By Colin Lewis, Head of Strategic Advice, Fitzpatricks Private Wealth
January 2023

A problem with personal deductible contributions

Making a personal deductible superannuation contribution shouldn’t be difficult, right?

Well, many people are discovering this is not necessarily the case.

Take Chris who made a personal deductible contribution in June 2022 wishing to reduce his tax bill.

Chris did things right. He lodged a notice of intent (NOI) to claim a tax deduction for this contribution and received an acknowledgement from his fund – 15 per cent tax was deducted from the contribution.

He did not touch his contribution – rolling a contribution over to another fund, withdrawing it, or starting an income stream before lodging an NOI will muck up a tax deduction.

Chris lodged his tax return on time.

Chris’ total superannuation balance (TSB) was $2 million on 30 June 2021. Consequently, his non-concessional contributions (NCCs) cap is zero because his TSB was $1.7 million or more – meaning he’s ineligible to make after-tax contributions.

But Chris received an excess NCCs – that’s right, non-concessional contributions – determination from the ATO in respect of his contribution. Not an uncommon occurrence.

How could this be when he made a pre-tax concessional contribution?

It’s important to understand the process

Personal contributions are NCCs and count towards your NCCs cap unless you claim a tax deduction for them – lodge an NOI to claim a deduction with your fund, have it acknowledged and claim the same on your tax return.

The ATO makes its assessment using information from your super fund(s) and tax return and sometimes it’s too quick in issuing excess contribution determinations – like where you’ve lodged your tax return, but the ATO hasn’t processed it (as in Chris’ case).

Without his tax return being processed, Chris’ contribution is treated as an NCC and being ineligible to make after-tax contributions, Chris ended up with an excess.

What happens if I exceed my NCCs cap?

The ATO issues an excess NCCs determination explaining your options and you have 60 days to decide.

Option one allows you to withdraw the excess contributions and 85 per cent of ‘associated earnings’. The earnings are then taxed at your marginal rate plus Medicare levy less a 15 per cent tax offset for tax already paid.

Option two is to leave the contributions and earnings in super, but the excess will be taxed at 47 per cent. As NCCs are from after-tax money, you’re effectively paying double tax. This option must be selected if your only super is in a defined benefit fund.

Do nothing and the ATO automatically defaults you to option one.

So, you can have the excess NCCs refunded and pay tax only on earnings or have the excess taxed at 47 per cent – an easy decision.

Associated earnings

Associated earnings approximates what your excess contributions earned while in super.

The average of the general interest charge rates for the four quarters of the financial year in which the excess NCCs were made is applied on a daily compounding basis from 1 July in the year of the excess NCCs to the date of the ATO’s determination – even if the contribution was made late in the tax year.

Clearly, associated earnings will not be the same as what your fund has earned.

Back to Chris

If the ATO does not process Chris’ tax return before their determination is actioned, then the problem is threefold.

First, money comes out of super that need not have come out. Chris is having to withdraw his contribution and 85 per cent of associated earnings – earnings his fund will not have made especially in 2022 when many superannuation balances dipped.

Second, Chris pays tax on these earnings, so he’s paying tax on something he wouldn’t have ordinarily paid tax on.

Third, if Chris’ TSB was $1.7 million or more on 30 June 2022, then he’s unable to contribute the money back to super and must remain outside the tax effective environment.

Can I avoid this happening?

Unfortunately, the self-employed (and retirees under age 67) wishing to make tax effective super contributions have no choice but make personal deductible contributions. But employees can choose to make salary sacrifice contributions – provided their employer offers this – which are concessional contributions (CCs) from the outset.

What’s the best way as there are pros and cons of each?

Salary sacrifice allows you to ‘set-and-forget’ as contributions will automatically be made for you on a regular basis.

Making regular deposits into an investment at regular intervals over a period of time – ‘dollar cost averaging’ – is a powerful way to invest. It allows you build exposure to growth assets in a disciplined way, can reduce the risk of investing in volatile markets and avoids the pitfalls of attempting to ‘time’ entry into markets. A salary sacrifice arrangement with your employer is a way of implementing dollar cost averaging.

However, it’s rigid. To salary sacrifice to super, you must enter into an arrangement with your employer before any income is earned. So, an unexpected bonus cannot be tipped into super.

Also, you don’t know if and when your employer will actually put the money into your fund, making it difficult to target the CCs cap.

Making your own personal deductible contributions gives you greater control, flexibility and certainty over the amount and timing of contributions and dealing with the CCs cap at year end.

Reducing a capital gain on the sale of say shares or property may be achieved at any point without having to incorporate it into a salary sacrifice arrangement. But the downside of making a large deductible contribution is you lose the benefits of dollar cost averaging.

If you wish to dollar cost average, you’ll need administer this yourself.

Contributing yourself means you’re not reliant on someone else doing it and you have peace of mind knowing your money gets to your fund. Many employers leave it for months between deducting money from wages and making the contribution. For some the money never gets there!

Also, it avoids a nightmare should your employer go into administration/receivership, as money deducted from salary but not contributed may take years to recover.

But it may mean ending up with an excess NCCs determination from the ATO (like Chris) – something that could be avoided by making salary sacrifice contributions via your employer.

*The information in this document (information) has been prepared by Fitzpatricks Private Wealth Pty Ltd (ABN 33 093 667 595, AFSL 247 429) (Fitzpatricks). The information is of a general nature only and does not take into account the objectives, financial situation or needs of any person. Before acting on the information, investors should consider its appropriateness having regard to their own objectives, financial situation and needs and obtain professional advice. No liability is accepted for any loss or damage as a result of any reliance on the information.