| The various components of super |
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| Written by Travis Morien | |||||||
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Perhaps the most confusing bit about superannuation is all the various components that a super may have. I have heard conspiracy theories that this is all part of some nefarious scheme by financial planners to make things complicated, planners have actually been lobbying for simplification. In the 2006 major measures were introduced to simplify the system. I'll start with the new system, because its simpler and because its more relevant to the future: The simplified post 1 July 2007 componentsOn 1 July 2007 all of the components of superannuation below will be simplified into just two components:
Withdrawals of these components will be taxed as follows: Exempt components will be tax exempt. Taxable components will be taxed at 20% for people under 55. The amount up to the low rate threshold ($140,000 in 2007/08 and indexed to AWOTE in $5,000 increments) will be tax exempt, the balance will be taxed at 15% for people aged 55-60 For people over 60 taxable components will be exempt. Pre July 1983 components (see below) will be calculated as at 1 July 2007 and frozen at that value. Components pre 1 July 2007The most common three components are the Pre July 1983 component, Post July 1983 component and undeducted contributions. For 90% of the population these will be the only components that you have to worry about. The calculation of the components of an ETP are relatively straightforward. The components will include:
Pre July 1983, Post July 1983 and Undeducted contributionsPre July 1983If you started with an employer before July 1983 and have worked there ever since, or if you joined a super fund prior to then you probably have a Pre July 1983 component.When you draw out a pre July 1983 component, 5% of the amount drawn is assessable income (the remaining 95% exempt) and this 5% of the withdrawal is taxed at your normal marginal tax rate. To determine your pre July 1983 component you need to do a calculation, there are two formulae. You use whichever one gives the lowest number:
Pre July 1983 component =or alternatively:
Pre July 1983 component = (ETP - C - IC - NQ - CGT - EC) - UDC where The other components are all explained below. It is important to note that the size of the pre July 1983 component depends on the amount of money in all the other components. Because the pre July 1983 component is very tax efficient it makes sense to manipulate the other components somehow in order to increase the amount of money that is deemed to be pre July 1983. The recontribution strategy, which I talk about in the very next article on tax reduction and components is the most common way to do this.
Post July 1983 componentThe post July 1983 component is whatever is left over after you take away all the other components. The component can contain taxed and untaxed elements, for example if you are withdrawing from an accumulation fund that has had tax taken away over the years it will be a taxed post July 1983 component, if the money is being withdrawn from a fund that hasn't yet paid any tax (for example a defined benefits scheme or other employer termination payment) then it is called an untaxed post July 1983 component. The tax treatment of taxed vs untaxed post July 1983 components differs generally in that you must pay an extra 15% tax (if over age 55) on lump sum withdrawals of an untaxed component.Confused? Well it probably isn't as hard as it sounds. If you are part of a "normal" accumulation fund your post July 1983 component will be taxed, if you withdraw that money from super as a lump sum, any amount exceeding the tax free withdrawal limit will be taxed at a rate of 15%. If you were part of a defined benefits scheme and receive a big lump sum on which no tax has already been paid you will pay 30% on the amount over your tax free limit. This is explained in a table in the article tax on lump sum withdrawals. Undeducted contributionsWhen you make a contribution into superannuation and you don't claim a tax deduction on it, this goes in as an undeducted contribution. This does not include money that your employer has put into super (so she claims a tax deduction) either super guarantee money or salary sacrifice money. It also obviously does not include money that a self employed person has put into super and claimed a tax deduction on.Undeducted contributions are made out of your after tax income, if you pay income tax and then put a bit into super this is an undeducted contribution. Money that you pay as a spouse contribution on which you claim a rebate is also an undeducted contribution, (see deductions and rebates). Undeducted contributions are very handy, they are not subject to any further tax on withdrawal so when you take out an undeducted contribution as a lump sum it is tax free and the proportion of any income stream that you receive that comes from an undeducted contribution is called a deductible amount which is not taxed either. They don't count towards your RBL either. Undeducted contributions made on or after 1 July, 1994 and before 1 July 1999 are generally classified as restricted non preserved benefits (subject to the rules of the fund). However, from July 1, 1999 all contributions made by or on behalf of members to a superannuation fund (ie including undeducted contributions), and all earnings of the fund, are to be preserved. The super fund keeps track of the amount of money that goes in as an undeducted contribution. The amount of undeducted contributions that you have is not calculated according to a formula, it is simply the sum total of what you have put in as undeducted contributions over the years. This amount does not increase above what you put in because earnings go into your pre and post components. Putting in an undeducted contribution can reduce the amount of tax you pay overall. As I said earlier in this article most people have just pre, post and undeducted contributions. If that is the case then the formulae simplify:
number of pre July 1983 daysor
Pre July 1983 component = ETP - UDC Whichever of those gives the lower number is the one that applies. Then the next step is to calculate your post July 1983 component. Given that this is what is left over after everything else has been taken away it looks like this:
Post July 1983 component = ETP - Pre July 1983 component - UDC Now if you can it would be nice to reduce the post July 1983 component since this is the one that has tax applied to it at a higher rate. One trick then would be to make a large undeducted contribution. If you make one large enough you could remove the post component altogether, meaning that when you withdraw from super you would pay tax on 5% of the pre July 1983 and no tax at all on the rest. Some people achieve this by taking out a loan just before they retire and making a huge contribution to super. The Australian Tax Office has started taking a keen interest in last minute contributions to super and regard this as a tax avoidance measure. Seek professional advice before considering something like this. If you don't have a pre July 1983 component then of course that little strategy is not available to you. There isn't a lot of benefit in making an undeducted contribution if you are just going to take it out again if you don't have a pre July 1983 component, but nevertheless there is one common "trick" used to convert some of your post July 1983 money into undeducted contributions. This is called a recontribution strategy. It involves withdrawing post July 1983 money from your super up to your tax free threshold and then putting it back in again as an undeducted contribution. You could put it back into your own account, or contribute to a non-working spouse's account, which is potentially even better because then you may be entitled to a spouse rebate and also it gives the opportunity to even out the amount in each partner's super so when pensions are later drawn better use is made of each partner's lowest marginal tax rates. You can use a recontribution strategy if you have a pre component as well, but things get a little bit more complicated as you will have to pay tax on 5% of the pre component which you withdraw and thus you will need to consider the merits of paying this tax now vs savings later. It is not possible to selectively withdraw from a super fund, deferred annuity, RSA, ADF, allocated pension or annuity either your pre July 1983 or Post components. These components must be withdrawn proportionately. On the other hand, concessional components, invalidity components, CGT exempt components and undeducted contributions can be selectively withdrawn. Once again you need to take care when using this tax reduction strategy because it is open for abuse and can attract the scrutiny of the Australian Tax Office. The Tax Office seems to have no problem at all with people using the recontributions strategy but take a dim view of contrived arrangements such as multiple recontributions. One can imagine that you would withdraw up to your tax free threshold and make a spouse contribution with the money, then your spouse would do the same and recontribute what is left of his or her post component as a spouse contribution into your account. You could probably go on doing that sort of thing for a while until your super is entirely undeducted contributions. Be careful and seek professional advice before doing that because it is another thing the Tax Office takes a very dim view of. As a rule I would suggest to stay out of trouble you can use a recontributions strategy but only once. A rebate operates under Section 159S of the Tax Act to ensure that the lump sum tax liability on the post June 1983 component does not exceed that which would be due if the post June 1983 component were treated as assessable income. Tax free thresholdI have just mentioned a couple of times that there is a tax free threshold on post July 1983 components. You need to pay lump sum tax on withdrawals above these limits, but no lump sum tax is generally payable if your withdrawal is less than the threshold. In 2006/07 the threshold is $135,590.
Less common components of superCGT exempt componentThe government recognises that for many small business owners, the goodwill and hard assets of their business are their retirement savings. Therefore provided certain criterion are fulfilled a capital gains tax exemption is granted to the total (lifetime) value of $500,000 and if this facility is taken care of the capital gain becomes a type of ETP called a concessional component.This was introduced on 1 July 1997 and relates to the rollover of a capital gain on the sale of an active asset under the small business retirement exemption. If you didn't run a small business after 1 July 1997, or if you did but made no capital gain on asset sales you won't have one of these. If you elect to receive the exemption (and there are complicating factors so I strongly urge small business owners to work with their tax agent on this one) the money then goes into superannuation as a concessional component and must remain there until you meet a condition of release, such as retirement after age 55 or on reaching 65, or the various other release requirements. If you are over 55 you may elect to take the benefit as a cash ETP, which has its own tax and possibly surcharge consequences. Once created the concessional component is fixed and earnings on this component are allocated to your standard pre and post components. If withdrawn from super it attracts no further tax, so in that sense it is similar to an undeducted contribution. Unlike an undeducted contribution, the CGT exempt component does count towards your RBL. Concessional componentA concessional component relates to bona fide redundancy payments, approved early retirement payments and/or invalidity payments from prior to 1 July 1994. Since 1 July 1994 there have been no new concessional components created. If a concessional component is rolled over into another super fund it will retain its concessional status.Concessional components do not count toward your RBL. If taken as a lump sum, 5% of the value of the concessional component withdrawn is taxed at your marginal tax rate, similar to the way a pre July 1983 component is taxed. Investment earnings are allocated between your pre July 1983 and post July 1983 components. Excess componentThe excess component does not exist until you actually decide to withdraw money from a super fund, and it is the amount that is in excess of your reasonable benefits limit. It doesn't exist prior to making a withdrawal from super because until you actually decide whether you want to withdraw money with a lump sum, allocated pension or pension RBL compliant income stream there isn't any way of telling which RBL (pension or lump sum) applies.When taken as a lump sum, the excessive component is taxed at the highest marginal tax rate (47% plus Medicare levy). If a pension or annuity is purchased with an excessive component, then the pension/annuity is non-rebatable. That is, it does not attract the 15% tax rebate. If a pension or annuity is purchased partly with excessive and non-excessive funds, it will be non-rebatable to the extent it is excessive. In this case it may attract some rebate but not the full 15%. A common strategy used is to buy an allocated pension with the excess component if you are just above your lump sum RBL. You don't pay any further taxes on it except tax at your personal marginal tax rate on withdrawals, you don't get the 15% tax rebate but this is definitely more tax efficient than losing almost half of it by withdrawing it as a lump sum. See the article on RBLs to read a bit more. Non-qualifying componentIn 1984 some tax adviser found a loop hole exploit that allowed a nifty tax dodge using annuities bought only partially with super money commuted back to a lump sum. The result of this exploit was that you could turn ordinary money into ETP money, which allowed some people not eligible to contribute to put money into super. Specifically to stop this scheme legislation was enacted that made money funnelled through this type of scheme a non-qualifying component.A non-qualifying component can only be created by the commutation or residual capital value payment of an annuity, which was not wholly purchased with rollover monies. The non qualifying component is the part of the ETP that represents investment income accruing between the time of purchasing the annuity and the time of payment. This component is fully assessable as income, cannot be rolled over, and is not assessed against and RBL.
Post June 1994 invalidity componentThe Post June 1994 invalidity component replaced concessional payments for invalidity from 1 July 1994. If withdrawn as a lump sum, no tax is payable on this component, it may be rolled over and retains its fixed dollar value but it does not count toward your RBL.Just like an undeducted contribution or concessional component the post June 1994 invalidity component does not grow, but any earnings from this money is split between your pre and post July 1983 components. There are three criteria for a payment to be classed as a post June 1994 invalidity payment:
All three criteria must be met. The post June 1994 invalidity component is calculated at the time you receive an ETP as the proportion of the ETP that relates to a disability payment. The component is determined from the formula:
number of days to last retirement dateSo if you were to work until age 65 but were struck with some sort of disability 3,650 days (10 years) prior to that, cutting short a career that should have lasted 40 years (14,600 days) then if you receive a $2.5 million ETP, the Post June 1994 Invalidity Payment would be 3,650/14,600 = 25% of $2.5M = $625,000. Where the last retirement date is not stated, it is usually taken to be the 65th birthday of the employee. |
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