One of the more attention-grabbing proposals in the recent Federal Budget is that first home buyers will be able make voluntary contributions of up to $15,000 per year to their superannuation fund to help them buy a home.
The idea of the proposal is that it will help first home buyers save up for a deposit by taking advantage of the lower taxed superannuation regime, as well as allowing them to benefit from the deemed earnings generated by the super fund.
Voluntary contributions are in addition to the standard Superannuation Guarantee contributions and include: salary sacrifice contributions; contributions made by self-employed individuals who plan to claim a personal tax deduction; and non-concessional (after-tax) contributions.
Any voluntary contribution must still be within existing annual contributions caps, which are $25,000 a year for concessional (before tax) contributions and $100,000 a year for non-concessional (after-tax) contributions.
The total amount of voluntary contributions that can be made under the scheme is $30,000.
How does the scheme really work?
For those receiving a salary, concessional contributions can be made via salary sacrifice arrangements.
Self-employed people will be able to claim a personal tax deduction for their contributions.
For both, the amount contributed will be taxed at 15 per cent.
Once in the super fund, contributions will accrue deemed earnings. The deemed earnings rate is currently 4.78 per cent per annum, which is calculated at the 90-day bank bill rate plus 3 per cent.
Then from July 2018, the after-tax contribution plus the after-tax deemed earnings can be withdrawn upon the purchase of a first home.
This withdrawal will be taxed at their marginal rate less a 30 per cent tax offset.
However, it will not count toward the income test for university loans such as HELP/HECS repayments, or family tax benefits or child care benefits.
Non-concessional contributions can also be made to superannuation, and are not taxed when they enter superannuation, but as the contribution is made from money that has already been taxed at the individual’s marginal tax rate, it isn’t as tax-effective.
Here’s our Financy example
Jenny earns a salary of $70,000 and is keen to buy her first home.
She decides to salary sacrifice, from her pre-tax income, $10,000 a year over three years to superannuation under the First Home Super Saver Scheme (FHSSS).
The impact to Jenny’s cash flow would be a reduction in her take-home pay of $6,450 a year, or $538 a month.
In the first year, Jenny’s FHSSS would increase by $8,500 (that is, her $10,000 contribution less tax of $1,500) after the 15 per cent contributions tax is paid.
Furthermore, this contribution would accrue deemed earnings at the current rate of 4.78 per cent per annum less income tax at the super rate of 15 per cent.
So at the end of year one Jenny would have $8,212 available for a first home purchase, after taking into account tax on the withdrawal at her marginal tax rate less a 30 per cent tax offset.
If Jenny were to continue making salary sacrifice contributions for another two years, by June 30, 2020 she would have $25,892 available to purchase a first home.
The benefit of this strategy is that Jenny is able to save for her first home using before-tax money resulting in an annual tax saving of $2,050 (that is, a personal tax saving of $3,550 less $1,500 tax on the contribution).
Taking into account the deemed earnings and tax on withdrawal this equates to a total saving of $6,210 over the three year scenario.
This tax saving is calculated under the assumption that rather than salary sacrifice, Jenny invested after-tax income of $10,000 per annum into a term deposit with an interest rate of 2 per cent per annum over the three years.
This is a significant saving and would put Jenny ahead in saving for a first home compared to saving in a standard bank account from her after-tax pay.
Note, the higher the marginal tax rate, the better the tax saving associated with using the scheme.
With the $25,892 saved through the scheme, Jenny would have a five percent deposit on a property worth $500,000.
This is unlikely to meet the minimum deposit requirement and is also short of most bank lending ratios, so further funds from outside of the scheme would be required for the deposit.
If Jenny had a partner who was also eligible for the scheme and employed the same three year strategy, together they would have $51,784 to purchase a first home.
This would represent a 10 per cent deposit on the $500,000 property.
While the scheme offers a tax-advantaged way to save for a first home, there are some concerns.
We are yet to see how this scheme will operate in practice and how quickly first home savers will be able to access the funds for their deposit.
For instance, with a house auction, funds for the deposit are required on the same day as the offer while for a sales process the exchange cannot occur until the deposit is received.
In addition, the reality is that the amount that can be saved through the scheme alone won’t accumulate enough for most home deposits in major cities.
Another concern is how this scheme will operate for couples where one partner is a first home buyer and the other is not.
It is also yet to be seen how super funds will honour deemed earnings.
Investment earnings can’t be guaranteed so a question the superannuation industry is asking is how will the deemed earnings be funded in years when the fund doesn’t generate returns above the rate used.
The release of funds to purchase a first home under the scheme will be administered by the Australian Tax Office who will assess the individual’s eligibility to withdraw the amount from superannuation.
There is therefore some risk that if the individual doesn’t satisfy this criteria that the amounts contributed could be locked away until retirement.
Nonetheless, the discipline of sacrificing regular amounts to superannuation could be a way for younger people to engage with their superannuation.
And the deposit would tick away over time.
It is likely that people will need a multi-strategy approach and should consider employing other savings strategies in conjunction with the scheme to accumulate a meaningful deposit.