Pre-retirees are often well placed to give their nest egg a boost – after all, the kids are grown up, the mortgage may be paid off and you could be earning a decent income. But you need to take care with pre-tax, or ‘concessional’, super contributions as the government has halved the annual limit you can tip in from $50,000 down to $25,000, and there are steep penalties for going over this maximum amount.
The appeal of pre-tax super contributions is that they are taxed at just 15% for up to a total of $25,000 in a single financial year (effective from 1 July 2012). If you earn more than $18,200 annually your personal tax rate is at least 19% – so in this case, and for higher income earners, making pre-tax super contributions means that a greater proportion of your money goes into your nest egg than into the tax man’s coffers.
However trying to play catch up with your super by contributing as much as you can through, say, salary sacrifice (where part of your pre-tax salary goes to super rather than your pay packet) could mean being slugged with penalty tax payable on over-the-annual-limit super contributions.
That’s because concessional super contributions don’t just include amounts you add to your fund. They also include your employer’s compulsory super contributions.
To be fair, you have to be a very high income earner, on a salary of around $277,000 annually, for your employer’s 9% contributions to approach $25,000 in a given year. But if you’re also adding to your nest egg through salary sacrifice, the two can quickly add up.
Exceeding the $25,000 annual limit on pre-tax contributions will mean facing penalty tax of 31.5% of the contributions over $25,000. That’s in addition to the standard 15% contributions tax, in other words, 46.5% all up – ouch!
Now, out of your own pocket, i.e. out of your after-tax money, you can contribute up to $150,000 annually, to a total of $450,000 over three years if you are aged below 65. However, if you exceed this limit, once again you face tax penalties on the excess contributions, also at 46.5% (which is equal to the top personal tax rate).
The after-tax contribution limits may sound quite generous but you don’t have to be a high income earner to exceed these caps. For example if you sell a property or other investments and tip the proceeds into your super, you could go over the annual contribution limit.
At this point you could be forgiven for thinking super is all too hard and confusing. It’s worth remembering though that payouts from a super fund are tax-free for most over-60s, and that’s a big saving when you’re in retirement.
I firmly believe that super is good for us despite the constant fine tuning and complex rules. The reality is that without super many Australians would face a very bleak retirement. The key is to monitor how much is going into your fund each year, and whether the contributions are being made using before-tax or after-tax money.
Your financial adviser can help you find the balance between adding to your super in the lead up to retirement while avoiding unwanted tax penalties. Super is one area where most people do need good professional financial help to achieve the best outcomes.