The $2 Million Tax-Free Opportunity

As of July 1st this year, the allocated pension opportunity will be indexed to $2 million for an individual with the increase to the transfer balance cap. This is a significant milestone for retirees and pre-retirees, as it represents an opportunity to hold a substantial amount of wealth in accounts where earnings and gains are tax-free. While there have been numerous changes to the superannuation system over the decades, it’s hard to argue that holding $2 million tax-free super for individuals and $4 million for a couple isn’t a generous tax concession. It’s certainly worth aiming to maximise this opportunity as much as possible.

A Brief History of the Cap

The $1.6 million transfer balance cap was introduced on July 1, 2017. This measure was part of the Federal Government’s superannuation reforms aimed at limiting the amount of superannuation that could be transferred into a tax-free retirement phase account. Prior to this point, the tax-free phase was uncapped.

The primary reason for introducing the cap was to ensure the sustainability of the superannuation system and to limit the tax concessions available to individuals with large superannuation balances. By capping the amount that could be transferred into the tax-free pension phase, the government aimed to make the superannuation system fairer and more equitable, ensuring that tax concessions were more evenly distributed among all superannuation members. While some argued that these restrictions were punitive, for most people this still represents a significant super transfer balance cap opportunity. The $1.6 million cap has been indexed in $100,000 increments and will reach the $2 million milestone this July.

The Benefits of a Higher Superannuation Balance

The Association of Superannuation Funds of Australia publishes a retirement “standard” that indicates a home-owning couple will need a lump sum of $690,000 by age 67 to afford a comfortable retirement. When combined with the age pension, this would see a couple living on approximately $70,000 per annum. Many Australians who start planning early aspire to have a higher superannuation balance, which can then lead to lifestyle benefits.

An individual or a couple with $2 million tax-free super could generate an estimated $120,000 per annum, and a couple with $4 million could live off a tax-free income of $240,000 per annum. The lifestyle dividend that comes with this could include upgrading cars, overseas holidays, and assisting family.

Planning for the Future

For many Australians, the allocated pension caps might seem out of reach. However, even for those in a fortunate position to have the cash flow and assets available, careful planning is essential to ensure the opportunity doesn’t pass them by. The risk lies with the yearly caps and the restrictions on adding money into the superannuation system, as an allocated pension has to start with a superannuation balance.

The first cap is the concessional cap (before tax), which is currently $30,000 and includes employer contributions. Even if someone were able to top up their employer contributions with a salary sacrifice arrangement and maximise the full cap, it is a long way to $2 million in contributions and earnings, especially for someone who might be ten years from retirement.

It is usually the non-concessional cap (after tax) where the heavy lifting is done, with a yearly cap of $120,000 and the ability to bring three years forward and contribute $360,000 in a single year. The compound earnings go to work as the balance grows, but usually, a long runway is needed to maximise the opportunity in time for retirement. The opportunity to add after-tax to super exists right up until the age of 74, and this was enhanced with the work test being removed. While this assists with flexibility, if the goal is to retire between the ages of 60 to 65, the runway needs to commence years before this milestone. Otherwise, wealth may be trapped outside of the superannuation system and taxed at marginal tax rates.

Conclusion

The $2 million tax-free super opportunity is a significant milestone for retirees and pre-retirees. With careful planning and strategic contributions, it is possible to maximise this opportunity and enjoy a significant lifestyle dividend in retirement. If you have any questions or need assistance with your financial planning, please don’t hesitate to reach out to our team. We’re here to help you make the most of your superannuation and achieve your retirement goals.