New Contribution Rules – Detailed Case Study

James Smith is 45 and works in the mines earning $150,000 per annum with a 39%marginal tax rate. He has a SMSF and annually contributes $25,000 into his superannuation fund. To reduce tax he has built a residential property portfolio using negative gearing but wants to diversify his portfolio and acquire a portfolio of shares. Following the introduction of the ECT, James has been advised to make $30,000 of additional concessional contributions using salary sacrifice into his fund to acquire a portfolio of bank shares paying 6% fully franked dividend.

James tax and cash flow position is as follows:

Super Fund

Item  Amount   Assessable Tax 
Shares Acquired with Salary Sacrifice  $55,000  $55,000  $8,250
 Dividend  $3,300  $4,714  ($707)
 Total  $58,300  $59,714  $7,453

James Tax: James has made an additional $30,000 excess concessional contribution, which is to be taxed at 23.5% - the difference between his marginal tax rate and the 15% tax offset. James excess concessional contributions tax bill is -$30,000 x 23.5% = $7,050 which will include an ECCC for the fact that this will not be payable for some months and that James has this money in the fund for use over that time as opposed to PAYG. So all in all, James and the Trustee of the Fund will have to pay $14,503 of taxes on his $55,000 concessional contribution. Importantly these will have to be funded from future contributions, current year and next year dividends and use of franking credits or disposal of part of the share portfolio.In contrast if James invested in the same shares outside of super then there is instant pain courtesy of the PAYG laws:

Outside of Super

Item  Amount  Assessable  Tax 
 Salary  $55,000  $55,000  $21,175
 Shares Acquired  $33,825    
 Dividend  $2,029  $2,898  $203
 Total  $35,854  $59,714  $21,278

So what is going on here – it looks a nightmare to invest outside of super! Let's seethe ups and downs of the strategy:

The Good
First and foremost the salary sacrifice contribution into the fund means James has all$55,000 to put into the market. This could be significantly increased if James went into a leveraged investment such as instalment warrants but at the end of the day –leverage has its own risk/reward profile (remember the GFC). In comparison if James takes his salary then the PAYG tax deducted upfront is $21,175 leaving a lot lesser amount to invest in the market as well as a lot smaller dividend payment. Although in this case taxes are paid up front so he does not have to worry about future cash flows.Secondly the difference in the value of imputation credits to the fund – at a 15% tax rate versus James $37% tax rate is just over $900 per annum. And these will continue into the future year on year until he sells the shares.Thirdly the $25,000 invested by way of salary sacrifice is not subject to excess concessional contributions taxes as they are under the cap, which leads to another important strategy – use it or lose it. This is a real benefit as PAYG on the $25,000 takes a big chunk out of investing capital.Finally and the most important strategy is that investing in tax preferred investments can make a significant on-going difference to remaining in cash – engage, invest and build is the motto!

The Bad
The payment of the Trustee's tax and James excess concessional contributions taxes at his marginal tax rate plus the Shortfall Interest Component needs to be cash flowed into James on-going tax planning strategy. In addition the $25,000 contributed annually under the concessional contributions cap threshold is a concessional contribution in the fund rather than a non-concessional contribution.Finally the big one for most Generation X and Gen Y members is that once you put your money into super you will not be able to touch it until age 60 at the very least –unless disabled or dead, hardly inspiring circumstances to get super.

The End Result
The James Smith example is a simple one but means that from 1 July 2013 it is a whole new ball game in terms of making salary sacrifice or concessional contributions and one which brings a new round of investing in shares or managed funds and property via an LRBA.!