This cap is too small for my retirement can I have another that fits?

There are some of the more famous (paraphrased!) quotes from history, “Hitler’s a pretty cool dude, I doubt we’ll go to war with the likes of him.” – British Prime Minister Neville Chamberlain, 1938. “No child will ever live in poverty… soon, sometime in the near future… Okay, well maybe that’ll never happen.” – Prime Minister Robert Hawke, 1989. And then there’s the clincher of all time from the smartest guy in the room and treasurer of the century after nutting out some momentous changes to our ‘super’ super system. “No one will ever need a financial adviser again.” – Mr Peter Costello, mid-2007.

Genius! Mastery strategist! Simple super hey, how about simpleton politician, if anything, it’s more complex and harder than ever for the average punter to understand.

A timely review

Like never before you simply have to be aware of the rules and regulations surrounding contributions to super. For SMEs and entrepreneurs it might be simply a change of ownership of our assets our business or personal investment assets or there are those who are genuinely planning for their retirement or are close to selling the business to retire or, god forbid, it could even be a gracious old aunt who’s left you a swag of cash or shares.

Swanny has been skilled up on his economics and retirement planning 101 and loves getting the penalty tax whip out if you get it all wrong, and he’ll make you pay a penalty… a BIG ONE!

Technical warning folks

Let’s have a look: As a substantially self-employed person the maximum you can claim as a tax deduction is $25,000* for the financial year if your over that age until (50-65) it rises to $50,000 until the 30th of June 2012*, that’s it, that’s all Swanny will give you. Isn’t that generous of him? For other contributions you contribute but don’t need a deduction, you can place $150,000* in per year or if you are under 65 you can bring forward two future years worth and wack in a maximum total of $450,000* in. Get the rules around it all wrong and you’ll have Swanny on your tail.

Transformers more than meets your tax take

Okay you say, that sounds simple enough, but let’s just have a look at a few situations where the Swanny may attack. Let’s have a look at Optimus Prime’s situation: Optimus Prime is 59 (let’s just call him OP) he has just sold his business and makes a contribution to his super fund of $500,000 (450k, three year rolling maximum non-deductible plus a 50k for the max deduction).

OP sells his business early in the financial year and his income is only $20,000 for the year, therefore the ATO will only allow a deduction of $20,000. OP will have the remaining extra amount of $30,000 treated as part of the non-deductible amount, which now becomes $480,000 instead of the maximum $450,000.

Here comes Robin ‘Swanny’ Hood again… the $30,000 over the 450k limit is classed as an excess and is taxed at 46.5%, plus the 15% contribution tax or $18,450, however there is some scope to vary down the notice where the ATO denies the deduction, so they will kindly give you back only the 15% of contribution tax the fund has paid ($4,500) but if he has already started to draw down on the funds in a pension, then sorry that’s tough, all the $18,450 is gone in penalty tax.

Swanny helps Optimus out of some cash with more tax

Let’s change a few small things for example and Swanny is in tax revenue heaven. OP’s income is now $300,000 for the year (not $55,000). OP is a workaholic and does a bit of extra work at night for another employer and without realising he fails the 90/10 rule (where more than 90% of your income comes from being self-employed).

Now this is how it rolls: the super fund first deducts the 15% contribution tax for OP on the $50,000, he then decides to start a pension with his money. After failing the test, OP has to pay 46.5% tax on 50k (as this is his marginal tax rate after adding it back to his income) then there’s the 46.5% penalty tax on the $50k deductible amount (now called a concessional amount) as the 50k is disallowed it is then added to the 450k non-deductable amount and deemed an excess. He is penalised a further 46.5% plus the 15% contribution tax when he contributed it. Total for Swanny Hood’s coffers – potentially 108% tax or $58,000 tax on the $50,000 amount. Yeesh!

But wait, here come the steak knives.

Let’s say that OP has just turned 66 in the financial year he made these contributions instead of 65. The “bring forward” provisions will not apply and OP will only be allowed $150,000 instead of $450,000, he will have to meet the work test** and Swanny will help him out of a swag of cash in penalties.

Stay tuned next week for more of OP and Swanny’s adventures and a few more tips, work outs and remedies.

*Note: all these figures apply to the 2009/2010 financial year.

** for the work test you have to be employed on a basis of no less than 40 hours in a period of no more than 30 consecutive days in the financial year the contribution is made.

Nick Christian is a Financial Adviser and planner and authorised representative of Millennium3 Financial Services.

The views and opinions expressed within this letter are those of the author and do not necessarily reflect those of Millennium3 Financial Services Pty Ltd.