Assets Outside Super Can Be Tax-Free

A few weeks ago, in my Eureka Report column Super vs Non-Super, I wrote about the balancing act between building assets inside of superannuation and outside of superannuation as people accumulate assets over their working life.

Yuri B asked an interesting question — was there a way to keep some funds outside of superannuation while still paying no tax? How much could you keep outside of super after retirement to take advantage of the tax-free threshold and save on super fees?

If we assume that investing outside of superannuation incurs lower costs, then there is an argument to hold some assets outside of superannuation – making sure that we still do not pay any tax. I suggest that there are five factors that should be considered around this decision, and in rough order of importance they should be: tax paid (we should be keeping this to $0); fees; the way superannuation withdrawals increase over time; legislative risk; and, finally, access to funds.

Tax paid

The bottom line for most retirees in Australia is that they should not be paying tax in retirement. The combination of the $1.7 million transfer balance cap allows a healthy superannuation balance to be transferred to a retirement pension fund where, if you are over age 60, withdrawals and fund earnings are tax free.

We can often get enamoured with this superannuation tax-free promise and forget that outside of superannuation the tax-free threshold for an individual is $18,200, meaning you can hold a significant level of assets outside of superannuation and still pay no tax.

Consider Australian shares with a gross income yield of 6 per cent. Some $300,000 invested outside of superannuation in shares might provide around $18,000 per year of income and means that a person does not have to pay tax if they have no other taxable income.

One element to keep in mind is that if there is other taxable income, including from the age pension, it needs to be considered in the tax calculation.

Fees

There are many different fee structures. Let’s consider the impact of a superannuation fund that has asset-based fees of 0.75 per cent (perhaps an administration fee of 0.5 per cent and an investment management fee of 0.25 per cent).

If a couple were to move, say, $150,000 each of their superannuation assets and invest in their own names, they are unlikely to pay any tax assuming they have no other taxable income. If they invest in assets with the same investment management fees of 0.25 per cent, they will save their administration fee of 0.5 per cent on their combined assets of $300,000. This is an extra $1,500 per year – enough for a quick domestic holiday somewhere.

Super Withdrawals

Most people aged under 65 start with a minimum superannuation pension withdrawal of 4 per cent of the fund balance. The minimum withdrawal increases each year, up to 7 per cent by the time they reach 80.

Because of this, people often find themselves forced to withdraw more than they spend, increasing the funds they have invested outside of superannuation.

We said that around $300,000 of investments outside of superannuation, earning $6,000 per year, would take you to close to the limit of the tax-free threshold of $18,200 per year for income tax purposes. Starting with less than this seems a reasonable strategy to allow for excess pension withdrawals to be invested there.

Legislative Risk

The changing rules of superannuation mean that some retirees might feel confident that if they have some assets outside of superannuation, and some assets within superannuation, they might be in a stronger position to cope with any changes in retirement rules. If the rules around superannuation pension funds changed unfavourably, having some assets outside of superannuation might help counter that change.

Liquidity

Liquidity refers to the ability of transforming an investment into cash.

The reality is that even with money invested in superannuation, it is reasonably easy to make a superannuation withdrawal and access cash. While a minimum pension withdrawal is stipulated, a maximum withdrawal is not, and most superannuation funds have efficient withdrawal processes so retirees can access additional funds relatively quickly.

The advantage of holding some assets, including some cash assets, outside of superannuation is probably better characterised as simplicity rather than superior liquidity. If you need some extra funds over the course of a year some people will prefer holding assets in an online cash account, or similar, where they can access them immediately, rather than having to go through the process of an additional superannuation pension withdrawal.

Conclusion

The headline benefit of superannuation is the tax-free promise of both fund earnings and pension withdrawals for a person over the age of 60. Tax-efficient and simple, what more could we want?

Stepping back from that, it is likely that people will be able to hold some assets outside of superannuation at retirement and still pay no tax. As a way of saving fees, hedging legislative risk, and having simple access to funds, this may be an attractive option.

The balance of assets during retirement held inside and outside of superannuation will be personal. However, starting retirement with some savings and investments outside the superannuation environment is reasonable, and adding to it as compulsory superannuation withdrawals increase might build this asset base over time.