Good fortune of a defined benefits fund

Q For the last year we have been salary sacrificing 75% of our $83,000 income into super. We were told by Super SA's Triple S that as we are an unfunded or untaxed fund and we could sacrifice all of our income if we wanted. I am 53 in June and my partner just turned 55 and we are hoping to retire when I turn 55. Are we liable for some hefty penalties, should we reduce our sacrifice level immediately so as not to be fined or are we exempt?

A  You are in a unique position as you are one of a lucky few who are members of a Super fund that pays a pension (or lump sum) on retirement based on a percentage or multiple of your salary when you retire.  These funds are called Defined benefit funds. The vast majority of Superannuation funds pay out an account benefit based on actual contributions received to the fund and the investment performance of the fund.

Your  fund is technically referred to as an “Unfunded” Defined benefit Superannuation fund. These funds are usually State or Commonwealth government funds. What this means is that the Government (employer) doesn’t actually make contributions while you’re working (at least not for the entire employer super obligation) but pays out this money from the Government’s ‘consolidated revenue’ on retirement. Hence the contributions have not been “funded”.  Members of these types of super fund are most likely to be long-term public servants. If you are in these types of funds you tend to know it!

In a quirky twist of circumstance, your Salary Sacrifice contributions do not attract the 15% contributions tax when made but rather when you leave the fund!  In addition Concessional Contribution Caps do not apply. There is one restriction, your total Employer Contributions including Salary Sacrifice over your total years of membership of the fund must not exceed $1.205 million, This figure changes each Financial Year.  Contributions in excess of this are taxed at 46.5%

You lucky people!

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This article was published in The Australian on 25 February 2012.  For a direct link to the article click here.

How will future Financial Advice (FOFA) legislation which is currently being debated impact my own financial planning?

Q:  I have been reading about the Future of Financial Advice (FOFA) legislation now being debated and was wondering how it will impact my own financial planning. I have been with the same planner for ten years and I’m happy with his service. I am concerned that this legislation may increase the costs of advice. What can I look forward to, good or bad?

A:  The  FOFA legislation reforms are a result of the 2009 Ripoll review into Financial Products and Services following a number of high profile investment collapses.

The draft legislation aims to address the following areas to restore trust and confidence in the financial advice sector.

• Planners will have a duty to act in the clients best interests

• Clients will need to elect to “Opt In” to ongoing fee arrangements with their Financial Planners

• Insurance commissions to be banned on Superannuation

• Removal of commissions on investment and Superannuation products

• Statutory Compensation Scheme for consumers

On the face of it the objectives of the FOFA reforms appear logical and beg the question “what is all the fuss about?”   Any reforms that ensure consumers are better off through greater savings, adequate insurance cover and having access to more affordable advice are worthy objectives. 

The primary angst for industry participants is whether imposing additional administration and regulatory requirements will lead to better outcomes for consumers.  Will the reforms make Financial Planning more accessible and affordable?

As you have an existing relationship with a Planner that you are happy with, I would suggest that frankly not a lot will change. 

There is a great deal of controversy about the requirement to “opt in” to service agreements on an ongoing basis with your Planner. The sticking point is that clients currently can “opt out” of their relationship with a Planner.  By imposing an “opt in” it creates additional administration for what is arguably available to consumers now.

How a client chooses to pay for their advice is a discussion that should be had between a client and their Planner.  Restricting how a Planner is paid for their advice could have the unintended consequences of making the provision of advice more expensive.

The Parliamentary Joint Committee PJC is holding public hearings this week to collate and examine submissions from industry stakeholders about the draft reform bills. Whether the reforms are ultimately good or bad for you will depend on what the final bill looks like.  Stay tuned.

This article was published in The Australian on 28 January 2012. A direct link to the article can be found here.

If you have a question you would like Andrew to answer, you can go here and click on the "Your Questions" section.

Why should I set up an allocated pension while working?

Q: I am turning 55 next year and I have been told I should look to set up an Allocated Pension even though I am still working. I earn $140,000, have a little more than $600,000 in Super. I don’t need any more income and don’t want to draw on my Superannuation savings. Why should I consider an Allocated Pension now?

A: Even though you are still working, as you are over 55, you are entitled to establish an Account Based Pension (an Allocated Pension is one of these). The strategy to draw on your Super whilst working and continue to contribute to Super is called a Transition to Retirement Strategy (TTR) .Even though you draw on your Super savings, you can actually boost your overall Retirement position.

The advantages of establishing the Account based Pension are as follows:

Super funds pay earnings tax at 15% on income to the fund, Account based Pensions are tax free and are still entitled to claim back Franking Credits.

At 55 you are only required to draw income from the pension at a minimum rate of 3% a year. The maximum you can draw whilst still employed is 10% a year. As you get older the minimum amount required to be drawn increases but the maximum you can draw will remain at 10% until you reach age 65, retire or meet another condition of release.

The pension payment drawn from an Account Based Pension is taxed concessionally. The portion of funds contributed from after tax dollars within your fund can be received tax free as income. This component is referred to as your “tax free component”. The “taxable component” which comprises earnings on funds and contributions made where a tax deduction has been claimed by an individual or employer, is taxed at your Marginal tax rate but also attracts a 15% tax rebate. When you turn 60, all pension payments received will be tax free.

After drawing down your pension payments, you can then contribute more of your before-tax salary back into Super through salary sacrifice contributions. This salary sacrificing, combined with the above pension tax benefits, can result in a boost to your retirement nest egg and reduce your overall tax paid.

It is important to remember that there are limits to the amount that can be salary sacrificed into Super without incurring tax penalties. The “Concessional” Contribution cap is $50,000 per year for those aged 50 and over. From 30 June 2012 this cap will revert to $25,000 for those with more than $500,000 in Super. Please be careful as the amount counted towards this cap also includes employer’s existing contributions, such as the 9 per cent Super Guarantee Contribution.

If you are already making Salary Sacrifice contributions at the maximum rate, you can still make contributions into your Super fund as “Non-Concessional” contributions i.e. from after tax dollars. The limits on these contributions are $150,000 a year or $450,000 every 3 years if you are under age 65.

In most cases, if you are 55 or older you will benefit from using an Account based Pension to optimise retirement savings. A Financial Planner will be able to estimate the benefits of using the strategy. Whilst the tax concessions remain, use them. Make sure you get advice as getting it wrong can lead to unintended consequences.

This article was published in The Australian on 17 December 2011. A direct link to the article can be found here.

If you have a question you would like Andrew to answer, you can go here and click on the "Your Questions" section.

Redundancy: the deal

Q: I have just been retrenched after nine years’ service. I am 45 and my income is $87,000. My redundancy package is one month’s pay plus two weeks income for every year of service. They are paying out my annual leave and pro rata long-service leave. I have a lot of sick leave accrued but I get no compensation for this. Is this fair and what are my options?

A: For your employer to have offered you redundancy, they will have decided that your skills and duties were no longer required and your position will no longer exist.  They should have offered you redeployment and/or retraining to an alternative role. The minimum entitlements for redundancy are set by the National Employment Standard managed by Fair WorkAustralia. If you work for an organisation with 15 or more employees, given your length of service, you are entitled to the following under NES:

• 16 weeks’ pay (at your base rate, it does not include allowances, overtime, bonuses or commissions).
• Annual leave entitlements (accrued).
• Long-service leave (pro rata).

Accumulated sick leave does not accrue benefits. If your employer has fewer than 15 employees, they are not obliged to pay redundancy and your entitlements are limited to provisions in your employment contract or relevant workplace agreement. You  would still be entitled to receive all accrued annual and long-service leave. Your employer’s offer exceeds legal requirements under NES.

Redundancy packages are eligible termination payments and hence have tax benefits. The first $8,435 plus $4,218 of each year of completed service is tax-free and the remainder of an ETP is taxed at 30 per cent. If you are older than 55, the remainder is taxed at 15 per cent. You should get a package of $37,365 plus accrued annual and long-service leave entitlements. As that is less than the ETP tax-free threshold, you will receive your entire ETP tax-free. You cannot roll over these funds into superannuation. They must be taken as cash benefits. Annual and accrued long-service leave payments are taxed at 30 per cent. Further concessions are available for those who began employment before August 16, 1978.

Don’t rush to invest or spend the funds. Use some of the funds to reduce any personal debt. Inform your credit providers if you are unable to make loan repayments. Your financial planner can confirm that your package is calculated correctly and help with a strategy for your change in circumstances.

This article was published in The Australian on 10 December 2011. A direct link to the article can be found here.

If you have a question you would like Andrew to answer, you can go here and click on the "Your Questions" section.

July 1 changes – what should I do

Q: I understand that the government has just announced changes that may affect Super, Allocated Pension and Tax from 1 July 2012. What are they and what should we do now?

A: On the 29 November the Government announced their Mid Year Economic and Fiscal outlook (MYEFO) for 2011-12 and 2012-2013. The headline numbers were an increased Budget Deficit of $37.1 Billion for 2011-12 returning to a surplus of $1.5 Billion in 2012-2013.

You need to be aware of the following changes that impact on an individual’s investments, benefits and tax planning.

Minimum Allocated Pension drawdown discount retained

The government proposes to continue with the 25% reduction of the minimum payment from account based pensions. From 1 July 2012 the minimum payment for someone under age 65 will be 3% and 3.75% for those between age 65 and 74.

Maximum Government Co-contribution cut by 50% to $500

From 1 July 2012, the government proposes to halve the Maximum Government Co-contribution to $500. A super fund member with total income of less than $31,920 or less will receive a $500 co-contribution by making an after tax payment of at least $1,000. The co-contribution will reduce to nil once total income reaches $46,920.

Concessional Contribution Cap frozen until 1 July 2014

Tax effective Salary Sacrifice or Personal Deductible Contributions will remain capped at $25,000 until at least the 2014-2015 tax year. For those over age 50, the 2011-2012 Financial Year will be the last opportunity to contribute at the higher cap rate of $50,000 unless you have less than $500,000 in Super. Given the budget position, it wouldn’t be too much of a stretch to see this cap reduced. Warning, use the higher caps whilst we still have them!

50% Tax discount on Bank interest deferred until 1 July 2013

This tax benefit was announced in the 2010 Budget with a 1 July 2012 start date but had been deferred a further 12 months. Therefore income tax payable on 100% of interest earnt.

Standard deduction for work related expenses deferred until 1 July 2013

Again this benefit was announced in 2010. The proposal was to give tax payers a standard tax deduction for work related and tax management expenses of $500 in 2012-13 tax year and $1,000 from 1 July 2013. Keep all those work related receipts and claim as you would have previously.

Dependent Spouse Tax Offset phase out extended to those age 59 or less

In May 2011, the Government announced the phase out of the Dependent Spouse tax offsets for dependent spouse born on or after 1 July 1971. This has now been extended to include dependent spouse born on or after 1 July 1952. This will take effect from 1 July 2012. Previous exemptions will remain.

The key point to recognize out of all the changes is that it is vital that you use any available strategies and benefits as and when they are available to you before they shrink or disappear! Stay tuned….

This article was published in The Australian on 3 December 2011. A direct link to the article can be found here.

If you have a question you would like Andrew to answer, you can go here and click on the "Your Questions" section.

SMSFs and hybrids

Q: Should a SMSF have hybrids in their portfolio instead of term deposits?

A: Hybrid investments are securities that have debt and equity features. Generally they offer a semi annual coupon (interest) payment and potential for convertibility to the underlying issuers shares at a predetermined time, at the discretion of the issuer.

The attraction of hybrids is that they often will pay a higher interest rate than conventional fixed interest investments such as Term Deposits (generally a consistent margin over the Bank Bill Swap Rate, depending on the credit worthiness of the issue). However, the key difference is that the value of the Hybrid is generally heavily aligned to the performance of the underlying issuer stock (and hence investors will be exposed to a relatively higher level of Capital volatility compared to investing in a Term Deposit.

Due to the above, the investor is taking on a variety of equity like risks with Hybrids which they would not be taking on through investing in a Term Deposit, whose main risk is the bank being solvent through the term. Whilst Term Deposits can be cashed with the bank at full value with a penalty on interest, Hybrids need to be sold on market and the price could vary dramatically from the face value.

A quality Hybrid investment can be a very important mechanism for an SMSF to generate strong yield with potential for capital growth (if bought on market at a discount to face value).

For companies issuing hybrids, they are an attractive mechanism to borrow funds (at a discount to borrowing from Financial Institutions), to finance the business and afford them the flexibility to convert to shareholder equity if so required.

The decision whether to invest in either Term Deposits or Hybrids will be based on your time frame to invest, the issuer’s credit worthiness, the structure of the note and appetite for the above mentioned risks.

This article was published in The Australian on 26 November 2011. A direct link to the article can be found here.

If you have a question you would like Andrew to answer, you can go here and click on the "Your Questions" section.

Please explain the carbon tax impact

Q: Can you please explain the likely financial impact of the Carbon Tax. I earn $92,000 and my wife $50,000 working part time. We have 3 kids. Will we have more or less money in our pocket each week as a result?

A: On Tuesday 8 November, the Government’s Clean Energy Bill passed the Senate and will now become law. From 1 July 2012, Carbon emissions will be taxed at a rate of $23 per tonne. From 2015, the price of Carbon will be set by the market. Carbon tax will be paid by Australian businesses emitting more than 25,000 tons of Carbon each year (around 500 Companies).

According to the Government, 9 out of 10 households will be no worse off with the imposition of the tax as a result of tax cuts and increases to family benefits.

Treasury estimate that an average family is expected to see weekly Household bills increase by around $10 per week. Overall household expenditure has been forecast to increase by .7%. If you are a heavy consumer of gas or electricity, the impact will be greater with expected increases of 8% for power and fuel costs. Full details of the estimated impacts of the Carbon Tax on household expenditure items can be found at www.treasury.gov.au.

To compensate for the Carbon Tax, the Government has introduced changes to Income Tax rates, Thresholds and also the Low income Tax Offsets (LITO).

Currently the Maximum LITO of $1,500 creates an effective tax-free threshold of $16,000. From 2012/13, the Maximum LITO of $445 creates an effective tax-free threshold of $20,542.

Assuming you have Private Health Insurance, this Financial Year you and you wife will pay Income Tax of $32,670 (excluding $210 in Flood Levy). Next Financial Year you will pay $31,914, a reduction of $756.

Your ability to reduce your families Carbon emissions will directly impact on your costs of living. Provided that your weekly living expenses do not increase by more than $14.50, you will not be worse off.

For more information visit www.climatechange.gov.au

This article was published in The Australian on 19 November 2011. A direct link to the article can be found here.

If you have a question you would like Andrew to answer, you can go here and click on the "Your Questions" section.