Planning your SMSF contributions for better tax effectiveness

By Mark Causer, senior advisor at Perspective Group

As you are all aware, post 30 June 2007, contributions to superannuation funds are now subject to annual contribution caps and strict penalties apply if these limits are exceeded. As a result, a greater level of care has now been applied to the annual superannuation contribution strategies with particular focus on concessional contributions (tax deductible contributions / salary sacrifice).

In some cases however, for Self Managed Super Funds (SMSFs) it makes sound financial planning sense to enter into a contribution strategy with a view to breaching the concessional cap, thereby further enhancing the tax effectiveness of funding insurance premium (Death / TPD) via superannuation.

The strategy works as follows:

An individual has purchased Life and TPD insurance through their SMSF. In some circumstances, the premiums for this cover are funded by the individual making concessional contributions (salary sacrifice / personal deductible) to the SMSF.

In the case of concessional contributions, we have stated above there are annual caps and that any excess concessional contributions above the individual's cap ($25,000 <50yrs and $50,000 >50yrs to 30/6/2012) will attract a penalty tax rate of 31.5 per cent. Interestingly this payment can be paid from the SMSF or personal funds. Personally funded payments will not be treated as additional contributions.

When the SMSF prepares the annual tax return, the trustees are then entitled to use the insurance premiums paid by the fund as allowable tax deductions. Where concessional contributions (say salary sacrifice) are used to fund these premiums, the SMSF will NOT attract the 15 per cent contributions charge (tax) as the SMSF will claim a tax deduction for the exact same amount paid. Therefore if a 45 year old sacrifices say $60,000 to the SMSF and $10,000 is paid out as insurance premiums during the year, while there is an excess contribution, there is NO contributions tax as the premium offsets (deducts) the contribution.

As a result, by removing the 15 per cent contributions charge (tax), any excessive concessional contribution will now only incur a 31.5 per cent penalty tax. If the SMSF trustee was an individual on the TMTR (46.5 per cent or even 41.5 per cent) this strategy allows them a tax efficient way to fund insurance premium inside the SMSF without eroding the monies available for direct SMSF investment.

SMSF Trustees should however be wary that they do NOT breach their non-concessional contribution cap ($150k or $450k, three years) when adopting this strategy. If the trustee breaches both of these caps they will then be liable to a 78 per cent penalty tax.

The strategy above suggests that where the SMSF has annual allowable deductions, the strategy could have wider applications.