Nick Bruining: The twist in contribution cap rules that can give cashed-up teenagers a super head start

As crazy as it seems, a teenager who starts work today has an opportunity to access a $132,500 tax-deductible investment and — potentially — set themselves up for retirement. That same 18-year-old could be worth more than $1.9 million at age 60, without any additional money being set aside. Fly-in, fly-out workers, young sport stars, social media celebrities and beneficiaries of a deceased estate might be some of those lucky enough to be earning high incomes and looking to reduce their tax bills by using a safe and perfectly legal strategy. And it’s not just for young taxpayers, but almost anyone who receives a large taxable payment during the year. Based on superannuation, the strategy makes use of a quirk in the special carry-forward cap rules that apply to concessional contributions to super. A concessional contribution is one where a tax deduction has been claimed. It includes the employer’s 11 per cent compulsory superannuation contribution, but also voluntary contributions such as salary-sacrificed amounts or payments made directly to a fund and claimed as a personal tax deduction by the member. It is the latter type of contribution which lies at the heart of this strategy. Under the current rules, the annual concessional contribution limit — or “cap” — for an individual is set at $27,500 a year. It increases in $2500 increments and is linked to average weekly ordinary time earnings. It was increased from the initial $25,000 cap limit three years ago and many believe it will rise to $30,000 next July. Provided the member’s account balance is less than $500,000 on June 30, an individual can carry-forward unused cap amounts for up to five years. Including this financial year, a person who received no compulsory super over the past five years now has two years at $25,000 plus three years at $27,500 — or a grand total of $132,500. And here’s the twist — the rules do not specify a minimum age for the carry-forward contribution cap to start accumulating. In essence, the carry-forward cap starts accumulating the moment a child is born. Age restrictions kick in at the other end of life, when you reach 67 years of age. While the carry-forward concessions still apply, between the ages of 67 and 74 you must satisfy a work test where you must work at least 40 hours in a consecutive 30-day period to be able to make a concessional contribution to super. Our 18-year-old who makes a $132,500 tax-deductible contribution to super now will see at least 15 per cent come out as a contribution tax. If their total income exceeds $250,000, this tax effectively increases to 30 per cent, which is still much less than their marginal tax rate of 45 per cent. Assuming the 15 per cent contributions tax applies, that leaves $112,625 to be invested. Given our young member has 42 years to go until he or she can access the benefit tax-free at 60, it makes sense to invest the funds in a long-term growth strategy. While there’s bound to be a share market crash or two between now and retirement, an average return of 7 per cent a year over that period would see the super pot grow to $1.93 million by the age of 60. You can thank the magic of compound returns for that. According to research house Chant West, the 31-year average return for a “growth” type fund is 7.8 per cent a year. That also assumes no other money is invested between now and retirement. If our teenager just receives compulsory super over that same period, in addition to the $132,500 contribution at age 18, they would be looking at a superannuation benefit easily exceeding $5m by the time they reach retirement. Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association