Indexation round two

The current situation in the domestic economy means a double application of indexation is highly likely to occur on 1 July 2023. BT head of financial literacy Bryan Ashenden examines how this may impact SMSF members.

With just over six months to the end of the financial year, is it still too early to start planning around endof-financial-year issues and opportunities?

The simple answer to this question would of course be no, as it is never too early to start planning for 30 June. In fact, when it comes to financial planning, arguably there should never be a focus on end-of-year financial planning as it should be scoped, planned for and potentially addressed throughout the course of the year.

How many times do you hear the cries for help and the tales of woe when actions have been left too late? One story that may be familiar is a contribution being made close to 30 June, but the super fund not receiving the contribution until 1 July or after, and therefore the contribution ends up being counted as part of the next financial year’s superannuation caps. Another is a notice of intent to claim a deduction failing to meet the legislative requirements because a client has become too diligent and lodges a personal income tax return early (perhaps in the belief of being entitled to a refund) before the notice requirements for the deductibility of a contribution have been completed.

Of course, when it comes to superannuation, there is a natural inclination among many, both clients and advisers, to leave some aspects of super planning until year end. With money contributed to super being preserved until a condition of release is satisfied at some point in the future, many clients want to delay making contributions until just about the last possible moment. There is a natural desire to hold onto the money in case another need or use for it arises. This is despite the concessional tax treatment that would apply to earnings on those funds if invested in the superannuation environment.

There are some very important reasons why planning shouldn’t be left until close to 30 June. However, this financial year, there are potentially strong arguments in favour of delaying superannuation contributions and other related actions because of the expected indexation of certain super thresholds or caps. This should be taken into account when considering the best time to execute certain superannuation-related strategies.

Indexation of the transfer balance cap

Indexation of the transfer balance cap (TBC) is determined by reference to movements in the consumer price index (CPI), but only increases in increments of $100,000. This means if the movements in CPI don’t get the overall increase to more than $100,000, then no indexation occurs. When originally introduced with effect from 1 July 2017, the general TBC was initially set at a level of $1.6 million. It took four years for indexation to take effect, with the general TBC indexing by $100,000 to $1.7 million from 1 July 2021.

However, less than 18 months later, it is certain we will see another indexation of the general TBC from 1 July 2023. Further, because of the rapid increase we have seen in the CPI level during 2022, it is almost certain we will actually see a double indexation, or double increase, in the general TBC.

Indexation of the cap is based on the relative change in the rates of CPI based on the all groups CPI – the weighted average across the eight capital cities. The base rate used for the TBC indexation is the December 2016 quarter, which was 110.0. In December 2020, the index number was 117.2. If you apply this to the original TBC, the result is 117.2/110 x $1,600,000 = $1,704,727. As this was just over a $100,000 increase from the base number, the indexation of the TBC, which only rises in $100,000 increments, took effect from 1 July 2021.

As we approach 1 July 2023, it will be important to see what the CPI outcome for the December quarter 2022 is, which won’t be published until January 2023. However, we know the relevant outcome for the September quarter 2022 was 128.4. Again, using the indexation formula, this would currently index the base amount from $1,600,000 to $1,867,636, that is 128.4/110.0 x $1,600,000. Based on this, we know the TBC will at least index to $1.8 million from 1 July 2023.

However, if the index factor for the December quarter results in a factor of 130.625 or above, the result will be a TBC from 1 July 2023 of $1.9 million. How likely is this? To achieve this outcome, we would need to see a December quarter inflationary increase of 1.8 per cent, which is the same increase seen for the September quarter. With many economists forecasting the CPI will actually peak in the December quarter, this increase is highly likely.

What would a double indexation of the TBC mean?

An increase in the TBC means it is possible for more superannuation savings to be converted into super income streams. However, the benefit of the $200,000 indexation depends on each individual’s personal TBC.

A person only has a TBC triggered when they first have a pension commenced or would have been triggered if they had a pension as at 1 July 2017. When you have already triggered a TBC assessment and there is a subsequent indexation of the cap, you only gain a proportional benefit of the indexation which is equivalent to the amount of your highest-ever transfer balance account (TBA) to determine what was unused at 30 June.

For example, if a client had used 75 per cent, or $1.2 million, of their TBC when the general cap was $1.6 million, the 2021 indexation of the cap would have benefited them to the amount of $25,000 as only 25 per cent of their cap remained unused. Their personal TBC would have increased to $1.625 million.

Come 1 July 2023, what will their TBC look like? Well, if no further amounts had been assessed to their TBC, the unused amount of their TBC remains at 25 per cent as it is still determined at the time of the superannuant’s highest-ever TBA balance and the applicable general TBC at that time. This would be an additional $25,000 if the general TBC only indexes by $100,000, or will be a $50,000 increase in their personal TBC, resulting in a new total of $1.675 million, if the increase is $200,000 as expected.

Of course, all of these calculations are quite complex. But the good news is the ATO will calculate a person’s individual TBC and publish it on their myGov account. However, there are a few important rules to bear in mind when trying to anticipate what a client’s personal TBC looks like, such as:

• indexation is based on the highest balance a person ever had in their TBA. If a pension was started and subsequently commuted in full, an amount would have been assessed,

• if the TBA for a person reaches the TBC, they would never benefit from any indexation of the general TBC,

• If a person has not yet had an amount assessed to their TBA, they would benefit from full indexation, and

• indexation of the TBC is only relevant if a person has sufficient funds in the system which would result in them exceeding their personal TBC.

Given the benefits of indexation will be maximised when the balance in a TBA is kept low, if you have clients who are considering commencing a retirement income stream before 30 June 2023, it is worth pausing to reflect if this is the best outcome for them. For example, would they be better off delaying the commencement of the income stream until after 1 July 2023 to gain the maximum indexation benefits? If the client has sufficient superannuation savings, this may allow them to place more into a tax-effective income stream. Of course, the potential for this to be the case may have increased during this financial year with the removal of the work test until age 75, allowing more Australians to contribute more to their superannuation fund.

If the client needs some of their super to live on before 30 June 2023, they could consider withdrawing lump sum amounts as these do not impact their TBA. Naturally, consideration would have to be given to the need to access income via lump sums versus the tax-effectiveness of starting a retirement income stream, and the answer may differ from one client to the next. But with pending indexation, it is an assessment that must be had.

One further reason for potentially delaying the commencement of the income stream for a client who is not even close to reaching the TBC is the potential future impact of a death benefit pension. When a client passes and their super is paid to their spouse in the form of a death benefit pension, it will be assessed to the surviving spouse’s TBA, with the timing of that assessment dependent on whether the income stream was reversionary. The combination of a client’s own retirement savings, plus the potential size of a future death benefit pension, which may also include insurance proceeds, could cause a client to breach their personal TBC. As a result, strategies to maximise their potential TBC should be considered.

Indexation of the total super balance threshold

Related to the TBC is the total superannuation balance (TSB) threshold. The TSB is used to determine the level of non-concessional contributions that can be made by a client into super in a particular income year. The TSB threshold is an amount equal to the general TBC. As a result, it is currently $1.7 million but will increase to either $1.8 million or, more likely, $1.9 million from 1 July 2023.

As the amount of non-concessional contributions a client can make is determined by comparing their TSB at the previous 30 June to the threshold amount for the year of contribution, managing contributions in the current year may open up opportunities next year.

For example, if a client were considering using the bring-forward rules this financial year, the increase in the threshold from 1 July 2023 could mean the client would be better off only making an annual contribution this financial year and triggering the bring forward next financial year.

It will also be important to re-engage with those clients who thought their days of contributing to super were over.

Even though a client may have been prevented in one year from making any nonconcessional contributions because their personal TSB exceeded the TSB threshold, an increase to this threshold may make them re-eligible to contribute to super again. This would happen if their TSB at 30 June 2023 is below the indexed threshold that takes effect on 1 July 2023.

Again, when coupled with the removal of the work test for those aged up to 75 for non-concessional contributions, there may be many clients able to avail themselves of that opportunity.

Final comments

Despite the high levels of CPI and the resultant increases in the TBC and TSB that are likely to take effect from 1 July 2023, we don’t expect to see an increase in the contribution caps at the same time, as these are measured by changes in the Australian Bureau of Statistics’ average weekly ordinary time earnings data. Wages growth has not kept pace with inflation in recent years and so it’s expected there will be a divergence in the indexation timeframes for different superannuation thresholds.

However, any increase in the TBC and the TSB will create opportunities for some clients to be able to contribute more to their super and have more savings placed into tax-effective income streams.