Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 22

Look at super with different eyes

Too often I hear from people that the only important thing about super is ‘the return on my investment’. When you have a better understanding of superannuation regulations, you quickly find out super returns are far from the most important thing.

The purpose of this article is to encourage people to think differently about super, not to provide the only answer to a problem. The only golden rule of super is that there are no golden rules. Everyone’s situation is different. It is important to make your fund work for you, not you for it.

Thinking differently starts with the terms we use. Most people think of super as that thing we do for when we are old. Pensions are things we only use when ultimately we stop work, again about being old. Not so. Super is simply a trust structure, and pensions are just distributions from a trust. They are actually called income streams not pensions. In the same way, a distribution from a company is called a dividend and a distribution from a family trust is a trust distribution. The real driver is the tax benefits that the super environment provides everyone. Anyone who is paying tax on their investments should be asking the question, how can I do this better?

Let’s take it away from super for a moment. Here is a simple example of how to think differently:

  • person aged 55 with small business
  • expects to work for another 15 years then retire with children taking over the business
  • trustee of an SMSF with $200,000, all concessional amounts in accumulation
  • wants to acquire the business premises valued at $1 million
  • has $400,000 cash outside super.

What would normally happen?

  • continue to work and pay the base super guarantee amount to the fund, but no additional amount because borrowing money so will want to pay loan off quickly
  • head off to the accountant who will set up a Family Trust to buy the property
  • contribute or lend the $400,000 cash to the Family Trust and then go to the bank and borrow the remaining $600,000, giving bank security over the property in the Family Trust. This will ensure the asset is there for the family and a few tax benefits of distributing the earnings and capital gains around the family via the Trust.

Sound familiar? There is nothing wrong with this strategy, but there may be a better way to do it that ensures the whole family ends up better off with debt paid off faster. I suggest a rethink.

Starting with the existing SMSF, the first step is to commence a pension. This is where most people fall down – they don’t want a pension because they are not old.

By commencing the pension, there will be no income tax or capital gains tax in the fund on the income generated from the assets in the fund. I do note, however, being 55 and with the SMSF money coming from a concessional source, there will be some tax on the pension paid as outlined later. If the pension money is not needed, put it back into the SMSF. This is also a start of estate planning. It changes assets that would be taxed against the children into assets that won’t be taxed against the children. If the asset were in a Family Trust, the income every year would be distributed and tax would be paid.

Next, contribute the $400,000 cash to the SMSF and start a second pension with it. There are tax and estate planning benefits here as this is all a Non Concessional Contribution(NCC) therefore not taxed as it goes in and not taxed as it comes out, regardless of who it is paid to.

The client then buys the property through a holding trust entity within the SMSF, following the superannuation rules for borrowing money and buying property. Follow the rules when considering borrowing within your fund as getting it wrong can have adverse consequences. Don’t rush out and do this without getting proper advice. The bank is given the security. Strangely, this sounds exactly like the first scenario. The key benefit is that the asset in the fund is not subject to income tax or capital gains tax. If it were in a Family Trust, they would be. Which one do you want?

So what are the benefits of all this?

  • pension from the $200,000 @ 4% is $8,000 and is taxable at marginal tax rates less 15% (from age 55 to age 60)
  • commence a separate pension for $400,000 with all NCC tax free money (need to ensure the property is segregated to this account and the rent will cover the loan interest payments)
  • pensions are paid on net pension amount ie $400,000 not $1 million as the debt is taken off the calculation and 100% tax free even at age 55 ie 4% of $400,000 is $16,000 tax-free.
  • capital gains tax on the property if sold is nil under current legislation
  • net rent received is taxed at nil, yet fully deductible to the small company
  • in retirement 100% of income to client is not taxable
  • on death asset passes from NCC account to children tax free (no capital gains tax or ETP tax)
  • more effective loan payment (rent received is tax free so more money to pay off loan more quickly).

I do stress, this is not the only answer. This example was put together to illustrate my point. We don’t think enough about how to get the best out of superannuation. Take some time to talk through the options and design it for yourself. Get some advice, super is designed for your benefit, use it if it helps but if nothing else start the thinking process. And go and see a professional.

 

Andrew Bloore is Chief Executive Officer of SMSF administrator, SuperIQ.

 


 

Leave a Comment:


RELATED ARTICLES

Getting the most from your age pension

Give this risk the credit it deserves

SMSFs and infrastructure is marriage made in heaven

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.