31 May 2010

End of year financial planning strategies
With Mark Allara, Director - Financial Advisory, Vincents Chartered Accountants

It's that time of year again!  With only a month to go before 30 June, now is the time to review your financial position and planning for the new year. The following tips can be useful as you consider your year end financial planning strategies.

Superannuation Contributions
Maximising your superannuation position is a fundamental strategy to ensuring a better position for retirement.  However, since the halving of contribution limits from 1 July 2009, many individuals have had to curtail their original plans so they do not exceed contribution limits and incur excess penalty tax.

The reform to income tests from 1 July 2009 and what counts as 'income' has also affected many popular superannuation strategies, particularly self employed contributions and co-contribution.

Let's review the key superannuation strategies for 2009/10 financial year.

Salary sacrifice strategy - stay under the concessional limit and avoid the 31.5% tax
Salary sacrificing can be an effective strategy for boosting your long term retirement savings and for the tax savings it can provide. This is because you are foregoing taxable salary by contributing this amount into super instead. However, the tax savings can be a waste if you then incur excess penalty tax by exceeding the concessional contribution limit.

Therefore, the key here is to be aware of how much you can contribute to super for the year. If you are under 50 years of age, this financial year your concessional contribution limit is now $25,000 pa.  If you are over 50, or turning 50 this financial year, your concessional limit is now $50,000 pa.

The limit counts all taxable contributions, so this means employer SG contributions as well as your salary sacrificed amount. When planning your strategy, deduct what SG contribution amounts your employer will make on your behalf this year from your concessional contribution limit. Base your salary sacrifice strategy on the balance remaining. If you exceed your concessional contribution limit, any excessive amount will attract 31.5% tax.

Consider also whether your salary is likely to increase, or whether you are due any bonuses, prior to financial year end. You may need to adjust the amount you are currently sacrificing from your salary so that your total contributions (SG and salary sacrifice) are within the limit.

Tip: The arrangement must be for salary not yet earned. You cannot sacrifice salary that has already been accrued or received. This includes annual leave and long service leave.

Self employed contributions strategy - changes to the income test
Eligible self employed persons and substantially self-employed persons (including individuals under 65 years of age and not working) can make personal contributions to superannuation and claim 100% tax deduction for the contribution. 

Unfortunately, due to the reforms to the income test, a person who considers themselves 'substantially self-employed' can no longer use the salary sacrifice strategy to reduce their employment income to meet eligibility conditions for personal tax deductible contributions. This is because all income is now counted, so any salary sacrificed amounts must be added back to calculations to determine whether a person meets the 10% test. 

Read more information about Self employed contributions strategy.

Tip: You can only claim an amount that reduces your tax liability to zero, regardless of how much you contribute to super.  If you try to claim a greater amount the ATO will reject the tax deduction. Speak to your accountant to make sure you qualify as a substantially self-employed person in the first instance, then make sure you claim only what is allowable.

Government co-contribution strategy - at least $1000 available
Employees and self employed individuals earning less than $31,920 this financial year may be eligible for the full government co-contribution payment of $1,000 if a personal (after tax) contribution of at least $1,000 is made into superannuation. If you earn more than $31,920 but less than $61,920 this financial year you could still be eligible for a pro rata amount.

Tip: As with self-employed eligibility, the income test for co-contribution eligibility has changed from 1 July 2009. Speak to us to determine your position.

Spouse super contributions strategy - contribute & claim

Does your spouse earn less than $10,800 or no more than $13,800 each year? If yes, you could make a superannuation contribution on behalf of your spouse and claim a tax rebate of up to $540.

Tip: Contributions for which the spouse rebate is claimed will not be eligible for the Govt Co-contribution payment. Speak to us about what contribution strategy would provide the best outcome for you and your spouse.

Superannuation pension benefits - account-based pension strategy

If you are considering retiring this year and will be transferring your accumulated super to the pension phase, you can establish your pension fund after 1 June and defer payments until after 1 July. This is a useful strategy if you don't need the income until after the new financial year.

You can nominate how much you want to be paid and how regularly you want your payments (i.e. monthly, quarterly, half-yearly or yearly) - as long as you receive at least the stated minimum amount according to your age for that year.

Pension income from superannuation paid to individuals over 60 years of age is tax free (non-assessable for tax purposes). The tax free status of your pension payment is based on your age when you receive payments, not when the pension commenced. If you are turning 60 during the year, if cash flow permits, you can choose to defer any pension payments for the year until after you turn 60 thus ensuring tax free payments.

Tip: The Government has announced a 50% pension relief on the minimum payment for individuals in receipt of a superannuation pension this financial year. Speak to us if you would like to take advantage of this relief.

Superannuation pension benefits - transition to retirement strategy

If you are over age 55 (or preservation age) and still working, you can access your super benefits as a non-commutable income stream - referred to as a "Transition to Retirement" pension (TTR pension). No work test applies, so there is no need to reduce your work hours. The operation of the TTR pension follows the same rules as a normal account-based pension, except there is a restriction on how much you can take in total payments for the year. The maximum limit for the year is 10% of the purchase price.

A popular strategy used by many is a combination of a TTR pension and salary sacrifice. This can be an effective way of boosting retirement wealth as well as minimising income tax but remember to consider contribution limits (as discussed above).  Speak to your advisor first if you are considering a TTR pension to make sure it is an appropriate strategy for you.

Tip: Lump sum withdrawals are not allowed from a TTR pension. However, unlike the 4% minimum pension requirement, the 10% maximum limit is not pro-rated if the TTR pension is commenced after 1 July. Payments can be made as a one-off annual payment if desired. This means you can commence a TTR pension, say, on 1 May and still take a pension payment up to the maximum 10% limit prior to 30 June. 

Self managed super funds (SMSFs) - deductible expenses

If you are managing your own SMSF, be aware of what your super fund can claim as a deduction e.g. ongoing portfolio management fees, ongoing accounting/administration fees and ATO/APRA lodgement fees.

If you purchase insurance via your SMSF, the insurance premiums may be deductible to the fund. This is in contrast to purchasing insurance directly (i.e. the individual is the policy owner). Insurance premiums are not generally deductible to the individual, unless it is income protection insurance.

Investment Strategy
It is also a good time to review your investment strategy, given the past year has seen a recovery in investment markets. Review your asset allocation benchmarks. Are they in line with your fund's investment strategy? Start thinking about your income levels for 2010/11 if you are currently drawing a pension. Do you have sufficient liquidity to cover pension liabilities?

Small Business CGT Concessions and Super

Changes in the small business definition means more small businesses could qualify for the CGT concessions.  It is worthwhile, therefore, for you to investigate with your accountant whether you are eligible for one of these concessions this financial year.

Tip: You can use one of two 'small business' tests to meet the definition - either aggregated turnover per annum of less than $2 million OR $6 million maximum net asset value of business and associated entities.

Investment Planning Strategies
Key investment planning strategies for 2009/10 financial year are discussed below.

Franking Credits
Investing in listed shares that pay 100% franked dividends is an effective income strategy used by many people, particularly those on a low marginal tax rate e.g. retirees and self managed super funds.  The grossed-up value of franking credits provides a more tax-effective return than normal bank interest rates.  Any excess franking credits are refunded to the investor.  For SMSFs, this is a good 'top up' for account balances.

The following table highlights the grossed-up effect of various dividend yields, as well as the equivalent after tax yield based on flat 15%, 30% and 45% tax rates.

(Assumes $10,000 investment)

Private Companies and Trusts
The key issues this year for those involved with private companies relate to the Division 7A rules.  The first entails changes to legislation relating to the use of company assets by shareholders, their family members and associated entities such as trusts.  The second involves a draft ATO ruling that looks at treating withheld trust income as a loan back to the trust.  This will apply where the income has been allocated to beneficiaries, but no actual distribution has been paid.

Tip: Seek specialist tax advice from your accountant / registered tax agent if you would like more information on whether these two issues are relevant to you.

Capital Gains and Losses
It is a good idea to review your investment portfolio prior to 30 June as you may want to clean out any "dead wood" in your portfolio.  Or you may want to use this opportunity to rebalance your portfolio so that it is more aligned with your objectives for investing.  Losses can be carried forward (including from previous years); however, gains must be declared in year-end returns for the financial year the gain was made.  You may be eligible for a discount on any assessable capital gains if you have held the asset for more than 12 months.  Should you wish to take such action, please contact Mark Allara and we will be able to assist.

Tip: You must deduct capital losses from capital gains before you apply the 50% discount on any remaining capital gains. 

Share Purchase Plans and Rights Issues
Have you participated in share purchase plans this year as part of capital-raising strategies offered by listed companies?  If you have purchased additional shares as a result, make sure you retain your records for cost base purposes.  You will need this information should you decide to sell the shares in the future.

Prepaying investment Expenses
Interest on an investment loan is generally tax deductible.  Pre-paying interest before 30 June, for the next 12 months, is a popular strategy - particularly for high income earners - as the total interest can be claimed prior to financial year end.  This is also a good strategy for those investors planning their cash flow for the next year.

If you are using a borrowing strategy make sure you have also considered your earnings capacity.  Loans must be repaid regardless of your earnings position so taking out income protection insurance is a must.  This ensures that in the event you lose the capacity to earn income through illness your debt can still be managed. Premiums payable for income protection insurance are tax deductible to the policy owner so it becomes an effective way to insure your earnings.

Tip: Pre-payment of interest is not obligatory.  Some investors may not have available funds to make a large lump sum payment prior to 30 June. You may also be more comfortable repaying interest on a regular basis throughout the year.

Protected Equity Loans (or Capital Protected Loans)
Capital protected loans involve an interest cost and a cost to protect against the devaluation in a portfolio of assets (usually shares). Interest costs are deductible; however, the “capital protection” component of the loan cost is not deductible.
 
The variable home loan benchmark rate set by the Reserve Bank of Australia determines the deductible component on protected equity loans.  Fortunately for investors, rates have been increasing since October 2009. This is good news for individuals with capital protected loans, in particular, as more of their loan repayment will be considered deductible interest and less of the loan repayment will be considered part of the capital component. 

Tip: Your loan provider should be able to supply you with the breakdown between interest and capital component in relation to your loan product.  Make sure you only claim what is allowable.  Speak to your accountant / tax agent for guidance.

Family (or Discretionary) Trusts
Family trusts provide an opportunity to split income and/or capital between family members, particularly those who earn little or no income.

If you have a family trust make sure you review the trust's investments and potential franking credits. This becomes essential if the trust holds more than $5,000 in franking credits (about $15,000 in dividend income), or if the trust holds capital losses.  If a family trust election is not made at that point the franking credits may be lost. 

Note for future: Family trusts have also been included in proposed legislation in relation to Tax File Number (TFN) withholding arrangements.  It is proposed that where assessable distributions are paid to beneficiaries who have failed to quote their TFN to the trustee of the trust prior to the trustee making the distribution, the trustee must withhold amounts from the assessable distribution.  This proposed legislation is expected to take effect from 1 July 2010.

Tip: The 'Low Income Tax Offset' increased to $1,350 (from $1,200) for the 2009/10 financial year.  This means more income can be distributed to minors before tax becomes payable.  Speak to your accountant / tax agent on how you should best structure distributions from your family trust to beneficiaries.

Salary Packaging (non-super)
Another popular strategy available to many individuals is to maximise tax benefits for the next financial year through salary packaging.  For example, you may be able to sacrifice a new car or your home loan* if eligible.  The new Fringe Benefits Tax (FBT) year commences 1st April for most businesses so consider an arrangement sooner rather than later with your employer (if employer provisions allow) if this strategy interests you.

Tip: *If you are a Government Health employee there are substantial packaging benefits available to you.  Speak to us for more information.

IMPORTANT NOTE: The above tax planning strategies should only be considered as a part of your overall wealth management and/or retirement planning. It is very important you seek further advice on any tax consequences these or other strategies may have on your personal circumstances from a registered tax agent or your accountant at Vincents.