Tax trap for super investors rushing to reinvest by end of year

Posted 25 April, 2017

Source: The Australian

Cash is flowing into self-managed super funds in the lead-up to the changes due on July 1 but it is clear investors may not be investing that cash very wisely just now as they urgently try to place funds in super before the cutbacks are unleashed by Treasurer Scott Morrison later in the year.

With the introduction of a lifetime balance to be capped at $1.6 million from July 1, 2017, those with balances below this lifetime balance are using the opportunity to contribute.

They are also aiming to get in prior to the pending reduction of the post-tax non-concessional contribution (NCC) limit, which drops down from its current $180,000 a year to $100,000 a year. There is also the effect of the lowering of the three-year NCC bring forward option by $240,000. Thus, where fund members have the resources, as June 30 approaches many are using these existing limits to contribute up to $540,000 each under the current conditions.

Remember, this is on top of the pre tax-concessional contribution (CC) they can make from $30,000 (those aged 48 or under at June 30, 2017) or $35,000 those aged 49 and above. From July 1 the CC drops down to a flat limit of $25,000 a year, regardless of age.

Therefore, in some instances and depending on their age, SMSF members are contributing up to $575,000 each through combining both the existing NCC and CC maximum limits. They are also no doubt noting that, where their lifetime balance exceeds $1.6m their fund can remain in the super system — with the proviso it remains in accumulation mode.

But here’s where investors may be making a slip: there is no need to rush to invest the cash. I have noticed many investors moving money directly into managed funds inside this financial year.

Now, trustees should bear in mind that with the S&P ASX 200 Accumulation Index up 22.15 per cent for the 12 months to the end of March — and for international equities over the same period the MSCI World Net Total Return Index (Aud) up 15.7 per cent (unhedged) and the MSCI World Net Total Return Index (hedged to Aud) up 18.9 per cent — managed equity funds in unit trust structures will make large distributions for the year ending June 30, 2017.

Strong returns are all very well but the effects of taxation naturally have an impact on your total return. Whether you invest through your marginal tax rate — or through structures such as superannuation which are tax advantaged — it is important to take any tax implications into account.

Managed funds using a unit trust structure are a collective investment vehicle that pool funds together which represent the fund’s portfolio. As such all investors are treated equally whether they purchased this investment on July 1, 2016 or last week. Whether as a new investor investing in the fund or an existing investor redeeming units, the managed fund generally issues or cancel units in the trust to align with the transactions.

Consequently, after strong equity market performance investing in a managed fund now, prior to June 30, still means all investors are treated equally. The flow through effect can be that new investors may inherit the embedded tax liability by the way of distributed capital gains, on gains in which they did not participate in.

I appreciate that funds in an SMSF in accumulation mode incur a tax liability of 15 per cent; franking credits also distributed can offset any liability. But my caution is to beware investing in a strong performing managed fund at this stage of the financial year as you potentially could receive a large distribution and with that a potential and larger-than-anticipated tax liability.

Other vehicles available for investment such as listed investment companies (LICs) do not necessarily have the same tax liability issues, due to the closed-end nature of the structure. However, I reinforce my dislike for the higher fee-paying versions of these investment structures that we have seen listed lately and the high fees they pay away at the initial public offering stage.

There is an alternative, however, where investors can invest at this stage the year without triggering a potential tax liability. That is through considering separately managed accounts (SMAs) or individually managed accounts (IMAs).

In both these cases, the investor maintains direct ownership of the underlying investments in a portfolio — and these are held through a platform usually that aligned with your wealth manager. As with a managed fund, and in the case of an SMA model portfolio the fund manager runs this aligned with a model portfolio. In the case of an IMA, this is tailored as holdings are deemed as individual securities. In both cases, when purchases or sales are made these are adjusted proportionately as with the model portfolio.

The key advantage is that there is no embedded tax liability. Since the investor is deemed to own individual securities they do not inherit the taxation consequences of other investors, as there is no pooling of assets. Therefore, the actions of others cannot affect you.

As large amounts of cash enter the superannuation system — and especially into SMSFs taking advantage of the change in regulations in the new taxation year, my advice is to think twice before investing before June 30. Beware of unforeseen liabilities and plan to ensure you don’t receive an unexpected taxation assessment.