How to avoid paying the new superannuation tax
The great majority of superannuation savers are undoubtedly not worried in the least about the looming new superannuation tax on nest eggs greater than $3 million.
At the moment the new 15% tax is set to hit just 80,000 people and to generate around $2 billion a year when it is set to be introduced from the middle of 2025.
That is a tiny, wealthy sliver of the population but it is worth remembering that this so far unlegislated tax at this stage appears not to be indexed to inflation, which means that it is worth keeping on the radar even as a sort of aspirational dream scenario.
Taxes have a habit of both changing behaviour and over time applying to a greater share of the population – both characteristics which apply to this tax in particular.
Stamp duty designed for the rich now paid by the middle class
A good example to look at is stamp duty, which in a state like Victoria was initially designed to be progressive, with the top rate only applying to the really rich buying mansions in Toorak and Brighton.
Over time, those higher thresholds gradually started to apply to more property buyers until we hit the current situation in which the very top rate of 6.5% which applies to properties above $2 million is far from hitting just the very wealthy.
At the other end, there would be very few applications for the lowest rate of stamp duty of 1.4% which only applies to properties worth $25,000 or less.
These days when a property sells for a million dollars or more, it is far from exceptional, with around half of Melbourne suburbs now having median prices above a million dollars.
The $3 million superannuation tax is somewhat similar in that what at the moment seems an incredibly large sum might one day become far more common as the purchasing power of each dollar falls and salaries continue to rise to keep up.
Inflation will work to broaden this tax
The other reason that the $3 million super tax of 15% should still register on the radar is that this tax behaves a little differently to others.
While for most people retiring above the age of 60 there is no tax on their super, that could possibly change down the track if their super account continues to swell even after they stop working.
The combination of a smallish initial mandatory drawdown rate of just 4% a year combined with a few good years on investment markets could easily see a superannuant surprisingly breach the $3 million mark when they least expected it – while still drawing down a super pension in retirement.
It should be noted here that a 15% tax on earnings above $3 million is far from a disaster and may, in fact, be a very good policy but there are some subtleties with this tax to bear in mind.
One is that the drawdown amount can be included in the calculation – that is, you may believe that you will remain below the threshold of the tax but may be mistaken.
Say you have $2.9 million in super and are retired and drawing a 4% super pension of $116,000 a year.
If your fund unexpectedly earns a return of 8% for the year – or $232,000 – you might think that the tax impost would be small given a final balance of around $3,016,000.
However, it appears that the drawdown amount of $116,000 will also be added in to work out the taxable amount, which would make the tax more substantial in this example.
With what is called an “adjusted closing balance” of $3,132,000 in this example, the tax might be higher than expected.
It should be noted here that the exact details of how the tax will operate will depend on the legislation which we do not have yet but the above example is one that informed super experts are using as they workshop ways to prevent their clients having to pay the proposed new tax.
Strategic withdrawals could keep the tax at bay
The main tactic being considered by accountants and tax experts is to keep this adjusted closing balance below the $3 million mark through strategic withdrawals.
By keeping the amount within super at a maximum of $2.95 million by consistent withdrawals, the tax should not apply and the extra withdrawals can then be invested elsewhere.
Depending on the amount invested outside of super, there might come a time when paying the 15% super tax becomes worthwhile and the balance could be allowed to rise.
For example, once you earn above $120,000 a year outside of super, you would be hitting a marginal tax rate of 34.5% including the Medicare levy and further strategic withdrawals to keep the super balance below $3 million would become moot.
Telephone number calculations for the uber rich
All of this might seem like telephone book numbers for super rich people at the moment, especially since the average super balance for those aged between 60 and 64 is $402,838 for men and $318,203 for women.
It would take heroic investment returns indeed for these sort of balances to ever trouble the ATO to assess any 15% investment tax.
However, over the sort of timelines that super accounts work across, it might be worth considering what to do should your account do particularly well in the future.
Tax could be hit even during retirement
It is not impossible to project, for example, that a $2 million balance at retirement could increase to broach the $3 million mark, depending on the sequencing of returns and the amount withdrawn.
The positive thing about superannuation in the pension phase is that for those over 60, all withdrawals are tax free and there is no maximum amount for withdrawals so it should always be possible to keeps super funds below $3 million and avoid paying this tax.
With plenty of alternative investments to super around including fully franked dividends on Australian shares that come with franking credits, it should still be possible for retirement to be a no or at least very low tax paying period of life other than for the really fabulously wealthy.
And it may not be a bad thing for them to pay some more tax anyway.