Chapter 01 – What is super?

Superannuation is a long term savings arrangement designed to assist individuals accumulate wealth to enable them to fund their own retirement and therefore reduce their reliance on government services such as the age pension.

The Federal Budget of 2016 introduced substantial changes to the superannuation system within Australia. These changes are discussed below, and are summarised in Chapter 6 of this part of the Dover Way. 

As a financial product, super is potentially both a wealth-creation vehicle and a life-insurance vehicle. The basic idea of a super product is that it is a form of savings to which access is restricted. That is, the money saved into super can only be withdrawn under certain circumstances. By restricting access, the idea is that the assets held within a super fund are more likely to be available for the client (typically referred to as a member of the fund) when they (the client) retires. In Australia, employers are obliged to make super contributions on behalf of most employees; therefore, super is essentially a form of compulsory saving.

Amounts paid into a super fund are known as ‘contributions’. There are two main types of contributions, concessional contributions and non-concessional contributions.

Concessional contributions

Concessional contributions are ‘before tax’ contributions, meaning that they are made using income that is yet to be taxed. They include employer contributions (also known as super guarantee contributions or SGC), salary sacrifice contributions and any other contributions which a member has effectively claimed a tax deduction for. These contributions are generally taxed at 15% going into the super fund. Contributions on behalf of high income earners who have an adjusted taxable income in excess of $300,000 per annum are taxed at a higher rate of 30%. The income limit will fall from $300,000 to $250,000 from 1 July 2017

Until 30 June 2017, super fund members can only claim a tax deduction for a concessional contribution if they are self-employed, substantially self-employed or not employed, and meet the ‘10% rule.’ The 10% rule states that a contribution is only deductible if less than 10% of the member’s assessable income comes from employment sources other than self-employment (eg salaries, fringe benefits, termination payments). From 1 July 2017, all members of super funds can claim a tax deduction for contributions up to the concessional contributions cap, provided they flag their intention to do so with the recipient fund. 

There are limits on the amount of concessional contributions that can be made each year, depending on the age of the member. For members under the age of 50, the current cap for the 2015/16 financial year is $30,000 and for members over the age of 50 the cap is $35,000. From 1 July 2017, the annual cap will change to be $25,000 for all people. However, for people with superannuation balances below $500,000, they will effectively be able to average this annual contribution out over a five year period. This means that if a member makes a contribution in one year of, say, $10,000, then he or she can make a concessional contribution in the second year of $40,000, such that the average across the two years is $25,000 per year.

Contributions in excess of these caps will be taxed at the member’s marginal tax rate and included in the member’s non-concessional cap (see below), unless the member elects to withdraw the excess funds. The member can elect to withdraw up to 85% of the excess funds.

Until 30 June 2017, there are also age limits on what type of contributions the super fund can accept. There is no age limit for a fund to receive Superannuation Guarantee Charge (‘SGC’) payments, however after the age of 65 members will need to meet the “work test” to be able to make voluntary concessional contributions. After age 75 the only concessional contributions that can be made into the fund are SGC payments. From 1 July 2017, people aged between 65 and 75 will no longer need to meet the work test

The work test

To satisfy the “work test” the member must be gainfully employed on a part-time basis during the financial year for at least 40 hours in a period of not more than 30 consecutive days. “Gainfully employed” means that the member is employed, self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or form of employment. This test will no longer apply after 30 June 2017

Non-concessional contributions

Non-concessional contributions are ‘after-tax’ contributions which a member can elect to personally contribute. These contributions are not taxed going into the super fund as they comprise after tax dollars and form part of the tax free element within the fund. Members do not receive a tax deduction for these contributions.

There are limits on the amount of non-concessional contributions that can be made. Up until 3 May 2016, the cap was $180,000 for a given financial year. Members who are under the age of 65 could use the “bring forward” rules to contribute 3 years’ worth of non-concessional contributions (i.e. $180,000 x 3 = $540,000). If a member was under the age of 65 and they contribute an amount in excess of $180,000 they will automatically trigger the “bring forward” rules.

This all changed with the 2016 Federal Budget (3 May 2016). As of that night, there is a lifetime cap. The cap is  the greater of: non-concessional contributions that had already been made as of May 3 2016, or $500,000. As of 3 May 2016, the Government stated that only 1% of people had made contributions of greater than $500,000. This means that, for the vast majority of people, the cap is $500,000. 

Contributions that exceed the allowable cap will be taxed at the current highest marginal tax rate of 49%, and earning on the excess contributions will be taxed at the member’s marginal tax rate. The trustee of the fund is required to return the excess contributions to the member.

Until 1 2017, there are also age limits for non-concessional contributions. Once a member reaches age 65 they must meet the “work test” to be able to make non-concessional contributions. Once a member reaches age 75 the fund cannot accept any further non-concessional contributions. This work test will be removed from 1 July 2017

Contribution splitting

A member is permitted to split certain contributions between themselves and their spouse by transferring the contributions they have made from their super account to their spouse’s account. The purpose of this rule recognises that (typically) female spouses have restricted work patterns compared to male spouses. Women often take time off work to have children and raise the family, which prevents them from accumulating significant funds in their super account. This concession is designed to recognise and address this imbalance.

The rules allow for up to 85% of a concessional contribution made in the previous financial year to be transferred to the spouse’s account. The funds that are transferred to the spouse are treated as a rollover and not as a contribution. As the funds were initially a concessional contribution, the funds will be an entirely taxable component and form a part of the recipient spouse’s taxed element in their fund.

Trish Power’s website SuperGuide provides a simple description of contribution splitting in a q and a format

Investments and member benefits

Having received these contributions, the super fund then combines the contributions held on behalf of all other members of the fund and invests them. These contributions are invested by the super fund for the benefit of the members. The investment returns derived from these contributions are then added to the account of each member and are available as benefits for the member when they become eligible to withdraw their money.

In addition to making investments on behalf of members, a super fund can also purchase certain forms of life insurance for its members. Superannuation funds use contributions made on behalf of members to either purchase or provide an insurance policy. Any benefit payments are then paid to the member or the member’s beneficiaries in the event that the insured event occurs.

Conditions of release

The overall purpose of a super fund is to accumulate, manage and grow assets on behalf of the member, to eventually provide benefits once the member meets a condition of release.

The conditions of release are:

  • The member has reached the age of 65;
  • The member has reached their preservation age and retires;
  • The member has reached their preservation age and begins a transition to retirement income stream;
  • The member ceases an employment arrangement on or after the age of 60;
  • The member has died.

Members can also access their super in other special circumstances, including:

  • Termination of gainful employment;
  • Permanent incapacity;
  • Temporary incapacity;
  • Severe financial hardship;
  • Compassionate grounds;
  • Terminal medical condition.

The trustee of the super fund must ensure that the member has met a condition of release before any funds can be released to the member. Funds that are released to a member who has not met a condition of release are treated as ordinary income and taxed at the member’s marginal tax rate (i.e the funds are not treated as super benefits). This is particularly important if a member is also a trustee of a self-managed super fund, as there are significant penalties that apply to a trustee that releases funds when a condition of release is not met.

Once funds have been contributed to the super fund, they can be freely transferred tax free between complying super funds.

Regulation of super

The Reserve Bank of Australia (RBA) has the central responsibility for ensuring the stability of the Australia’s financial system. The retirement system is regulated by the Australian Tax Office (ATO), the Australian Securities & Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA).

Australian Tax Office (ATO)

The ATO is the federal government’s main revenue collection office and its main role is to administer the taxation and super systems. In particular it administers the super contributions, earnings and benefit payment rules. The ATO is also responsible for the regulation of self-managed super funds (SMSFs). The main responsibility here is to ensure that the SMSFs comply with the Superannuation Industry (Supervision) Act (“SIS Act”) and to ensure that the funds are not used for unauthorised purposes.

Australian Securities & Investment Commissions (ASIC)

ASIC is primarily responsible for the regulation of companies, financial service organisations and professionals who advise on investments, super, insurance and credit. They contribute to Australia’s economic reputation and wellbeing by ensuring that Australia’s financial markets are fair and transparent, supported by confident and informed investors and consumers.

In relation to the super industry, ASIC is responsible for licensing, complaints and disputes, product disclosure statements and member reporting.

Australian Prudential Regulation Authority (APRA)

APRA is the prudential regulator for the financial services industry. Its role is to develop and enforce the prudential framework for insurance companies, super funds and other financial institutions.

APRA supervises all super funds (except for SMSFs), approved deposit funds (ADIs) and pooled super trust which are regulated under the SIS Act. They are typically large funds with thousands of members.

Department of Human Services (DHS)

The DHS assesses applications for early release of super funds on compassionate grounds.

Why super?

Superannuation is a tax-efficient financial planning tool that integrates tax planning with investment strategies to produce superior long-term results. Superannuation is so good because of the Government’s deliberate policy on retirement incomes. The population is aging. Future governments cannot afford to pay a pension to the aged in the way that these pensions are paid now. The numbers do not add up. There will be too few workers and too many non-workers for things to go on as they are now.

The government’s emphasis is to create an environment conductive to self-sufficiency in old age. The tax system encourages people to put money away to pay for their retirement by offering generous tax concessions. There are three main concessions. They are:

  • deductions for concessional contributions;
  • low tax on income and capital gains in the accumulation phase; and
  • no tax on income and capital gains in the pension phase.

As a result, an investment in super will typically perform better than an identical pre-tax investment in a non-super environment. The tax concessions means more cash is available for investment and the after-tax return on investments is higher. This means an investment will almost always get a greater after tax return in the super environment than in the client’s own hands.

Superannuation, whether through a SMSF or a managed fund, should be a critical part of any financial planning strategy. This is particularly so once a person approaches or passes age fifty. As retirement draws near, the limit on concessional contribution increases and, hopefully, income and other assets are rising, creating an increased ability to contribute.

It’s fair to say the tax rules for super are now so good that many people age 60 or approaching age 60 will not pay tax at much more than 15%, if not less.

Getting the snowball rolling early is critical to the amount available on ultimate retirement.

Women’s Superannuation

The experience of women in the super stakes deserves special comment.

Women are seriously under-represented in the super stakes. The reasons for this are quite obvious: women spend less time in the paid workforce, due to being primarily responsible for child-care and earlier retirement ages. Women usually have lower incomes than their male counterparts. They are also less likely to regard themselves as being responsible for their own retirement planning and more likely to spend their incomes on current consumption for themselves and their families.

The Australian Bureau of Statistics (ABS) says 49% of women expect super to be their main retirement income, compared to 56% of men; 18% of women expect to rely on  their partner’s income, compared to just 4% for men; and 27% of women expect the old age pension to be their only retire income, whereas it’s just 25% for men.

The OECD estimates that Australian men are in the paid workforce for 38 years before retirement, which is almost twice the women’s equivalent of 20 years. There are also significant differences in pay rates (in 2012 women were paid on average only 82.4% of male salaries).

But super is probably more important for women than it is for men, since women live longer, and are increasing less likely to be married or otherwise part of a family economic unit in the future.

The 2001 study, ‘Women and Superannuation in the 21st Century: Poverty or Plenty?‘ by the National Centre for Social and Economic Modelling at the University of Canberra, has found that unless there is complete equality in the labour force roles women’s super will remain lower than men’s due to lower female earnings and different workforce participation.

The study found that in 1993 women’s average accumulated super was only $9,647, less than half of the average accumulated super of men. By 2030 the average woman’s super nest egg will increase nine-fold to $89,591 in 1999 dollars, but it will still only be 70% of men’s.

The study found that 10% of women aged 55 to 64 will have accumulated less than $27,300 in super by the time they contemplate retirement (which, at the time, was likely to occur in 2010). This is obviously far too little. But it is still a vast improvement over the 2000 picture, when the bottom 10% of women considering retirement had super nest eggs of less than $3,850.

More recently, the Australian Industry Super Group report that women typically have 47% less in super than men do at retirement, and that almost 30% of women over the age of 65 live below the poverty line. These findings mean that the majority of women are vulnerable to living below the comfortable or ‘plenty’ level in retirement. While most women will have some super due to the introduction of the Superannuation Guarantee Contribution in 1992, the amounts are not likely to take the average women from ‘near poverty’ to ‘plenty’. Most people feel 60% of pre-retirement income is required to live comfortably in retirement, and the projected amounts, combined with a full or partial age pension, will still not achieve this level.

The problem is particularly pronounced for older women, say the 40 plus group. Most have little or no super and the high costs of raising families in the next ten years or so means for most the situation will not change before age 50. At age 50 most women have less than ten years of equivalent full time work ahead of them. By then it’s usually too late to make too large a dint in the problem.

The federal government has tried to balance the gender super bias with special rules for spouse contributions, contribution transfers and co-contributions.

It is critical that younger women do not repeat the mistakes of their predecessors, by not compensating for their systemic disadvantage with additional super contributions in their younger years. Women’s contributions should start as soon as possible and should be as much as possible. The earlier the snowball starts, the greater it becomes. Women should not assume they will share someone else’s super in retirement: it may work out that way, but it may not. Under-superannuated older women will be over represented in the ranks of the poor in twenty years’ time, as they are now.

SMSF Guru Trish Power has written a number of articles that address the unique issues regarding women and super. These articles can be accessed here

A special note about self-employment and super

Advisers with self-employed clients should pay particular note of a piece of research produced by the Australian Super Funds Association (‘ASFA’). In 2012, ASFA found that 25% of self-employed people had no super at all. For self-employed people, super is simply too easy to overlook. Superannuation is not compulsory for self-employed people (it is compulsory that they pay it on behalf of their employees), which means that many businesses prefer instead to use all cash generated from their business to meet the expenses of the business and their day-to-day financial needs. Superannuation becomes something they will attend to ‘next year.’ 

Too many small business owners consider the business itself to be ‘our super.’ This is a mistake and can seriously compromise the wealth creation for these business owners.

The Dover Group