This week’s piece arises from a question I received from Daniel. He wrote:
Quick question that might be good to discuss – there is a significant difference between my Super Balance and my partner (self employed) which will only get bigger over time.
I’m 39 and based on the current situation I will be fairly close to the cap amount at retirement whilst my partner will be sub $100K.
What is the best strategy to even up super balance to limit any restrictions in 20+ years plus maximise tax advantages.
Now I don’t know Daniel’s full situation and a podcast isn’t the place to provide detailed strategy recommendations any how, however his question is an issue that many people face where one member of a couple has significantly more super than the other, so this week I thought we’d explore strategies you could use if this is a problem you face.
Before we kick off, a quick reminder that the information in this podcast is generally nature and the strategies that I mention here may not be suitable for you. When we’re talking about superannuation, in the long run we’re potentially considering very large sums of money, so I would strongly encourage you to seek advice that is specific to your circumstances.
Let’s begin by covering why uneven super balances are an issue at all. I mean for a couple, if one member of the couple dies their super balance will almost always go to their spouse, so uneven balances have no impact in that scenario. And in the event of a separation all assets are considered, and superannuation can quite easily be split as part of a financial settlement, so again, uneven super balances are of no concern on this front.
The issue however, which Daniel alludes to in his question, is that there is a maximum amount that you are able to put into a tax free pension when you retire. Australia’s superannuation system provides some tax concessions whilst you are working and building up your superannuation savings. But the largest benefits within our superannuation system come at the point that you retire and your superannuation benefits are converted into a pension. The maximum amount of superannuation that you can currently get into a tax free pension is $1.7 million. Now that does get adjusted up for inflation, though they only do it in $100,000 increments so the adjustment only occurs every third year or so. This $1.7 million cap is per individual, so a couple could potentially have $3.4 million in tax free superannuation savings if they are able to even out their balances. Without good planning however, rarely is it the case that balances are even. Typically one member of the couple is a higher income earner and therefore receives larger employer contributions. Add to this the potential for one member of the couple to have time out of the workforce to raise children, and the scenario Daniel describes where his wife is likely to have a very low balance, is not at all uncommon.
The scenario that Daniel is wisely trying to avoid then is for them as a couple to have combined super somewhere north of $1.7 million (higher by the time he actually reaches retirement but let’s just use today’s numbers because we know what they are), But most of those savings being in his name, meaning the excess above the cap is not able to be put into a pension at all and must remain in accumulation, continuing to be subject to income and capital gains tax.
So now you appreciate what the issue is let’s consider what strategies could be used to improve this outcome.
The number one tool specifically designed to address this is known as Super Splitting. You can request that your super fund direct your contributions from the previous financial year across to your spouses account. This is all of your employer and other tax deductible contributions. Note that 15% tax is paid when those contributions hit your account, so it is 85% of what was contributed that gets shifted across to your spouse. Super Splitting is by far the most impactful way to even up superannuation balances between a couple and optimise the tax efficiency of your retirement savings.
Next you could consider making additional tax deductible contributions for your spouse. Now this would only make sense if your spouse’s income is higher than $45,000. In the past it was difficult for salary and wage earners to make top-up tax deductible super contributions, with the only avenue being salary sacrifice, which then prohibited lump sums. The rules around these contributions have been greatly relaxed in recent years. Now anyone can make top up contributions whether on a regular monthly basis or as a single lump sum, and claim them as a tax deduction provided their total deductible super contributions do not exceed $27,500 for the year.
An extension of this is the ability to now use prior years unused contribution caps. So for instance if for the last several years your spouse’s super contributions have been $5000 per year, then there is another $22,500 of unused caps per year that you could use to make top up contributions. You can go back up to five years for these unused caps, and you can learn how much unused caps you have available via MyGov.
Now as with tax deductable top-up contributions, these catch-up contributions only make sense where your spouse has taxable income that the deduction can be used against. Keep in mind that these contributions, when they arrive in the super fund, will be taxed at 15%, so if your spouse is paying little or no tax, then contributing to super in this way would be not in their best interests.
Spouse contributions are another mechanism to help even out superannuation balances across couples. The limitation here is that the dollar amount involved, a maximum of $3,000, is too small to have an enormous impact. Nonetheless every bit helps and if done consistently for many years, it will move the dial. Under these provisions, where one member of the couple earns under $40,000, the higher income earning member of the couple would pay $3,000 into their spouses superannuation account and then claim a tax deduction of $540, 18% which is an odd figure and I have no idea where it comes from but that’s what it is. So this is different to a normal tax deductible contribution where the tax deduction is for the person whose account the money has been put into. Under spouse contributions the tax deduction is given to the person making the contribution on behalf of their spouse, so typically the high income earner.
A final strategy that can be used with significant impact is a withdrawal and re-contribution strategy. Now this isn’t feasible until the person with the higher superannuation balance has retired and is over 60 years of age. Once retired and over 60 you have met a condition of release which means you can access your superannuation. At this point the person with the higher superannuation balance could make a lump sum withdrawal from their account and then deposit that money into their spouses account. They would not claim a tax deduction for this. Currently up to $330,000 could be transferred across this way. Not only would such a strategy help to equalise superannuation balances between a couple, but they would also serve to reduce the amount of tax payable by a couple’s beneficiaries assuming they had adult children who will one day inherit any residual savings.
The challenge of superannuation balances being uneven is a common one. Most frequently in a heterosexual couple it is the male with the larger balance and the female with the lower balance, but I’ve seen the same problem with our same sex couple clients as well. Taking steps to even things out not only makes good financial planning sense, it likely makes good relationship sense too. So consider whether you should be developing strategies to even out your superannuation account balance with your spouse.
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