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How will downsizer contributions work for SMSFs?

With downsizer contributions coming into effect on 1 July 2018, what are some tips and traps for SMSFs and their members

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To reduce pressure on housing affordability, downsizer contributions provide an incentive for super fund members aged 65 years or older to sell a main residence. The Treasury Laws Amendment (Reducing Pressure On Housing Affordability Measures No. 1) Act 2017 (Cth) which introduces downsizer contributions received royal assent on 13 December 2017.

Downsizer contributions comes into effect on 1 July 2018 and members intending to make downsizer contributions can enter into a contract of sale from this date. In preparation of this we should consider two key questions:

  • How do downsizer contributions work?
  • What are some tips and traps for SMSFs in utilising downsizer contributions?

How do downsizer contributions work?

There are four broad steps that need to be taken if a member would like to be eligible to make downsizer contributions.

Step 1: Eligibility
The first step the member needs to take is to confirm that their contributions will be eligible downsizer contributions. Broadly, an eligible downsizer contribution is where:

  1. the contribution is made to a complying super fund by a member aged 65 years or older;
  2. the amount is equal to all or part of the capital proceeds received from the disposal of an ownership interest in a dwelling that qualifies as a main residence in Australia, under the downsizer provisions;
  3. the member or the member’s spouse had an interest in the main residence before the disposal;
  4. the interest in the main residence was held by:
    • the member;
    • the member’s spouse;
    • the member’s former spouse;
    • a trustee of the estate of the member’s deceased spouse;

      during the 10 years prior to the disposal; and
  5. The member has not previously made downsizer contributions in relation to an earlier disposal of a main residence.

Note that a caravan, houseboat or other mobile home does not qualify as a main residence for these purposes.

The member should determine whether they are eligible to make downsizer contributions and whether their main residence satisfies the above criteria prior to the disposal of the main residence.

Step 2: Contributions

Upon the sale of a main residence a member can make up to a maximum of $300,000 in contributions to their super fund. Further, there is no age limit or gainful employment test that needs to be satisfied (however many SMSF deeds will preclude such contributions and an SMSF deed update is likely to be required). These contributions are not counted towards the relevant member’s contributions caps or total superannuation balance in the financial year a downsizer contribution is made.

Once the member sells their main residence, they are required to make downsizer contributions to their super fund within 90 days after the day the ownership changed (typically 90 days from settlement). An approved form should be completed and given to the trustee of the super fund detailing the amount that is to be attributed to downsizer contributions. While multiple downsizer contributions in respect of the sale of the same residence can be made, the total amount of downsizer contributions made by each member cannot exceed $300,000. This total amount includes the amount of all downsizer contributions a member makes in respect of all of their superannuation funds.

It is important to note that the $300,000 downsizer contribution cap is for only one member, therefore this would potentially allow for additional contributions of $600,000 for a couple (ie, 2 x $300,000).

Given this 90 day timeframe, a member cannot make downsizer contributions if settlement is, for instance, on vendor terms that go beyond 90 days unless they have been granted an extension from the ATO.

Step 3: Reporting and Verification

Upon the super fund’s receipt of the downsizer contribution form the super fund must inform the ATO during the super fund’s annual reporting. The ATO will then run verification checks on the amount and may contact the member for further information.

If the ATO has verified that the member has made eligible downsizer contributions, no further action is taken.

However, if the contribution does not qualify as a downsizer contribution the ATO notifies the superannuation provider. The amount will then either be allocated as a non-concessional contribution — if permitted by superannuation law and may result in the member exceeding their cap — or refunded to the member.

What are some tips and traps for SMSFs and their members?

SMSF Deed Provisions

As the downsizer contribution is a new type of contribution, the SMSF’s deed should have express wording that allows members to make these contributions to the fund, especially as a member over 65 years may not be gainfully employed and in many cases a member may be in excess of 75 years (and to date contributions cannot generally be made for such members under reg 7.04 of the Superannuation Industry (Supervision) Regulations 1994 (Cth)). Additionally the SMSF deed should provide appropriate mechanisms in resolving what happens when a downsizer contribution is deemed ineligible by the ATO. As a matter of reporting, the SMSF will need to receive approved downsizer contribution forms from the SMSF and report those contributions to the ATO.

Age Pension

Additionally, members should note that disposing of their main residence and contributing downsizer contributions to their super fund may adversely impact on their Centrelink entitlements. Broadly, the age pension provided by Centrelink is assessed against, among other things, an assets test. A person’s family home is generally not included in the assets test, however superannuation savings are included once a member reaches pension age. This means that if a member disposes of their main residence and make a downsizer contribution, the member may either be:

  • subject to reduced age pension payments; or
  • no longer eligible to receive any age pension payments altogether.

Further adverse impact on other government entitlements may also follow as a result of the greater level of superannuation assets. This aspect will significantly reduce the attractiveness of the downsizer provisions for many who would otherwise be interested in the scheme.

Proceeds and Borrowings

It is important to note that the downsizer contributions cap is the lesser of $300,000 or the sum of the capital proceeds. Any debt outstanding on a mortgage over the relevant property is not considered for the purpose of determining the capital proceeds.

For example, John bought his main residence 12 years ago for $1 million. He then sells for $1.25 million when his outstanding borrowings are $1 million.

John received capital proceeds of $1.25 million. Thus, John can make downsizer contributions up to $300,000.

Members should also be aware that downsizer contributions are not deductible.

 

By Christian Pakpahan, lawyer and Daniel Butler, director, DBA Lawyers
12 JANUARY 2018
www.smsfadviser.com

Economic Developments

Australia:

  • The Reserve Bank of Australia [RBA], reduced the Cash Rate to a record low of 0.75% on 1 October, well below the yearly inflation rate of 1.6%. This also took bank Term Deposit rates below the inflation rate, for example, the Commonwealth Bank 6 month Term Deposit rate has moved down from 2.3% to 1.55% over the past year. Concerns with why the RBA has been so aggressive on monetary policy has seen consumer confidence decline. Central bank policies have not created the growth or inflation targets desired, thus offshore actions give some insight into likely effects on the Australian economy of similar policies.
  • As the RBA mimics offshore monetary policy it increases the risk that ultimately they will try quantitative easing [QE]. The reality is that removing the reliance on credit growth for economic growth, removing Over the Counter derivative risk from the financial system, sound fiscal policy and the implementation of a sound strategic vision for the future by Governments, are necessary to revive and develop sustainable economies. However, to date, there appears to be little recognition of what is needed and indeed such a strategy may be too complex to successfully move through a democratic system.
  • It is possible that technological change over the next 20 years will be so substantial that a complete redesign of the current economic system will become necessary.
  • It is also possible that another economic crisis will provide the political opportunity to move to a cashless system, which would ultimately be highly beneficial to banks but would erode individual rights and increase government control. As we have noted in prior newsletters, there are currently efforts by the Australian government to ban the use of cash for transactions above $10,000. While this is said to be necessary to reduce the black economy, it has also been suggested by the International Monetary Fund [IMF] that a cashless economy is necessary to lock people into the banking system should interest rates need to be pushed into the negative. Thus there is some speculation the Australian government is positioning for a possible eventual move to negative interest rates in Australia.
  • Australia’s unemployment rate lifted to a 12-month high in August of 5.3%, following a reduction in 15,500 jobs, the figure was partly saved by a 50,200 lift in part-time employment.
  • Given high household debt levels in Australia, the economy is vulnerable if unemployment was to increase substantially.

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·         Approximately 30% of global tradable bonds are now at negative yields worth approximately $25 trillion. As we have noted in prior newsletters this situation is essentially a soft default and demonstrates a lack of confidence in the financial system.

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  • Governments combined with banks and central banks have essentially created a global economic system that can perhaps best be described as “a Titanic looking for an iceberg” big pension funds and other financial managers know this and hence they are electing to take a small loss in percentage terms to reduce the risk of taking a big loss should the system fall apart. Remember that large pension funds are investing for the very long term and thus taking long term defensive positions in negatively yielding government bonds are more attractive than say listed companies that are commonly significantly judged on quarterly performance. 
  • A problem for fund managers and investors, and to continue the Titanic comparison, is that the Titanic could have sailed back and forth across the Atlantic for decades and today be largely forgotten. It needed a collision with an iceberg to reveal the vessel’s structural problems. The global economy is essentially in the same situation.
  • This makes fund management difficult, because of the timing problem, and the reality that an iceberg need never be hit. By buying negatively yielding government bonds the large fund managers have concluded that there are sufficient icebergs around for highly defensive positioning.
  • The Australian market is anticipating further cuts to the Cash Rate, possibly to 0.50% in 2020 when the RBA may follow the US, EU and Japan into Quantitative Easing, though this could be a risky strategy given the Australian currency is not a major currency. Additionally, this leads the world dangerously close to competitive currency devaluation, an error that was made in the lead up to the Great Depression in the 1930s.

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  • The gold price [US$1507/oz.] and silver price [US$17.57/oz.] were both weaker over the past month as traders took some profits from the move up since May. Nickel prices have remained strong following the Indonesian nickel export ban [US$17,434.00/tonne].

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  • Iron ore prices are continuing to weaken, as are coal prices. 

Bond Markets:

  • The Australian 10-year bond yield is 0.88%. The record high yield for 10-year bonds was 16.50% in 1982, the record low was 0.85% in August 2019.
  • The 2-year yield is 0.63% and the 5-year yield is 0.617%. 

World:

  • The US Government 10-year bond yield is 1.54% continuing its long term downtrend. Rates were cut for the first time in 11 years in July. The current Federal Funds rate is 1.75% to 2.25%.
  • The US Federal Reserve has recently advised that it will start to expand its balance sheet again, which is essentially an admission that moves to decrease the balance sheet and thus monetary policy efforts have been, at least to date, unsuccessful.

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  • The next Federal Open Markets Committee meeting is expected 29-30 October, the Federal Reserve has hinted that it will reduce the Federal Funds rate again at this meeting.
  • The European Central Bank [ECB] looks to be in watchful waiting mode, with what appears a slight leaning away from further interest rate cuts. EU economic growth remains subdued.
  • China and the US remain in trade negotiations, with China’s GDP expected to slow to 6.1% in the July- September quarter.
  • China-US trade negotiations look increasingly fragile, with the IMF advising it sees a global slowdown possible due to the trade negotiations.

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Market Movements

Australian Equities:

  • The ASX200 Index lifted 0.613% over the last 25 trading days. ASX200 is shown below.
  • The five best and worst percentage stock performers on the ASX200 over the last 25 trading days were BELLAMY’S AUSTRALIA ORDINARY [BAL] 50.93%, NUFARM LIMITED ORDINARY [NUF] 37.98%, MAYNE PHARMA LTD ORDINARY [MYX] 28.26%, PREMIER INVESTMENTS ORDINARY [PMV] 24.76%, COLLINS FOODS LTD ORDINARY[CKF] 21.06% The poorest performing stocks were WEBJET LIMITED ORDINARY [WEB] -18.33%, AMAYSIM AUS LTD ORDINARY [AYS] -18.60%, BRAVURA SOLUTION LTD ORDINARY [BVS] -19.76%, RESOLUTE MINING ORDINARY [RSG] -20.80%, SYRAH RESOURCES ORDINARY [SYR] -31.15%.
  • The five best and worst percentage performing sectors in the ASX 200 over the last 25 trading days were EMERGING COMPANIES [XEC] 3.28%, CONSUMER STAPLES [XSJ] 1.68%, S&P/ASX SMALL ORDS [XSO] 1.43%, ENERGY [XEJ] 1.36% and CONS DISCRETIONARY [XDJ] 1.31%.The poorest performing sectors were METALS AND MINING [XMM] -0.79%. INVERSE DAILY INDEX [XIN] -1.18%, REAL ESTATE SECTOR [XRE -1.53%, A-REIT [XPJ] -1.77%. GOLD [XGD] -4.48%.

Global Equities:

  • US third-quarter earnings, expected to get underway shortly, are forecast to see a 4.1% fall in S&P company earnings over the same period a year ago. If this forecast is correct it will be the third quarter in a row of lower earnings over the previous corresponding period a year earlier.
  • The broad global equities index (MSCI ACWI) delivered a -2.28% in the past month and was 13.59% higher year to date. THE MSCI Emerging markets index ended the month of September down 4.3%. The US S&P500 fell 2.88% in September, and is up approximately 21% year to date, the STOXX Europe 600 Index was down 4.19% over the past month, and up 15.41% year to date. The Shanghai stock index was down 3.30% over the past month and up 3.70% year to date.

Looking Ahead:

  • As US-China trade negotiations drag on, and despite the strongly negatively yielding bond markets there was some sign of yields drifting higher in some markets. Expectations of a global economic slowing are being in part offset by continued expectations of central bank moves to reduce interest rates and the Federal Reserve’s move to once again expand its balance sheet, something that may have been anticipated by the negative-yielding bond buyers.
  • An anticipated decline in US Company earnings is starting to see volatility return to the stock market.
  • As we noted last month, it is important to remember with the market to the tune of US$17 trillion positioned for further declines in bond yields, should bond yields actually rise, this would create massive loss-making positions for these investors. However, these investors appear to think the downside of their positioning is covered by the Federal Reserve, They could be correct.
  • Last month we speculated that the US$17 trillion flooding into negatively yielding bonds looked like it was acting on some type of forward information, this month we find out what that information was with the announcement that the Federal Reserve will return to increasing its balance sheet.
  • We currently think that technology will ultimately force a decline in employment opportunities, eventually forcing a redesign of the economic system towards a universal basic income. What happens to the Fed will ultimately be determined politically. This probably clarifies President Trump’s recent attacks on the Federal Reserve. The Fed is not an independent body and is owned by the major commercial banks.
  • We continue to see the Australian economy as vulnerable to external shocks and expect the global economy to remain lacklustre. We expect stock market volatility to increase and recommend maintaining conservative positioning.

 

Words by TWD:
The information in this Blog is of a general nature. It does not take your specific needs or circumstances into consideration. You should look at your own financial position, objectives and requirements and seek financial advice before making any financial decisions.