Super concessional caps avoid needless tinkering – for now

The amount of money held in superannuation has now topped $3 trillion, making Australia the fourth-largest holder of pension fund assets in the world. Sadly, when this amount of money is mentioned, all the vested interests come out of the woodwork to suggest ways to “improve the system”.

Last month the Association of Super Funds of Australia (ASFA), which represents some of Australia’s biggest funds, made several recommendations. One of them was that if a person had a balance of more than $5 million, the surplus should be removed from the superannuation system. Another was that indexation should be abolished for both the non-concessional contribution cap and the transfer balance cap. Both are currently $1.6 million, which – due to indexation – will rise to $1.7 million on 1 July.

Sledgehammer and nut situation

These recommendations are not unexpected, because the ASFA is not a fan of self-managed superannuation funds (SMSFs). But the recommendations are unrealistic and unworkable. For starters, fewer than 1 per cent of self-managed funds have balances of more than $10 million, and the assets of these funds are usually in big, illiquid assets.

Let’s work through a hypothetical example to see how it may work.

Jack and Jill are both aged 75 and have an SMSF with a balance of $16 million. Apart from some listed shares, the principal asset is a large industrial building from which they have been running their business for more than 30 years, and is now worth $15 million. Thanks to improvements and renovations over time, the cost base of the asset is $10 million. (Cost base simply means the amount paid to acquire and/or hold an asset.)

ASFA argues that this is not fair, as Jack and Jill are taking advantage of the 15 per cent tax environment afforded to super contributions and earnings, but the bulk of the value of their SMSF is in unrealised capital gain that will contribute nothing to government coffers until the property is sold.

Admittedly, when Jack and Jill do dispose of the asset, the capital gains will be taxed at 10 per cent because the asset is held in their SMSF, instead of the 22.5 per cent in capital gains tax that would apply if the asset was held in their own names. But the tax saved on the capital gain of $5 million when the property is sold is only $625,000.

These continual attacks on the relative few with large balances miss a major point: within two decades, almost all these funds will be gone!

Jack and Jill, like most trustees of large self-managed funds, are in their senior years – their life expectancy is likely to be about 15 years. When they die, the most they can leave to a dependent within superannuation would be $1.7 million. Any remaining funds have to be removed from the system. So the bottom line is that within 15–20 years almost all the big funds will be a thing of the past. (I talk about these topics and much more in my new book, Retirement Made Simple, which you can purchase from the Starts at 60 Marketplace here.)

Needless tinkering with super

I also fail to see the reasoning in the ASFA’s suggestion that indexation of the superannuation caps be abolished. The purpose of indexation is to preserve the status quo in real terms; in a perfect world, income tax rates, payroll tax and stamp duty thresholds would all be indexed. The reality is that governments are quick to index items that produce revenue, such as fines, but slow to use indexation in tax areas, because this would benefit taxpayers and not the government.

The classic example in Queensland is the land tax thresholds, which have not been indexed for 13 years. This has hit landlords hard, as land tax bills have been increasing in line with their assessed site value.

Superannuation should be the cornerstone of Australia’s retirement system. For God’s sake, leave it alone, and let people accumulate money for a welfare-free future, free from constant tinkering. Continual changes to the system lead to distrust in it. Did I mention that we have the fourth-biggest system in the world? That’s a major achievement!

Thankfully, indexation on superannuation caps is still with us for now and the new numbers that will take affect from July 1 have been announced.

The concessional cap – which is the amount that is tax deductible – will go from $25,000 a year to $27,500 a year. This could have implications for anyone who is trying to reduce CGT by making tax-deductible contributions to superannuation. In some cases, the catch-up contribution rules could enable a much bigger deductible contribution in the year the capital gain is made. This is an area where expert advice should be taken.

The limit for non-concessional contributions will increase from $100,000 to $110,000, and in addition the maximum amount a member who was under 65 at the start of the year can contribute under the bring-forward rules will increase from $300,000 to $330,000. Also note that the $1.6 million non-concessional threshold is also changing due to the indexation of the general transfer balance cap to $1.7 million. For example, from 1 July a person’s non-concessional cap will be nil if their total super balance on June 30, 2021, is $1.7 million or more.

Noel’s new book ‘Retirement Made Simple’ is available on the Starts at 60 Marketplace for $29.99. Click here to buy now!