Changes to SMSF earnings 1st July 2014

Proposed changes, from 1 July 2014 earnings on assets supporting a SMSF superannuation income stream will be tax-free up to $100,000 per financial year for each individual.

Earnings above $100,000 will be taxed at a concessional rate of 15 per cent. Importantly, the $100,000 threshold is proposed to:

  1. Apply per financial year;
  2. Apply to each individual and not the fund; and
  3. Be indexed to the Consumer Price Index (CPI) in $10,000 increments.

In cases where an individual has multiple superannuation income streams, the $100,000 tax-free threshold will apply to combined earnings from all funds.

Earnings will include interest, dividends, rental income, distributions and realised capital gains.

However, transitional arrangements will apply to capital gains, depending on when the asset was purchased. For assets purchased:

  1. Before 5 April 2013, only capital gains that have accrued after 1 July 2024 are included;
  2. Between 5 April 2013 and 30 June 2014, individuals will have a choice of including the entire capital gain or only that part of the gain that accrues after 1 July 2014; and
  3. On or after 1 July 2014, the entire capital gain is included.

If the proposed changes become law, they are likely to have a significant impact on certain superannuation fund members and will open up further opportunities for discussions between financial planners and their clients.

For some of these members it may be more tax effective to invest a portion of their capital outside of the superannuation environment in comparison to having all of the capital retained in superannuation.

Compare a client's situation where all of the capital is invested in a superannuation income stream, versus splitting the capital and investing a portion of it outside of the superannuation environment.

Case Study

Peter (aged 64) and Jane (aged 62) are retired and are members of an SMSF, valued at $5,000,000. The member split is 50/50 and the fund is generating 5 per cent return per annum, which equates to $125,000 in total or $25,000 for each member.

Under the proposed changes, 15 per cent tax will apply to earnings exceeding $100,000 per member.

Therefore, the remaining balance of $25,000 for each member will be taxed at 15 per cent. As such, the tax liability will be $3,750 for each member.

Consider an alternative strategy where a portion of their retirement capital is invested outside of the superannuation environment (ie, managed funds, direct shares, cash, fixed interest etc).

Peter and Jane have made a lump sum withdrawal of $1,000,000 from superannuation and invested the proceeds outside of superannuation. The balance of their SMSF is now $4,000,000.

Assuming investments generate an annual return of 5 per cent, Peter and Jane's tax liability within the SMSF will be nil as they will not exceed the tax-free earnings threshold of $100,000 each.

The taxable income generated from their jointly held investments outside of superannuation will be $25,000 for each. Their personal tax liability (assuming no other taxable income) will be $1,347 each, including the Low Income Tax Offset and Medicare Levy at 2 per cent (see Table 1).

Table 1

 

$5,000,00 invested in SMSF

$4,000,000 invested in SMSF and $1,000,000 invested outside of SMSF

Rate of return 5%

5% = $250,000

5% on $4 million = $200,000 in SMSF

5% on $1 million = $25,000

Tax liability each individual

$3750

1347

Tax liability combined

$7,000

$2694

Net Benefit combined

 

$4306

As demonstrated in the above case study, if this proposal becomes law, investing a portion of available assets outside of the superannuation environment may be a more tax-effective strategy for members with large superannuation fund balances than when compared with all assets retained in superannuation.

Similar savings can be achieved by establishing a family trust and investing a portion of the capital in the family trust. However, there will be a cost in establishing and maintaining the trust.