Investors have one year to restructure their superannuation strategies before the harsher taxation regime applies from July 1, 2017. The crucial issue for most taxpayers is whether the proposed $25,000 annual cap on tax deductible contributions will allow them to accumulate sufficient funds to provide a comfortable retirement.
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Especially when the answer to this question is "no" or "not likely", the key focus will then be on alternative methods. The $25,000 cap has its harshest impact on middle-aged and older taxpayers with relatively small amounts of super currently.
The shorter the period to retirement, the more difficult the task of accumulating sufficient super will be. After deducting the 15 per cent contributions tax, the maximum annual concessional contribution is about $22,000. Even 20 years of contributions at this level earning a compound annual real interest rate of 3 per cent would boost the account balance by less than $700,000.
To accumulate the proposed $1.6 million cap on pension accounts would require more than 30 years' contributions at this level and real fund earnings rates higher than 3 per cent. Clearly the only way to accumulate a sizeable account balance is to boost concessional super contributions at as early an age as possible.
These calculations assume continuing high real rates of return are unlikely for some time. Lower rates of return greatly reduce the exponential benefit of compound interest. A real interest rate of 3 per cent requires 24 years before the value of the investment doubles.
Even if compulsory employer super contributions are increased to 12 per cent of salary, on an $80,000 annual salary, the required annual employer contribution will be less than $10,000.
What then of the benefit of voluntary sacrifice super contributions of up to $15,000 annually? These additional contributions reduce annual tax bills by between $3000 and $5000 depending on marginal tax rates, but these tax benefits can only be redeemed with accrued interest at age 60 or later retirement.
If the $15,000 is not salary sacrificed, take home pay will be between $7600 and $9700 higher annually. For younger people, having more take-home pay to reduce a mortgage could more than compensate for having a larger personal tax bill.
Increasing annual mortgage repayments by between $7600 and $9600 would provide more immediate benefits than accumulating money in super tied up until age 60 or later retirement.
As a general rule the shorter the period to retirement, the more attractive salary sacrifice super will be compared with paying off a mortgage for two reasons. First the compound interest benefits of paying off a mortgage are higher for younger people. Second, waiting till 60 or later to gain access to super is a lesser problem for older taxpayers.
Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au
