An effective and simple way to increase your retirement savings, while also reducing your tax bill is to sacrifice your salary to superannuation.  For a worker earning a salary of $125,000, sacrificing $25,000 to superannuation will save $5,875 in tax in the first year.

For those aged 55 or over, who are still working, a transition to retirement pension (TTR) is a great way to provide you with options as you approach retirement.  This is because:

• You have the ability to sacrifice your fully taxed salary income to superannuation, while you make up the shortfall by taking a tax free or concessionally taxed TTR pension;
• Alternatively, you may choose to reduce your working hours, and top up your income by taking a TTR pension;
• Payments drawn from your TTR pension are concessionally taxed if you are over 55 or tax free in your hands if you are over 60;
• Income and capital gains earned on your investments held inside a transition to retirement pension are tax free.

Case study – salary sacrifice and TTR pension strategy

John is aged 60 and his taxable income is $100,000 per annum.  He pays $26,450 in tax, meaning his take home pay is $73,550.  His current superannuation balance is $450,000.  John decides to take a TTR pension of $26,350, and sacrifices $41,000 of his salary to superannuation.  This means his take home pay remains the same, while his income tax bill has been reduced to $11,795.  This represents a tax saving (including superannuation contributions tax) of $8,505 in the first year.

A further benefit John will enjoy is the tax savings on pension earnings, as the earnings tax of 15% does not apply to money invested in his transition to retirement pension.  Based on a balance of $450,000 and earnings of 7.5% this can mean a tax saving of around $5,000 in the first year, available for his retirement.

For a confidential discussion on how this or other strategies may improve your financial position, call Power Wealth Management today on 1300 975 224.

Small business concessions – Case study

If you own an eligible small business, you may be entitled to generous tax concessions on the sale of your business if you direct your proceeds to superannuation.

Janice is 55 years of age and is a sole trader.  Contemplating retirement, she decides to sell her business to Jeff for $750,000.  She started the business from scratch in 2004.  She will generate a capital gain of $750,000 on the sale of the business, and be subject to tax of $147,925.

Janice contributes the whole $750,000 into superannuation by claiming the 50 percent CGT discount, and then using the small business retirement exemption to make a contribution equal to the CGT exempt amount (being $375,000). The remaining $375,000 is contributed to super as a non-concessional (after tax) contribution. By doing this, she reduces her capital gains tax payable to nil, saving her $147,925.

For a confidential discussion on how this or other strategies may improve your financial position, call Power Wealth Management today on 1300 975 224.

• If you or any of your partners were to sell your share of your business tomorrow, how much would you want and under what terms?
• Who will look after the business in the event of death or disability tomorrow to you or one of your partners?
• Would you or any of your partners be able to raise the required funds to purchase another partner’s share of the business if it were required tomorrow? And how?
• Do your beneficiaries have the required knowledge, motivation, skill and inclination to successfully take over your share of the business in the event of death or disability?

Business succession planning facilitates the orderly transfer of a business from one owner to another person(s).  It takes into account the questions listed above, specifies how the business is to be valued and also considers how this transfer would be funded.  To retain ownership of the business, the owners will need a buy-sell agreement to be drafted by a lawyer that grants a call option to the continuing owners to buy the share of business from the exiting owner, while the exiting owner is granted a put option to sell their share of the business to the existing owners.  There are several ways to fund the transfer, for example, by borrowing cash, selling assets or paying gradually.  But the cheapest and most effective way to fund this transfer is to insure the risk, by taking out a combination of term life, total and permanent disablement and trauma policies on each partner.

Development of an effective business plan requires collaboration between you and your business partners, your accountant, your financial adviser and your lawyer.  There are several tax consequences to consider, with respect to who holds the insurance policies and how the buy-sell agreement is structured, and care must be taken to ensure all proceeds are received tax free.  As the value of the business will change over time, the agreement should be reviewed every 12 months.

For a confidential discussion on how this or other strategies may protect your business, call Power Wealth Management today on 1300 975 224.

• How will the business perform tomorrow if one of the key persons suffered either death or permanent disability?
• If the business will be adversely affected by the loss of the key person, is there sufficient cash readily available to ride out the disruption?
• Is there anyone readily available to take over the role of the key person; or does the business need to recruit externally?  How much would this cost and how long would it take?
• Would the business lose clients due to the loss of the key person?
• Would raising funds become more difficult as a result of the loss of the key person?
• Will any outstanding loans owed by the business to the key person be called for immediate repayment?
• How would the loss of a key person impact the value of goodwill?

The purpose of a revenue protection strategy is to provide the business with sufficient cash to compensate for the loss of revenue and replacement costs in the event of a loss of a key person.  Without considering such a strategy to deal with the loss of a key person, the financial viability of the business may suffer as a consequence.  While it may be feasible to plan for this day by putting aside a cash reserve, borrowing cash or absorbing the losses, it is unclear how effective these strategies will be when the business needs it the most.  For example, will the lenders still provide credit if the business loses its key person?  For how long can the business survive sustaining the losses?  Transferring the risk to an insurer by taking out business protection insurance can provide a low cost and effective outcome.

For a confidential discussion on how this or other strategies may protect your business, call Power Wealth Management today on 1300 975 224.

• The ability to use your current superannuation balance as a deposit;
• The ability to use your superannuation contributions to service the loan.  This not only includes your employer contributions, but also your salary sacrificed contributions, effectively giving you a tax deduction for the whole repayment, not just the interest;
• Concessional rate of tax on income in superannuation of 15%, and zero in pension phase means you can use your tax savings to claim ownership of your property much sooner;
• Concessional rate of capital gains tax in superannuation of 10%, and can be zero once you have commenced a pension.  It represents a great way to purchase a future holiday home as you can also significantly reduce any unrealised capital gains tax liabilities.

Before you choose to purchase property inside superannuation using a limited recourse borrowing arrangement, you should first pay close attention the following important considerations:

• Ascertain whether this strategy is suitable for you….you should have at least a 30 percent deposit in superannuation to give you breathing space in the event of non-tenancy and also ensure the fund will be able to achieve the necessary levels of liquidity and diversification. You should also consider your age and risk profile;
• Establish a self managed superannuation fund, or if you already have one, engage a specialist to ensure the fund’s trust deed allows the fund to enter into a borrowing arrangement and the investment strategy allows the fund to invest in direct property;
• Work with your solicitor to set up the necessary documentation and holding trust (custodian).  This is critical as the property will need to be in the name of the custodial trustee rather than the superannuation fund or the actual names of the investors;
• Obtain finance pre-approval, either bank finance or self-funding.  Be aware self managed super fund loans are different to ordinary loans, and the use of a broker would assist greatly;
• Source a suitable property for purchase.  It is advisable to obtain a property that requires minimal repairs or improvements. The tax office recently released a draft tax ruling SMSFR 2011/D1 that clarified that it is possible to improve the asset provided the fund uses its own money rather than borrowed money (such as installing a swimming pool or new kitchen);
• Once a suitable property is found and a purchase price negotiated, all documentation will be completed and executed and the purchase contracts signed in the name of the custodial trustee. The bank will provide the finance and the property is now settled;
• Obtain adequate insurance cover, both for the property and also adequate life / TPD cover.  This is essential as some lenders may call in the loan on the death of a member;
• The fund must report to the ATO each year and the trustee must ensure the fund is complying with superannuation regulations at all times.

Care must be taken if you are to embark on this strategy, as mistakes are easy to make and time consuming and expensive to fix.  For a confidential discussion on how we can assist you with a limited recourse borrowing arrangement, call Power Wealth Management today on 1300 975 224

SCENARIO 1 – SEA CHANGER

Chris (50) and Lorraine (48) wish to retire down the coast when they retire in 15 years. While on holiday down the coast, they stumble across the perfect unit located opposite the beach. They would love to purchase the unit, but have insufficient income capacity to do so.

Personal situation

• Their home is worth $500,000 with a $300,000 mortgage;
• They also have $375,000 of combined superannuation;
• Chris earns $80,000 per annum plus super while Lorraine earns $40,000 per annum plus super;
• Their living expenses are $5,000 per month;
• The asking price of the unit is $500,000, forecast to generate $500 per week in rent.

Strategy

• Chris and Lorraine can establish a SMSF and pool their superannuation;
•  The SMSF borrows 75 percent of the purchase price ($375,000);
• Chris and Lorraine’s employer super contributions, SMSF investment income and rental income can be used to service the loan.

Results

• Chris and Lorraine are able to purchase the beach unit without a personal deposit and without affecting their personal cash flow;
• If Chris and Lorraine retire just before Chris turns 65, they can sell their current home, contribute the proceeds to the SMSF (up to $900,000), commence a pension for both of them, then withdraw the beach unit from the SMSF free of capital gains tax and stamp duty.

Assumptions

• For a $300,000 mortgage at a 7.5 percent interest rate, repayments of $2,777 pm are required to pay off the mortgage by the time Chris turns 65;
• Purchasing and set up costs would be approximately $25,000, paid by the fund;
• Assuming the property is let for 45 weeks and has annual expenses of $6,000, the net rental income would be $16,500;
• Combined employer super contributions are $10,800 and an income yield of 6 percent is applied to the remaining $225,000 of investments in the fund (generating $13,500 income);
• The total income of the fund would be $40,800, while the repayments on a 15 year loan (principal plus interest) at 8 percent would be $2,867 per month.

SCENARIO 2 – SELF-EMPLOYED DOCTOR

Jim is a self-employed doctor currently renting his office. He would like to own his business premises to provide certainty around his rental agreement. He makes an offer for the premises he is working from of $250,000.

Personal situation

• Jim pays himself a salary of $100,000 plus 9 percent super;
• The business (a company) pays $400 per week in rent ($20,800 per annum);
• Jim does not have sufficient funds to purchase the office, however he has $150,000 in superannuation.

Strategy

• Jim can establish a SMSF to purchase the property;
• The SMSF can borrow up to 65 percent of the purchase price ($162,500);
• Jim’s company to now lease the property from the SMSF;
• The rent can be used to service the loan repayments while Jim’s super contributions can be used to cover any property expenses.

Results

• Jim will now pay the $400 per week rent to his SMSF, effectively becoming his own landlord;
• Jim now uses super to provide for his retirement, something few business owners manage to do;
• The strategy will deliver a tax advantage to Jim of $6,240 per annum;
• When Jim turns 55, he will be able to commence a pension from the SMSF. If he does so, any income or capital gains earned from the fund will be tax free.

Assumptions

• Purchasing and set up costs would be approximately $20,000;
• Loan repayments of $1,645pm ($19,740 pa, assuming an interest rate of 9 percent and a 15 year term, principal and interest);
• Jim’s business receives a 30 percent tax deduction for the rent, but the tax rate of his SMSF is only 15 percent. As the interest on the loan, depreciation and any property expenses are tax deductible to the fund, the fund will effectively pay no tax on the rent.

SCENARIO 3 – DOUBLE INCOME EARNER

Mike (45) and Michelle (45) wish to purchase an investment property for $400,000. They find an ideally located townhouse which has an estimated rental income being $400 per week.

Facts

• Mike earns $80,000 p.a. plus super and Michelle earns $40,000 p.a. plus super working part time
• Their only assets are the family home worth $500,000 (which has a $250,000 mortgage) and combined super worth $125,000

Strategy

• Mike and Michelle can purchase the property in a SMSF
• The Fund can borrow up to 80 percent of the purchase price ($320,000).
• Mike and Michelle’s employer superannuation and fund investment income are used to make the loan repayments in the SMSF. Mike also sacrifices $10,000 of his salary to super;

Results

• The total cost to Mike and Michelle using super is $571 per month;
• If the same property was purchased in Mike’s name (to maximise the tax effectiveness) with the same loan, the total cost would be $1,054 per month;
• The value of the property would be worth $1,061,319 when Mike and Michelle retire at age 65;
• If the property is sold, the proceeds if held in the SMSF would be $1,034,786 (no tax if in pension phase) and $913,648 if held in Mike’s name (due to capital gains tax payable of $121,138 based on today’s tax rates).

Assumptions

• Purchasing and set-up costs would be approximately $20,000;
• Assuming the property is let for 45 weeks and has annual expenses of $6,000, the net rental income would be $12,000;
• Mike and Michelle’s superannuation from their employer is $10,800;
• The total income of the fund would be $22,800, while the repayments on a 20 year loan (principal plus interest) at 8 percent would be $2,673 per month;
• Mike needs to sacrifice $10,000 per annum of his salary to superannuation, so the total income of the SMSF will increase to $32,800, necessary to cover the repayments of $32,076;
• The total cost to Mike and Michelle represents the salary sacrificed to super;
•  The total cost of property purchased in Mike’s name inclusive of a tax deduction of $7,434 (assuming a 2.5 percent building allowance). It is important to note the SMSF receives the same tax deductions, but this is almost offset by the superannuation contributions of $19,900;
• Annual growth rate of 5 percent per annum;
• Selling costs of 2.5 percent.

SCENARIO 4 – SOLE INCOME EARNER

Susan (40) is married to John (40) and is interested in building wealth through property investment. They find a unit close to the City for $450,000, paying $450 per week in rent.

Facts

• Susan is the sole income earner in the household earning $150,000 per annum plus super;
•  Their assets are the family home worth $500,000 (which has a $250,000 mortgage) and super of $150,000;

Strategy

• Susan can purchase the property in a SMSF;
• The Fund can borrow up to 80 percent of the purchase price ($360,000);
• As Susan already receives superannuation from her employer of $13,500, this can be used to make the loan repayments in the SMSF.

Results

• The total cost to Susan using super is $293 per month;
• If the same property was purchased in Susan’s name (to maximise the tax effectiveness) with the same loan, the total cost would be $696 per month;
• The property would be worth $1,523,860 when Susan retires at age 65
• If the property is sold, the proceeds if held in the SMSF would be $1,485,763 (no tax if in pension phase) and $1,271,398 if held in Susan’s name (due to capital gains tax payable of $214,365 based on today’s tax rates).

Assumptions

• Purchasing and set-up costs would be approximately $25,000;
• Assuming the property is let for 45 weeks and has annual expenses of $6,000, the net rental income would be $14,250;
• The total income of the fund would be $27,750, while the repayments on a 25 year loan (principal plus interest) at 8 percent would be $2,776 per month;
• If Susan sacrifices $6,000 per annum of her salary to superannuation, the total income of the fund will increase to $33,750, necessary to cover the repayments of $33,312;
• The total cost to Susan represents the salary sacrificed to super;
• The total cost of property in Susan’s name inclusive of a tax deduction of $10,707 (assuming a 2.5 percent building allowance). It is important to note the SMSF receives the same tax deductions, but this is almost offset by the superannuation contributions of $18,960;
• Annual growth rate of 5 percent per annum;
• Selling costs of 2.5 percent.

An October 2010 study by the Association of Superannuation Funds of Australia Limited (ASFA) found that a couple looking to achieve a comfortable retirement needed to spend $53,456 per year, while those seeking a modest lifestyle in retirement needed to spend $30,382 per year.  At present, the full age pension, including pension supplement amounts, is $29,354[1] per annum which is slightly less than what is required to fund a modest retirement lifestyle.  In December 2008, ASFA found the average superannuation balance for persons aged 60-64, the normal age for retirement, was $136,000 for men and $63,000 for women, giving a total for a couple about to retirement and of a similar age of $199,000. For those who want to fund a comfortable lifestyle in retirement, they need more than the average amount of superannuation to fund their retirement.  So what strategies could you employ to boost your superannuation balance?

Government co-contribution

This strategy is available to workers[2] aged under 71 years whose total income[3] is less than or equal to $61,920, with the full benefit available to those whose adjusted taxable income is less than or equal to $31,920. The maximum benefit available is $1,000, where effectively the Government will match your after-tax contributions on a dollar for dollar basis up to this amount (subject to scale down at the rate of 3.333 cents for each dollar of adjusted taxable income above $31,920 until it cuts off completely at $61,920).

Salary sacrifice to superannuation

This strategy is available to any employee earning a salary and involves the employee sacrificing their cash salary (or bonus) for superannuation. It is important that the conditions specified in tax ruling TR 2001/10 are adhered to for the arrangement to be effective, the most important being that the arrangement must be ‘prospective’ – meaning the employee must not already be entitled to the salary or bonus that is sacrificed. The benefit of the strategy is the contribution will be taxed in superannuation at 15 percent rather than the employee’s marginal tax rate of up to 46.5 percent.

BEWARE: High income earners should ensure they do not breach their pre-tax contribution limit, which is $25,000 for those under 50 years of age. Failure to comply with these limits will be extremely expensive to fix.

Government contribution for low income earners

The Government has proposed to provide a maximum $500 tax rebate in the form of a superannuation contribution. The contribution rate is expected to be 15 percent of pre-tax superannuation contributions, with a cut off income threshold of $37,000. This measure is not yet legislated but is expected to commence on 1 July 2012. 

What is the impact of boosting your superannuation balance?

ASFA found in its September 2009 report that a middle-income family with superannuation is better off  by around $116,711 over the life of the family than a middle-income family without superannuation, principally due to the concessional tax treatment offered by superannuation. It also found a low-income family that makes additional contributions to superannuation are better off than a low-income family without superannuation by around $148,717, again due to the more favourable tax treatments and the government co-contribution.

So if superannuation can improve your family’s quality of life, what are you waiting for? Call Power Wealth Management today on 1300 975 224 to discuss how we can work together to secure yours and your family’s financial future.

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