation account up to a maximum of $540. Therefore, to earn the maximum amount, the contribution must at least be $3,000. In addition, the following criteria must be satisfied:
- The spouse receiving the contribution must be on a low income of $37,000 or less. The tax offset is gradually phased out as a partner earns up to $40,000
- The super contributions were not deductible
- Both partners are Australian residents at the time of the contribution
- Both partners are living together at the time of the contribution
While such an offset may prove attractive, couples are still required to find up to $3,000 of additional non-concessional contributions to be eligible for the benefit.
Splitting superannuation benefits after divorce
An unfortunate reality of modern life is that relationships can break down. After years of a partnership, where financial decisions have been made in tandem and funds moved into superannuation, an inevitable question in the face of divorce is how to treat each partner's superannuation balance.
Superannuation is an asset that forms part of the matrimonial property asset pool that is divided up when couples split, just like any other asset.
Liquidity limitations are a key consideration when dividing up superannuation assets in the event of a divorce. If you are the recipient of the superannuation from a divorce, it is probably not that advantageous because you do not have access to the capital to buy a new home or pay down any debt. If that is the case, and both partners are in similar circumstances, you would probably agree to split the super 50/50.
Given that these funds are not able to be accessed until a condition of release is met, superannuation is likely to be worth more to a comparatively older partner. If one person is older and can access the super a bit earlier, it may be an opportunity to get the lawyers to negotiate in terms of the split.
Should you wish to speak to us about your particular circumstances and work out some options that would work best in your situation please contact our office.
Do you have family or friends who are considering a separation, divorce or property settlement?
Collaborative Practice is an option for out-of-court family law property settlements when you wish to keep ongoing constructive communication lines open.
Collaborative Practice has now become popular in the USA, Canada, the UK, Europe and Australia.
What is Collaborative Practice?
Collaborative Practice involves the parties and their collaboratively trained lawyers meeting to negotiate a property settlement and/or children's issues without going to court, preparing court documents and complying with court rules and procedures. Importantly with collaborative practice, all involved parties and advisers:
- commit to proceed honestly, respectfully and in good faith for the parties and the process;
- agree to negotiate a mutually beneficial settlement;
- create shared solutions taking into consideration the interests and priorities of both parties; and
- engage in an honest and complete exchange of information and documents.
Throughout the process the separating couple will be:
- present for all negotiations and for all legal advice that is given;
- given the option of having a collaboratively trained financial adviser present who can assist with gathering information, preparing a list of assets and reality testing various financial options. The financial adviser remains neutral and does not give advice; and
- given the option to have a collaboratively trained relationship counsellor attend to assist in dealing with children's issues and the emotional atmosphere.
The counsellor also remains neutral.
When a resolution is reached, which may take one or a number of meetings, orders can be drawn and sealed by the Family Court so they become enforceable.
At the start of the process the lawyers for each party provide a retainer agreement to their client which sets out the scope and duties of the lawyer. If settlement cannot be reached or if one party decides to terminate the process and head to court then the lawyer's retainer is terminated and they are disqualified from representing the party in court due to the frank and open nature of the process. However, this will lead to more costs being incurred.
- There is no litigation so no court timetable to follow.
- The issues and solutions are not limited by the Family Law Act 1975.
- The parties communicate directly with each other.
- The parties, not a judge, control the process including the timetable and make the final decisions while having the support and guidance of their own collaboratively trained lawyers, financial advisors and relationship specialists.
- The parties can create shared solutions acknowledging the highest priorities of all parties.
- All involved parties and advisers work towards a mutually created resolution of all issues.
- The process is private so it can be attractive to high profile people.
- It can lead to ongoing constructive communication between the parties into the future, which is vital when children are involved.
- It minimises hostility and conflict.
- The overall cost should be less than the court process, but it may depend on how many meetings are held to reach a resolution.
- It is flexible and allows for creative solutions.?
- If settlement cannot be reached for whatever reason and court proceedings are issued, the lawyers are not able to represent the parties – this adds to the costs.
- Each party gives up their right to unilateral advocacy, access to the court system and to object to producing documents and/or providing information that is relevant and appropriate to divulge.
- If a Iawyer believes that the other party is not acting in good faith, perpetuating dishonesty or is using the process to delay litigation then the lawyer can withdraw or terminate the process.
- The lawyers cannot guarantee that the parties will adhere to the Collaborative Practice principles or that a resolution will be reached.
It's Not For Everyone
The lawyers, financial advisers and relationship counsellors have to undertake training to be able to participate in the process. Much of the success of the collaborative process depends on them initially undertaking an assessment as to whether the case and the client are suitable.
The parties need to feel comfortable being in the same room and talking face to face to their former partner while they address difficult personal and emotional issues. They have to be able to consider the needs and interests of the other party and anything that clouds this ability could make the process futile.
If you need a collaboratively trained financial adviser to assist with your property settlement, please call Karen Nyberg at our office on 8241 8444. She can also recommend suitably trained and experienced lawyers and relationship counsellors to be involved in this process.