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It’s July 2014, don’t wait until June 2015 – Some things to consider in the New Financial Year

by Mark Causer

Another July  and another new financial year. Most do not make new Financial Year resolutions like we do at midnight on 31 December, but taking the time to review your options for the next financial year may well be a resolution that pays off in the long run.

In the weeks and months leading to the 30 June, Financial Keys has provided various updates and notifications on the topics of Tax, Superannuation and legislative change. For many of us, there is a lot going on at work, and at home, and we can only hope we have looked after our own finances/affairs as well as our own clients, whatever your vocation.

As some of the dust settles on the May Federal Budget and, for some, July can be a slower month; we thought it would be a good idea to provide a review. Below, we look at a range of areas for you to consider early on in the financial year with regard to your financial affairs. The aforementioned changes are in place, so what now can you do to place yourself in a better financial position?

For some of you already tucked away in retirement, these may offer little benefit. For those still accumulating or approaching retirement, then added value may well be available.

It is important to note that this article is not advice and we have not provided all of the necessary details in order to implement the ideas and strategies mentioned. Therefore, if you would like to discuss whether any strategies mentioned are appropriate for you, please contact our office.

Tax for high income earners

The Highest Marginal Tax Rate (HMTR) has been increased from 45% (for those earning above $180,000) to 47% with the introduction of the Governments new Temporary Budget Repair Levy of 2%. This will apply for the next 3 financial years. There is also the increased Medicare Levy of 2% (increased from 1.5%). This means that those on the HMTR will pay tax and levies totalling 49% for income over $180,000. Last year this figure was 46.5%, which equates to an increase of 2.5%.

Additionally, in order to prevent high income earners using fringe benefits ‘packaging’ to avoid the additional Temporary Budget Repair Levy, the fringe benefit tax rate has also been increased to 49%.

For those in this tax bracket, an effective marginal tax rate of almost half of your income is material. However, we should always look for ways to turn this into a positive, or to take advantage of the strategies available to us. An increase in your effective tax rate of 2.5%, means that existing or NEW tax deductions are worth 5.4% more than in the 2014 financial year.

This rate of ‘return’ of 5.4% is well above the best cash rate available with ANY Australian bank.

The fact that tax rates have increased, means that the dollar value of your tax deductions will also increase. So, you should consider strategies that will result in you receiving a tax deduction. Gearing (borrowing to invest) into investments may be considered in order to receive tax deductions for interest payments. So too should ways to take advantage of the concessional tax environment of superannuation and various strategies available; as well as the ownership structure of personal insurance cover that may result in a tax deduction.

If you are aged over 49 in 2014-15, your concessional contributions cap $35,000. Dependant on your income, if you are an employee you can achieve this contribution amount through increased ‘salary sacrifice’. Please remember that the superannuation guarantee levy has increased ever so slightly to 9.5%. If you are self- employed, you can make a tax deductible contribution to super up to this amount. This means that you can earn $214,000 and keep your taxable income below $180,000. It is likely you will have other deductions as well.

Transition to Retirement Pension

Those over 60 and still working, who have moved their super to a Transition to Retirement Pension (TTRP), can make concessional contributions to super and receive pension payments tax free. The tax saving between the HMTR and the super contributions tax rate is as follows: 49% - 15% = 34%.

To put this into a dollar value, on the concessional contribution limit of $35,000, there is a potential tax saving of $11,900 per annum. Due to the increase in the Medicare Levy and introduction of the Temporary Budget Repair Levy, there is an increased tax saving of 2.5%, or $875 compared to last financial year when the HMTR was lower.

With the above numbers in mind, it is important to note that the tax saving may not be as great for those with income above $300,000 per annum. This group will pay additional super contributions tax of 15%, equating to a total of 30%. However, there is still a potential tax saving compared to their marginal tax rate of 49%. As the calculation for total income includes concessional super contributions, if it is an individual’s concessional super contributions which take them above this limit, they will only pay the additional 15% contributions tax on the amount above $300,000.

For example, if a person earns income of $285,000, but also has concessional contributions of $20,000, this takes their total income to $305,000. The additional super contributions tax of 15% would apply to $5,000 of the person’s super contributions, not the entire $20,000. 

Tax Deductible Insurance Premiums

Income Protection insurance (also called salary continuance insurance) premiums are tax deductible. Policies can be owned by your super fund or by you as an individual. The best ownership structure for Income Protection insurance is different for every person and based on a number of factors.

However, if we look at which ownership structure will provide you with the lowest net cost of cover, most of the time, individual ownership outside super wins.

We have just stated that the effective HMTR for those earning above $180,000 is 49%. This compares to the super tax rate of 15%. Therefore, the net cost (after the tax deduction) for income protection insurance, will be much cheaper if paid by the individual. Consider the example below for a gross income protection insurance premium of $3,000:

  Super
(15% Tax Rate)
Individual
(49% Tax Rate)
Individual
(39% Tax Rate)
Individual
(34.5% Tax Rate)
Premium $3,000 $3,000 $3,000 $3,000
Tax Deduction $450 $1,470 $1,170 $1,035
Net Cost $2,550 $1,530 $1,830 $1,965
Saving NA $1,020 $720 $585

In the example, there is a significant saving in the net cost for individuals on the HMTR if they pay their income protection premium themselves, rather than from their super account. As the marginal tax rate of the individual decreases, so does the net cost saving, but it is still a significant amount in dollar terms. Those earning between $37,000 and $80,000 with a marginal tax rate of 34.5% (including Medicare Levy), would still incur a net cost saving of 23% compared to the net cost of paying their premium from super.

Super Splitting

Superannuation contribution splitting is a strategy that allows couples to take advantage of moving their superannuation balances between their accounts. This strategy has been around for some time and it is not necessarily anything exciting. But in the effort of remaining forward looking, it is paramount to ensure that available strategies are known and understood so that they can be utilised when the time is right. Although not yet approved, recent Federal Budget proposals regarding the Age Pension and superannuation accessibility now bring the strategy of super splitting to the fore.

Currently, you can split 85% of the value of your concessional contributions to your spouse. To re-iterate, concessional contributions include employer contributions made for you (including salary sacrifice contributions) and personal contributions that you have claimed a tax deduction for (for self-employer people). The 85% that you can split, takes into account the 15% super contributions tax applicable. So essentially, you are able to split up to your entire net concessional contribution. For example, if you have $10,000 of employer contributions in a year, the after tax value of these contributions will be $8,500, all of which you can split to your spouse (transfer to their super account). Note also that you are generally only allowed to split contributions you have made in the previous financial year.

“The Budget proposals that may influence the way we think about super splitting are as follows:

  • For people currently in their early or mid careers, 2035 sees the age pension qualification rise to 70. This will affect people in their late 40s now.

  • The budget reduces the attractiveness of the age pension over time as it increases by the rate of inflation, rather than the rate at which wages increase.

  • The age pension will become harder to qualify for as income and assets tests thresholds are frozen for three years.

  • The Audit Commission recommended that the age of superannuation access be linked to the age pension age; and be set five years earlier than the age of entitlement to the age pension. So for those people who will be retiring when the age pension entitlement limit reaches 70, that means they won’t be able to access their superannuation until age 65 if legislation is approved.” (Eureka Report)

The proposed changes mentioned above, even if not approved, suggest that some thought is going into reducing the potential benefits of the Age Pension. It makes one think that achieving a retirement independent of the Age Pension should be our objective. It also suggests that with the potential for the superannuation accessibility age to be increased – very likely to be pushed out to age 65 years in the years to come, it may make sense to split superannuation assets towards the older member of a couple, so that their benefits can be accessed sooner.

This also fits in with the TTRP strategy mentioned earlier. Dependent on the individuals age, one can potentially move their superannuation assets to ‘pension phase’ from age 55. In pension phase, income and earnings on super investments are tax free. Also, from age 60, pension payments can be taken tax free. Having more superannuation assets in the name of the older member of the couple may allow this strategy to be more effective earlier.

All of these strategies are very easily implemented.

A couple of hours spent today may mean saving thousands of dollars towards your retirement future.

 

July 14, 2014
 
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