This is great news – the possibility of retiring and having another 25 years to live ahead of you.
But… do you have enough retirement savings to get by? While superannuation is arguably one of the most important investments you can make, recent changes to the superannuation system have far-reaching policy implications for many. Therefore, it is important to consider tax-efficient strategies outside of superannuation that can be used to bolster your retirement savings.
Since July 1, 2017, major changes to the retirement pension have entered into force. These changes include:
- restrictions on the amounts that can be contributed to the pension scheme, both as concessional and non-concessional contributions;
- a cap of $1.6 million on the pension transfer balance on the total amount of pension an individual can transfer in retirement; and
- the abolition of the tax exemption for retirement.
There are no proposed changes to the current tax position of an investment bond, other than a reduction in the favorable tax rate (from its current rate of 30 percent) in the future.
The limits of super
The superannuation can be a tax-efficient way to save for retirement. The maximum tax payable on the retirement pension is 15%; low compared to the highest marginal personal tax rate of 47% (including the Medicare levy).
However, there are limitations and constraints with super, and you may need complementary investments to supplement it as part of your overall retirement investment strategy.
1. Limited contributions
To contribute to the retirement pension, you must comply with the eligibility rules. Persons under the age of 75 are allowed to claim a tax deduction for personal super contributions. If you are eligible, contribution limits will limit the amount you can contribute to your super fund.
An employer’s contributions, including amounts paid under a wage sacrifice agreement, and contributions for which a personal tax deduction is claimed cannot exceed $25,000 in a fiscal year.
After-tax personal contributions are not taxed on amounts up to the nonconcessional (after-tax personal) contribution limit, which is $100,000 per fiscal year.
Below age 65, you may be able to combine limits for three years to contribute up to $300,000 in a single year. This is subject to the new transfer balance cap of $1.6 million.
The superannuation receives tax relief, but in exchange access to the money is restricted until a ‘release condition’ is met. This usually means that you cannot access your retirement pension until you reach ‘retention age’ and retire.
2. Access Restrictions
If you were born before July 1, 1960, your retention age is 55; it rises to 60 for people born after that date. In some cases, such as permanent disability, early access may be permitted.
An alternative tax-efficient structure, such as an investment bond, can be used to supplement the superannuation and give you access to your savings at a time of your choosing.
How can investment bonds complement super?
An investment bond is a tax efficient structure. Like the superannuation, the tax is paid as part of the investment obligation rather than personally by the investor. The maximum tax paid on income and capital gains from an investment bond is 30%, although franking credits and tax deductions may reduce this effective tax rate. This makes it an attractive investment option for high income earners.
A key feature of investment bonds is that if you hold the investment for 10 years, regardless of the amount invested, you pay no personal tax. Nothing. If the investment is redeemed within the first 10 years, you will pay tax on the taxable portion of the growth. On the other hand, your savings are always at your disposal.
The use of investment bonds to supplement the retirement pension has obvious advantages:
1. Contributions are not limited
There is no limit to the amount you can invest to establish an investment bond. In addition, you can make subsequent investments up to a maximum of 125% of the previous year’s contribution without restarting the 10-year period. You can choose to start a new investment bond if higher amounts need to be invested later.
2. Access Restrictions
Unlike retirement investments, investment bonds are not subject to preservation, so you can access your savings before age 55. This is ideal if you are looking to fund early retirement.
Investment bonds give you the freedom to name anyone as your beneficiary in the event of your death. Beneficiaries are not limited to “dependents”, as is generally required for retirement investments.
Investment bonds offer a tax-efficient way to invest and much more flexibility
Case study – what happens next once pension contributions have been maximized?
Anthony is 45 years old and has invested wisely in the real estate market. He thinks real estate returns have plateaued and sold his downtown investment property, realizing a healthy capital gain. He paid off his mortgage and maximized his concessional and non-concessional contributions in retirement.
Anthony is considering options for investing the excess proceeds of $200,000 in a tax efficient manner. Because he earns a good income and doesn’t need access to his funds, Anthony can adopt a long-term investment horizon of 10+ years.
He initially plans to invest in Australian stocks, either directly or through a managed fund. Franking credits are important to him because they can help him reduce the tax paid, since he is at the top marginal tax rate.
Anthony’s adviser suggests investing in a bullion bond as he can benefit from Australian equity franking credits within the bullion bond. The investment bond pays tax at a maximum rate of 30 percent per annum.
Anthony can also afford to invest additional amounts of $20,000 per year in the investment bond for the first three years; he is unable to direct excess funds to the superannuation without exceeding his contribution limit. In three years, he intends to reduce the contribution he invests to $5,000 per year.
His advisor confirms that he can redeem his investment bond and pay no additional tax after 10 years.
When Anthony turns 55, the investment bond has accumulated to approximately $551,646 (tax paid). This amount is estimated to be $35,763 more than the alternative of investing at his personal marginal tax rate.
Portfolio balance (after tax) over 10 years ($35,763 more than an investment at his personal marginal tax rate)
Provided for illustrative purposes only based on the base income and growth assumptions described above. This illustrative example does not purport to represent the actual possible yield of any of the Centuria investment bonds. An investment is subject to risk, the degree of which depends on the assets in which the bond invests. Assumptions: 8.5% pa total returns (4.5% pa income (80% franked), 4% pa capital growth, 100% annual portfolio turnover, 50% CGT reduction if apply to managed funds).
When considering long-term investments to supplement your super, it is important to ensure that the investment meets your needs, your investment schedule, has the flexibility to deal with unforeseen circumstances and, if possible, that it is tax efficient. Compared to other investments, investment bonds are the ideal vehicle to supplement your retirement savings.
Neil Rogan is Managing Director of Investment Bonds at Centuria Investment Bonds.