Superannuation tax concessions aim to decrease reliance on welfare and increase economic independence in retirement. There are three main concessions. They are:
This seems simple enough. And for most people they are a generous set of rules that, if acted on, almost guarantee a comfortable retirement and a significant legacy to the next generation.
When these rules are combined with the height, stability and longevity of a GP’s income, and the fact that most GPs are self -employed, they become an irresistibly powerful wealth creation strategy well beyond what can be achieved by most people. This is because:
Super has existed for almost 30 years. This means there are now doctors who have accumulated more than $7,000,000 in super benefits just by paying the maximum amount to their SMSF every year for the last 25 years, ie from the time we first met, and invest the SMSF in share based index funds.
A simple, low cost, commission free strategy that any GP can implement.
They have not lived frugally. They have enjoyed themselves, put their children through a good education, travelled, socialised and generally had a great time.
At age 60 they are worth about $10,000,000, made up of a home worth $3,000,000 and the SMSF worth $7,000,000. They confess to being surprised at how easy it was. Just pay those super contributions every year, and pay off the home loan as fast as possible.
The $10,000,000 is invested tax-free. Realistically, it will grow by about $800,000 to $900,000 a year from here on. They are still working, and are still contributing the maximum amount every year. They expect to do this for at least another 10 years, and possibly another 15 years, and realistically the SMSF will be worth more than $30,000,000 by then.
The big payoff is peace of mind. They are financially secure, and it’s hard to see what can go wrong from here. The property and share market could both fall 50% and they would still be very well off (while everyone around them is ruined). They do not lose sleep worrying about their financial future. But they often stay up late planning their next overseas holiday.
This peace of mind extends to the next generation too. Each of their children will inherit a significant amount of wealth. Like most parents they do worry about their children. But unlike most parents they do not worry about whether their children will be able to earn a living. That’s not an issue.
This is why we implore every GP we meet to pay the maximum super contributions every year, ideally to a SMSF, and then invest in blue chip shares, property and index funds, with a 20 year time horizon and a “never sell” philosophy.
(Admittedly, a GP with $7 million in super has been able to take advantage of many generous super concessions that are not available today: for example, the old $100,000 contributions cap meant some years they paid $200,000 into super. Its fair to say $10,000,000 over 25 years is a tough target these days. Perhaps $5,000,000 over 30 years is more realistic. But you can see our point.)
Even if you do nothing else, pay the maximum super contributions every year. Just do this and you will end up wealthy. Maybe not super-rich. But certainly happy.
Careful planning over the years, even the decades, leading up to age 60 is the key. GPs should start super planning as soon as possible.
Paying the maximum deductible contributions each year, for both yourself and your spouse, is a good start. Get your super balls rolling as early as you can and make a big effort to pay the maximum deductible contributions whenever possible.
The potential tax savings for deductible contributions depend on the GP’s age (which determines the amount that can be contributed) and marginal tax rate.
From 1 July 2014 the general cap on maximum concessional contribution is $30,000, and $35,000 for those over age 49 on 30 June 2014. The tax saving is shown here:
| Taxable Income | Marginal SMSF Tax Rate* |
Net Tax Saved % |
Tax Savings on cap of $30,000 |
Tax Savings on cap of $35,000 |
|
| $37,001 to $80,000 | 32.5% | 15% | 17.5% | $5,250 | $6,125 |
| $80,000 to $180,000 | 37% | 15% | 22% | $6,600 | $7,700 |
| $180,001 and above | 47% | 15% | 32% | $9,600 | $11,200 |
| * Does not include Medicare Levy or Deficit Reduction Levy | |||||
Many GPs can employ and superannuate a spouse. This means these amounts are doubled.
The ATO accepts that a spouse who is a genuine employee can be superannuated up to the deductible contribution limit. This is so even where the amount is excessive relative to the market value of the work done by the employee spouse.
Special care is needed when the spouse is a director of a company. The ATO requires directors to be general law employees before contributions are deductible to the employer.
To make sure there are no problems we recommend a three-pronged approach:
If this is done there should be no problem in claiming a deduction for contributions paid for a GP’s employee spouse.
Industry funds come from the ACTU accord with the Hawke government in 1983. The idea was simple: the government would legislate for mandatory employee contributions for the previously un-superannuated union members, and the unions would set up super funds to receive these contributions. (And the unions would not go on strike.)
These early union funds were not for profit and adopted a “members first” orientation which manifested in low costs and no commissions. Over time they grew, widened their membership criteria, and became more efficient, but never lost their members first orientation. This is why we recommend industry super funds to GPs who do not have enough super, or the inclination, for a SMSF.
Favourable features of industry funds include:
GPs tend to be members of one of two main health industry funds, being HESTA and Health Super, which merged with fellow industry fund First State in 2011.
HESTA and First State are well regarded and are popular with GPs and their family members. Unless a GP wants to run a SMSF we rarely see any reason to switch out of HESTA or First State and we routinely recommend GPs become or remain members of these funds.
According to the Australian Prudential Authority report on Super fund-level Rates of Return at 30 June 2013 (issued 8 January 2014) industry super funds were the highest earning funds under its jurisdiction. This report can be accessed on www.apra.gov.au. Self-managed super funds were not included in this report.
SMSFs suit most GPs.
Over the last 30 years we have seen SMSF clients record consistently better investment results, experience lower operation costs and enjoy greater control, information and protection compared to both retail super funds and industry super funds.
This is consistent with empirical studies showing SMSFs achieve better investment results and have lower costs than both retail super funds and industry super funds.
Any investment will do better in a SMSF than in some other part of a GPs’ financial structure.
Where the GP faces a marginal tax rate of 37% or 47% (which is virtually every GP) any investment will perform better in a SMSF. This is because:
This advantage is deliberate government policy. The old age pension is being replaced by a system of private pensions. It is a mathematical certainty that an investment in a SMSF will do better than and identical investment in a non-super environment.
A SMSF means you don’t have to wait for months after 30 June each year to find out how your investment is performing (or even what it is invested in). The information is always readily available. Most trustees can access information on virtually a daily basis.
The rapid growth in internet trading is increasing the amount of information. Most e-traders provide free portfolio tracking software, which means clients get immediate reports on the state of their portfolios at any time.
Cheap software packages make it even simpler for SMSFs to run their own investment portfolios with minimum effort and maximum fun.
SMSFs can create synergies with the GP’s other investment and business activities. The SMSF’s investment strategy should be part of an overall investment strategy reflecting the GP’s attitudes and goals. The member’s will and estate planning should be considered as part of this strategy.
For example, it can make sense for a SMSF to only invest in Australian shares if the GP’s family trust is investing heavily in property. The overall portfolio is balanced and diversified, even if the SMSF invests solely in shares.
The 2013 ASX Report says Australian shares averaged 9.8% and Australian property averaged 9.5% in the two decades to December 2012. If a SMSF has a simple buy and hold strategy costs are very low.
It’s hard to see how a managed retail super fund with thousands of members of all ages, from all walks of life and with vastly different financial profiles can be as efficient as a SMSF.
One retail fund cannot be all things to all people. But one SMSF can be all things to one GP and her partner.
In most cases eligible termination payments paid direct to a deceased GP’s dependants are tax-free in the dependant’s hands. This applies to all super funds, not just SMSFs. But as SMSFs are usually controlled by the deceased member’s nearest relatives there is more tax planning potential and certainly more control.
SMSF assets are protected from bankruptcy. This means a trustee in bankruptcy cannot access the benefits and the benefits are held for the member. Benefits paid out during a bankruptcy, say, on the member reaching a specified age, or before bankruptcy may not be protected.
(Keep perspective: few GPs go bankrupt, and we have never seen a GP go bankrupt from running a practice. It’s always bad investing, and abuse of debt.)
SMSF investment income is taxed at 15% and capital gains are taxed at no more than 10%, provided the asset is held for more than 12 months while it is in accumulation phase. This gives SMSFs a significant advantage when it comes to deciding which entity should hold an asset that is expected to increase in value. But the tax benefits get even better once the SMSF starts to pay a pension to members: SMSF investment income becomes tax free.
Remember that capital gains are applied in the year the gain is realized, not in the year the gain accrues. Unrealised capital gains are not taxed. SMSFs allow GPs to eliminate CGT by controlling the timing of asset disposals. This means the realization of gains (and, in many cases, other income) can be deferred to a year when the SMSF pays nil tax, ie when the members are being paid pensions from the SMSF. With planning most capital gains can be derived tax-free using this method.
For example, a forty-year old GP may decide to roll $200,000 of her super benefits from HESTA to a new SMSF, borrow $400,000 and buy a property for $600,000. The $25,000 a year rent covers the interest on the loan. The SMSF will not sell the property until the GP is 60 and the SMSF is in pension mode. The whole of the capital gain from age 40 on will be CGT free. This is so even though most of it accrued while the SMSF was taxable.
SMSFs can be used to obtain retirement benefits for spouses, children and even grand children. SMSFs are a sophisticated method of cross-generational wealth transmission.
SMSFs can choose to only hold investments they believe are ethical. Trustees can structure the SMSFs’ investment strategy so that no unconscionable investments are held, and socially advanced investments are emphasized.
Most GPs with SMSFs simply enjoy managing their own super. They are genuinely interested in investing. They enjoy learning about investment opportunities. They feel safe knowing exactly where their money is at all times and not being exposed to someone else’s bad investment decisions. They know most fund managers do not beat the market and they are
SMSFs do not have to take up a great deal of time. Some GPs get by with just a few hours a year. They only buy quality blue chip shares or other conservative investments, such as index funds, and never sell. This strategy has worked well over the last few decades and has the benefit of lower administration costs since there are fewer transactions to monitor.
Other GPs enjoy spending a few hours a week or in some cases even a few hours a day attending to their SMSF investments. They believe they can add to its performance by paying closer attention and investing. Older GPs who are retired from full time practice are more inclined to do this. With the low cost of e-trading, and the huge amount of information available on the Internet, we are seeing a new class of investor who works his or her SMSF hard to make extra profits.
Whether one method is better than the other is not clear. And it really depends on the ultimate choice of investments. But for many clients spending a few hours on their investments beats playing bowls. As Barbara Smith and Austin Donnelly said in “Do It Yourself Superannuation” under the heading “Psychological Benefits”:
Other benefits enjoyed by some trustee members are the interest and satisfaction from buying shares or property and watching market developments closely, particularly in relation to the share market. This process is an absorbing interest for some people.
Life insurance premiums paid through a SMSF are tax deductible. This can almost halve the cost of the cover and is the cheapest way to arrange insurance. Often the tax benefit of deductible premiums more than covers the cost of running the SMSF.
Any insurance benefits paid will be included in the SMSF’s assessable income. Whether there is a tax charge or not will depend on the fund’s tax profile: the worst case is a tax charge of 15%, and the best case is a tax charge of 0%, which will apply if the SMSF is paying an allocated pension at the time of the member’s death.
Small businesses, including businesses in companies and trusts, can roll over taxable capital gains on the sale of their businesses into their SMSF. This rule acknowledges that businesses are often the main retirement asset for many people. Conditions apply and expert advice should always be obtained whenever a business is sold.
Goodwill values for general practices are quite low, and it’s rare to see a significant roll over.
An exception is a sale to a large corporate for say $500,000. Here the $500,000 is usually received CGT free, due to a combination of CGT exemptions, including an exemption for amounts rolled over to a super fund.
If a business is sold at a capital gain of $500,000 the CGT position will often be like this:
| Capital gain | $500,000 |
| Less 50% exemption | $250,000 |
| – Sub-total | $250,000 |
| Less Active asset exemption | $125,000 |
| – Sub-total | $125,000 |
| Amount rolled over | $125,000 |
| – Amount taxed Reversibility | Nil |
If for any reason a GP decides a SMSF is not for them, it’s the easiest thing to reverse the decision. This can be done by paying an ETP, paying tax, and then reinvesting in a non-super environment or by rolling over to a managed super fund. This reversal is simple and cheap to complete, and the GP has not wasted thousands on entry fees and even more thousands on exit fees!
Other reasons for SMSFs are:
GPs are sometimes concerned that super based strategies mean their money is locked up and unable to be accessed, or at least easily accessed. This is true. Supe rbenefits are generally locked up, or preserved, until normally at least age 55. But this is unlikely to be a problem for GPs. This is because:
It can cost less than $1,000 (plus GST) to set up a SMSF. This includes the trust deed, ATO registration, tax file number application, assistance with bank accounts and assorted other minor tasks connected to setting up the SMSF.
We have seen GPs charged as much as $8,000 to set up a SMSF.
It pays to shop around, and search the internet. Don’t be misled by an adviser saying they have a special quality deed or other document. SMSF documents are amazingly standardised (which is actually a good thing) and virtually all advisers source them from a small group of bulk suppliers, such as www.legaledocs.com.au, which sets up SMSFs for about $100.
In most cases the accountant attends to these matters for the trustees, but technically they are still the responsibility of the trustees. This list is not in chronological order.
Retail super funds market their products through controlled financial planners. These financial planners are usually not allowed to recommend any other type of superfund to their clients and are strongly encouraged to only recommend in-house products.
Retail super funds have high operating and marketing costs and these are passed on to members. This means net investment returns are much less than otherwise.
GPs should generally roll out of retail super funds to industry funds or SMSFs depending on their circumstances and preferences, and recommend GPs do not use retail super funds.
