Superannuation is usually talked about as having three tax benefits.
It is a tax-effective way of receiving income because contributions are taxed at 15 per cent. The fund's earnings are only taxed at a maximum rate of 15 per cent. In the pension phase, the fund's earnings are taxed at 0 per cent with tax-free pension payments for most people.
In regard to the first benefit of being a tax-effective way of receiving income, a change to superannuation contribution rules from the 2018 financial year now provides another avenue for employed people to make tax-effective superannuation contributions. People can claim a tax deduction for their personal superannuation contributions - ie. contributions made from their own money.
As we head toward the end of a financial year, people are thinking of the usual end of financial year strategies to minimise their income tax liability. These strategies may include interest on investment loans, making charitable donations or paying any work-related expenses. Most employed people now have a new option of making a personal superannuation contribution (from their own money) and claiming a tax deduction for it.
What exactly is the change?
Up until this recent superannuation rule change, people working for an employer could only make tax-effective superannuation contributions (on top of their compulsory superannuation contributions) by salary sacrificing to super. Salary sacrifice contributions effectively reduced the taxable income of the person making the contributions.
People who were considered self-employed - who earned less than 10 per cent of their total income as an employee - had another way to make tax-effective superannuation contributions. They could make personal superannuation contributions and claim tax deductions for them.
That 10 per cent rule has now been removed, allowing employed people to make personal contributions (of their own money) to superannuation, and claim a tax deduction for these contributions.
You can find out more about this change here.
From a practical perspective, this change will have a positive impact for people trying to get money into superannuation.
Being able to make ad-hoc superannuation contributions and claim a tax deduction for them is a new personal finance strategy that provides more flexibility for getting money into super tax-effectively.
Making the most of the change.
As a useful personal finance strategy it's important to keep in mind that, where a tax deduction has been claimed, superannuation contributions are taxed at 15 per cent. This strategy only becomes tax-effective at a tax rate of 19 per cent (above $18,200 of income), and particularly, 32.5 per cent (above $37,000 of income).
In terms of timing of contributions, the end of the financial year is likely to see the greatest level of these tax-deductible personal contributions. People look to contribute closest to the time where they receive their benefit - ie. when they lodge their tax return.
This strategy can potentially be used by a lot of people earlier in their saving and investment lives – before they want to commit to making regular salary sacrifice contributions, but when they find they have extra funds they are comfortable adding to their superannuation balance.
The most significant likely change is for those who are currently using a salary sacrifice strategy. These investors may be faced with the dilemma of whether to continue salary sacrificing into super, or make use of this new opportunity that allows them to claim a tax deduction for their personal contributions. Both strategies have the same tax impact to reduce taxable income and see superannuation contributions taxed at 15 per cent.
Salary sacrifice vs claiming a tax deduction.
There are two clear situations where maintain a salary sacrifice strategy will be superior to using tax-deductible personal contributions.
The first involves the situation where employers match, or partly match, salary sacrifice contributions made by an employee. If you are fortunate enough to have a workplace where this happens, it's a simple decision to continue your salary sacrifice contributions - you'll be better off financially.
The second situation involves the ‘pay yourself first’ principle. If you automatically have money going into a savings plan, it is the easiest way to make the savings plan successful. A salary sacrifice contribution is almost the ultimate ‘pay yourself first’ savings plan. The money goes straight from your employer into your superannuation account where it is unlikely to be touched until retirement.
The third advantage of a salary sacrifice strategy is the positive tax effect is immediate – your employer will usually reduce the calculation of your fortnightly PAYG tax by the amount of your salary sacrifice contribution. This might even allow people to make slightly higher salary sacrifice contributions because their ongoing tax liability decreases immediately.
Overall, it appears a salary sacrifice strategy still has worthwhile advantages over tax-deductible personal contributions.
There are times when the two strategies might work well together. For example, you could use a conservative salary sacrifice strategy and top it up with a tax-deductible personal contribution at the end of the financial year. You could also make a tax-deductible personal contribution when you receive a lump sum - this can supplement a salary sacrifice strategy. In both situations, remember to keep your contributions limits in mind to avoid excess penalties.
How to make tax-deductible personal contribution to super.
Your superannuation fund (or self-managed super fund administrator) is the key contact here. They will be able to advise you about:
- how to make a personal contribution that you intend to claim a tax deduction for;
- when it has to be made by to ensure that it is received in the current financial year; and
- what paperwork needs to be lodged, and by when, to claim the tax deduction.
It is important to stress that you are not just wanting to make a personal contribution, but that you are wanting to make a personal contribution and claim a tax deduction for it.
This changes the way they treat the contribution (they have to take out 15 per cent tax), and then the reporting that you have to provide to the fund about the contribution.
Do new ways beat old ways?
Discovering a new way for employed people to get money into super is exciting, and being able to claim a tax deduction for a personal superannuation contribution is another way of getting money into the superannuation environment in a tax-effective manner. Our guess is that this approach will be mainly be used in two scenarios.
Firstly, by people who want to add extra amounts into super before they get to the stage where a salary sacrifice strategy is a core part of their financial plan, and secondly, by people looking to make contributions when they receive a one-off financial windfall.
While the cash flows from a salary sacrifice strategy and making tax-deductible personal contributions end up the same, my expectation is that for most people, the immediate benefit of the tax deduction and the financial discipline of automatically making the contributions will see a salary sacrifice strategy judged superior.
If you want to know more about superannuation investing strategies that will suit your financial situation, our Financial Advisers would be happy to take you through the different options.