thinkBIG 2018 Superannuation whitepaper: discussing the real impact of the overhaul to the superannuation system - what now?
Find below the additional commentary on the investment and broader financial planning implications.
The raft of changes to the rules can also have an impact on investment strategy both for SMSF trustees and retail super fund members with large balances.
As part of the introduction of the $1.6m cap on pensions, a number of unintended consequences relating to investment strategy have arisen. Firstly, members with SMSF with multiple member accounts, converting pension accounts into accumulation super to avoid the breach of $1.6m cap now and in the future, may benefit from assessing the investment returns likely given their investment approach versus the minimum drawdown requirements for their pension/s.
Retired SMSF members with total super balances well in excess of $1.6m, with $1.6m in pension phase, could seek to spend accumulation super first. Accumulation phase earnings are typically taxed at 15% versus 0% in Account Based Pension phase. If a member has multiple pension accounts, some with high tax-free component (paid out tax-free on death) and other pension accounts with high taxable component (potentially 15% tax applies if paid to adult children), choosing which accounts to commute to accumulation involve some analysis, assessing investment earnings versus pension drawdown requirements may be required.
If pension income consistently exceeds pension earnings, trustees may prefer to have their pensions funded mostly with taxable component as they will deplete the account and tax-free component over time. Accumulation accounts comprising tax-free component could mean tax-free component is better preserved, as it is not withdrawn. Alternatively, if a higher growth/return investment strategy is used, and returns tend to on average exceed pension drawdowns, pension balances may grow, and therefore proportionally, tax-free component may grow over time by ensuring tax-free component is housed in pension phase. Maximising tax-free component in super requires careful account management throughout the duration of a retirement strategy as investment conditions, aged based minimum pensions and personal circumstances change.
One cannot separate taxable component and tax-free component within an accumulation or pension account, so advice should be sought in this area.
For retail fund members within a pension and accumulation account who take an overarching balanced investment approach, as a general rule, may focus low risk investments in an accumulation account (generally a 15% tax on earnings) and higher yielding/return assets in account based pension phase (0% tax on earnings).
challenges and the future
Finally, we have all heard that saving early allows the eighth wonder of the world, compound interest, to work it’s magic. This is true more than ever, as limitations on what can be contributed at the last minute (late career) make it more important to contribute and invest early to maximise tax effective income in retirement.
New challenges for younger members which should be addressed with sound financial planning include:
- budgeting to contribute from an earlier age
- financial modelling to determine whether debt reduction is preferred to salary sacrifice
- an assessment of whether superannuation is the best entity to house insurance policies; the trade-off being cash flow affordability versus using up more limited tax friendly super capital to fund insurance premiums, for those that contribute late, and have more limited opportunity, funding insurance outside of super may be preferable.
We can speculate as to future changes to the tax system, certainly Labor’s attempt to limit franking credit refunds may have significant investment implications. It may in fact mean that holding Australian dividend paying shares in accumulation super is preferred to account based pensions, at present the converse is true.
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