Superannuation contributions, whether paid by your employer or out of your own hip pocket, are the foundation on which Australians build their retirement wealth.
But when contributing to super, you need to tread a fine line in order to get the balance right: put in too little and you could find yourself spending your golden years in a less than ideal situation; put in too much and the amount could be taxed into non-existence – almost.
There are a number of different factors to think about when putting money into super. There are before- and after-tax contributions, cap limits, age restrictions and strategies like the “bring forward rule”, which allows you to lump three years’ worth of contributions together.
To encourage us to save for our own retirement, the Australian Government has made superannuation a tax-friendly place to store and grow savings. The amount of tax we pay depends on how the contribution is made and whether it falls within the contributions cap.
Concessional contributions (or before-tax contributions) include the compulsory 9 per cent Super Guarantee paid by employers, as well as salary sacrifice and contributions made by the self-employed (for which a tax deduction is claimed).
Put simply, this money enters the superannuation system before it has been taxed. Concessional contributions are taxed at 15 per cent in the fund and are capped at A$25,000 a year. If the cap is exceeded, the excess contributions are taxed an additional 31.5 per cent, meaning you are effectively paying 46.5 per cent tax (unless you qualify as a high-income earner and have exceeded the cap out of no fault of your own).
This means it's important to make sure that if you plan to salary sacrifice into super, you calculate the sum of your Super Guarantee and the salary sacrifice amount.
Many people use salary sacrifice not only to boost their super while enjoying the reduced tax rate, but also to potentially reduce their income tax as well. This is because “sacrificing” some of your pay straight into super reduces your taxable income and, in some cases, may cause your taxable income to fall within a lower tax bracket.
There is another way to inject money into super and this is via non-concessional contributions (or after-tax contributions). This is your normal take-home pay that has already had the pay-as-you-go (PAYG) withholding tax removed at a rate consistent with your tax bracket.
Since you have already paid tax on this money, it is not taxed again when you contribute it to super. You are eligible to make non-concessional contributions of up to A$150,000 a year, but if you exceed this limit, the excess funds are taxed at 46.5 per cent.
Concessional contributions (before-tax) A$25,000
Non-concessional contributions (after-tax) A$150,000
It is possible to pay up to 93 per cent tax on excess contributions. This can occur if you’ve broken both your caps. Any amount over your concessional cap is then counted towards your non-concessional cap, after it has been hit with the penalty tax, of course. If you then also break your non-concessional cap, this excess amount will be taxed at that penalty rate as well; that is, 46.5% + 46.5% = 93%!
So, you can see it makes no financial sense whatsoever to exceed your caps, unless you are using the “bring forward rule”.
The bring forward rule
This rule allows you to contribute three years' worth of non-concessional super contributions in one year, meaning you can put up to A$450,000 into your super (based on the non-concessional contribution limit, so A$150,000 + A$150,000 + A$150,000 = A$450,000). This rule is automatically triggered when you contribute more than A$150,000 in a financial year. After this, you will need to make sure you don't breach the A$450,000 level within that three-year space or you will be hit with a penalty rate of tax on the excess.
The bring forward rule is useful for people who may be receiving a large sum of money, such as an inheritance, because it allows you to get it into the super system faster. To access the bring forward rule, you must be under 65.
How age affects contributions
If you are over the age of 50, it is important to recognise that the cap rules changed on 1 July 2012. The government had provided a window whereby you could put in up to A$50,000 in concessional contributions. This window of opportunity has now closed and the limit is back at A$25,000.
The contributions rules start to change slightly once you reach age 65. Between ages 65-74, you can continue to contribute to super as long as you meet the “work test”. This test is not hard to pass. It requires you to have been "gainfully" employed (that is, you have been paid for your services, ruling out volunteer work) for 40 hours in the space of any 30-day period in the relevant financial year.
Once you hit 75, you can no longer contribute to super; the idea being that you start to use your retirement benefits. This rule will change in 2013-14 to allow those who are still employed to receive the Super Guarantee.
Your spouse's super
If you contribute super on behalf of your spouse, there are also some age limits of which you need to be aware.
There are two ways you can contribute to your spouse's super: spouse contributions and super splitting. Spouse contributions are after-tax contributions that can be used to boost your partner’s retirement income and potentially generate a tax offset of up to A$540 for the contributing spouse. These are considered to be non-concessional contributions and count against your spouse’s non-concessional cap. Your spouse must be under 65, or between 65 and 70 years of age, and satisfy the work test. If your spouse is over 70 years old, you cannot make a spouse contribution.
The maximum tax offset of A$540 is available if your spouse’s assessable income plus reportable fringe benefits is less than A$13,800, and you contribute A$3000 or more.
Super splitting is when you share your concessional contributions with your spouse. Your spouse must be below preservation age (which for most people is under 55 years), or between preservation age and 64 and not permanently retired. If your spouse is over 65, you cannot split your concessional contributions.
The maximum amount that can be split is A$21,250, which is 85 per cent of the concessional contribution cap (that is, A$25,000 less 15% tax = A$21,250). You can elect to split concessional contributions after the end of the financial year when the 15 per cent tax has paid.
Superannuation funds are not obliged to offer contribution splitting, so it may pay to check with your fund before contemplating this strategy.
Alia McMullen is former economics reporter at the Financial Post.