Federal Budget 2020-21: Is super still worthwhile?

As widely publicised, tax cuts formed the basis of this year’s Federal Budget. Apart from confirming some changes they had already announced and changes likely to mainly impact large funds (as outlined here).

But any reduction in personal income taxes does inevitably have an indirect impact on superannuation. Superannuation is most attractive when its relatively low rates of tax on income (0% - 15%) compare favourably to much higher personal income taxes outside superannuation. Hence, what have the most recent tax cuts done to the equation? Do they reduce the tax benefits of superannuation for the people most likely to make salary sacrifice contributions? Do they encourage retirees to leave the superannuation system entirely and withdraw their balances?

The Announced Tax Cuts

In summary the measure brings forward “Stage 2” of the Government’s previously legislated tax changes from 1 July 2022 to 1 July 2020 with some additions (highlighted below):

1. The Low Income Tax Offset (LITO) is to increase from $445 to $700.
2. The top threshold of the 19% tax bracket will increase from $37,000 to $45,000 providing up to $1,080 tax saving.
3. The top threshold of the 32.5% tax bracket will increase from $90,000 to $120,000.
4. The Low and Middle Income Tax Offset (LMITO) of up to $1,080 for individuals or $2,160 for dual income couples will be kept in 2020/21. 

Note that Stage 3 - the abolition of the 37% tax bracket and the reduction of the 32.5% tax bracket to 30% - has been legislated to commence from 2024/25 and has not been brought forward at this stage.

The LMITO is currently a feature of our tax rules but was slated to be removed once the Stage 2 tax cuts were introduced.  By continuing the LMITO and introducing the tax cuts, the Government has instead provided a temporary boost to those earning less than $126,000. This will be wound back once the Stage 3 tax cuts arrive in 3 years’ time and in fact anyone earning between $37,000 - $88,200 will see their personal income tax increase when we move from Stage 2 to Stage 3 if the current program remains in place.

Salary sacrificing

Of course, the decision to make salary sacrifice contributions is more than just a tax issue. Directing salary straight into a super fund rather than receiving it as cash has non-tax benefits such as:

• Forced savings – salary sacrificed contributions generally can’t be accessed until later in life. An individual who salary sacrifices might therefore be better off simply because they save more of their income while someone who doesn’t may simply spend the money now.

• Compound returns on those forced savings.

However, looking purely at the tax differential, we see salary sacrifice will be:

• largely irrelevant for people earning $37,000 - $45,000,

• about the same as it was before the announcements for those whose net income (after the salary sacrifice) is around $45,000 - $90,000 – ie modestly valuable

• not as valuable but still positive for those in the $90,000 - $120,000 bracket, and

• no change at all (still highly valuable) for those earning more than $120,000.

So how valuable is a $5,000 salary sacrifice contribution and how will that change when the Stage 3 tax cuts are introduced?

The table below shows some sample income levels and savings. Note that we have deliberately selected people who are well within a particular tax threshold range – otherwise the size of the salary sacrifice contribution matters as it might take the saver down to a lower marginal tax rate.

The figures below mean (for example) that someone earning a $50,000 pa salary (before salary sacrifice) would save $825 if they made a $5,000 salary sacrifice contribution. This represents 16.5% of the contribution.

(Tax rates include Medicare)

 Some points to take from the analysis:

• While the personal income tax paid by someone earning (say) $50,000 or $80,000 will go down overall in 2020/21 thanks to the budget announcements, this is happening because more of their income is being taxed at 19% (+ Medicare).  Their marginal rate remains the same at 32.5% (+ Medicare).  Since salary sacrifice contributions reduce the tax paid on the last dollars of income, the reduction in personal income taxes has no impact on the benefits of salary sacrifice.
• Notice how the person on $50,000 actually stands to gain a little more from salary sacrificing in 2024/25 when the Stage 3 tax cuts are introduced?  This is because at the moment, reducing their income from $50,000 to $45,000 via salary sacrificing reduces their normal income tax (just applying the marginal rates) on the one hand but also reduces their LMITO.  In 2024/25 there will be no counterbalancing impact of the LMITO.
• The position is different for someone earning $100,000 (before their salary sacrifice contribution).  Under the changes they will see a reduction in their marginal rate of income tax (from 37% to 32.5%, both plus Medicare).  As they pay less tax on their last dollars of income salary sacrifice is worth less to them.  When their marginal tax rate is reduced even further in 2024/25 the benefit will reduce even more. 

Higher income earners will continue to see a tax benefit from salary sacrifice arrangements.

All of this reminds us that the 2020/21 personal income tax cuts don’t, in and of themselves, reduce the tax effectiveness of salary sacrificing.

I’m over 60 – do the tax cuts mean I should just cash my super in and hold the money personally?

This is a question that should always be considered when personal income taxes change – and 2020/21 is no different.  It is definitely a question that should be considered with care, however, as any decision to withdraw superannuation late in life is almost certainly irreversible.

Let’s consider a single person first. In the analysis below we have assumed that the individual has no other assets producing taxable income.  If they do, to make a rough allowance for this, assume that the total portfolio figures shown below include these non superannuation assets.

For a very small portfolio (let’s say $200,000) it is probably obvious that the tax results are at best neutral:

• In most years (ie barring large capital gains etc), the individual will pay no income tax if they invest that money personally, and

• their superannuation fund will pay no income tax if it is held in a retirement phase pension in superannuation.

Since superannuation funds usually result in additional costs, this individual would likely withdraw the balance.

What about a larger portfolio?  For the purposes of this illustration assume:

• the portfolio generates 3% income each year regardless of whether the money is invested in superannuation or personally

• If the balance is in superannuation, it will be in a pension up to $1.6m and any excess is in an accumulation account (in which case the superannuation fund will pay some tax on investment earnings)The table below shows the amount of tax saved in a given year if the portfolio is invested via superannuation.

TAX SAVED EACH YEAR IF THE PORTFOLIO IS IN SUPERANNUATION

There is only a very modest tax saving even at the $800,000 mark.  At this point, the earnings from the portfolio (3% of $800,000 ie $24,000) would result in a small amount of income tax whereas there would be none payable in superannuation.

By the time the portfolio is worth $1.5m, the annual income ($45,000) would result in just under $5,000 in income tax, meaning a superannuation pension would be preferable from a tax perspective.

If we assume that there are additional costs associated with having the portfolio in superannuation, the cutover point (ie the point at which an individual should make sure they keep their money in superannuation) should be the point at which the tax saving is enough to cover this.  If we assume, for example, that the additional costs are approximately $3,000, the portfolio would need to be over $1.2m before the tax saving is worthwhile.

The personal income tax changes don’t make much difference here because the income levels are so low (ie even at $1.3m the income of $39,000 is only slightly impacted by the tax changes announced in the budget).  So while this is an important question to ask, for people near the tipping point (say less than $900,000) it probably hasn’t become any more important due to the budget announcements.

This may come as a surprise – it suggests quite large superannuation balances should be wound up!

But before leaping into a decision, it is vital to note four things:

Firstly, this assumes annual income of 3% of the portfolio.  Even an increase to 4% would see the “neutral” point reducing to $500,000 and savings of over $3,000 at $1m.  An income return of 5% would see savings of over $3,000 coming in at $700,000.

Secondly, this modelling makes no allowance for capital gains.  Let’s imagine assets were sold from a $1m portfolio during a particular year and doing so resulted in a $30,000 capital gain:

• If the portfolio was invested personally, this would add $15,000 to the individual’s taxable income (resulting in more tax) but no additional tax in superannuation.

• The tax saving available if the portfolio had instead been in superannuation would then be closer to $4,800 (increasing further to $5,700 in 2024/25 when the personal income tax for someone earning $45,000 will actually increase due to the removal of the LMITO).

Thirdly, we have assumed no other income producing assets.  Any assets at all would move the tipping point lower.

And finally, forget the Commonwealth Seniors Health Card at your peril.  Remember many clients with pre-2015 account-based pensions have all income from those pensions ignored for the purposes of the income test for this card.  Dissolving their superannuation arrangements (whether in an SMSF or large fund) will mean that future income counts in full.

What about couples? 

Since they have two tax thresholds, it would seem logical that they would need a much higher portfolio to warrant leaving the money in superannuation. Using the same assumptions as outlined earlier but assuming the portfolio is divided between the two (note we have started from a portfolio value of $1m rather than $500,000).

TAX SAVED EACH YEAR IF THE PORTFOLIO IS IN SUPERANNUATION

In this case the tipping point is obviously twice as high. Some important points to note, however:

• The same comments about higher levels of income, capital gains tax and the Commonwealth Seniors Health Card apply

• This only works while both members of a couple are alive.  Should one die, the ability to share two tax thresholds will cease

Again, if the income was closer to 4%, the tax saving for a couple with a portfolio of around $1.4m would be approx. $3,000. This is likely to be more than enough to convince them to leave their wealth in superannuation.

Given that the decision is irreversible, it’s perhaps not surprising that may singles and couples in this position choose to keep their superannuation anyway! The best approach is likely to still include a combination of both superannuation and personal assets.

Importantly, the tax cuts won’t make a significant change to this decision.

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