Tax on Superannuation: Wealthy Still Prefer to Keep Funds Invested
One issue that has been lost in the highly emotional debate about taxing superannuation benefits above $3 million is the fact that for many wealthy people leaving their money in super will still be the best option.
Most of the debate has centred around issues such as the lack of indexation on the $3 million total and the fact that unrealized capital gains will also be captured by the tax.
While the proposed tax will initially only hit around 0.5% of the population or 80,000 people, over time those numbers could grow due to the lack of indexation of the $3 million figure.
Running the numbers shows the tax is still concessional
Meg Heffron, managing director at SMSF specialist firm Heffron, has run the numbers on a wide variety of scenarios and for many of them, the best strategy is still to leave the super where it is and pay the extra 15% tax on the amount above $3 million.
Gifting to children an option
This may not be the case for those few who have $100 million or more in their super funds, but for the overwhelming majority of the population, it appears that the best strategy is to do one of two things – leave the super exactly where it is and pay the tax, or withdraw some of the total (for those who have met the usual conditions of release) and gift it to their children.
While there is no gift tax in Australia, there may still be some issues for the super fund member in gifting too much because it may interfere with eligibility for things such as the Commonwealth Seniors health care card – although that is likely to be less of a consideration given their overall wealth level.
Roll out the family trusts, investment companies and investment bonds?
While there has been no end to suggestions for avoiding the tax, ranging from the use of family trusts to investment companies, insurance bonds, and a range of other strategies, the problem remains that under most scenarios paying the Division 296 super tax is cheaper than the alternative.
The reason that it is often cheaper to hold amounts above $3 million within super is that capital gains tax would be payable within the super fund if assets need to be sold to realise that withdrawal.
Plus, for assets once they are held outside of superannuation, the usual marginal income tax rates and capital gains taxes still apply.
There are some limited exceptions to this such as insurance bonds which are tax paid after 10 years because the taxes are paid within the fund, but in general terms and for most scenarios, paying the division 296 super tax is a simpler and more economical decision than the alternatives.
One of the reasons for this is the way that capital gains tax works within super funds.
For most super funds, it’s between 0% and 15% tax on two-thirds of the growth in the investment ever since it was first purchased.
That contrasts with Division 296 tax, which is only taxing new growth above the $3 million threshold, while capital gains tax applies to all of the growth in an asset since it was purchased.
That means if the investment has done well over many years, the capital gains tax bill will often be larger than the Division 296 tax bill.
The same applies to many options for investing outside of super – the income tax and capital gains tax bill on dividends, income and value growth are often higher than they would be if the asset had remained within super.
Running the numbers shows tax avoided is clawed back
When Meg Heffron ran the numbers using many different models and over varying tax rates, they all led to the same conclusion – the high rates of tax paid when the asset outside superannuation is finally sold claw back most of the benefit the super fund member could have gained by avoiding Division 296 tax.
Most of us should still be making super our main investment
Of course, for the vast majority of the population, there is no need to even consider such scenarios because they will never get close to having $3 million in their super.
While it is interesting to consider the ‘problems and complications of the rich’, there will not be any need to change strategy with super other than to build up your balance as much as possible while working to enjoy a great retirement.
The other thing to consider is that this tax is tackling a bit of a legacy issue from when there were much looser limits on how much money could be paid into super.
Under the current rules, in which super contributions are more tightly controlled, only those on very high incomes would ever need to worry about hitting $3 million or more in their superannuation fund.
In broad terms, the tax and other concessions within super are still overwhelmingly positive and useful, and even those who do manage to eventually breach the $3 million mark might find it better to simply pay the Division 296 tax and continue to enjoy the otherwise tax-free income that super provides.