If we invest money in our personal name, any investment earnings are taxable in our hands. Our personal tax rate will dictate the actual amount of tax we will pay. This may be anywhere from 0% to 45%, depending on our total taxable income.
However, if we have money invested in the superannuation system, the earnings our super fund receives are generally taxed at a maximum rate of 15%. On the other hand, if our super is held in what’s known as the ‘retirement phase’, the super fund will generally pay no tax on its investment earnings.
Consider a simple example – we have a superannuation account that is in the accumulation phase (that is, it is not paying a pension to the member). The fund invests our super savings and the fund receives income (dividends, interest or rent, depending on how the money is invested). The investment earnings are included as income of the super fund and the fund will pay tax at a rate of 15%.
In reality, most super funds will actually pay less than 15% tax as the fund may be entitled to tax deductions for expenses and may receive ‘franking credits’, where the super fund has invested in Australian shares.
Let’s take the same example but this time we will assume the super fund is now paying pensions to its members.
The income the super fund earns on the investments supporting pension payments is tax free to the super fund.
But it gets even better that that.
Where the super fund paying pensions invests in Australian shares, the fund will also receive a cash refund of the franking credits.
Let’s assume a super fund receives a dividend of $1,000 from an investment it holds in an Australian company. For the sake of this exercise, we will assume the dividend is ‘fully franked’. This means that the company has already paid $428 tax on its profit before paying the dividend.
When our pension paying super fund receives its $1,000 dividend, it will also receive a ‘franking credit’ of $428. When the super fund lodges its tax return it will declare total income of $1,428. The fund pays tax on $1,428 but receives a tax credit of $428 to use to offset the tax otherwise payable.
I realise this sounds too good to be true – but it reflects the way taxation of super funds works in Australian today.
However, this may not always be the case!
The Federal Opposition has announced they intend to make changes to cash refunds of excess franking credits. How individual taxpayers will ultimately be affected will depend on any exemptions, and the ultimate direction any legislative changes take.
By Peter Kelly, Retirement Strategies and Solutions Centrepoint Alliance