Legislation to make superannuation downsizer contributions (downsizer contributions) has now passed enabling individuals who are 65 or over to contribute proceeds from the sale of one eligible property to superannuation without needing to satisfy the work test.
The new rules provide more flexibility for retirees to fund their retirement using capital released from their homes. From 1 July 2018, retirees can make downsizer contributions and use the contributions to access superannuation retirement income products (subject to their transfer balance caps).
Downsizer contributions are also exempt from the concessional and non-concessional contribution rules and provide scope for retirees in different situations to enhance their retirement outcomes.
This article will examine the rules around making downsizer contributions and discuss some of the planning considerations that can help enhance outcomes for those utilising the new rules.
For a contribution to be a downsizer contribution, the following conditions will need to be met:
- At the time of the contribution, the individual is 65 or over (there is no upper age limit)
- The contribution is in relation to the sale of an eligible property (see below) that the individual or their spouse owned just prior to the sale, and where the contract of sale was entered into on or after 1 July 2018 (there is no requirement to purchase another property)
- The total amount of downsizer contributions in respect of an eligible property does not exceed the capital proceeds, or $300,000 per individual
- The contribution is made within 90 days after the change in ownership of the property (usually the settlement date) unless the Commissioner has allowed a longer period; and
- The contribution is made using the approved form.
Cap on the amount of downsizer contributions
The amount of downsizer contributions is not governed by an individual’s concessional or non-concessional caps (or their total super balance) and can be made in addition to these contributions. However, the amount that can be contributed is capped at the lesser of:
- $300,000 for each individual;
- and the capital proceeds received (before any mortgage repayments).
For example, if a couple received $600,000 from the sale of an eligible property, they can each contribute up to $300,000 as a downsizer contribution. If their property was sold for $500,000 instead, the most they could contribute is $500,000 between them up to $300,000 for each person (the combination does not matter) i.e. each could contribute $250,000 or have one person contribute $300,000 and the other $200,000.
Importantly, downsizer contributions are not deductible and cannot be made in respect of a second property regardless of how much was contributed for the first.
Although contributions can only be made in respect of one eligible property, multiple contributions can be made for that property (to different superannuation funds for example) if it is made within the above cap and timeframe (90 days).
For the property to be an eligible property, it must be located in Australia and cannot be a caravan, houseboat or mobile home. In addition:
- The property must have been owned by the individual, their spouse or their former spouse for 10 continuous years just before the sale of the property. This means the 10-year period is still met where ownership changes between spouses (e.g. relationship breakdown or death of a spouse) during the period. The 10-year period is calculated from the day the ownership commenced to the day it ceased (usually the settlement dates).
There are certain events that do not ‘break’ the continuous 10-year period including where:
- a property was vacant because it was destroyed or knocked down and a new home built;
- a substitute property was purchased and owned for less than 10 years because the former property was compulsorily acquired. However, the former property had to have been initially acquired at least 10 years prior to the sale of the substitute property.
- Note that all conditions of section 118-47(1) of the Income Tax Assessment Act 1997 (ITAA97) need to be met in relation to the purchase of the substitute property, including the requirement that the substitute property was purchased within a year after the end of the financial year that the former property was compulsorily acquired.
- a property was vacant because it was destroyed or knocked down and a new home built;
- The individual must satisfy all requirements (apart from the fact that their spouse owned the property) to qualify for a full or a part main residence capital gains tax (CGT) exemption for that property. The property does not need to be the individual’s main residence for the entire 10-year period or at the time of sale. It also does not need to be owned by both members of a couple for each of them to make downsizer contributions.
For properties acquired before 20 September 1985 (pre-CGT asset), this requirement is still met if the individual would have qualified for a full or part main residence CGT exemption had the property been a CGT asset (it was not an investment property for the entire time it was owned).
There are a number of planning considerations that can help enhance outcomes for clients looking to make downsizer contributions. These include:
- Downsizer contributions will form part of the superannuation benefit’s tax-free component. To maximise the effectiveness of re-contribution strategies, downsizer contributions should be made after the re-contribution strategy has been implemented.
For example, Tom retired on 1 September 2018 on turning 65 with $500,000 in super (all taxable, taxed element). He has not made any non-concessional contributions in the past and is able to access the bring forward provisions to implement a $300,000 re-contribution strategy. He is also planning to downsize his home (expecting to release capital of $300,000) as it’s too big for him to maintain on his own.
If Tom made a downsizer contribution of $300,000 before implementing a re-contribution strategy, his superannuation would have a tax-free component of $300,000 and a taxable component of $500,000 prior to the re-contribution (37.5% tax-free portion).
If he then implemented the re-contribution strategy by withdrawing $300,000, the amount withdrawn would include a tax-free amount of $112,500 (based on the proportioning rule) and a taxable amount of $187,500. This leaves $500,000 in the fund with a tax-free component of $187,500 and a taxable component of $312,500. Once the $300,000 is re-contributed as a non-concessional contribution (3-year bring forward period) Tom’s account balance would be $800,000 with tax-free and taxable components of $487,500 and $312,500 respectively.
Alternatively, if the re-contribution strategy was implemented prior to his downsizer contribution, Tom’s superannuation would have $600,000 as a tax-free component and $200,000 as a taxable component.
- In cases where a person is unable to meet the work test or may not have released additional capital when downsizing, the downsizer contribution rules create a new opportunity to implement a re-contribution strategy. For example, individuals who do not release capital from downsizing their home (for example, they may have moved to a smaller home in a better location) can make a lump sum withdrawal from their super benefits and use those proceeds to re-contribute as a downsizer contribution (without the need to meet the work test or other contribution rules).
- Although downsizer contributions do not count towards an individual’s concessional or non-concessional contribution caps, they do contribute to their overall total super balance. This can impact their ability to make future non-concessional contributions or catch-up concessional contributions.
- The downsizer contributions are not treated differently for Centrelink purposes and are assessable under the pension income and assets tests. This can impact Age Pension entitlements where capital is accessed from an individual’s exempt principal home. Downsizer contributions must relate to a sale of a property which qualifies for a full or partial main residence CGT exemption. This means an investment property which was a former main residence can be an eligible property.
- Where a downsizer contribution does not meet the eligibility requirements (including exceeding the allowable amount), the individual’s super fund will be notified. The fund may assess whether the contribution could have been accepted under personal contribution rules or decide to return the contribution.
Case study – extending a retirement lifestyle
David and Holly (both age 75) have enjoyed their retirement over the last 10 years. They are enjoying an active lifestyle and are in good health (much better than what they thought they would be when they initially retired) and want to continue their current lifestyle for many more years.
After seeing an online advertisement for a retirement village, they are sold on being able to live in a community with other retirees. Being a social couple, they love the idea that they can access the many facilities and participate in activities with the other residents.
Faced with the financial reality of having spent a substantial portion of their retirement savings, they also like the idea that a move to the retirement village will also unlock some additional capital to help them maintain their lifestyle.
Their current home (worth $800,000) is owned by Holly and they have lived there for over 35 years. The only other assets they have include $10,000 in personal assets, $20,000 in a cash account for liquidity and $100,000 in David’s account-based pension (100% taxable component, no untaxed element).
After downsizing into their new home, they expect to net an additional $250,000.
To fund their current lifestyle, they require $60,000 per annum and are topping up their full Age Pension (currently $35,058 per annum) with income from David’s account-based pension to achieve this.
They understand this level of income is unlikely to be achieved forever and nor do they see the need to. However, as a minimum they would like $42,000 per annum to fund their essential needs. While they can live on the full Age Pension, they would feel a lot more comfortable if they always had an amount above it.
David and Holly’s eligibility to make downsizer contributions
As David and Holly are over age 65, have owned their home for at least 10 years and their home qualifies for the main residence CGT exemption if it were sold, they both (despite the home being owned by Holly) will be eligible to make downsizer contributions if the contract of sale was entered into on or after 1 July 2018.
Although their property is a pre-CGT asset, they would still have qualified for the main residence exemption had it been acquired post 20 September 1985.
If their home is sold for $800,000 then David and Holly can make downsizer contributions of up to $300,000 each and will need to provide their super funds with the approved form electing to have the contributions treated as a downsizer contribution.
Incorporating downsizer contributions into David and Holly’s retirement income strategy
To achieve their income objectives, David and Holly can consider the following strategy:
1. Commute David’s existing account-based pension ($100,000);
2. When combined with $250,000 of capital released from downsizing, David and Holly will have a total of $350,000 to contribute to super as a downsizer contribution;
3. Split their downsizer contribution so that each contribute $175,000 to equalise benefits;
4. Use these amounts to commence a combination of income streams for each of them, one which provides a guaranteed level of income payable for their lifetime (such as a lifetime annuity) and another which provides them with income and capital flexibility (such as account-based pensions) to meet income and lifestyle wants.
By implementing the above strategy, David and Holly would be able to:
- Increase the amount they have available to achieve their retirement income goals
- Reduce tax if superannuation death benefits were paid to non-tax dependants
- Achieve a guaranteed layer of income in addition to any Age Pension entitlement for life as well as maintain income flexibility.