New rules if you put too much into super

It’s well-known that there are limits on how much can be put into super every year. We call these limits “contribution caps” and the size of the cap depends on the type of contribution.

“Concessional contributions” include things like employer contributions, salary-sacrifice amounts or amounts people contribute themselves for which they claim a tax deduction. The concessional contribution cap increased to $27,500 from $25,000 on July 1, which is a good thing for those wanting to put more into their super fund.

But there’s also a more subtle change that has just been passed by Parliament (for contributions made on or after July 1, 2021) that relates to the consequences of going over the concessional contributions cap.

Until this change, there were three consequences:

• The excess (ie, the amount of the contribution over and above the cap) was retrospectively added to the individual’s personal taxable income for the year in which the contribution was made and taxed like other income, less a special tax offset of 15 per cent. This usually resulted in an extra tax bill being issued to the individual;
• There was a special additional amount to pay called the “excess concessional contributions charge”. Conceptually this was like interest on the extra tax bill; and
• Unless the excess (with some adjustments) was taken out of superannuation, it would count towards the individual’s other contribution cap – the limit on non-concessional contributions. (These are the contributions people make from their own money without claiming a tax deduction.) If this in turn caused the individual to exceed their non-concessional cap, more consequences applied which generally meant the money was taken out of super.

Conceptually the three make sense together. Someone going over the concessional contributions cap is effectively getting too much into super on a very tax-preferred basis.

So the first step was designed to reverse this and make sure the money is taxed just like it would have been if received directly by the individual. The 15 per cent tax offset reflects the fact that the super fund would have already paid tax on this contribution – so taxing it again at full marginal tax rates would be unfair.

The second step was to provide extra incentive not to exceed the cap – by charging interest on the “underpaid tax” (and the interest is calculated in a fairly harsh way).

Finally the third step was designed to ensure that excess concessional contributions didn’t provide a roundabout path to getting more into super than the law allowed. One way or another, it would be limited by a cap.

The change will remove the second step – there will no longer be an excess concessional contributions charge.

To be honest, this doesn’t suddenly make it enormously attractive to exceed the concessional contributions cap. There is certainly no real tax incentive to do so (the first step takes care of that). And it won’t allow a whole lot more money into super that wouldn’t otherwise be possible (the third step takes care of that). It just removes an extra sting in the tail for people who do it by accident.

It does mean there’s an opportunity to use excess concessional contributions as a mechanism to delay paying tax but I suspect this is more theoretical than practical.

For example, imagine Ivy who is normally on the highest personal tax rate (45 per cent + Medicare levy of 2 per cent). She deliberately asks her employer to salary-sacrifice $50,000 extra (over and above her concessional contributions cap) into super. That means she initially avoids the personal income tax on this amount ($23,500) and the super fund pays tax at only 15 per cent ($7,500) – an apparent saving of $16,000. After a while (but possibly not for a year or two after she made the contribution), she will receive the extra tax bill for $16,000. The fact that she won’t also be charged interest on this $16,000 means she has had a benefit of sorts – she has managed to hold on to an extra $16,000 until the ATO caught up with her. But it’s unlikely to be an enormous benefit.

One particular word of warning on these excess contributions is that when the ATO first flags that one has arisen, it will make it clear that the money can be refunded from super (rather than being left in the fund and counting towards the non-concessional contributions cap). In the example here, Ivy would be invited to have up to $42,500 refunded (the $50,000 excess contribution less the 15 per cent tax that will have already been paid by the super fund).

It is almost always beneficial to take the refund option. Some people will need it to pay the extra tax bill!

But even if this isn’t the case, there are downsides to just leaving the money in super. In this example, it would mean that the whole $50,000 would count towards Ivy’s $110,000 non-concessional contributions cap. This is despite the fact that only $42,500 of it is left in the fund (after the 15 per cent tax paid by the super fund) and even more tax will have been paid by Ivy personally. The whole $42,500 (plus earnings) will also be part of her super that is taxed if it is taken out before she turns 60 or if it is inherited by someone who is not a dependant – such as an adult child.

By contrast, refunding the $42,500 out of super and then putting it back in as a non-concessional contribution gets a completely different result. Ivy only uses up $42,500 of her cap and it goes into the “tax-free” bucket in her super – so it can come out tax-free when she is eligible to draw on it no matter who ultimately receives it or how old she is.

This article was first published in the Australian Financial Review 7th July 2021.