Superannuation – everybody has it, but only 40% of Australians know how much they currently have in their super.
Fewer understand the mechanisms behind it. And annual changes to superannuation laws don’t make it easy either.
Case in point: as part of the 2016 federal budget, changes were made to the way defined benefit income streams are taxed.
Our personal accountants answer how will this affect your super fund? And how will it impact your retirement?
But first, what are defined benefit schemes?
When it comes to retirement, there are two main options:
- Accumulation superannuation funds
Most Australians have their super in an accumulation scheme – unless you’re a government employee or work for a large corporate, chances are your retirement fund is one of these as well.
These funds get their name because money builds up over time as you and your employer make contributions.
Accumulation funds generate earnings from your investments, meaning your retirement may depend on current market factors.
Less common are defined benefit schemes.
Unlike accumulation schemes, these are schemes where the employer provides clearly-defined, set retirement benefits.
For example, that might mean a lump sum or monthly payments based on length-of-service, seniority and and salary.
This can take the form of superannuation funds or retirement pensions.
As such, these schemes can be very generous. Additionally, they’re generally much safer than conventional superannuation funds since amounts are locked-in.
Changes to how defined benefit schemes
Since July 2017, the $1.6 million transfer cap limits how much you can transfer from your superannuation fund into a tax-free retirement account.
In short, this cap changes the tax-free portion of your super to a total of $1.6 million.
If your total tax-free pension already exceeds $1.6 million, you’ll have to either move the excess to a different location or pay up.
For the sake of consistency, the federal government has also made changes to defined benefit schemes too.
What’s tax-free and what isn’t?
It’s important to note that the value of your defined benefit pension lump sum value is included in that $1.6 million sum.
That means if your defined benefit scheme is a lump sum payment of $900,000, you’ll be entitled to an additional $700,000 in tax-free retirement pension.
It’s important to note that there’s nothing saying you can’t set your retirement pension up so that you only have $1.6 million to fall back on.
What it does mean is that you’ll have to pay tax on it!
It’s not just lump sums either – what happens if you opt for instalments?
It’s not just total pension and lump sum payments you’ll need to look out for. Depending on your annual payout, you might still be affected by these changes.
Is your pension paid out in instalments rather than a lump sum? If so, you may have to watch the amounts closely.
Pensions greater than $100,000 per annum will also be taxed at full marginal rates, with the excess being added to your assessable income.
That means if you have a $150,000 pension, you may be required to pay an excess contribution tax on $25,000 of your excess at your current rate.
Will this affect super contributions?
One potential consequence of this change is that you may not be able to make further non-concessional contributions to your super, as the ability to make non-concessional contributions is governed by how much you already have in super.
Long story short, if your total super already exceeds $1.6 million, further non-concessional contributions may no longer allowable.
As soon as you claim your defined benefit pension, the special value will apply, and may exclude you from making further contributions.
Talk to a superannuation accountant about what your options are, and what the best course of action is.
Our personal accountant Melbourne also discussed work test exemption for voluntary super contributions for Australians aged between 65 and 74 in this article.
What about member contributions?
Many defined benefits schemes require the beneficiaries to make member contributions to maximise the final entitlement payable on retirement.
Sometimes this is because of how the scheme is set up. In others, it could be an explicit condition of membership.
In either case, member contributions may be needed to see a bigger payout.
Of course, like we mentioned above, the $1.6 million cap can be problematic!
If your total super already exceeds that number, then any further member contributions will be considered excess contributions and will incur a tax penalty.
However, since member contributions can maximise your final payout, the benefits of continuing to make contributions often outweigh the accompanying tax obligation.
This isn’t a hard and fast rule – continued contributions may not be beneficial in every instance.
While we’re talking about benefits, you might be interested in checking out this article that our personal accountants explain about Fringe Benefits Tax (FBT).
H2> Speak to our personal accountants if you’re unsure
Retirement planning can be confusing.
This is just one of the countless rules that apply to pensions and superannuation.
For more than 50 years, Bruce Edmunds & Associates has helped individuals like you prepare for retirement.
From financial planning to wealth planning, our personal accountants specialise in getting you the best retirement outcome. We navigate the treacherous waters of personal tax and superannuation so you don’t have to.
Get in touch with our expert accountants on (03) 9589 5488 or request an appointment here to learn more about the changes to defined benefit schemes, and how you can retire comfortably.