People fortunate enough to accumulate large amounts of superannuation benefits are often confronted with an unpleasant surprise in the form of a large tax bill on their super benefits. In particular, disproportionately high tax liabilities can be generated where a taxpayer receives an eligible termination payment (ETP) containing an “excessive component”. The excessive component refers to that portion of an ETP which exceeds the taxpayer’s reasonable benefit limit (RBL). For 2002-03 the lump sum RBL is set at $562,195 and the pension RBL is $1,124,384.
Broadly, the tax system seeks to only provide concessional tax treatment on super savings considered reasonable to provide an adequate standard of living in retirement. Any amount in excess of a taxpayer’s RBL is therefore taxed at the top marginal rate plus Medicare Levy (which amounts to 48.5 per cent).
Currently, the intricacies of the tax system can result in an ETP that has been paid from a super fund (which has already been taxed on contributions), being subject to an effective tax rate above 48.5 per cent on the excessive component. Further, there has been little in the way of political urgency to correct this anomaly for fear of it being portrayed as a tax break for corporate high flyers. However, it is not just corporate executives that feel the impact of such double taxation anomalies. Increasingly, baby boomers who have been contributing to super over their working lives have also generated retirement savings above the lump sum RBL of $562,195.
Amendments to reduce tax rate
To address these issues, the Government has finally introduced legislation to give effect to its 2001 election promise to make the excessive component of an ETP sourced from a super fund taxable at a rate no higher than a maximum 48.5 per cent. Specifically, the Government’s legislation proposes to tax the post-June 1983 taxed element of an excessive component of an ETP paid from a super fund (which has already been subject to contributions tax) at 38 per cent (plus Medicare Levy) for ETPs made on or after July 1, 2002. The remainder of the excessive component will continue to be taxed at 47 per cent (plus Medicare Levy).
The “post-June 1983 taxed element” of an excessive component is defined as the difference between the amount that would have been the taxed element of the retained amount of the post-June 1983 component of the ETP (if the amount of the excessive component had been nil) and the taxed element of the retained amount of the post-June 1983 component of the ETP.
Although the amendments appear to represent a generous 9 per cent tax reduction for taxpayers with excessive benefits, the actual operation and effect of the measures is a little more complicated, as outlined in the following example from the Explanatory Memorandum accompanying the bill.
Example
Harry receives an ETP from his super fund of $700,000, which consists of a post-June 1983 component of $450,000, (comprising a taxed element of $300,000 and an untaxed element of $150,000), and a pre-July 1983 component of $250,000.
The commissioner makes an RBL determination taking into account Harry’s previous super benefits, and finds that $350,000 of the ETP is excessive.
The commissioner recalculates the components of the ETP. The new taxed element of the post-June 1983 component is $150,000, the new untaxed element of the post-June 1983 component is $75,000, and the new pre-July 1983 component is $125,000. The difference between $300,000 (the taxed element of the post-June 1983 component of the original ETP) and $150,000 (the taxed element of the post-June 1983 component of the ETP recalculated by the Commissioner after the determination of the excessive component), is $150,000. This amount represents the post-June 1983 taxed element of the excessive component and is taxed at 38 per cent plus the Medicare levy.
The remainder of the excessive component (ie. $200,000) is subject to a tax rate of 47 per cent plus the Medicare levy.
As seen from this example, the tax benefit generated from the change results in 50 per cent of the post-June 1983 taxed element (ie. $150,000) being taxed at 38 per cent (plus Medicare levy) instead of 47 per cent (plus Medicare levy) — a tax saving of $13,500.
Surcharge amendments
In addition, the super surcharge legislation will be amended to reduce the impact of the contributions surcharge tax on an ETP paid from a super fund with an excessive component.
Conclusion
Limiting the effective tax rate on the excessive component to 48.5 per cent is a welcome recognition of the unfair operation of the current provisions. Nonetheless, the measures still highlight the potential tax consequences for accumulating excessive benefits. Moreover, people who may generate an excessive component are well-advised to obtain professional advice. In particular, there are several strategies for managing the potential tax implications of an excessive component that can produce significant tax savings. Chief amongst these is to delay the payment of any benefits until the next financial year to gain the benefits of the increase in the RBL from indexation.
— Stuart Jones is a tax writer at Australian Tax Practice. E-mail: Stuart.Jones@Thomson.com.au
