Mike’s case

Mike and Terri are both aged 38 and have three children under six. Mike earns $100,000 a year and Terri and the children rely on his income. They have a $300,000 mortgage and know they are taking a big risk not having life insurance. However, they rely on every dollar Mike earns and don’t think they can afford the premiums.

They discuss their circumstances and needs with a financial adviser and agree that ideally they need about $1.6 million dollars of cover. This would include funds for Mike’s medical and funeral expenses if he got very ill and died, paying off the mortgage and providing an income for Terri and the children. Mike is charged a premium of about $3,500 in the first year.

Their adviser shows them how they can afford the premiums by arranging the cover in superannuation and salary sacrificing the premiums. The table shows their expenses are $40,000 a year and have a very small surplus at present (insufficient to meet the insurance premium). Mike would need to salary sacrifice $4,117 (to allow for the 15% tax in superannuation) but this would reduce the amount of income tax he pays and maintains some of their surplus as well as paying for the necessary life cover.

The need for review

This case is based on Mike and Terri’s circumstances today. What if they had another child or received an inheritance? Next year the premiums will be higher because Mike is a year older – will they still need the same level of cover? Mike’s employer will be paying into superannuation for him and as his account grows he may need less cover.

Some types of insurance are treated differently when held in a super fund and there is a range of issues to consider, so it’s important to seek professional guidance from your financial adviser first.

Disclaimer: The Case study in no way suggests that a single income family earning $100,000 with a $300,000 mortgage requires $1.6M of insurance and should your circumstances be similar an individual review of your needs is still required.

Sources: www.ato.gov.au

Disclaimer

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Call (02) 4926 2300 or email us.

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Key benefits of tax deferred income for investors

• Tax is not applicable in the year in which income is received (thus the term “deferred”). The compound impact of reinvesting cash that has not attracted tax over many years is significant.
• Tax deferred income is brought to account when the investor sells the asset and is discounted by 50% (PAYE) or 33% (Super).
• Tax deferred income in a superannuation fund can be transitioned to an allocated pension, without triggering an income or capital gains tax event. Allocated pensions pay no tax.

Tax deferred component of a distribution affects an investor’s tax

Commonly, an investor would pay tax on the income received from an investment at their marginal tax rate (MTR) in the financial year in which the income is received.

The tax deferred portion of the income received from a property trust is treated differently. The tax deferred portion of the income received is deferred until the property trust investment is sold. At this time, the investor includes the tax deferred income as part of the capital gains tax (CGT) calculation.Tax is then paid at the investor’s MTR that applies when the investment is sold.

An investor (individual) may benefit from the CGT rule that only 50% of the gain is taxable if the investment is held for longer than 12 months. This benefit also applies to the tax deferred income.

Tax deferral can be of particular benefit to investors who redeem an investment when they retire and move into a lower income tax bracket. Commonly retirees have a low marginal tax rate compared to their marginal tax rate prior to retirement.

Case Study – Invest $20,000 in cash

Hayley has invested $20,000 in a one-year term deposit that pays her an interest return of 6% p.a. Her MTR is 39.5%.

Hayley receives interest of $1,200 ($20,000 x 6%) on her term deposit. She needs to include this income in her tax return for that financial year. Based on her marginal tax rate, Hayley is likely to pay tax of $474 on the interest from her term deposit ($1,200 x 39.5%).

Case Study – Invest $20,000 in unlisted property

John is two years from retirement and invested $20,000 in a direct property investment that pays an income distribution of 8% of which 70% of this distribution is tax deferred. His MTR is currently 39.5% and expects it to fall to 16.5% in retirement.

John will receive an income return of $1,600 p.a. of which $1,120 is tax deferred and only $480 is taxable in each financial year at his MTR. This equates to tax payable of $189.60 each financial year. The tax on the remaining income amount is deferred until the investment is sold.

John decides to redeem the direct property investment when he retires. To illustrate the potential benefits of the tax deferred component compared to an investment with no tax deferred component, it is assumed that the capital value of the direct property investment has not changed. When sold, the tax payable on the deferred component is:

Capital gain = Redemption price – (Acquisition price – Tax deferred income received during the time held) x MTR

As such, the capital gain in this example is: $2,240 = $10,000 –($10,000 – $1,120 x 2 years)

The CGT payable on this amount is: $184.80 = 50% x $2,240 x 16.5%

The total tax paid (income + CGT) on the distributions over the two years has been: $564.00 = ($189.60 x 2 years) + $184.80

If the income distribution did not contain any tax deferred components, then the total tax payable each year would amount to $632 ($1,600 x 39.5%) or $1,264 in two years. Over the two years the tax deferred component of the income distributions and the movement into the lower tax bracket saved John $700 ($1,264 – $564).

Case Study – Invest $20,000 in direct property via SMSF

Adrian is two years away from retirement and invested $20,000 in a direct property trust via his self managed super fund (SMSF). The trust pays an income distribution of 8%, of which 70% is tax deferred.

The MTR of his superannuation fund is 15%. Adrian’s superannuation fund will receive an income return from the property trust of $1,600 p.a. of which $1,120 is tax deferred and only $480 is taxable in each financial year at 15% MTR. This equates to tax payable of $72 each financial year. The tax on the remaining income amount is deferred until the investment is sold.

Adrian transfers the investment from his superannuation fund to allocated pension funds at retirement. This does not trigger an income or CGT event. Adrian decides to redeem the direct property investment after he retires. The deferred income amounts are included in the CGT calculation. Any CGT is taxed at the pension funds marginal tax rate, which is zero.

Effectively Adrian pays no tax on any capital gain made on the trust and the deferred tax income amounts of $2,240 ($1,120 each year) are tax free. If the income distribution did not contain any deferred components, then the total tax payable each year would amount to $480 ($1,600 x 15% x 2 years). Over the two years the tax deferred component of the distributions saved Adrian’s SMSF $336 ($480 – $72 x 2 years).

Buying direct property in a superannuation fund and selling it after retirement

Some investors may invest in a direct property fund through their superannuation fund. When the investor retires after age 60 and commences the pension phase, the marginal tax rate of the pension fund is zero.

This may mean that if the direct property trust is sold in the pension phase, the tax deferred portion of the income is received effectively tax free.

Speak with your financial planner about how the benefits of tax deferred income may apply to you.

Source: Charter Hall Direct Property, October 2011

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See article below

"Whose interests does superannuation fund consolidation serve?

6 April 2011 | by Mike Taylor
 

Super funds are experiencing another round of mergers and consolidation, but whose interests are really being served? And will the funds become too big to fail?
Less than a decade ago, this magazine published a feature titled ‘Top 300 Superannuation Funds’. Super Review stopped publishing the feature when the number of funds that fulfilled the criteria of ‘top’ declined below 100.

To be included in the original Top 300, a superannuation fund needed to boast a given level of membership and a given level of funds under management (FUM). In the early days, only the top 20 or so of the Top 300 funds could be expected to have more than $1 billion in FUM.

Times have changed. These days few mainstream funds have less than $1 billion in FUM, and the non-corporate funds that do are inevitably earmarked for amalgamation.

But it is not natural market forces that have been responsible for the decline and fall of Super Review’s Top 300 series. It has been Government policy and regulatory initiatives – the most recent of which is giving rise to a further round of negotiations between superannuation funds, and has been prompted by the looming expiry of tax relief measures which have made such mergers more attractive.

Prior to the tax relief measures, the major driving force behind superannuation fund consolidation in Australia was the Australian Prudential Regulation Authority’s (APRA’s) imposition of a new superannuation fund licensing regime – something which, according to APRA chairman John Laker, saw a dramatic drop in the number of superannuation trustees.

In 2007, Laker told a meeting of the then Investment and Financial Services Association that “at 30 June, 2004, the day before licensing began, there were around 1300 trustees. At 30 June 2006, there were just over 300 licensed trustees”.

And he made clear that APRA itself was a major beneficiary of the reduction, saying: “This consolidation will impact on the way in which APRA allocates its resources. In the past few years we have allocated a greater proportion of our resources to superannuation to handle the licensing transition. I expect that from the next financial year we will see a redeployment of some resources back to the other regulated industries.”
More recently, the chairman of the Cooper Review into superannuation, Jeremy Cooper, has pointed to the desirability of fewer but larger funds, citing the experience in Canada and the ability of large funds to directly invest in major infrastructure.

The evidence is clear to see: the consolidation that has occurred in the Australian superannuation industry has occurred as a result of Government policy initiatives rather than by market forces.
What is more, the nature of the rules about superannuation fund mergers and amalgamations means that individual members do not really have a say. It may be members’ money in the superannuation funds, but it is the trustee board members who decide who will manage it.

Where the most significant recently proposed fund merger is concerned – Westscheme and AustralianSuper – the views of the members of Westscheme will not be canvassed. Notwithstanding the notoriously independent views of West Australians, they will be asked to take on trust the benefits that will flow from being taken under the umbrella of mega-fund AustralianSuper.

There exists a lingering question about whether ‘bigger’ actually equals ‘better’, and over the past decade there has been plenty of evidence to suggest that while some very small funds may struggle, many mid-size funds manage to do perfectly well in terms of investment performance and delivery of services to members.

There is no doubting that AustralianSuper has an admirable track record, but it is worth noting that it has not been regularly topping the charts maintained by the major ratings houses. Indeed, the top performers have inevitably been larger mid-size funds.

Perhaps the most disturbing fact to emerge from an examination of the consolidation that has occurred within the Australian superannuation fund industry over the past decade is that beyond Government policy, the major consideration for superannuation fund trustees has been the rising costs associated with regulatory compliance.

Almost without fail, trustees of funds that have chosen to merge with larger funds have cited rising regulatory compliance costs and the consequent need for better resourcing.

Fewer but larger superannuation funds will certainly make life easier for Australia’s regulators and would certainly seem to fit with the views of people such as Jeremy Cooper, but it is uncertain whether the best interests of members will ultimately be served.

The Government may well end up creating institutions that are too big to fail. "

Article written by Mike Taylor

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