If you have a self-employed client with an established business and sufficient cash reserves, you may want to discuss effective strategies to help them build their superannuation and reduce their tax. An effective contribution strategy will need to be implemented for them utilising their contribution caps and may include a contribution reserve.
Most Australians are required to compulsorily contribute at least 9.5 per cent of their salary to a complying superannuation fund. However, self-employed individuals are not required to set aside money to pay superannuation contributions. For many self-employed Australians on a modest income and approaching retirement age, they have not set aside enough money for retirement and this has restricted their ability to retire. Therefore, it is important to establish a contribution strategy for these clients as early as possible, to build their super and, importantly, reduce their tax.
Contribution reserve strategies
A contribution reserve is simply a 'suspense' account as it holds contributions for a short period of time before they can be allocated to the relevant members account within 28 days of the following month of the contribution being made.
Why use a contributions reserve?
Contribution reserves have the obvious benefit of doubling the client’s contribution and allowing them to claim a deduction for the equivalent of double the contribution cap in each financial year. Therefore, the member can bring forward the tax deduction from the next financial year to the current financial year – without breaching the concessional contribution caps. This is a 'win-win' where the client can claim a deduction and minimise their tax and also increase their superannuation balance. This is particularly effective for members with a large capital gain and is looking to minimise their tax bill.
When to use the contributions reserving strategy?
A contribution can be made to the reserve prior to 30 June – usually after 2 June as the contribution must be allocated to the member account within 28 days of the following month. For instance, a contribution made on 15 June must be allocated to the member account by 28 July.
A real-life example
Jack is a carpenter and is 51 years of age and a member of ABC SMSF. Jack’s concessional contribution cap for the 2016 year is $35,000. In the 2016 year, Jack has made a significant capital gain on a sale of property and is looking to minimise his tax.
On 2 September 2015, Jack made a contribution of $35,000 to ABC SMSF. It would seem that if Jack makes any further contributions, he will exceed his contribution cap for the 2016. That’s where the Contribution Reserve strategy takes effect. On the 15 June 2016, Jack makes another personal contribution of $35,000. Jack can allocate the contribution within 28 days of the following month of the contribution (ie, July 2016).
Accordingly, Jack can claim a deduction in the 2016 year for $70,000 yet not exceed his concessional contribution cap for the 2016 year. The additional $35,000 will be counted to Jack’s contribution cap in 2017. This is particularly effective for Jack to minimise the large capital gain in the 2016 year and may result in a significant tax saving.
Jack has checked his trust deed to ensure it allows the use of reserves and provides ABC SMSF with the notification of his intent to claim the $70,000 as a deduction.
The example of Jack shows that contribution reserves are awesome for the right client at the right time. Contribution reserves can be used to double their deduction in a financial year and increase their superannuation balance. It is important to remember that consideration is provided to the tax benefit provided in the current year as well as the year following the allocation.
How does the 2016 budget affect contributions to my SMSF?
The 2016 budget announcement – if implemented – will have a major impact on contribution strategies for the self-employed. They include:
- reduction in the concessional contribution cap to $25,000 regardless of age;
- carried forward concessional cap for account balances below $500,000;
- removal of the work test for those aged 65-74;
- all individuals under 75 will be eligible to claim a tax deduction for personal contributions lifetime non-concessional contribution cap limit of $500,000;
- removal of existing annual non-concessional cap and bring forward provisions; and
- lifetime non-concessional contribution cap limit of $500,000.
These changes have been a talking point since the announcement was made; however, with the prospect of a hung parliament, there is uncertainty in relation to the implementation of these changes, which may be a relief for many that have used the carry forward non-concessional rules to buy/transfer property. Watch this space for sure.
The example of Jack the carpenter shows that an effective contribution strategy can be used for the self-employed to effectively reduce their tax by claiming a deduction for the contribution made and boosting their super to benefit their retirement nest egg.
Ivan Filipovic, director, Redwood Advisory