You probably feel like over the years you have paid enough taxes throughout your lifetime, and the last thing you want to do is end up paying more taxes in retirement. There are some steps you can take now that will help improve your tax situation later, and a lot of it comes from smartly using your superannuation fund. Let’s take a look at seven things you can do now to reduce your tax burden later on.
One of the main ways you can reduce the amount of tax you have to pay after you retire is to start a pension in your super fund. You immediately eliminate the 15% tax that is applied to fund earnings. Plus, if you are over 60, your pension income is not taxed either, and you can take out any amount. There is a bit of a tax penalty on your pension income if you are between 55 and 59, but your fund earnings will remain free of tax under this plan.
There is a bit of trickiness in implementing this plan, however. There are some minimums you need to keep in mind when it comes to your pensions. They are called the minimum annual pension payment factors, and they mean that a minimum percentage of your total fund balance must be drawn in a given year. That amount goes up as you get older. It’s important to keep this amount in mind if you are over 65 and you have other retirement income funds as you may make too much money to put the excess back into your superannuation fund.
A self-managed super fund or SMSF gives you options that are not available with other superannuation funds. You will find that you have additional ways to try to alter the amount of tax you are obligated to pay with an SMSF, both before you retire and after. To start, you don’t have to withdraw funds to gain the 15% tax benefit.
Within an SMSF, you can make your own decisions about the timing of your fund investments. There are franking credits, also called imputation credits, derived from Australian share dividends that you can use within your SMSF to cover the 15% tax assessed at the end of the year when the fund files its tax returns. That’s because you have already paid the tax on the dividends, so you can’t be taxed twice.
The dividends are taxed at a 30% corporate tax rate, so your imputation credits are also calculated at 30%. When this amount is greater than the taxes owed in a given year on your earnings, you will get a refund. And it’s possible that not only will you cover your 15% tax obligation but you might even end up ahead.
You have a lot of options once you reach 60, and even more if you are over 65. Your superannuation pension is one way you can earn retirement income, but if you are a male aged 65 or a female aged 64 you might be eligible for the Senior Australians Tax Offset that puts you into a different bracket, leaving you with more income that is free of taxes. A few years ago the income amount was $30,685 for individuals before they were expected to pay any taxes. Couples could make $26,680 each.
If you have retired but are not yet 65, you can claim a low income tax offset of $6,000 and still earn as much as $16,000 before you have to pay any tax. That lets you keep some other income sources besides your superannuation fund and not have to pay any taxes.
Being able to sell some of your other assets and put the proceeds in your superannuation fund can help make things a lot easier to manage, as well as put you at a tax advantage, particularly if you have an SMSF. Your pension income from your superannuation fund is tax-free so long as you are over 60.
Income from assets you have besides your super fund are often considered taxable income in retirement. You can also simplify your estate planning by selling off other assets as everything you have is part of your estate that your heirs will have to deal with. Interestingly, your super fund is not part of your estate. You designate beneficiaries for your super fund and they are paid a sum from your fund and pension without having to go through probate. That also means your super fund will be exempt from any challenges to the disbursement of your estate, and any creditors cannot attach a claim to any of the fund.
Any assets you have that are not part of your superannuation fund that have realized substantial gains could mean you get hit with a large capital gains tax. You can use a contribution to your super fund to reduce the amount of tax you’ll have to pay. The proceeds of the sale can be added to your super fund as either a concessional or a non-concessional contribution.
How do you know if you are eligible to take advantage of this option? Start by looking at how much taxable income you get in a year and what your marginal income tax rate is. You will then add in your expected capital gains to your estimated annual income to see what kind of income you want to live on, and to see what amount you want to put into your superfund. You can do this over the course of several years so you don’t end up taking a huge tax hit at one time. Now, if you have had the asset for longer than 12 months, you do get a 50% capital gains tax discount.
Your heirs will appreciate this method, too, since, as we discovered above, super funds are exempt from probate and it has a tax benefit as well, so long as you have started your pension.
As long as you are under age 65 but still retired, you can make some personal contributions to your super fund and even get a tax benefit from it. You do have a cap on how much you can contribute per year without penalty, however, because of the concessional contribution cap. If you are retired and you do have an income tax responsibility, you can alter your taxable income amount and give yourself a lower tax to pay each year.
This also gives you the added bonus of increasing the amount in your superannuation fund and the amount you could end up having available to use should you start your pension at age 60. And remember, that income is tax-free to you, but the amount in your concessional portion of the fund may mean your heirs will have an estate tax to have to pay.
Any deductible contributions are subject to a 15% contribution tax inside the superannuation fund, and if you exceed your cap for the year, you may be subject to a penalty tax on the overage.
If you are retired but are not yet 60 (preservation age is 55-59), there is another option that helps reduce the taxes your heirs may be subject to. It’s called the re-contribution option. It lets you take a lump sum withdrawal from your superannuation fund, then redeposit it into your fund as a non-concessional contribution. It changes the amount in each portion of the fund (concessional versus non-concessional) and therefore creates a better tax position for your heirs, since non-concessional proceeds are not taxed.
There is a catch – be sure your withdrawal amount is not over the low rate cap with regards to taking lump sum benefits. Anything taken out above the cap is subject to taxing.
When making a contribution to your super fund, you do have an interesting option. Your non-concessional contribution cap per year is $150,000, but there is something called the bring-forward rule. You can put three years together into one, and “bring forward” the next two years’ contribution cap into one much larger cap. That lets you deposit as much as $450,000 in one year. Just remember you did that, so you don’t exceed the limits for the next two years.
Does all of this sound confusing? Don’t worry –it is a very complex subject, and the tax ramifications are significant. The above notes are factual information only and does not take your personal circumstances into account. Please contact us for further help on understanding the right options for you. We’d be happy to evaluate your situation and connect you with a specialist that meets your needs.