Insight

Negative earnings and the impact on super

08 September, 2020

The impact of COVID-19 on investment markets means many Australians have lower super balances compared to the start of the year. We investigate the impacts on retirement savings.

Impact on tax components

Assuming you can access your super funds, for example because you have retired, the tax you pay depends on your age and tax components within the fund. Super funds can have both tax-free and taxable components and any withdrawal needs to come from a proportion of these components. While you clearly wouldn’t need to pay tax on the tax-free component of your super, there could be a tax liability when accessing your taxable components.

The tax-free and taxable components are only calculated when a super benefit is either:

  • paid as a lump sum to your bank account
  • used to start an income stream such as an account-based pension
  • rolled over to another super fund.

When super earnings have reduced your super balance, your taxable components are only notional, meaning they are only calculated when one of the above events happen.

If there are positive earnings, the super fund will add these to the taxable component. In contrast, if there are negative earnings, the super fund will reduce the tax components in the following order:

  • Firstly reduce the taxable components.
  • Then reduce the tax-free components.

Case study -large negative earnings and the impact on taxable components

Ben has a super fund with a balance of $400,000. It has the following tax components:

Super balance as at Year 1

Tax components

$400,000

$50,000 taxable

 

$350,000 tax-free

Due to a downturn in investment markets his super balance has reduced to $300,000. It  now has the following tax components:

Super balance at Year 2

Tax components

 

Nil taxable ($50,000 – $50,000)

$300,000

$300,000 tax-free ($350,000 – $50,000 with a potential of $350,000 tax-free

  

Since the super balance has fallen by $100,000 and this is greater than the original taxable component of $50,000 it reduces the taxable component to nil. The tax-free component is then reduced by the remaining $50,000 to $300,000.

These amounts are notional values, which means they haven’t yet been calculated. The tax-free component can still potentially be restored back up to $350,000 when there are positive earnings if we assume no rollovers or commutations are made and the fund remains open.

On the other hand, if Ben was to rollover his super fund to another super fund at this point in time, then the super fund needs to calculate the tax components and the negative earnings will now have an actual impact on his super fund as follows:

Super balance in super fund B

Tax components

$300,000

$300,000 tax-free

 

Nil taxable

His tax-free component has been locked in and can only increase if he makes non-concessional (after-tax contributions) or the fund receives a rollover including some tax-free components, otherwise it cannot be restored back to $350,000.

Impact on preserved components

Generally, most people only have preserved super components which they can’t access while they are still working.

However, if you do have unrestricted non preserved amounts for instance, because you have previously met a condition of release, you can access these amounts at any time. Recent investment market declines can affect the ‘Unrestricted non-preserved’ amounts in some circumstances.

As a rule, positive earnings in super funds only increase your ‘Preserved’ benefit. In contrast, negative earnings in super funds impact your preservation components in the following order:

  • First reduce preserved benefits.
  • Then reduce unrestricted non-preserved benefits (URNP).

Super fund earnings are generally credited or debited to your preservation components at 30 June each year. However, this date may differ between super funds so it’s best to confirm the date with your relevant super fund.

Once negative earnings are debited from your unrestricted non-preserved benefit, this amount becomes fixed and is permanently reduced, unlike the tax components explained above.

Case study

Negative earnings impacting super preservation components

Jenny’s super balance as at the end of 30 June 2020 is $300,000. The preservation amounts are:

Super balance

Preservation components

$300,000

$260,000 unrestricted non-preserved

 

$40,000 preserved components

Jenny’s super balance at the end of 30 June 2021 drops by 20% ($60,000) so her super balance is $240,000. The preservation amounts become:

Super balance

Preservation components

$240,000

$240,000 unrestricted non-preserved

 

Nil preserved components

Firstly, the preserved components are reduced to zero. The negative earnings are larger than the preserved components. The excess of $20,000 reduces the unrestricted non-preserved components. Jenny’s super fund calculates her preservation components at 30 June 2021 and the unrestricted non-preserved component reduces by $20,000 permanently.

Later, when investment markets recover and Jenny’s super goes back up to $300,000 her unrestricted non-preserved benefit remains at $240,000. It cannot increase back up to its original value of $260,000 until she meets a new condition of release.

There are ways to avoid the impact of negative earnings on your unrestricted non-preserved benefits, for example by making contributions to your super fund or accepting a rollover from other super benefits before the 30 June calculation date.

To find out more please speak to your adviser.