What to do when your super reaches its limits

The caps on super mean many of Australia’s wealthiest families are looking to park their savings elsewhere. So what are the options?

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It’s been five years since the Federal Government turned Australia’s superannuation rules on their head, imposing strict caps on the amount people could contribute to their super, as well as how much they could transfer into the pension phase.

The limits rose this financial year in line with indexation. Yet it’s little surprise that Australia’s wealthiest families are looking for compelling alternatives to park their savings.

“While super remains a great option – in fact the number one option – it has been a challenge for many of our clients,” says JBWere Technical Services Manager, Wealth Advice, Kym Bailey. “Particularly for those who have already amassed very large super balances in the accumulation phase.”

A family approach

So what are some of the more attractive alternatives?

It will very much depend on your age and your individual or family circumstances, Bailey says.

If you still have a while until you retire – with children thrown into the mix – it could be that a family trust meets your objectives. These discretionary trusts can help reduce your tax bill by allowing you to distribute income among beneficiaries on lower marginal tax rates. And because ownership resides with the trust, they can also protect your assets while providing greater flexibility than super when it comes to investing in property.

“Family trusts are something a lot of our clients already have, and we definitely use them as an alternative to superannuation,” Bailey says.

Certainly it makes sense if you want a structure for the long term, one that can grow alongside you and your family. “When it comes to structuring, you don’t want to consider changing investment vehicles further down the track because capital gains tax can become a real impediment,” says Bailey, a former accountant. “You’ve got to choose your structures based on your assumed trajectory and long-term goals.”

However, family trusts come with their own challenges. For starters, you have no choice but to distribute your income each year. “You can’t actually hold on to it, otherwise you end up paying top marginal tax rates [as trustee],” Bailey explains. “That becomes a fairly inefficient tax vehicle [if you and your partner are high earners].”

One way to manage this is to install a corporate beneficiary, essentially a bucket company, so you can move any excess distributions over to it, effectively capping your tax at 30 per cent. As Bailey points out: “It doesn’t have to be distributed, so it becomes a really good parking vehicle.”

Meanwhile, if your partner does happen to earn a lower income, you can make good use of the marginal tax rate to distribute investment income to them up to an effective tax rate of 30 per cent.

You may also wish to distribute to other beneficiaries – your children, for instance. However, there are issues here too. “The biggest problem is you can’t stream much income to children under 18, because anything over about $400 is taxed at a top marginal tax rate,” Bailey says. “That was a loophole that was closed up many years ago.”

Children over 18 may offer more options though. “Once they hit 18 and are possibly studying and not earning a lot, they become very good beneficiaries,” Bailey says.

Unfortunately, that doesn’t last. “Eventually they join the workforce on a full-time basis and then their personal income precludes them from being eligible if you’re trying to manage a tax strategy as such,” Bailey says.

Giving for good

In the absence of any other beneficiaries, it could be time to think about formalising your philanthropic activity, Bailey says, channelling additional money into contributing to lasting, positive impact areas that matter to you and your family.

For those with significant capital to allocate ($1 million and above) and an interest in being more involved in granting and investment decisions, a private ancillary fund (PAF) is the preferred vehicle. A PAF is a charitable trust that enables you to set up a personalised giving program. Essentially you donate money to the PAF, receive an immediate tax deduction, then distribute the money to your chosen charities.

Bailey describes it as “the self-managed super funds of the philanthropic world”. Like a SMSF, you can manage your fund’s investment capital while also being involved in the finer details of your giving program. “Rules and regulations aside, you’re the one in control,” Bailey says. “You can have the joy of designing your policy, selecting your charities and deciding how much and how you give to them.”

For those who want a vehicle for long-term giving but aren’t interested in the day-to-day management, there are also public ancillary fund (PuAF) accounts, which can be established with a more modest starting value of $20,000.

Preparing for the later years

New concerns arise as you and your partner age and potentially become incapacitated – particularly for those who have large balances that predate the current super limits.

After all, your super can only be transferred tax free to a spouse, a minor, or a child with a disability. If there are any other beneficiaries they may well face back tax, Bailey warns.

One way to minimise any potential tax here is to set up a testamentary trust in your will. “The main difference [compared with a family trust] is that beneficiaries under 18 years of age can be afforded the adult tax rates,” Bailey says.

If your children are now adults though, you might want to consider transferring your assets into your own name or a joint tenancy. Putting assets into your own name might concern you if you’re still running your own business as it can leave you open to personal liability. However, it’s much less of a concern once you’ve retired. “Usually by the time somebody is in the retirement phase, the asset protection risks are diminished or non-existent,” Bailey points out.

Joint tenancies are available to couples regardless of their gender. Moreover, they allow you to transfer your money to your partner quite seamlessly. “When the first of the couple passes, the capital goes automatically to the survivor, so it’s not a succession issue,” Bailey says. “You don’t need the executor to work all that through for you.” Meanwhile, you get two marginal tax rates rather than one, which means more income can be generated.

Don’t forget the grandchildren…

Another approach is to move your money into an investment company, or investment bonds as they are often known.

While this is available to anyone, Bailey views it as the sweet spot for grandparents. Instead of transferring their spare wealth to their offspring who may also face high taxes, they can direct their extra money into investment bonds for the benefit of the next generation.

If you keep the capital intact for 10 years, anything that’s drawn afterwards is tax free. This is because the bonds are taxed internally at a flat rate of 30 per cent in line with their company status.

Investment bonds do have their drawbacks, including the fact you can only contribute 125 per cent of the previous year’s contribution. This means that if you fail to contribute one year, your hands are permanently tied. “If one year you forget to contribute, you actually can’t do anything thereinafter because you’re [looking at] 125 per cent of zero dollars, which is zero,” Bailey explains.

It’s a matter of being careful, she adds. It’s why JBWere makes a point of modelling the trajectory of the client’s chosen contribution rate so they don’t face any unintended consequences.

… or your super

But none of these alternatives should mean you ignore your super. After all, with super, you’re only paying 15 per cent in tax. “It’s still the best tax structure that you can get,” Bailey points out.

And while you may be nearing that $1.7 million limit, that shouldn’t stop you from adding your annual tax deductible $27,500 in concessional contributions.

“That’s your number one strategy,” Bailey says. “It’s good from a tax planning perspective, it’s good for wealth creation, and it’s good from a retirement planning perspective.”

In fact, these are the three things that determine how JBWere and NAB Private Wealth advise a client. “So we’ll end up with the best structure of appropriate vehicles for each client based on their needs, circumstances, goals and ambitions.”