Question 1: I am turning 54 this year and work full time. I am planning on slowing down at around 62 and working part time. My question is around superannuation.
I currently work at a university that provides 17 per cent super and my super is divided into defined benefit component and an accumulation component. This confuses me. What is the difference between these two components? What are the tax implications of these two components?
It’s always good to have a plan, and many people are also planning on slowing down in their sixties, going part time or working casually.
Firstly, let’s look at the difference between an accumulation fund and a defined benefit fund.
These days, most people’s super is in what is called an accumulation fund.
These funds are simple: Your employer, and possibly yourself, contributes to the fund. This money is then invested, and your balance is simply the total amount of contributions paid, plus or minus your investment earnings, less contributions and earnings tax of 15 per cent where applicable.
A defined benefit (DB) fund, on the other hand, can be more complex, and only a few of these funds are available today.
In these funds, your balance is unaffected by your investment earnings. Instead, the balance is ‘defined’ by other measures, such as how long you have been a member of the fund, your average salary over the past few years, whether you have worked full time or part time, and how much you contribute to the fund.
Investment earnings generally play no part, and the employer agrees to pay you the balance of the calculation.
UniSuper, to whom I assume you are referring, provide this example for their DB Fund:
- Name: Breanna
- Average salary over the past five years: $50,000
- DB membership: Five years
- Service history: Full time throughout her DB membership
- Age: 40
- Member contributions: 7 per cent throughout her DB membership.
Breanna is 40 years old (lump sum factor = 18 per cent) and has been a DB member for five years (benefit service = 5). She has worked full time since joining (Average Service Fraction = 100 per cent) and her average salary over the past five years is $50,000 (Benefit Salary= $50,000).
Breanna has made default member contributions throughout her DB membership (Average Contribution Factor = 100 per cent).
Breanna’s defined benefit component is:
$50,000 × 5 × 18% × 100% × 100% = $45,000
The key takeaway: The higher your salary, age and member contributions, the higher your end benefit.
Now let’s look at tax.
Most superannuation funds are ‘taxed’ funds. It’s only a handful of government and perhaps corporate funds that are untaxed schemes.
With taxed funds, payments are tax free from age 60.
A few people over the age of 60 have contacted me saying they have had tax deducted: They must must be in untaxed funds, such as SuperSA Triple S, GESB Gold State, CSS/PSS, or older corporate funds.
Although some older super funds are both DB and untaxed, this is rare.
Both UniSuper’s accumulation and DB funds are taxed schemes and no tax will be payable upon exit from age 60.
When contributing to the DB fund, the tax applied is ‘notional’ so it can get fairly complicated.
Question 2: I have a downsizer payment of $230,000 invested in a new super account. I do not take any payment from this. It is purely for our health reserve as we have not paid health insurance for 20 years. If I die first, will my wife or our children have to pay tax when it is drawn out? Will we have to pay tax on it if we draw it out now? I am 77 and my wife is 73. Thanks
Downsizer contributions to super form part of the ‘tax free’ component of super. This also goes for all after-tax ‘non-concessional’ contributions to super.
Whether you take out the funds yourself, or whether they are distributed as part of your estate, the tax-free component is always paid out tax free, regardless of whom the beneficiary is.
However, all earnings within super go to the ‘taxable’ component.
As an example, if your super fund with $230,000 earned 10 per cent – i.e. $23,000 – then 15 per cent earnings tax is applied totalling in $3450 tax paid (ignoring any offsets or discounts that may be applied). Your super fund would then be left with net earnings of $19,550, and your balance would have increased to $249,950.
As you are over the age of 60, you can draw down on your super tax free – from both the tax-free and taxable components. If you were to die before your wife and she was your nominated beneficiary, then she too would receive the funds tax free.
However, if your wife was already dead and/or you left the proceeds of your super to your adult children, or anyone else who was financially not dependant on you, then the taxable component is taxed at 15 per cent plus Medicare.
You do have the option of leaving funds in super, but another option is to commence an income stream with your super.
This would require you to draw down a minimum amount of your balance each year, depending on your age. But this would provide you with two advantages.
Firstly, once funds are moved into a pension, the tax free and taxable components are said to be ‘crystallised’.
This means, for example, that if your super fund has a 90 per cent tax-free component and a 10 per cent taxable component before you draw an income stream, then these percentages will remain fixed once you start a pension. But if kept in super, all your earnings will go to the taxable component.
So, in this example, instead of 100 per cent of all earnings going into the taxed component only 10 per cent would. This could mean a significant reduction in tax once you and your wife pass away, and your beneficiaries may have to pay tax on the taxable component.
Given you have a high tax-free component within your superannuation, this option might be appealing.
The second advantage of taking this path is that in the pension phase, while earnings still get attributed proportionately to their tax-free and taxable components, all earnings are tax free.
If left in super, the earnings would have been taxed at 15 per cent regardless of whether they came from the tax-free or taxable component.
Craig Sankey is a licensed financial adviser and head of Technical Services & Advice Enablement at Industry Fund Services
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