Debt reduction or super? $1m undeducted contributions?

Today's Financial Review contains a short article explaining how super can be used to retire debt tax efficiently. Its spot on. The new financial planning orthodoxy is to not pay back loans and to instead make tax deductible superannuation contributions with a view to ultimately using the increased superannuation benefits to pay back loans. Its tax advantaged debt reduction, and knocks off up to 31% of the cost of the debt reduction.

We take the strategy even further and say many clients should borrow to pay tax deductible superannuation contributions, ie to take on more debt but match it with a tax efficient growth investment in the hands of a superannuation fund. The immediate tax break of up to 31% of the amount contributed plus the on-going tax break of 45% tax deductible debt but only 15% (at max) taxed income means this is a great gearing strategy.

We are also using this principle with some clients to in effect gear up large undeducted superannuation contributions of up to $1,000,000 per member before 30 June 2007. Interest on amounts borrowed to pay undeducted contributions is not tax deductible, so care is needed and the trick is to borrow for tax deductible business or investment expenses and to use the freed up cash flow to pay the undeducted contributions to the fund

These strategies make more sense the closer you are to age 60, and are a no brainer once you are over about 50.

Some commentators say for younger persons the risks may be a bit too high. They say the risk of adverse legislative change, the risk that the fund's investments will not do that well relative to the market interest rate, and the long term nature of the strategy mae it unattractive for doctors and dentists. We are not that worried about these risks. The history of superannuation reform is to make super better and better, not to make it worse. Beware the government that takes on the baby boomers over super. Its just not going to happen. And economic theory and economic history both predict that on average in the long run the rate of return on growth assets will be greater than the cost of money, even before tax breaks are considered. And have you ever met an unemployed doctor or dentist? I have not. Provided you pay your income continuance premiums on time there are no cash flow worries going forward (and if you get really sick you can take some of the money out of super anyway, although this is really uncommon.)

Tax planning is starting a lot earlier this year. Its the weight of client numbers, legislative changes and planning opportunites. Get in touch now and beat the rush.