Super Funds and Tax Time
Changes to the laws target aggressive strategies that allow self-managed super funds to avoid tax. The Federal Government has signaled its intention to crack down on members of self-managed or “DIY” super funds who use loopholes in the law to reduce their tax, set up generous life pensions and undertake creative estate planning.
The Government recently announced a $216.4 million boost for the Australian Taxation Office to improve taxation compliance, and bring self-managed super funds under greater scrutiny.
Self-managed super funds have been growing at a rate of 2000 a month, with about 260,000 funds now in existence.
The move is likely to bring to a halt aggressive strategies that allow users of these funds to exploit special provisions within super rules to avoid the normal benefit limits that apply – the maximum deductible contribution (MDC) limits and reasonable benefit limits (RBL).
The MDC is the maximum amount an employer or self-employed person can claim as a tax deduction for super contributions. Limits are age-based and indexed and this year are: under 35 – $13,233; 35 to 49 – $36,754; over 50 – $91,149.
The RBL is the maximum amount that can be taken out of super at retirement. For those electing to cash out the benefit or convert it into an allocated pension, the limit this year is $562,195.
Most super funds are established as accumulation funds, where member contributions plus the earnings on those contributions form the basis of the member’s entitlement at retirement.
But many older employer-style funds are classified as defined benefit funds, where the benefit at retirement is determined by a set formula based on final salary and number of years in the fund.
Super funds providing defined benefit payments have different requirements to accumulation funds, as there is a need to provide certainty of benefits to members. When markets fall, there need to be sufficient funds on hand to cover any deficit. When benefits exceed the liability of a fund, it may be possible for employers to take a contribution holiday.
Managing the fluctuations is usually done through a reserve account, which the fund operates, to smooth things out.
The reserve account enjoys the same low tax concessions as the members’ account but, because it is unallocated, it may be possible for a self-managed super fund to have large sums in the reserve account, avoiding the RBL that is imposed on individual members.
A fund with two members could potentially have member account balances of $200,000 each, with a reserve account of $1 million.
This strategy is often used as a method of passing assets to children. They could join the fund with minimal account balances. On the death of the parent, the unallocated reserve is then allocated to the children.
Needless to say, normal access restrictions apply, but this method could potentially see thousands of dollars in assets pass through to children, potentially avoiding capital gains tax.
Use of defined benefit funds also means that some members are able to make tax deductible contributions to super which exceed the normal MDC limits.
This is on the basis that contributions are effectively topping up the reserve account.
But under the changes announced in the budget, self-managed super funds will now be required to allocate all contributions to specific member accounts, effectively terminating the reserve account arrangement.
Similarly, these funds will themselves not be permitted to operate defined benefit schemes unless they have 50 members (which by definition means they are no longer self-managed).
And the funds will not be able to offer defined benefit pensions, unless they are purchased through a life insurance company. Defined benefit pensions include complying annuities which have been popular among promoters of self-managed super funds. Effectively, the changes shut down self-managed funds offering anything in retirement other than an allocated pension or the new growth pension (which will become available later in the year).
According to Treasury officials, the changes don’t affect existing funds that are already operating as defined benefit schemes or funds already paying a defined benefit pension as of budget night.