(03) 9020 2905PORTFOLIO POINT: Want to cash out of a few profitable investments, but fear the capital gains tax? Here’s how you can reduce the burden with super.
There tends to come a time in many people’s lives when they begin to wish they’d made more of their investments inside super.
The introspection is often related to a potential tax problem. “There’s a bloody big capital gain sitting in that investment, and if I sell it, I’m going to lose tens of thousands in tax.” Often, that CGT issue is enough to stop people selling all together.
If only you’d made those big property investments in super! Well, for many reasons, it wasn’t possible. Until recent years, gearing in super wasn’t allowed. And decades ago, you didn’t have the money in super to make those sorts of investments without gearing. Mmm, a catch-22.
As is often the case, super is still here to rescue you. Granted, contributions limits aren’t what they used to be. But they can – and should – still be used to save tax overall.
Let’s assume that there is a capital gain of $300,000 sitting around from a property investment and have a look at the possibilities. That’s not a ridiculous gain to consider. Many purchasers who bought modest investment properties in the 80s or 90s could be sitting on gains that large now. Many will have individual properties sitting on double that. (And lucky for you if you have a pre-1983 asset, which is capital gains tax free.)
The issue of big capital gains don’t apply to the same extent when it comes to shares, largely because you can sell down shares in lots, which you can’t do with property. If you can manage the sale, you can manage the capital gains.
But let’s look at ways you can reduce CGT payable by using super as part of your overall tax reduction strategy.
For a start, there are some general conditions that will make it easier to minimise tax in these sorts of events:
- The asset seller is older than 50 and therefore has access to the $50,000 concessional contributions limits (for the 2010-11 and 2011-12 financial years)
- It will generally be more advantageous if there is more than one owner – great if both husband and wife jointly own the asset and the profit can be split 50-50
- The asset owners are working and under the age of 75 and can therefore make concessional contributions.
For this piece, we’ll assume that our example taxpayer/super member is over the age of 50. It can still be done for those under 50, but the concessional limits are obviously going to be $25k.
Essentially, the strategy involves using your concessional contributions limit to reduce the overall tax in your personal name and that of your super fund.
We’ll assume that the $300k gain was made over more than a year and is therefore eligible for the 50% CGT discount, so a gain of $150k will be taxed.
At the top marginal tax rate of 46.5%, a gain of $150,000 would require tax bill of $69,750. And unless you are sitting on a large pile of realised capital losses, then you’re unlikely to get away with paying no tax on a gain.
Let’s take someone earning $70,000 a year. With a $150,000 gain, they will end up having to pay tax as if they earned an income of $220,000 a year.
A person on an income of $70,000 would pay about $20,550 in income tax during FY2010-11. If the capital gain took you to $220,000 for the year, you’d be paying $75,850 for the year.
If the person over 50 was employed, they would receive $6300 in SG contributions from their employer, leaving them with the ability to salary sacrifice another $43,700 into super.
They know they’ve got this big capital gain coming. So, they could potentially salary sacrifice their income by that amount. This would reduce their taxable income from $70,000 to $26,300.
Now they are adding $150,000 to $26,300, making $176,300. This would leave you with a total income tax bill for the year of $55,825. To this, you need to add the 15% contributions tax that has been paid on the extra $43,700 that was contributed to super, which is $6555.
This investor’s total tax bill (income tax, plus contributions tax) has now been cut from $75,850 to $62,380. A saving of nearly $13,500.
If the original investment was made in joint names and both investors were over 50, then the gain would be reduced to $75,000 each, which would reduce the likelihood that it could taxed at the highest rate. You might also have two concessional limits in which to “hide” the gain.
Is timing important?
What time of year you realise you are going to make the gain is actually crucially important. And the lower your income, the more important it becomes.
For example, if you are a salaried employee and earn $60,000 and you don’t realise you’re going to make this gain until December 31 of a financial year, you’re only going to be able to salary sacrifice about $30k of your income, if you’re prepared to forgo the remainder of your income for the year. Add the 9% SG contributions and you’ll have contributed a total of $35,400 a year. If this same investor had realised that they were going to make this gain in about September, or October, they could have managed their concessional contributions to be much closer to the maximum of $50,000 for the financial year.
If an investor on $100,000 made the gain and wanted to protect as much as possible, they could still do so from about the end of January. From that point, they could salary sacrifice $41,000. When added to their SG contributions of $9k, they would then be at the $50k limit.
Employee versus self-employed
Being self-employed is obviously a huge advantage for these scenarios. Self-employed people have far more flexibility over when and where to pay themselves super. If they want to make a large super contribution on June 30, then they can.
Employees don’t have that luxury. The nature of salary sacrifice means that only future salary can be sacrificed. So, if you’re three-quarters the way through a financial year, then the maximum you can sacrifice of your salary is one-quarter.
*****
Well, the future of superannuation is going to have to wait. With a hung parliament, we’ve got some time before we’ll know whether we’re going to get Labor’s 12% superannuation guarantee, mysuper and commission bans, or the Coalition’s … er … not very much.
The Coalition have said they will ditch the MRRT (and the 12% SG levy would go as a result), believe industry should be left to introduce mysuper-style products and made various “unscripted” promises to the financial services industry that it would not seek to ban commissions on super and investment (as per Ripoll) or insurance in super (as per Cooper).
But the mysuper and commission promises didn’t get a run during the Coalition’s election campaign that I could see, so one can only assume they’re not high on their list. Nor did a return to more generous concessional contribution limits.
If you’re waiting for “what’s next with super?”, don’t hold your breath.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.