It is well known that any money withdrawn from superannuation after age 60 is tax-free. What is less well known is that a couple over the age of 65 can earn $57,948 outside super and also pay no tax.

This is so because of the operation of two tax offsets which together eliminate all the tax payable. It is important to note that a tax offset reduces the tax payable, whereas a tax deduction reduces the income on which tax is paid.

There is no tax to pay on incomes up to $18,200. The Low Income Tax Offset (LITO) is worth $445 and will eliminate the tax on incomes up to $20,542 which is the effective tax-free threshold for low-income earners. The LITO remains at $445 for incomes up to $37,000 and is progressively reduced for incomes above that level at the rate of 1.5 cents per dollar of income until there is no LITO on incomes above $66,667.

In addition to the LITO, people who have reached pension age are entitled to another tax offset called the Senior Australians and Pensioners Tax Offset (SAPTO). The important element here is not that the person receives the age pension but that they have reached pension age.

SAPTO is an additional tax offset that works in tandem with LITO and there is one amount for a single person and another for a couple. For a single person, the SAPTO is $2,230. This means that a single person over age 65 will have a combined tax offset of $2,695 and so they can earn $32,279 before they pay any tax as the LITO and the SAPTO together offset the tax payable.

The SAPTO for each member of a couple is $1,602, so their LITO and SAPTO combined tax offset is $2,047. That means they each earn $28,974 or $57,948 together as a couple and pay no tax. There is also no Medicare levy payable for taxpayers eligible for SAPTO.

Just as the LITO is tapered as income exceeds the threshold, the same applies with SAPTO, but the taper is much more severe. The SAPTO is reduced by 12.5 cents per dollar of income so that no SAPTO is available when the income reaches $50,119 for a single person and $83,580 combined income for a couple. Retirees with incomes below these levels will pay some tax but not as much as those taxpayers who are not eligible for SAPTO.

Implications

Thanks to the LITO and SAPTO, our hypothetical couple with a taxable income below $57,984 would pay no tax. In that case, their tax position is the same if their income was earned inside super or outside super. If we assume that these assets were generating an income yield of 6% it would mean that this couple could hold $965,800 in assets outside super and have the same tax-free income as if those assets were held inside super. If the income yield was 5%, the capital value would be $1,158,960.

For some seniors over the age of 65, this may provide an incentive to close their Self- Managed Super Fund (SMSF) with all its restrictions and regulations. By moving those assets to be held in their own name, they would have to go back to completing a tax return particularly if they wanted a refund of their imputation credits.

It also means that a couple over the age of 65 can hold substantial assets outside super with no tax to pay in addition to any tax-free income they earned from their super fund.

Risks

If the assets are held in their own name and the income they produced grew in value over time, then some tax may become payable if the income progressively exceeds the tax-free threshold for seniors at that time.

Capital gains are taxable income in the year the asset is sold, so any capital gains on assets sold in their own name may trigger a tax liability whereas that would not be the case in a super fund paying a pension because a pension fund is tax-exempt.

If one member of a couple survives the other, their effective tax-free threshold is reduced from the couple rate of $57,984 to the single rate of $32,279. If the surviving spouse continues to hold all the assets in their own name, the income produced could trigger a tax problem which may not arise inside a super fund.

Holding assets in their own name requires different estate planning and asset protection arrangements to that involved in holding assets in a super fund.

SAPTO is only available to people over age 65. At that age, the contribution caps make it difficult to contribute money into a super fund, unless the work test is satisfied. Therefore, if assets are transferred out of a super fund to benefit from SAPTO it is almost impossible to then put back into super. This decision is almost irreversible.

SMSFs are considered by many to be the investment platform of choice because of the tax concessions they offer but they are not cheap, particularly for retirees with modest investment balances. SAPTO may allow people with modest investment balances the opportunity to achieve tax-free income in retirement without the bother and expense of an SMSF.

This article is not designed to provide financial or tax advice as I am not qualified to offer either. Clearly, any decision to close down an SMSF has enormous implications for future tax liabilities and should not be taken without good advice from a qualified accountant and/or financial planner.

Jon Kalkman, AIA Director