A fix for super limits

PORTFOLIO POINT: The government seems to be coming around to the idea that some changes are needed to concessional contributions limits. And here’s one worth considering.

The way things are going, it could just get all too hard to get money into super.

If people are limited to $25,000 a year, there is a good chance that many will give up on superannuation as a long-term savings tool and divert their money elsewhere.

I have pointed out before (February 23, 2011) that the halving of concessional contribution limits – from $100,000 to $50,000 and eventually to $25,000 for the over 50s and from $50,000 to $25,000 for the under 50s – will make it very difficult for many to get a worthwhile sum in retirement.

If you are currently 40-years-old, you can get a maximum of a further $625,000 into super in concessional contributions before you turn 65 (although that figure is indexed). Depending on what you earn, that might not even allow for very much salary sacrificing at all.

And that’s only if you put in the maximum of $25,000 a year, EVERY year.

However, in your 40s, there are two expensive problems that get in the way, called mortgages and kids. Previous generations have had more generous limits that have allowed them to shovel money into super AFTER the kids have flown the coup and the mortgage is largely paid down.

The current rules don’t allow for that. But it’s particularly harsh on people in their 40s. They’ll have lower limits, plus won’t have the benefit of a working lifetime of 12% superannuation guarantee contributions that younger generations will have.

There is some conjecture about whether the move to cut the concessional contributions limits was based on revenue leakage or was purely philosophical.

The “purely philosophical” argument is that Labor believes that super should be means tested. Once you have $500,000 in super, you have enough. Any further savings should be outside super where you will pay full tax.

But there are growing signs that the government – and particularly Superannuation Minister Bill Shorten – thinks the cuts made when Kevin Rudd was Prime Minister went too far.

If he’s not saying so publicly, Shorten is certainly letting his thoughts be known to some industry members.

The first government backdown was made via 50-50-500 rule (my column on 19/5/2010), which essentially admitted that many simply couldn’t put enough into super before they turned 50 (because of family and mortgage commitments) and they deserved a higher limit to shovel more in later.

We still don’t have the final detail on those rules. And the government needs to hurry. They’re due to start in less than a year. And super members need time to plan.

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Regardless, there is growing optimism that Minister Shorten agrees the cuts went too far and might be prepared to act.

Shorten has been heard to say that he does not believe that even $1 million is enough super to retire on. If that is his belief, then there would have to be upwards pressure from inside the government on contribution limits.

And, if that were to occur, there would be a huge sigh of relief amongst the industry. Proper, orderly planning for a superannuation-based retirement could resume. People wouldn’t be forced to put money into super in their 40s when they, arguably, should be directing that money towards mortgages and kids.

However, even if it is more “revenue” than “philosophical”, then a few more “tweaks” to the system could or should be considered.

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One suggestion that is hard to argue with – partly because it already exists elsewhere in the same legislation – has been put forward by SISFA, the Small Independent Superannuation Funds Association, the oldest SMSF lobby group in Australia.

(SISFA have had some significant wins on government policy over the years, including tax-free super pensions – the idea adopted by Peter Costello.)

In their submission, yet to be put to the Government, is a proposal in regards to the concessional contributions limits.

While they argue that the eventual limit should be much higher than the proposed $25,000 limit for everyone – probably double – if that’s not going to happen, then some form of averaging should be introduced.

Currently, you have a $25,000 concessional contribution limit. If you can’t contribute $25,000 in a given year, tough. You’ve got another limit of $25,000 for the following year. And if you can’t use it in year two, tough again. Same goes in year three.

However, SISFA’s Andrew Cullinan says that some thought should be given to using averaging provisions – such as already exists for non-concessional contributions with the $450,000 pull-forward provisions – to allow more flexibility.

For example, take a small businesswoman. She earns enough money from her business in year one to make a CC of $25,000. However, in years two to four, the economy is lean and she needs every cent she can pull out of the business just to pay the mortgage. In year five, however, business bounces back and she is able to contribute her $25,000 limits.

Unfortunately, she is only able to contribute $50,000 over the five years.

Someone who is working as an employee, however, might be able to do the $25,000 in year one through a combination of the 9% SG contributions and the rest being salary sacrifice. As an employee, they must have at least 9% of their salary paid in during years two to four, even if times are personally bad in their household, then could potentially contribute up to the $25,000 limit again in years 4 and 5.

It’s actually a common situation.

By introducing, for example, a rolling five-year contribution system for CCs, it would allow people to potentially make larger contributions during years when they are able to, to make up for years when they couldn’t.

Table 1: Rolling five-year concessional contribution limits

If a rolling limit were applied, a few bad years could be made up for. Certainly, if the government is going to continue to keep these extremely low CC limits, then an adjustment of this sort – given they already do it elsewhere – seems only reasonable.

Or, here’s another option – a lifetime limit. A 40-year-old could put in that $625,000, whenever they could afford it, or it made sense for them from a tax perspective (with some indexation for rising limits later on).

You could put it in at the start, or the end, but that’s your limit.

The good news is that it looks like some sanity on contribution limits might prevail. Eventually. If enough pressure is applied.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.