Retaining the excess

In the event an SMSF member breaches their contributions caps, it can be instinctive to refund the amount in excess. However, Meg Heffron, managing director of Heffron, notes that in some situations retaining the excess in the fund can be beneficial.

After several false starts since 2007, the rules for excess contributions today are relatively straightforward and logical.

If an individual goes over the relevant cap, they can choose to take a refund out of superannuation. The benefits being:

• For excess concessional contributions – members can refund 85 per cent of the excess concessional contributions. Choosing the refund option makes no difference to the tax paid in relation to the excess. However, it does mean the excess will not count towards the member’s non-concessional contributions cap. For many people this makes sense – why use up the non-concessional contributions cap with a contribution that will not create a tax-free component and will be taxed at 15 per cent in the fund? A far better approach would normally be to refund as much as possible and contribute whatever is leftover (after paying additional tax) as a normal non-concessional contribution.

• For excess non-concessional contributions – members can refund the excess nonconcessional contribution plus 85 per cent of the ‘associated earnings’ amount (notional interest on the excess contribution). Choosing the refund option means extra taxes will be calculated in a different way. Rather than being subject to excess non-concessional contributions tax (47 per cent on the amount of the excess contribution itself that is paid from the superannuation fund), the member will be subject to extra personal income tax at normal rates (less a 15 per cent offset) on the associated earnings amount. For most people this means much less tax is paid.

But when does it work the other way where members might choose to leave the excess in superannuation?

Excess non-concessional contributions

It is rare members would not choose the refund option where the non-concessional contributions cap has been exceeded.

The imposition of tax at 47 per cent (and the fact this tax must be paid from superannuation) makes retaining the excess in super counterproductive in virtually every practical scenario. The rare case where it might be beneficial to leave the excess in the fund is where the associated earnings have accumulated over many years and the associated earnings amount is so high that:

• the personal tax cost of paying income tax on the associated earnings amount is higher than

• 47 per cent of the excess nonconcessional contributions.

It is always worth a quick sanity check before releasing in these situations.

Beware though – since 1 July 2018 the default position has been that excess nonconcessional contributions be refunded automatically. Someone wanting to avoid that outcome would need to respond promptly to the excess non-concessional contributions determination issued by the ATO and tell them not to instruct the superannuation fund to refund the money.

Excess concessional contributions

Excess concessional contributions are another matter entirely.

Remember, whether or not the member chooses the refund option has no real impact on the amount of tax paid. Hence, providing cash flow is not a problem (that is, the member has enough cash to pay the extra liability personally and doesn’t need a refund from the superannuation fund), there can be valid reasons for leaving excess concessional contributions in super.

No longer able to make nonconcessional contributions

Firstly, members who are no longer able to make non-concessional contributions due to age and work status may deliberately leave excess concessional contributions in superannuation. The logic here is they can’t adopt the normal approach of refunding and then putting whatever is leftover back into superannuation because they are no longer eligible to make non-concessional contributions.

For example, in 2019/20, Marcus was 68 and met the work test to make superannuation contributions. At 30 June 2020, his total superannuation balance was $1 million and in 2020/21 he will no longer meet the work test, nor will he be eligible for work test exempt contributions. This means he cannot make any voluntary contributions in 2020/21.

In 2019/20, Marcus made concessional contributions that exceeded his cap and triggered an excess of $10,000. He did not make any non-concessional contributions in that year.

Marcus might choose to leave his excess concessional contributions in the fund. While the full amount of $10,000 would count towards his non-concessional contributions cap for 2019/20 and would not create a tax-free component, he can at least leave the contributions in the fund. In contrast, if he withdrew $8500 (being 85 per cent of the excess), he would be unable to recontribute it as a normal nonconcessional contribution in 2020/21.

Current year’s non-concessional contributions cap is $nil

Secondly, members whose superannuation balances have grown and now have a nonconcessional contributions cap of $nil (but didn’t in the year the excess concessional contribution was made) are in the same boat.

Take Tristan for example, who is 55, had a total superannuation balance of $1.55 million at 30 June 2019 and made no nonconcessional contributions in 2019/20. He did, however, exceed his concessional contributions cap by $10,000. At 30 June 2020, his total superannuation balance was $1.65 million. Hence his non-concessional contributions cap is $nil in 2020/21 but was $100,000 in 2019/20.

Tristan might also choose to leave his excess concessional contributions in the fund. While the full amount of $10,000 would count towards his non-concessional contributions cap for 2019/20 and would not create a tax-free component, he can at least leave the contributions in the fund without creating an excess nonconcessional contribution.

This would not be the case if Tristan’s total superannuation balance was $1.6 million or more at 30 June 2019. His nonconcessional contributions cap would then be $nil in both years. Choosing not to release his excess concessional contributions would simply flow through to a $10,000 excess on his non-concessional contributions as well. This would make no sense as it would mean further taxes on the same excess. As such, Tristan would do better to refund the excess concessional contribution in the first place.

Have other plans for this year’s nonconcessional contributions cap

The above examples highlight a key point – when the excess concessional contribution is left in superannuation, it counts towards the non-concessional cap in the year in which the contribution was made. In contrast, if the amount is withdrawn and recontributed, it will count towards the non-concessional cap in the year it is recontributed.

This timing difference can be vital in ensuring non-concessional contribution plans are not disrupted.

For example, Mark is currently 66 but turning 67 in October 2021. He is pretty confident the new rules allowing bring- forward non-concessional contributions up until the year in which the member turns 67 will be passed into law very soon. Since he reaches 67 in 2021/22, his plan is to make non-concessional contributions of $100,000 in 2020/21 and then $300,000, or even more now the contribution caps are indexed from 1 July 2021, in 2021/22. His total superannuation balance won’t be a problem, it’s only $1 million, and he didn’t make any non-concessional contributions in 2019/20.

Unbeknown to Mark, he actually had an excess concessional contribution of $10,000 in 2019/20. By the time he receives the ATO determination, he’s already contributed his $100,000 of nonconcessional contributions for 2020/21.

If Mark refunds the excess concessional contribution, he won’t be able to recontribute it as a non-concessional contribution in 2020/21 without disrupting his plans. Going even $1 over the $100,000 cap this year will mean he triggers his three-year bring-forward a year early. He can’t opt out of doing that; it will happen automatically.

Since he didn’t make any nonconcessional contributions in 2019/20, Mark decides to leave his excess concessional contributions in the fund. He will use up $10,000 of his non-concessional contributions cap in that year, but since he didn’t use that year’s cap anyway, there’s no real downside.

As an aside, remember that it’s all in the timing. Mark’s position would be completely different if the excess concessional contribution occurred in 2020/21. Leaving his excess in super would mean it was counted as a nonconcessional contribution in 2020/21 – the year when he absolutely did not want to exceed $100,000. He would definitely need to make sure he took the refund option so the excess did not disrupt his plans. The refund would probably be received in 2021/22 and if he had already made his large ($300,000 or more) nonconcessional contribution for that year, he would simply keep the cash rather than putting any further non-concessional contributions into super.

The imposition of tax at 47 per cent (and the fact this tax must be paid from superannuation) makes retaining the excess in super counterproductive in virtually every practical scenario.

Funds with reserves

Not many SMSFs have reserves, but those holding them are frequently faced with the problem of how to distribute them to members quickly and tax effectively. This issue is becoming more acute as the members of funds with reserves get older. If all members were to die while reserves remain in place, these days there is no practical means of adding them to a deceased member’s death benefit and extracting them from the SMSF tax effectively.

Allocations from reserves are not contributions, but they are counted for the purposes of the concessional contributions cap unless the allocation meets both of the following requirements:

• the amount is allocated in a fair and reasonable manner to all members (or at least to the members in a particular group who contributed to the existence of the reserve), and

• the amount over a financial year is less than 5 per cent of the value of the member’s interest in the fund at the time of the allocation.

If the allocation does not meet these conditions, the full amount counts towards the concessional contributions cap.

However, it is worth bearing in mind that if the members are older, say beyond the age at which contributions can be made:

• they may not be using their concessional contributions cap in any case. For 2020/21, this means the first $25,000 of an allocation from a reserve will count towards their cap but this will have no impact,

• their concessional contributions cap may be even higher than the standard annual cap if they are eligible for the rules allowing certain members to carry forward any unused concessional contributions cap amounts to a later year (that is, their total superannuation balance is less than $500,000 at the previous 30 June), and

• while they will pay income tax on any excess over their concessional contributions cap:

− if their other taxable income is modest, this could have very little impact, and

− remember the 15 per cent tax offset is available on this additional ‘income’ even though the tax it was designed to account for, that is, the 15 per cent contributions tax, was not actually paid on the amount allocated to the member from the reserves.

Hence this may be one group that would deliberately create an excess concessional contribution. They may also choose to leave the excess in superannuation because they have the normal non-concessional contribution caps even though they are unable to make these contributions.

Conclusion

Most people try to avoid excess contributions and most will also opt to refund them from super much of the time. But it pays to understand when this may not be desirable as some valuable planning opportunities can emerge.