Losing money on shares doesn’t have to be the end of the world – in fact, there are times when capital losses are actually more lucrative than capital gains. How is that?
Take the instance of an in-specie transfer of shares into a super fund. This occurs when a person transfers their shares from their personal name into their superannuation fund.
Members of self managed super funds (SMSFs) usually make contributions to their super fund in cash – but members are not restricted to building up their super coffers with cash payments. They can also contribute listed shares (domestic or foreign), managed funds, business or commercial property, residential property, bonds and debentures. These are called in-specie contributions, which basically means non-cash payments. Allowable assets that can be transferred into super are listed in the super laws. If the asset is not listed, then it’s illegal to transfer it into the SMSF.
The attraction of holding investments within super is that earnings and capital gains are taxed at a maximum of 15%, compared to marginal tax rates of up to 45% if held in a person’s name. Once a pension is started upon retirement, any income or capital gain is tax free - which is arguably the biggest attraction of super for most Australians.
An in-specie transfer of shares from an individual to a super fund is regarded as a sale; essentially, you are selling the shares and your super fund is purchasing them - while you remain invested in the shares throughout the transfer. Because the shares are sold, capital gains tax must be paid on any share gains made from the date the shares were first purchased to the transfer date into the SMSF.
Capital gains tax is something that most of us like to avoid, and we do this by holding onto shares rather than selling them. But there are times in the market cycle when it might actually be profitable to trigger a capital gains event, particularly if the shares are sitting at losses, or have fallen considerably.
The Australian sharemarket measured by the S&P/ASX 200 index has fallen by 23% over the past five years, with many of our leading blue chips significantly lower than they've been for quite some time. Take, Commonwealth Bank, for instance. It is trading about the same level it was in 2006. Rio Tinto has come off by some 40% over the past 6 months, and BHP is 32% lower. Even market stalwarts like Wesfarmers lower than it was 5 years ago.
The moral of the story is - an in-specie transfer of shares into super at this time will most likely result in a lower capital gains tax liability. But if you delay the transfer to when the recovery starts, your CGT liability will probably be much higher.
As we’ve discussed in previous columns on TheBull Premium, there are limits on how much you can contribute to super each year, and the dollar value of an in-specie transfer is added to any other contributions you make to super for the financial year. You must ensure that you don’t breach those limits or else you could be hit with excess contributions tax of up to 46.5% on any excess.
If you’ve been thinking about setting up a SMSF, or amalgamating your investments into your SMSF, the current market downturn may be an opportune time. Remember, however, that once transferred to your SMSF, these funds are off limits until you reach preservation age, which is at least age 55. So these shares must be designated for retirement purposes; this is not money that you’ll need for upcoming holidays or home renovations (unless of course that you’ve reached preservation age).
Another important point to consider is whether shares have been held for less or more than 12 months. Shares held for over 12 months receive a capital gains tax discount of 50%, whereas shares held for less than 12 months cop the full capital gains tax head on. Clearly, the best shares to transfer are those that have either incurred a capital loss, or, if a capital gain has been made, you only pay 50% of the gain due to having held them for longer than 12 months.
Any capital gain or loss on the shares transferred is included in your personal taxable income, so if you’re at the highest marginal tax rate, then any tax payable on the in-specie transfer may be substantial. In this event, many financial planners recommend that investors delay a large in-specie transfer (particularly one that involves a substantial capital gains tax bill) to the year following retirement.
By delaying the transfer until year one of retirement - when no salary is received - could dramatically reduce the tax bill payable on the shares.
However, remember there are contribution caps to the amount that you can shovel into super in any one year. It would be unwise to wait until retirement, only to be left with a significant chunk of your investments outside of the tax-efficient world of super.
This article is of a general nature only and does not take into account your individual circumstances. For advice, TheBull recommends that you employ the services of a qualified financial adviser.