The end of the financial year is fast approaching and of course that means – TAX TIME.
Most people won’t think about their tax return until next financial year when they have to fill in all the details retrospectively about what they can claim for the year just gone. But the issue with that approach is – you’ve lost the opportunity to minimise your tax.
So this year, why not get ahead of the game and consider how you can use your super to save you tax. Let me explain.
If you are under the age of 65 you have the ability to make a tax-deductible contribution to your superannuation. If you are over 65, but under 75, you may also have this same opportunity provided you meet the work test which means you must have worked at least 40 hours within 30 consecutive days in a financial year. Over 75 and the door has closed.
The reason why you would want to make a tax-deductible contribution to super is because it could reduce your tax liability and may even get you a tax refund! Let me give you an example of how this works.
Let’s say you earn $100,000 gross (before-tax) per year and have no other investment income and have no deductions. Throughout the year you should have paid $25,717 in tax through PAYG. When you lodge your tax return you don’t have any additional income to declare nor deductions to claim. As a result you will not owe anything to the tax office nor will you receive a tax refund – the PAYG was spot on so you are all squared.
In the same situation lets assume you make a $10,000 tax-deductible contribution to superannuation. In this instance, you still would have paid $25,717 in PAYG tax throughout the year but now you have a $10,000 deduction to claim. As a result, the ATO will calculate that you have paid $25,717 in tax but only owe them $21,517 so you will get a tax refund of $4,200!
Now of course, everyone’s tax calculation is different and the amount of refund will vary depending on many factors. However, as this basic illustration demonstrates, getting a tax deduction for contributing to super is a beautiful thing!
Not only will you save money in personal income tax, when the money hits your super fund it will be invested and the compounding can begin.
But of course, like with everything, there are some restrictions around these contributions and potential downsides that you need to consider. Let’s look at the restrictions first.
As we already touched on, there are age restrictions which will limit your ability to contribute to super. In addition to this, there are contribution cap limits which you need to abide by each year.
A tax-deductible contribution to super will form part of your concessional contributions which has a $25,000 cap limit in the current financial year. Bear in mind that any employer contributions or salary sacrifice contributions will also fall under this cap limit so before you make any contribution it is best that you check your super fund and find out how much has already been contributed in the current financial year.
You also need to account for contributions which are still to come in from your employer before 30 June. To do this, just check the frequency and timing of previous contributions during the financial year.
This financial year is also the first year in which you can utilise the catch-up concessional contributions. What this means is that from 1 July 2018, if you haven’t utilised your full concessional contributions cap limit you can carry forward the unused amount for up to 5 years.
So for example, if you only made concessional contributions of $15,000 in the 2018/19 financial year, then in the 2019/2020 financial year you could contribute up to $35,000 ($25,000 current cap limit + $10,000 unused cap limit). This is only available if your super balance was less than $500,000 on 30 June of the previous financial year.
Before making a contribution, consider this…
Assuming you are eligible to make the contribution and you have the cap limit available to do so, there are still a few considerations that you should take into account before making a contribution.
Firstly, it is important to note that concessional contributions are taxed by your super fund at a rate of 15%. Given this, it is not tax effective to make a concessional contribution if you earn less than roughly $20,000 as you basically pay no tax outside super. The net tax saving from a concessional contribution can be calculated as the difference between your marginal tax rate and your superannuation tax rate of 15%.
If you are fortunate enough to earn over $250,000, then you will get slugged with the Division 293 tax. This is an additional 15% tax on any contribution that would otherwise take your income over the $250,000 threshold. So although you would essentially be taxed at a rate of 30% on super contributions, this is still a whole lot better than the top marginal tax rate of 47% when medicare levy is included.
Once inside superannuation you won’t be able to access funds until you meet preservation age. Now I won’t go into detail here about how to access your super, as that is a topic for a new day, but if you were born after 1 July 1964 then your preservation age is 60. There are also some limited circumstances which you could potentially access the money due to financial hardship or compassionate grounds.
Before making a contribution, you should understand how your funds are invested inside super. I always say to people, you should treat your super fund with as much consideration and intent as you do with the funds sitting in your bank account. It is YOUR money for YOUR retirement and therefore you should know the investments and the fee structure within YOUR super.
So you have until 30 June to get your voluntary contributions into super. The contribution is counted in the financial year in which it was processed and allocated by your super fund, not when the money was sent. So keeping this in mind, it is best to send in your final contribution prior to the 15th of June to allow for processing time.
Making the contribution is easy. All you need to do is contact your super fund and ask for banking details. Most super funds will allow you to either BPay the contribution or deposit the money via bank transfer (EFT). There will be a reference number to list in the description which will ensure the funds are allocated into your account.
Once the contribution is in, it is time to fill in a Notice of Intent to claim form which can be found on the ATO website. By completing this form you are letting your super fund know that you intend to claim a tax deduction for the contribution and therefore your super fund will allocate it as a concessional contribution.
Upon processing of the form, your super fund will send you out an acknowledge of the Notice of Intent. If you use an accountant to help with your tax return, they will want to see this before claiming the deduction.
And that’s it! You have successfully made a contribution, had it allocated correctly and are ready to claim a tax deduction. If you do this, you will thanks yourself twice – once when your tax bill shrinks and again in retirement when your super fund is looking juicy.