Subject to strict legally enforceable rules and sanctions, a self-managed superannuation fund provides a facility that is assisted by tax concessions to accumulate wealth which is locked away for retirement or death.  There are tax concessions that apply in three main ways.  A complying self-managed superannuation fund will generally pay tax at the special rate of 15%.  Secondly, tax concessions are awarded to contributors in that they are entitled to limited tax deductions for their contributions.  Thirdly, when the superannuation benefits are paid they are taxed concessionally or may even be exempt from tax.  

You are rewarded for the contributions that you make to the self-managed superannuation fund by the provision of a capped tax deduction.  The funds may not be accessed so that it is a form of forced saving.  Subject to some exceptions, the savings cannot be accessed until after 60 years of age and upon retirement.  But as from 1 July 2007 under the current superannuation regime, most lump sums and income streams paid from a complying self-managed fund will be tax free if the recipient is 60 years of age or more.  The tax concessions enable accumulation at a faster rate than other investment entities because there is a compounding effect that is achieved with the low tax applicable to earnings on investments by the superannuation fund.  It is a tax shelter.  The tax concessions have been provided as a matter of government policy to individuals so that they will provide for their retirement and so it has the effect of moving a significant part of the population from reliance on the old age pension by self-funding a pension and so relieving the government of that burden.

A self-managed superannuation fund is relatively cheap to establish.  It tends to be cost efficient if there is at least $300,000 to $400,000 in the fund.  The annual costs of both audit and accounting need to be factored into the cost benefit analysis.  

It is because the tax concessions have been so favourable and do tend to favour high income earners that the tax concessions available to self-managed superannuation funds have been the subject of constant annual changes, periodical re-writes of the entire superannuation regime and political debate.  More recently, the Australian Labour Party has indicated that if it is elected to government it will remove the tax concessions for some parts of the population. It proposes to amend the tax law so that income over $75,000 from a retiree's superannuation fund balance will be taxed at 15% rather than the current zero rating.  This would cover approximately 60,000 superannuation accounts with balances over $1.5 million.  Secondly, the Australian Labour Party proposes that the tax on concessional contributions would rise from 15% to 30% for member contributors earning $250,000 or more (which is down from the current $300,000 threshold).  So what is all the fuss about, and if it so good, is a self-managed superannuation fund something that you should be using?

What are the taxation benefits?

The current superannuation regime commenced after substantial reform on 1 July 2007.  The rules remain complex and it is important to take advice because the stakes are high if you get it wrong.  Let us begin by looking at the taxation of superannuation entities.  

What are the tax rates that apply to self-managed superannuation funds?

If the self-managed superannuation fund is a complying fund, then it will pay tax at 15% on the low tax component comprising income, including realised capital gains and assessable contributions.  But that rate will increase to 47% in respect of all non-arms length income.  On the other hand, if the superannuation fund is a non-complying self-managed superannuation fund, then it will be taxed at 47%.  

Where the self-managed superannuation fund is in retirement phase and is paying a current pension or is in the transition to retirement phase, then complying self-managed superannuation funds are exempt from tax on so much of their income as is derived from assets used to pay current pensions.  The exemption only applies to income earned once the pension has become payable.  The exemption does not apply to assessable contributions or to non-arms length income of the fund.  

Capital Gains Tax:

Special rules govern the way in which the Capital Gains Tax rules apply to self-managed superannuation funds.  A complying self-managed superannuation fund is entitled to a one third discount on the capital gain if the Capital Gains Tax asset has been held for at least 12 months.  If the Capital Gains Tax asset was acquired before 21 September 1999 and held for at least 12 months, then the self-managed superannuation fund can choose to use either the one third discount or the indexation method to calculate the amount of the Capital Gain.  

The Taxation of Superannuation Benefits

The taxation breaks do not end there and in fact you must examine the taxation of superannuation benefits provided by a self-managed superannuation fund.  The tax liability will depend upon the age of the recipient and whether the benefit is provided by way of a lump sum or an income stream.

For recipients who are 60 years and over, a lump sum and an income stream from a taxed source within the superannuation fund will be treated as not assessable and not exempt.  

If the age of the recipient is between the preservation age and age 59 years and the superannuation benefit is paid from a taxed source in the fund, then there will be no tax on the amount below the sum of $185,000 for the 2014 to 2015 income year but it will be taxed at a maximum rate of 15% on an amount over that threshold where the amount is paid as a lump sum.  Where the amount is paid as an income stream, then it will be taxed at marginal rates eligible for a 15% tax offset.  The tax offset can eliminate the tax that would otherwise be payable.  

If the recipient is under the preservation age, then a lump sum from a taxed source will be taxed at a maximum rate of 20% and the income stream from a taxed source will be taxed at marginal rates with no tax offset applying. 

Where the superannuation benefits are paid from an untaxed source within the superannuation fund to a recipient of 60 years and over, then the lump sum is taxed at a maximum rate of 15% on an amount up to the sum of $1.355 million and taxed at 45% on an amount over that threshold sum.  Where the benefit is paid as an income stream from an untaxed source to a recipient of 60 years and over, then it will be taxed at marginal rates but eligible for a 10% tax offset. 

Where the superannuation benefit is paid from an untaxed source to a recipient who is between the preservation age and 59 years of age, then if paid as a lump sum, it will be taxed at a maximum rate of 15% on an amount up to $1.355 million, taxed at a maximum rate of 30% on an amount above that threshold amount up to the low rate cap amount of $185,000 and taxed at 45% on an amount over the untaxed plan cap amount of $185,000.  These figures apply for the 2014-2015 income year.  If the superannuation benefit paid from an untaxed source to a recipient between the preservation age and 59 years of age, then the income stream will be taxed at marginal rates with no tax offset.  

Where the superannuation benefit paid from an untaxed source is paid to a recipient under the preservation age, then if it is paid as a lump sum, it will be taxed at a maximum rate of 30% on an amount up to the untaxed plan cap of $1.355 million for the 2014-2015 year and taxed at 45% on an amount over the untaxed plan cap of $185,000 for the 2014-2015 year.  If the superannuation benefit from an untaxed source is paid to a recipient under the preservation age, by way of an income stream, then it will be taxed at marginal rates with no tax offset. 

Example

By way of simple example, assume that Bob and Barbara have their own self-managed superannuation fund.  Bob is aged 64 years of age when he retires and takes a $950,000 superannuation lump sum benefit from the self-managed superannuation fund.  Assume that, the lump sum benefit is paid from an element that is taxed in the fund.  All of the $950,000 is non-assessable, non-exempt income.  Barbara who is aged 59 receives an income stream benefit of $50,000 from the self-managed superannuation fund which is made up of a $10,000 tax free component and a $40,000 taxable component.  On the basis that Barbara has no other income, then the $10,000 tax free component is non-assessable, non-exempt income while the $40,000 taxable component will be included in Barbara's assessable income and taxed at ordinary rates.  Assume that for the relevant year, the tax liability on that sum is $5,000, then because Barbara is entitled to a non-refundable tax offset of 15% of the $40,000 taxable component, that is, $6,000, Barbara's tax liability is reduced by the tax offset to nil. 

Insurance through a self-managed superannuation fund

Apart from the somewhat complicated taxation benefits that apply to members, insurance through a self-managed superannuation fund does offer some advantages in that the payment of insurance premiums by a self-managed superannuation for death and disability cover for its members are tax deductible expenses.  Those premiums would not be deductible if paid by an individual taxpayer.  In that way, a self-managed superannuation fund can be a tax efficient means of providing insurance.  However, the fund will be depleted if the fund is used to pay insurance premiums.  There will be an advantage where insurance cover or the insured sum is greater than the amount of the superannuation fund held on the premature death or disability of the member especially where the amount that has been accumulated by the member is relatively modest. 

Conclusion

While the area of superannuation is heavily regulated and the taxation rules that apply to superannuation funds are complex, the tax concessions that are provided mean that a complying self-managed superannuation fund is an effective tax shelter that enables the fund invested to compound and increase in value at a much faster rate than other investment entities.  Then, when the superannuation benefits are paid from a complying self-managed superannuation fund to a suitably qualified recipient further tax concessions are conferred so that in many cases the receipt may be tax free.