Chapter 1: The superannuation scheme: removing the mystique
Superannuation is an investment vehicle that you can use to help you save for your retirement. The federal government has introduced a number of tax incentives to encourage you to do so. The sole purpose of having a superannuation fund must be to provide benefits to members upon retirement, and benefits to dependants in the event of a member’s death. The amount you accumulate in your super fund will ultimately determine the standard of living you can expect to have in your old age. So it’s best that you understand how the system works. In this chapter, I provide an overview of the Australian superannuation scheme and the various tax benefits you can gain.
How you’re taxed in Australia
Under Australian tax law, tax is levied on your taxable income — ‘total assessable income less allowable deductions equals taxable income’. At the end of the financial year — which commences on 1 July and ends on 30 June — an Australian resident is statutorily obliged to lodge a tax return disclosing the taxable income they derive from all sources, whether within or outside of Australia. If you’re running a self managed superannuation fund (SMSF), you need to lodge a Self managed superannuation fund annual return disclosing the taxable income your super fund derived during the financial year (see chapter ;6).
Coming to terms with self-assessment
The Australian tax system operates on a self-assessment basis (or honour system). This means that, when you lodge your annual tax return, the Australian Taxation Office or ATO (the federal government authority responsible for administering Australia’s tax laws) will ordinarily accept its contents as being true and correct. Apart from correcting any noticeable errors (for instance, mistakes in adding up) no further action is taken. However, to keep you honest, the Tax Office conducts routine tax audits and data-matching checks, through which information disclosed in your tax return is matched with information from various external sources (such as records supplied by the banks of interest earned). This is to check whether you’re complying with the Income Tax Assessment Act. Stiff penalties may apply if you’re found to have understated your assessable income or overstated your allowable deductions. The onus is on you to comply.
If you plan to run an SMSF, each year you must appoint an independent auditor (at your own expense!) before you can lodge your super fund’s annual tax return. This is to check that you’re not cooking the books and that you’re complying with the Superannuation Industry (Supervision) Act 1993 (SIS Act). The auditor must report any significant contraventions to the Tax Office. So it’s important that you understand your legal obligations and responsibilities (see chapter 4).
Under self-assessment, if you’re not sure about a particular tax issue you can seek a private ruling from the Tax Office. This is a free service to taxpayers, where the Tax Office will give you a written response as to how they would interpret the tax law in respect of the tax matter you raised. For more details see the Tax Office publication How to apply for a private ruling.
Four types of super funds
The sole purpose of having a superannuation fund must be to provide benefits to members upon retirement (or permanent disability), and benefits to dependants in the event of a member’s death. There are four different types of super funds that you can make super contributions to in order to achieve this objective. They are referred to as:
• Public sector funds. These are super funds that have been set up specifically for public servants who work for the federal or state and territory governments of Australia. You may be ineligible to become a member of some of these funds unless you’re a government employee. AGEST Super, for instance, is a major super fund for members who work for the Commonwealth government.
• Retail super funds. These are super funds that have been specifically set up by Australia’s leading financial institutions, such as banks and life insurance companies. Anyone can become a member of a retail super fund. Retail funds ordinarily provide a wide choice of investment options (in various asset classes) to their members to help maximise benefits. In return, they will charge you management and administration fees for looking after your money. If you want more information about retail super funds, visit the Association of Superannuation Funds of Australia (ASFA) website <www.superannuation.asn.au>.
• Industry super funds. These super funds were originally set up for employees of specific industries. They are not-for-profit super funds and now anyone can become a member of most industry funds. The management and administration fees they charge to look after your benefits are ordinarily lower than those charged by retail funds, and their policy is not to pay commissions to financial advisers. For more information you can visit the Industry Super Funds website <www.industrysuper.com>. The major industry super funds you can choose from include:
• Accountants Super (accounting profession)
• Cbus (construction industry)
• Hesta Super Fund (health and community services sector)
• Host Plus (hospitality, tourism, recreation and sport sector)
• MTAA Super Fund (motor trade industry)
• Media Super (print, media, entertainment and arts sector)
• NGS Super (non-government education sector)
• Legal Super (legal sector)
• REI Super (property sector).
• Self managed superannuation funds (SMSFs). These are super funds that are set up by individuals who would prefer to manage their own super fund. It’s generally considered you need to have about $250 000 in super to make this a viable option. You need to comply with stringent rules if you want to set up and run your own super fund. And if you don’t agree to be regulated or you fail to meet these stringent rules, there’s a risk your fund could become a non-complying super fund. If this happened, you will not qualify for certain tax concessions, and your fund is liable to pay tax at the rate of 45 per cent (rather than 15 per cent if your fund is a complying super fund). (For more details, see chapters 3 and 4.)
Reading the fine print: what you need to do
As there are numerous super funds eager to get hold of your money, it’s best that you check out the super fund’s product disclosure statement (PDS) before you choose a particular fund. This is a legal document that will set out relevant information, such as:
• the different types of fees and charges the fund will charge to manage your accumulated benefits, the amount you’re likely to pay each year, and how fees and charges are calculated
• the different types of investment options you can select, and, more particularly, the investment and asset allocation policy followed to maximise member benefits (see The accumulation phase on p. 15); the investment choices available are a major factor when weighing up whether you should choose a retail fund or industry fund, or whether you should manage your own SMSF
• the death and disability insurance cover you can tap into
• the various services super funds offer their members (for instance, online access to member account details and free education material).
The Australian Securities & Investments Commission (ASIC) consumer website <www.moneysmart.gov.au> has a handy publication Super funds comparison worksheet to help you compare the different types of super funds. The ultimate test as to whether you should choose a retail fund or industry fund is the funds capacity to consistently generate a good yield on your investment, in return for the fees you must pay it to manage your money. It goes without saying that, the better it performs, the more money you will have when you retire. Incidentally, if you’re dissatisfied with your fund’s performance or feel the fees are too high, you can roll over (transfer) your benefits to another complying super fund (see chapter 5). Alternatively, if you decide to set up an SMSF, you need to determine whether you can outperform the various professionally managed funds from which you can choose.
Taking that first step: making a contribution
To get the ball rolling you need to make a contribution to a superannuation fund or an RSA. In the mid 1990s the federal government introduced a compulsory superannuation scheme to help employees fund their own retirement. Under the superannuation guarantee legislation, if you’re an employee, your employer has a statutory obligation to contribute 9 per cent of your ordinary time earnings (gross pay) into a complying super fund of your choice. An employee can include a director of a company. For example, if you earn $1000 a week, your employer must contribute $90 to your nominated super fund ($1000 × 9 per cent = $90). If you don’t choose a super fund, your employer will ordinarily choose a default fund for you (see MySuper on p. 18). To help build your nest egg the federal govern- ment intends to progressively increase the superannuation guarantee rate from 9 per cent to 12 per cent by 2019–20; see appendix A, table 11. As your employer can claim a tax deduction for making a concessional contribution (or before-tax contribution) on your behalf, your super fund treats the superannuation guarantee contributions as assessable contributions, and it pays a 15 ;per cent contributions tax (see chapter 6), which is deducted from your super account.
Individuals who are self-employed or substantially self-employed are given tax incentives to encourage them to make personal superannuation contributions. The carrot here is that the concessional (pre-tax) contributions they make to a complying super fund qualify for a tax deduction. Incidentally, under Australian tax law a deduction is allowed in the financial year the contribution is made. As these contributions are tax deductible; your super fund treats the contribution as an assessable contribution, and will pay a 15 per cent contributions tax, which is deducted from your account (as is the case with employer super guarantee contributions). (See chapter 6 for more information.)
The federal government has also introduced a number of tax incentives to help boost the accumulated benefits of low-income earners (see chapter 5). You can also make non-concessional, or after-tax, contributions (see chapter 5). As these contributions do not qualify for a tax deduction, your super fund does not pay a 15 per cent contributions tax, as is the case if you make a concessional contribution.
At a glance: the tax benefits you can gain
The major tax benefits you can gain from contributing to a complying super fund (and more particularly an SMSF) are listed here.
Taxation
• Super funds are liable to pay a 15 per cent rate of tax on investment earnings and concessional contributions that qualify for a tax deduction. But the amount of tax payable is reduced if your super fund receives dividend franking credits (see chapter 6).
• Your super fund (and more particularly an SMSF) can offer you death and disability insurance cover and the cost is a tax-deductible expense (see chapter 6).
Contributions
• A self-employed or substantially self-employed person can make personal pre-tax concessional contributions to a complying super fund. The payment (up to a cap amount) is a tax-deductible expense (see chapter 6).
• An employee can salary sacrifice some of their pre-tax salary (up to a cap amount) into a complying super fund and save paying income tax on the amount contributed (see chapter 5).
• You can make personal after-tax non-concessional contributions (up to a cap amount) if you’re less than 65 years of age. But you need to satisfy an employment test (work a specific number of hours over a set period of days) if you’re over 65 years of age (see chapter 5).
• A government superannuation co-contribution scheme aims to encourage low-income earners to make a contribution to a complying super fund. Under this scheme the government will make a co-contribution into your super fund if you make an after-tax non-concessional contribution up to a ;cap amount (see chapter 5).
• Tax incentives aim to encourage you to make a personal after-tax non-concessional contribution on behalf of your spouse. This is called a spouse contribution (see chapter 5).
• You can split concessional contributions you make to a complying super fund with your spouse (see chapter 6).
• If you operate a small business you can gain capital gains tax relief if you transfer capital gains you make on sale of active (business) assets to your complying super fund (see chapter 6).
Pensions
• When you reach your preservation age (currently 55 years of age), you can elect to receive a transition to retirement pension from your super while you’re still gainfully employed (see chapter 8).
• Pensions payable to members who are between 55 ;and 59 years of age ordinarily qualify for a 15 ;per cent tax offset. For instance, if you receive a $40 000 pension you can claim a $6000 tax offset (see chapter 8).
• Pensions and lump sum payments payable to members after they turn 60 years of age ;are ordinarily free of tax, and are excluded from their assessable income (see chapter 8).
• Investment earnings and capital gains on the sale of investment assets to fund pension options during the pension phase in a super fund are free of tax (see chapter 8).
At a glance: limitations of putting money into super
The major limitations of putting money into a super fund are listed here.
• Super funds are liable to pay a 15 per cent rate of tax on concessional contributions they receive from members (see chapter 5).
• Members cannot access their preserved benefits until they satisfy a condition of release; for instance, when they reach their preservation age and retire (see chapter 8).
• Members are liable to pay account-keeping fees on their super account.
• Stiff penalties apply if you operate an SMSF and contravene the SIS Act (see chapter 4).
• Statutory limits restrict the amount of concessional and non-concessional contributions you can make to a complying super fund each year. Excess contributions are liable to a 46.5 per cent rate of tax (see chapter 5).
The two phases of superannuation
There are two distinct phases in the life cycle of a complying super fund. They are commonly referred to as:
• the accumulation phase
• the pension phase.
Each phase has certain tax rules and regulations that the fund needs to comply with. And there are stiff penalties if these are contravened by the fund, or you, if you have an SMSF. Incidentally, the term complying super fund means a fund that has agreed to be regulated under the SIS Act. Only complying super funds can qualify for tax concessions.
The accumulation phase
The money that is contributed to your super fund each year is invested on your behalf. The investment earnings your fund derives are liable to a 15 per cent rate of tax, as against paying your marginal tax rate plus a Medicare levy (which can vary between 0 per cent and 46.5 per cent), if you invested the money outside the superannuation system. Your super fund will offer you a number of investment options (or range of asset classes) to help fund your retirement. This information is set out in the super fund’s product disclosure statement (PDS), which you need to read at the time you fill in the form to join the fund. The most common investment choices you can select from are listed here:
• Cash. This includes investments such as bank bills, fixed interest securities and government bonds. These investments normally pay interest only. They rarely make a loss, but the downside is that your investments are unlikely to appreciate in value.
• Balanced. This usually comprises a mixture of investments in shares, fixed interest securities and property. It’s called balanced because you are effectively spreading your risk (diversifying) over a number of asset classes, and you will derive regular income, as well as the potential for capital growth.
• Growth. In this case your money is predominantly invested in Australian and international share markets, as well as commercial and residential property. These assets normally pay you regular income, as well as the potential for capital growth, but there’s a risk they can fall in value.
• Equity growth. Your money is invested mainly in shares listed on the Australian Securities Exchange (ASX). These investments normally pay a regular income, and have the potential for capital growth. As these investments are market linked; there’s a risk they can fall in value. One significant benefit is that you could receive the benefit of dividend franking credits that can be deducted from the gross tax payable on the taxable income your super fund derives (see chapter 6).
• Property. Your money is invested predominantly in commercial and residential property. These investments normally pay you regular income, as well as providing the potential for capital growth.
• Foreign. Your money is usually invested in international markets (for instance, the United States, European countries and Asian countries). These investments normally pay you regular income, as well as providing the potential for capital growth.
• Indexed. Your money is usually invested in a particular index (for instance, the S&P 200 ;index, which consists of the top 200 companies and property trusts listed on the ASX). These investments normally pay you regular income and give you the benefit of dividend franking credits, as well as providing the potential for capital growth.
Before you choose a particular investment option, you need to understand how the various investments are likely to perform over a long period of time, and what risks are involved in particular asset classes, as well as the need to diversify (see chapter 7). You will usually find the various investment categories you’re offered are market linked, which means they will rise and fall in value in line with the prevailing market. So if you’re not sure what investment option to choose, you should seek professional advice. Fund members are normally permitted to switch their investment option at least once a year free of charge. But if you do switch frequently, your super fund may charge you switching fees.
MySuper
If you’re a novice or uninterested member or you would rather have someone make all the investment decisions for you, you will soon be able to benefit from a government-approved default superannuation product called MySuper. Incidentally, your employer will be obligated to choose this default option if you do not choose a fund to accept your employer’s superannuation guarantee contributions. This is a simplified, low-cost, no-frills super fund investment strategy that must meet certain conditions (and no financial planner commissions or fees are payable). Under this plan your super is invested in a limited choice of investment options with minimum reporting and disclosure. And you will receive basic life and disability cover. It’s proposed that MySuper will be offered to super fund members from 1 July 2013.
Member benefit statements
Complying superannuation funds are legally obliged to issue a member benefit statement each year to their members. The statement will normally provide the following information:
• Your personal details: including your name and address, fund member number, the date you joined the fund, your date of birth and whether you have supplied your TFN to the fund.
• Your investment option choice: your nominated investment option (for instance, cash, balanced, growth).
• Your investment’s performance: the rate of return on the investment option you selected, and how it compares with the other investment options you could have chosen.
• Your insurance benefits: if you have chosen insurance cover in your fund, the current accumulated death and permanent disability benefit payout balance.
• Your opening and closing balances: your opening balance as at a particular date (for instance, 1 July), and your closing balance as at a particular date (for instance, 30 June); you will be anticipating the closing ;balance will be higher than the opening balance, and if it is not, you need to find out why this is so.
• Amounts added to your account: all payments credited to your super fund account from various sources, such as:
• contributions, including employer superannuation guarantee contributions; salary sacrifice contributions; self-employed contributions; personal contributions (or non-concessional contributions); superannuation co-contributions; spouse contributions (see chapter 5)
• rollovers from other complying superannuation funds (see chapter 5)
• investment earnings (see chapter 7).
• Amounts deducted from your account: amounts deducted from your account balance, such as income tax; management and administration fees; and death and disability insurance premiums.
• Your transaction summary: a summary of the superannuation contributions your super fund received from various sources, and the date they were paid.
• Description of your benefits: covers three categories of super benefits, each of which members can legally access under different conditions:
• preserved benefit — benefits that you can’t access until you reach your preservation age and retire; since 1 July 1999 all contributions to super and investment earnings have been classified as preserved benefits.
• restricted non-preserved — benefits that you can access when you retire or satisfy a condition of release (for instance, you terminate your current employment at age 60).
• unrestricted non-preserved — benefits that you can access immediately.
• Your beneficiary details: your nominated beneficiary is the person you prefer to receive your benefits in the event of your death, and their details include their relationship to you, and the percentage they stand to receive; this section will also specify whether you have made a binding or non-binding nomination.
The pension phase
Although you can gain significant benefits putting money into a complying super fund; the trade-off is you can’t access your preserved benefits until you satisfy a condition of release, such as reaching your preservation age and retiring. For instance, if you were born before 1960, your preservation age is 55 years of age, and if you were born after 1964 your preservation age is 60 years of age. You need to adjust if you happen to be born between 1960 and 1964; see appendix A, table 13. When that historic moment in your life occurs, and you decide to retire from the workforce, all investment earnings to fund pension options during the pension phase are exempt from tax, and you have the option to receive a superannuation pension, a superannuation lump sum payment or a combination of the two. To add icing to the retirement cake, once you turn 60, all withdrawals from a complying super fund are exempt from tax and are excluded from your assessable income. Unfortunately, this may not be the case if you’re a government employee, but you will qualify for a 10 per cent tax offset (see chapter 8).
Superannuation Complaints Tribunal
If you’re dissatisfied with decisions by and the conduct of the trustee of your superannuation fund, you have a right to lodge a written complaint to the Superannuation Complaints Tribunal (SCT). This is a free, independent dispute resolution service to help members resolve certain superannuation-related complaints that were initially raised with the super fund, such as:
• errors appearing in member benefit statements (see Member benefit statements on p. 19)
• unreasonable delays in the payment of benefits to members
• payments of death benefits to beneficiaries (see chapter 9)
• miscalculation of benefit payments or lump sum payments to members
• refusal to approve member claims for a disability payment.
The tribunal cannot consider complaints about a super fund’s investment performance, the management of a fund ;as a whole and employer superannuation contributions. Further, members of an SMSF are ineligible to use this tribunal to resolve disputes arising among the trustees of an SMSF. For more details, visit the Superannuation Complaints Tribunal website <www.sct.gov.au>.
Getting professional help
Federal government websites provide a wealth of information about super. These will help you come to terms with any superannuation issues you’re having trouble with. The main ones are listed here.
• Australian Taxation Office (ATO) <www.ato.gov.au>. The Tax Office is responsible for regulating SMSFs. It has prepared a number of user-friendly publications to help you understand how the superannuation system works, particularly the tax rules you need to comply with. These publications are free of charge and you can download them from the ATO website (see Useful references: Australian Taxation Office publications at the end of each chapter of this book).
• Australian Securities & Investments Commission (ASIC) ;consumer website <www.moneysmart.gov.au>. ASIC provides general information about the superannuation system, plus financial tips about managing your money and getting investment advice.
• Australian Prudential Regulation Authority (APRA) website <www.apra.gov.au>. APRA is responsible for regulating how superannuation funds operate (except SMSFs, which are regulated by the Tax Office). APRA regularly issues superannuation circulars and superannuation guidance notes to help superannuation fund trustees comply with the Superannuation Industry (Supervision) Act 1993.
• Super Fund Lookup website <www.superfundlookup.gov.au>. This is a free service that provides general information about superannuation funds that have an Australian business number (ABN). It will provide contact details and advise whether the fund is a complying superannuation fund that is registered to accept superannuation contributions (for instance, employer superannuation guarantee contributions) and rollover payments. For more information see Super Fund Lookup Frequently Asked Questions (FAQ) on the website.
Professional service providers
If you know nothing about investing or you need personal advice about superannuation, a professional who holds an Australian Financial Service Licence (for instance, financial planners and certain accountants) can steer you in the right direction. All the major retail and industry super funds have financial planners if you need assistance. On the other hand, if you need taxation advice relating to superannuation issues, you can visit a recognised tax adviser and, more particularly, a registered tax agent. A tax agent is a person who is authorised to give you advice about managing your tax affairs, and they can prepare and lodge a superannuation tax return on your behalf. This is important to know if you plan to set up and manage an SMSF.
Useful references
• Superannuation information <www.australia.gov.au>, go to ‘Superannuation’
• Australia’s Superannuation System <www.supersystemreview.gov.au>
• Australian Securities & Investments Commission (ASIC) consumer website <www.moneysmart.gov.au>. Go to ‘About financial products’, then ‘Superannuation’
• Australian Government Employees Superannuation Trust (AGEST) website <www.agest.com.au>
• Seniors information website <www.seniors.gov.au>, ‘The online source for all Australians over 50’
Australian Taxation Office publications
• All super funds must lodge income tax returns
• Changes to super
• Choosing a super fund – How to complete your standard choice form
• Guide to superannuation for individuals
• Key superannuation rates and thresholds
• New SMSF member verification system
• Salary sacrificing super
• Searching for lost super (NAT 2476)
• Super for same-sex couples and their children (individuals)
• Super terms explained
• Superannuation and unclaimed super
• Superannuation spouse contribution tax offset
• Superannuation tips for young people
• Turning 60 — what does it mean for super fund members?
Other taxation rulings
• SGR 2009/2: Superannuation guarantee: meaning of the terms ‘ordinary time earnings’ and ‘salary or wages’