Q: I am trying to understand how my super is taxed and it seems that it is taxed at every turn. Can you please explain when, and how, a super benefit is taxed?
A: If it were not for tax, superannuation wouldn’t exist. You would simply invest in your own name. Superannuation is taxed at lower rates to encourage people to lock their money away for retirement.
Here’s the short story on the tax incentives surrounding superannuation. You receive tax incentives on superannuation at four different stages:
- Concessional (before-tax) contributions: when you, or your employer, makes concessional (before-tax) contributions
- Non-concessional (after-tax) contributions and the co-contribution: Indirectly, when you make a non-concessional (after-tax) contribution: although this type of super contribution does not directly receive any tax incentives – the investment earnings on those super contributions are concessionally taxed (see next bullet). Also, you may also receive a tax incentive when you’re eligible to receive a tax-free co-contribution from the federal government. You’re eligible for a co-contribution when you make non-concessional (after-tax) contributions of a certain amount, and your annual earnings are below a certain level of income. Spouse contributions may also receive a tax incentive via a tax offset.
- Investment income on super fund investments: when your super fund earns income on fund investments, and note that investment income is earned on both pre-existing super investments, and new investments purchased with your most recent super contributions (both concessional and non-concessional contributions)
- Superannuation benefit payments: when you eventually receive your superannuation benefit.
Stage 1: Making concessional (before-tax) contributions
If you are an employee, your employer is required to contribute the equivalent of 9.5% of your salary (more specifically, ‘ordinary time earnings’) to your super fund. These compulsory employer super contributions are known as Superannuation Guarantee contributions. Your employer receives a tax deduction for these contributions and your super fund must deduct 15 per cent tax on each contribution (and for certain high-income earners, an additional 15% tax will be deducted from their super accounts after they have lodged their income tax returns).
For example, Kate earns $55,000 plus 9.5% super. Each year her employer must make super contributions, at least quarterly, worth an annual total of $5,225.
You can also make voluntary super contributions, in addition to your employer’s compulsory contributions, although if you are over the age of 65, you must satisfy a work test before contributing.
You can make concessional (before-tax) contributions to a super fund. Concessional contributions fall into three main categories:
- Superannuation Guarantee (SG). An employer’s compulsory super contributions to an employee’s super fund. In relatively rare cases, an employer can also choose to make voluntary additional super contributions on behalf of an employee but these extra voluntary contributions are not classified as SG contributions. (For more information about SG contributions, see SuperGuide articles Employer super contributions: SG rate 9.5% for 2018/2019 year and Superannuation and employees: 10 facts about your super entitlements.)
- Salary sacrificing for employees. If you can arrange for your employer to direct some of your before-tax salary to superannuation as contributions, your super fund deducts 15 cents in the dollar, rather than the government imposing your marginal tax rate on that income, which can be up to 47% (45% plus 2% Medicare levy) for the 2018/2019 year and 2017/2018 year (and was up to 49% for the 2016/2017 year). This type of arrangement is known as salary sacrificing. The employer will receive a tax deduction for this contribution — your employer would also have received a tax deduction if the contribution amount had been paid as cash salary. (For more information on salary sacrificing, see SuperGuide article Salary sacrifice and super: A guide for employees and employers.)
- Tax-deductible contributions for self-employed or non-employed, and since 1 July 2017, available to employees too. You can make concessional contributions, more commonly known as tax-deductible contributions, if you are an employee, or if you are self-employed or even when you are not working. A 15% contributions tax is deducted from any superannuation contribution that has been claimed as a tax deduction. (For more information see SuperGuide articles Employees can now make tax-deductible super contributions and Who can now make tax-deductible super contributions?).
Note one: If you earn less than $37,000 your super account may receive a refund of the contributions tax deducted from your employer’s SG contributions, or deducted from your personal contributions. For more information on this potential tax refund, known as the Low Income Superannuation Tax Offset (LISTO) see SuperGuide article Learn to love LISTO: low income earners get their super tax refunded.
Note two: If your adjusted taxable income is greater than $250,000 a year, your concessional super contributions are subject to a further 15% tax, taking the total contribution for high-income earners to 30% (for more information on this extra tax on contributions, see SuperGuide article Double contributions tax for more high-income earners).
For more information on concessional contributions see SuperGuide article Super concessional (before-tax) contributions: 2018/2019 survival guide.
Stage 2: Making non-concessional (after-tax) contributions
A non-concessional contribution is a superannuation contribution sourced from money from which you have already paid income tax at some point in the past. After-tax contributions are not hit with the 15% tax on contributions when entering a super fund. For more information on non-concessional contributions see SuperGuide articles Non-concessional contributions: 10 facts about the $100,000 cap and Your 2018/2019 guide to non-concessional (after-tax) contributions.
After you make a non-concessional contribution to your super fund, the trustees of the super fund then invest that money on your behalf. Any investment income generated from that investment is taxed at a concessional rate of 15% (although certain capital gains are taxed at an effective rate of 10%).
In certain circumstances, non-concessional contributions paid to a super account can provide other benefits, such as:
- Co-contributions: If you make a non-concessional contribution, you may be eligible for a tax-free bonus from the government called the co-contribution if your assessable income is under $52,697 for the 2018/2019 year or was under $52,813 for the 2017/2018 year. For more information on the co-contribution see SuperGuide article Gaining from the government: How you can score a co-contribution freebie.
- Spouse contributions tax offset: A spouse can make super contributions on behalf of a spouse earning less than $40,000, and receive a tax offset for the super contribution. For more information, see SuperGuide article Spouse contributions tax offset: 10 facts you need to know
- Downsizing and super: Since 1 July 2018, an Australian aged 65 years and over can make non-concessional contributions into a super account of up to $300,000 from the proceeds of the sale of the person’s home. For more information, see SuperGuide article Contributing super by downsizing your home: 10-point guide.
- First Home Saver Super Scheme: You can make concessional or non-concessional contributions to a super account to go towards the purchase of a first home. For more information, see SuperGuide article 10-point guide to First Home Super Saver Scheme.
Stage 3: Paying less (or no) tax on earnings
The maximum tax that you will pay on your superannuation fund’s earnings is 15 cents in the dollar (apart from SMSFs that may pay extra tax on special income from related parties).
A super fund pays tax on its earnings in four different ways:
- Believe it or not concessional (before-tax) superannuation contributions are treated as earnings/income of a super fund and subject to a 15% tax. We refer to a ‘contributions’ tax for ease of explanation, but legally this tax is really the same as the tax on a superannuation fund’s income. If you earn less than $37,000 a year, and you, or your employer makes concessional (before-tax) superannuation contributions on your behalf, then you can expect a refund of the contributions tax deducted from your super account, paid directly to your superannuation account by the federal government (see SuperGuide article Learn to love LISTO: low income earners get their super tax refunded). At the other end of the income spectrum, if your adjusted taxable income is greater than $250,000 a year, your concessional super contributions are subject to a further 15% tax, taking the total contribution for high-income earners to 30% (see SuperGuide article Double contributions tax for more high-income earners).
- Fund earnings are subject to a maximum of 15% tax (apart from SMSFs that may pay extra tax on special income from related parties). In addition, if your super fund owns Australian shares that pay franked dividends, your fund will pay less than 15% tax on its earnings. A franked dividend is a dividend that currently has pre-paid between 27.5% and 30% in company income tax. For more information about franked dividends, see SuperGuide article Franked dividends and franking credits: How do they work?.
- Capital gains. Any capital gains that your superannuation fund makes, from the sale of fund assets, is subject to earnings tax. If the asset sold has been held for more than 12 months, then the fund only pays tax on two-thirds of the capital gain. In effect, a tax rate of 10% (see SuperGuide section Capital gains tax (CGT) and super)
- Non-arm’s length income (NALI). For SMSFs, earnings from an investment in a related party are taxed at a much higher rate than the usual 15% tax on earnings. The tax rate on NALI is 45%. For more information on NALI see SuperGuide article Guide to SMSF investment rules
Note: The superannuation system is split into two distinct phases:
- Accumulation phase. You are in this phase when you are still contributing to your superannuation fund and/or you have not yet withdrawn your super benefit or started a super pension. Your fund pays up to 15% tax on concessional contributions (and individuals with an adjusted taxable income of greater than $250,000 now pay an extra 15% tax on concessional contributions), and 15% tax on investment income.
- Retirement phase. Your super account is in retirement phase if you have commenced a retirement phase income stream (pension) from a superannuation fund. Your super fund does not pay tax on investment income from assets that finance a super pension in retirement phase. Since 1 July 2017, there is now a cap on the amount of super savings that you can transfer into retirement phase (for more information see SuperGuide article Retirement phase: A super guide to the $1.6 million transfer balance cap).
Stage 4: Accessing tax-free super benefit payments
The best news about super and tax is that when you access your super on or after the age of 60, you will receive your super benefit payments tax-free (with the exception of some public servants). That’s right. No tax for over-60s. For more information about the tax treatment of super benefit payments taken before, or after, the age of 60, see the following SuperGuide articles:
- Tax-free super for over-60s, except for some
- Retiring before the age of 60: the tax deal
- Retirement: 3 ways of taking super benefits before the age of 60
Although the first two tax articles listed above each contain a summary table of the tax treatment of super benefit payments, for a handy summary table of all taxes applicable to your super benefits, see SuperGuide article Super for beginners, part 15: Super tax – as easy as 1-2-3.
For more Super for Beginners topics, see the following SuperGuide articles: