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New rules mean self-managed super fund (SMSF) members can make additional contributions to their SMSF, which can bump up their balance and at the same time offset their tax bill.
There are two contribution strategies that could provide SMSF members with up to $50,000 in deductions against their income in a financial year, according to Azlin Lutfi, accounting partner, Pride Advice and Accounting.
So, what is contribution reserving and how does it work?
If you have an SMSF, you may be able to use a technique known as contribution reserving.
“In its simplest form, contribution reserving allows you to claim two lots of superannuation contributions as tax deductions in a single financial year,” Lutfi explains.
Under this strategy, individuals with an SMSF with a valid trust deed that allows reserving, may have an opportunity to contribute a total of $50,000 to their super in a single year, which is $25,000 more than the contribution limit. This may be used in the current financial year as a tax deduction.
But, says Lutfi, there are some important rules to follow to ensure SMSF members stay inside the rules. First, the SMSF trust deed must allow for a reserving strategy. Also, the amount contributed must be released from the reserve within 30 days.
All in the timing
From 1 July 2019, SMSF members whose super balance is under $500,000, who have not used up their previous year’s concessional contributions, are able to contribute the prior year’s unused contributions to their fund. “In so doing, they potentially reduce their taxes,” Lutfi adds.
This approach allows SMSF members – in fact, anyone with a super fund who is able to take advantage of this strategy – to add those unused amounts together, contribute those funds to super and in doing so, claim a tax deduction.
“The benefits accumulate over time and mean an additional $150,000 could be added to a super fund by 2024,” Lutfi says.
For the current 2020 financial year however, if you’re able to access this rule, you can claim a $50,000 contribution to super as a tax deduction.
Substantial capital gains tax benefits
It’s worth exploring how this works in practice. Let’s say an SMSF investor has achieved a substantial return on a property that has recently been sold. The asset has been held for 15 years and the capital gain on it is $500,000. Assume this is the SMSF member’s only income in the year, and they are aged 63.
“Under the CGT discount rule, you’re entitled to reduce the capital gain by 50%, and the remaining half is applied to your assessable income,” Lutfi adds.
This now gives the SMSF investor an assessable annual income of $250,000. These funds may be contributed to super, as the member is aged less than 65 years. Using the rules above, the investor elects to contribute $50,000 to their SMSF, which is $25,000 more than normal.
“The act of doing this reduces the member’s taxable income to $200,000, from a previous $250,000,” he adds.
It’s worth understanding how the tax payable under this scenario works, which is set out in the below table.
|Not accessing the strategy||Contributing $25,000 to super||Contributing $50,000 to super using either rule|
|Assessable income||$ 250,000.00||$ 250,000.00||$ 250,000.00|
|Super contributions||$ 0.00||$ 25,000.00||$ 50,000.00|
|Tax savings||$ 0.00||$ 8,000.00||$ 16,000.00|
Rules, eligibility and other considerations
While the strategy outlined above appears relatively simple, there are lots of boxes to tick for it to comply with super rules and also remain effective.
There are some considerations including:
- The member must be under 65 or meet the work test, which means the members must be employed on at least a part-time basis.
- The SMSF needs a compliant trust deed.
- Consideration of contributions already made in the current financial year must be made, prior to making an additional contribution.
- Implications should be taken into account that may arise in the following financial year as a result of bringing forward a contribution, that is, it’s important to understand that next year’s contribution limit has already been used.
“You’ll need to work closely with your accountant and your financial adviser to correctly apply these rules,” Lufti says. “Your accountant will need to calculate your expected taxable income, determine the final capital gain after allowing for any prior year’s losses and discounts and work out if you can meet the eligibility criteria,” he says.
The required paperwork must also be submitted to the Australian Tax Office (ATO) and all transactions must be correctly reported in your SMSF’s annual return. Also ensure your SMSF is set up in the correct way to receive future year contributions and that the strategy is aligned with your greater financial objectives and goals.
There are also other considerations, says Jordan George, the Self-Managed Superannuation Fund Association’s (SMSFA’s) head of policy.
“To be allocated in the next financial year, a contribution must be allocated by a super fund to a member’s account within 28 days of receipt to allow a contribution made before 30 June,” he says.
George also says SMSF trustees can make mistakes when making a contribution too close to the end of the financial year. The risk is the contribution doesn’t actually reach the fund’s bank account until after 30 June, meaning the contribution is made in the next financial year.
“Trustees also need to make sure they document the decision to not allocate the contribution until the next financial year and keep evidence that the allocation occurs within 28 days. As there are a number of complexities with this strategy, SMSF trustees should seek specialist SMSF advice before embarking on it,” he says.