Sunday 18 February 2007

Long Term Tax Planning

Although it's always risky to make long term plans based on the assumption of status quo - especially where tax laws are concerned - the recent changes to the Australian Superannuation rules bring some interesting long term tax planning ideas to mind.

Basically the new Superannuation rules are that any withdrawals (lumpsum or pension payments) from a "tax paid" superannuation fund will be tax free after age 60. One possible side effect of this change will be to make it more tax-efficient to realise capital gains on investments held outside of super once you are retired, over 60, and getting most of your income as an untaxed superannuation pension. The ATO information about the new rules states that "Individuals will not need to include lump sum superannuation benefits and superannuation pensions from a taxed fund made after 30 June 2007 in their tax returns. Superannuation funds will not need to report benefit payments made after 30 June 2007 to the ATO for RBL purposes." Presumably this would mean that such amounts are not taken into consideration when calculating capital gains tax for your personal tax return during retirement.

I'm thinking that I'll be able to live off my tax-free superannuation benefits during retirement, make use of margin lending to offset any non-superannuation investment dividends with tax-deductible margin loan interest, and thus have almost no taxable income during retirement.

This should mean that I could sell off, say, $100,000 worth of my non-superannuation portfolio each year during my retirement and have a fairly low capital gains tax liability each year (as the CGT calculation is based on the normal personal marginal tax rates applied to 50% of the realised gain for assets held more than 12 months).

For example, selling $100,000 worth of my portfolio during a retirement tax year, with say 75% of the amount being a "capital gain" would result in a CGT bill of:
75% realised capital gain = $75,000
50% discount applied = $37,500 taxable CG
tax on $37,500 = $6,600 (using 2007 tax rates)

I'm trying to do a spreadsheet comparison of holding my current non-superannuation geared stock portfolio until retirement and liquidating it during retirement using this technique, vs. liquidating the geared stock portfolio now (and paying considerable capital gains tax due to my taxable salary income) and contributing the after-tax amount into my superannuation account where concessional tax rates would apply to the investments. Regardless of what the modelling tells me is the more tax-efficient plan, putting all my investments inside superannuation may not be a wise choice due to the restrictions on accessing any superannuation investments prior to "retirement age". Although I do have an adequate undeducted, non-preserved amount within my superannuation account that could be withdrawn in an emergency.

I'll let you know if my spreadsheet modelling comes up with any useful insights.


The Bull said...

Will be interesting to see your results.

From similar scenarios I've looked at, on paper holding the geared portfolio in retirement usually wins. However, then there is the other issue of do you really want to be gearing into your retirement?

One big advantage of the new super rules is that lump sum withdrawals from super/pensions after age 60 are also tax free, therefore you can accumulate huge capital gains in there and not realise CGT gains when you liquidate.

If you retire prior to age 60, you can also use those years to liquidate your investments, and make deductible and undeducted contributions to super, lowering tax payable to 15%. said...

I've seen that comment about no CGT in superannuation after 60 before, and I don't think it's correct. Any payment of a lump sum or pension from a super account will be tax free after 60, BUT I think that any "huge capital gains in there" would have CGT paid by the super fund at the fund's 10% CGT rate BEFORE the money could be paid out of the super fund.

The Bull said...

Not if you convert it from super to pension first.

My original comment wasn't entirely correct. If paid out from a pension after age 60, the entire amount is tax free, however, if your funds are still within super and you make a withdrawal, then the 10% CGT applies.

You see, allocated pensions will now have a min pension of a percentage of the balance and max pension of the entire pension.

Therefore, if you have gains you want to realise, convert your super to a pension first and pull it out tax free.