A single pot strategy

PORTFOLIO POINT: If you’re over 50, do you treat your super and non-super assets as two pots or one for asset allocation? Here’s an argument for the singular.

Simply, the rules are different. Superannuation has one set of rules and taxation consequences. And your “normal” investments have another set of tax rules.

For example, superannuation income is taxed at 15% for all accumulation fund members, while non-super investment income is taxed at somewhere between 0% and 46.5%.

Capital gains is another story. Super accumulation fund members are taxed at 10%, which is a one-third discount on the income tax rate.

Outside super, there is a 50% discount on the marginal tax rate. But that could be anywhere between 0% and 46.5%.

Then complicate it with super pension funds. They pay 0% on income and capital gains. (Unless Labor’s plans to take pension funds earning more than $100,000 come into force.)

There have always been strong arguments as to whether you should tip all of your money into superannuation and invest it all there. Superannuation is taxed, in general, far more lightly than non-super money. I’ve covered that in the past and it’s a different argument with different risks. Even if the government’s tax on super pensions earning in excess of $100,000 comes into force, it is still a better deal than having the same $100,000 being earned outside of super.

But some people don’t want to do that. And there is the ever present legislative risk – don’t believe any politician who says they won’t tinker with it, until that power is actually taken away from them – that means that most will always want to keep some, even a substantial, portion of their investment assets outside super.

If they were in the same pot (say, in super), then you would treat it as one pot of money and invest it accordingly.

However, most of us have two pots. And we treat those two pots as two pots. Even though it might not make sense.

Particularly as we get closer to accessing super, it can make sense to treat it as one pot of money, with two sets of rules. (Sort of like China and the Special Administrative Region of Hong Kong.)

What’s close? Possibly any time from about 50 onwards, but certainly from 55.

Let me show you what I mean.

Example situation

Let’s take a couple with a net $3 million of net investible assets (not including the family home, and after debt).

And let’s break it down to $1.5 million outside super and $1.5 million inside super.

Of the $1.5 million inside super, $1.2 million belongs to one spouse and $300,000 to the other. And let’s further say that the couple, combined, would like a “balanced” investment portfolio.

Of the $1.5 million outside super, there are two investment properties (again, not home), reasonably geared. The properties are worth $1.1 million, but they have $950,000 of debt. Therefore they have $150,000 net value.

One partner has a very high income ($250k+), while the other will be retiring at the end of the year.

Their preferred asset allocation, inside and outside super, is balanced, with 40% in defensive assets and 60% in growth assets. If split evenly, that might look like the following.

Table 1: Separate super and non-super assets

And that’s fine. There’s nothing wrong with splitting up assets evenly both inside and outside super. And that’s how most people view it – as two separate buckets.

However, there can be advantages, particularly from a tax perspective, to taking a view that the entire $3 million is one pot of money.

Considering the benefits of making it one pot

However, if we decide to allocate it as one pot of money, according to what works best in each individual asset class, it broadens the possibilities for potential returns.

If the pots are combined, then you might get something like the following.

Table 2: Combined asset allocation

Now, how might you treat this differently? The following is simply working through a particular set of circumstances and won’t necessarily be the best for your situation.

Cash can be better outside super

Rates of return on cash at the moment are pretty poor. The best term deposits on offer stand at about 4.1%.

If you’ve got that sitting in your personal name and you’re earning the average wage, you lose 34%, so only get to keep a return of 2.71%. Our high earner would have that return reduced to 2.19%. If it’s in your super fund, you get to keep 3.5%.

Therefore, if you had $300,000 in cash outside super and $300,000 in cash in the super fund, you would earn a net $18,573.

However, the best return in this circumstance might be to hold all cash outside of super, in an offset account against the investment property loans. The offset account saves rather than earns. Savings can’t be taxed.

If we assume that the current interest rate is 5.3%, then approximately $31,800 a year in interest is saved. That’s improved your total cash return of 71%.

Fixed interest

As outlined above, one of the couple is going to be retiring at the end of the year, going from a salary of $60,000 a year to nothing.

As such, there is scope to use the $18,200 tax-free threshold. If $600,000 in fixed interest investments were earning 5%, then the income would be $30,000, the majority of which would be tax free.

If you’re really trying to make this work properly, then you might consider making a non-concessional contribution into super to hold those assets in excess of what would produce the $18,200 income.

Making the contribution to super would shift the split from 50-50 inside and outside super, but that could be a good idea also.

Property and shares

The intention is probably to hold the existing investment properties. Selling them would probably incur capital gains tax. And property is such an expensive asset class to get into (stamp duty) and out of (agent’s fees and advertising).

But property and shares are growth assets and are, therefore, more about capital growth than income. The real advantage in super is that they can potentially be sold CGT free, if sold in a pension fund. And that’s the real advantage here.

When sold outside super, property and shares are almost always going to be an event that incurs CGT. And even with the 50% discount, it can be quite a big bill.

While there would probably be some CGT to be paid on the non-super shares, it might be worth taking that pain now to either sell them and repurchase the shares inside super, or make an in-specie transfer of the shares into your super fund.

Future share and property purchases (managed funds, property trusts such as Westfield, or even direct residential property) should potentially be purchased inside the super fund.

Outside of potentially avoiding CGT on the eventual sale of growth assets inside super (if the laws in respect of taxing pension funds do not get changed), the other major advantage is, of course, lower income tax rates on distributions and dividends.

It could be worthwhile to hold all shares and other remaining property inside super.

Summary

Moving your thinking from having two sums of money that require separate management to thinking about it as a global sum of money can have some positive tax consequences.

Yes, you would be exposing yourself to higher risk inside your super fund. But you would be dramatically reducing your risk outside of super. The types of assets you held would not be any different.

*****

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au