The 1st July 2017 saw significant superannuation changes come into effect, so how are fellow advisers faring?
According to Netwealth’s Head of Technical Keat Chew, these changes were some of the biggest in over a decade, and not only impact clients but also create more arduous work for advisers.
They included the reduced contribution limits and new superannuation rules such as new restrictions placed on amounts that can be transferred into tax-free pensions.
Chew said whilst some of these changes were expected for quite some time, the extent of their impact cannot be underestimated.
“Financial plans and retirement objectives will need to be revised and amended, compounding the already heavy workload advisers have.”
But they also have systemic effects on super. “These changes will also impact the super system and its processes at a macro level, adding costs, which may ultimately be passed on to the end-user,” said Chew. “This all could create an environment of increased costs alongside reduced confidence in a super system that is perceived as forever changing.”
One example of the workload involved is the challenging and time-consuming impact of the CGT relief issues involved with meeting the Transfer Balance Cap, in particular for those with self-managed superannuation funds.
According to Chew, the technical issues were difficult to digest and the outcomes varied due to their dependent nature on unknown future investment performance and uncertain future client decisions.
Combined with the very limited timeframe advisers were given to understand the new rules, their impact and communicate this to clients, and it was essentially a logistical nightmare for advisers.
“Whilst these changes probably had relatively little direct or immediate impact on the client’s hip pocket as the tax impact was on fund earnings rather than the member’s personal tax bill, advisers still copped a lot of work for little reward,” he said.
What does Keat mean by a lot of work for little reward? Chew used a case study to explain. In it, the client is aged 65, retired and has $2 million in an account based pension. He is currently taking the minimum pension payment of $100,000 per annum.
Before 1 July 2017, the earnings of the super fund were all tax-free and the pension to the member was also tax-free in their hands.
Under the new rules, the client can only have $1.6 million in an account-based pension in retirement phase earning tax-free income. With any amount greater than $1.6 million has to either be withdrawn from super or remain in it but be rolled back to accumulation phase and taxed at 15%.
What does the adviser need to do?
The adviser needs to review all investments and decide which assets are to remain in pension or be rolled back to accumulation stage, with many factors to be considered including taking into account any CGT relief that may be available and decide if the relief is beneficial before making any recommendations.
“Advisers need to look at many factors when deciding what to do,” said Chew. “They need to decide which high growth assets will stay in the tax-free pension phase perhaps in order to quarantine possible future capital growth in the tax-free pension. There are also tax implications to consider, such as potential CGT when the assets are sold at a later date after they are moved back to accumulation.”
Whilst there is CGT relief available, which effectively re-sets the purchase price to the date it was transferred back to accumulation, it adds another layer of complications.
On the one hand, while any historical capital gain may be partially or wholly tax free depending on the asset if it is supporting both accumulation and pension or pension only, it also means any future capital gain is based on the difference between the more recent re-set price and the future sale price.
Of course, this difference is an unknown and to what extent the asset, if not 100%, is supporting the pension at the time of the eventual disposal is another unknown, leaving advisers with uncertain variables to try and take into consideration.
Chew said compounding this complex situation is the 12 months, one third CGT discount period is re-set which means advisers need to consider the impact on these assets if they are likely to be sold within the next 12 months.
Although still complex, the considerations are easier to manage with retail style fund. The situation and considerations can get extremely complicated with SMSFs, funds with multiple members, real estate assets and more.
Where does the $20,000 come from?
As it stands, the client was taking the minimum $100,000 per annum to maintain his retirement lifestyle.
However, from 1 July 2017, the minimum is 5% of $1.6m, which is $80,000 per annum. This means the client needs an additional $20,000 per annum.
According to Chew, it could be as simple as increasing the pension withdrawal to $100,000 per annum. However, to achieve optimal planning position, one needs to have a deeper financial thinking into the matter rather than adopting this simple approach.
This is because the Transfer Balance Account (TBA) operates like a bank account with debits and credits. Whilst a debit reduces the TBA, giving you more room under the TBC to transfer more money from the taxable accumulation account to the tax-free pension account, pension payments aren’t debits and don’t reduce your TBA. But commutations of a pension do, meaning it may be better for the client to take $80,000 per annum as a pension as a compulsory minimum and $20,000 per annum as a partial lump sum commutation.
Alternatively, the client can take $80,000 per annum as a minimum pension from the pension account and $20,000 per annum as a lump sum from the accumulation account. This acts to preserve the pension account and run down the accumulation account which is less tax effective.
Regardless of the option selected, the process in its entirety creates a considerable amount of extra work for advisers: from research and analysis, to explaining it to the client through to more complex statement of advices (SoAs) and supporting paperwork.
While advisers are faced with mounting background work, clients don’t see the substantial impact of these changes, as their personal income tax position remains unchanged.
“Pre 1 July 2017 clients had a $100,000 per annum tax free pension, post this it remains the same, leaving their personal tax position unchanged. But how it’s done is different, and can impact on eventual account balances over time if it’s not optimised correctly.
Although clients may not see a present-day impact, advisers need to do the hard yards to analyse the impacts to ensure they are recommending the right strategy to clients for the present and future.
“Whilst clients may do their own research, it’s ultimately the recommendations of advisers they rely on for the financial health,” noted Chew.
For more information, download the Netwealth Technical Guide which provides a concise overview of the recent (and proposed) super changes, looking beyond the concessional and non-concessional contributions changes.