Superannuation funds in pension phase for investors who are aged 60 and over have been a substantially tax free investment vehicle since 2006. There is no tax to pay on investment earnings within the fund and no tax to pay on either pension payments or lump sum withdrawals. It is what one might call fiscal nirvana. There is still potentially tax to pay when a superannuation investor dies and the funds are transferred to a non-dependant (as defined by tax law). Spouses are defined as dependants however in most circumstances adult children are not dependants.

Does this mean that for investors over 60 using a superannuation fund in pension phase is automatically the best strategy? Not necessarily. It may surprise some people to know that investors over 60 who do not receive employment income or have another source of income other than from their super are able to have substantial assets invested outside of superannuation (that is owned in their own names) and still pay little or no tax because of low marginal rates of tax and various tax rebates such as low tax offsets, Seniors rebates and so on. An added bonus is that the costs can be lower if investing outside of superannuation.

So why is this a big deal? I mean if an investor who uses superannuation is going to pay little tax whether they invest through superannuation or invest outside of superannuation does it really matter? It can when risk is taken into account. Managing investments is all about managing risk. And unnecessary risks should be avoided. Put the other way around a risk should only be taken if it is going to potentially provide a benefit that justifies the risk. If one consistently takes unnecessary risks one will sooner or later get caught by something.

This writer has always thought that the tax free status of pension and lump sum payments from superannuation funds in pension phase where the investor is aged 60 or more is generous. It is after all a tax break that other taxpayers do not receive. My view is that there must be a not insignificant risk that this tax free status will not continue indefinitely. With the federal government now actively looking for ways to try to return the budget to the black will superannuation be targeted at some time in the future? To base one’s investments planning on the assumption that superannuation will not be taxable in some way in the future would be as Sir Humphrey of Yes Minster fame would say “courageous”.

Now I usually do not recommend investors base their planning upon possible tax changes. After all there are so many possibilities and there always seem to be various rumours floating around. If there are, however, two low or no tax strategies available to an investor and one strategy has a higher future tax risk than the other then it should be a no brainer to consider the no or low tax strategy that has the lower risk of future tax changes.

If the government does make pension phase superannuation taxable for investors 60 and over at some time in the future this may include tax on lump sum withdrawals (as was the situation until 2006). In which case it may be too late to exit the super system without incurring a significant tax penalty if you don’t like the changes. Usually it is better to close stable doors before any animals bolt.

Other points that need to be considered are that exiting superannuation while lump sum payments are not taxable will effectively eliminate tax (in some cases potentially thousands of dollars) on any super death benefits paid to non-dependants (adult children). Also any investors considering a recontribution strategy to reduce potential tax on death benefits may not necessarily have until age 65 (assuming that they are retired) to do this. Introduction of a tax on lump sum withdrawals would certainly reduce the attractiveness of this strategy.

The main potential disadvantage of exiting the superannuation system is that it will bring investors back into the capital gains tax system. Given that only half of a realised capital gain is taxed (assuming that the asset has been held for at least twelve months) capital gains are going to, in many cases, need to be substantial (and maybe well above average historic returns) before staying in superannuation (particularly when potential tax on death benefits is taken into account) turns out to be the best option. This is possible although maybe not probable, however, if this is the case you may pay more tax however there will be the consolation that your portfolio is performing very well indeed. An investor’s financial security is not going to be compromised by receiving high positive after tax returns. There is always a risk (regarded as lower by this writer) of course of changes to the tax rules that relate to capital gains tax or dividend imputation. However it is impossible to avoid all risk.

As a vey approximate rule of thumb superannuation investors who are 60 or over with investable assets of up to $750,000 (this could be substantially higher if there may be substantial tax on death benefits) or investors who are between 60 and 65 and are considering a recontribution strategy should be seeking advice to see how the alternatives of investing through superannuation and investing outside of superannuation compare in their specific circumstances.

This blog is general in its nature and cannot take into account any investor’s individual circumstances. The potential benefits outlined above will be available for some investors and will not be there for others. Investors should seek professional advice before making any decisions with regard to staying with superannuation or exiting the superannuation system.