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Four common technical questions on SMSFs and super reform

We continue to field questions daily regarding the superannuation reforms and in particular the transfer balance cap and segregation when claiming exempt current pension income (ECPI). Here is a summary of some more frequent issues.

Q1. What is the ATO view in relation to segregation applied where the fund has a member with a balance that has grown above the $1.6 million cap?

Where an SMSF has a member who, at the preceding 30 June, had a total superannuation balance (across all their superannuation funds) of over $1.6 million, the fund’s assets cannot be segregated for tax purposes. To claim ECPI, this fund will need to use the unsegregated method and obtain an actuarial certificate. This is true even if the fund’s only member interests are account based pensions meaning that the resulting actuarial certificate will provide a 100% exemption for income.

This test is done each year to determine whether an SMSF is eligible to use the segregated method to claim ECPI. The $1.6 million limit is not indexed or linked to the transfer balance cap so it is likely that more funds will be impacted over time.

Q2. If a fund receives a contribution and immediately starts a new income stream with that contribution, do the trustees need to complete a new set of accounts for the new income stream? Can the fund remain 100% tax exempt if at all other times of the year the fund had only retirement phase income streams?

If a member is commencing a new income stream this will require the trustee to prepare appropriate pension commencement documentation that sets out the terms of the new pension such as calculating and recording the tax-free and taxable components, identifying the type of income stream, the reversionary status, etc.

Assuming the fund is solely supporting retirement phase income streams for the rest of the year, the question here is whether income earned on the day the contribution is received should be treated as segregated or unsegregated. Income earned on all other days of the year must be claimed as ECPI using the segregated method. Whether income earned on the day of the contribution should be claimed under the segregated or unsegregated methods will depend on the documentation and how the fund is administered.

For example, if the documentation identifies that the pension is to commence immediately upon receipt of the contribution with the total value of that contribution, then this may provide sufficient evidence that there was no period where the fund was unsegregated. In this case the fund may be able use the segregated method to claim ECPI for this and all income earned during the year. If income is earned between the time the contribution is received and the time the pension commences and there is no clear segregation strategy documented, then the fund would need to use the unsegregated method to claim ECPI and would require an actuarial certificate for this period.

Note that for the 2017-16 and prior income years it is possible to use the unsegregated method to claim ECPI for all income in this scenario. The required actuarial certificate is likely to provide a tax exemption at or close to 100%. This may prove to be a simpler approach where documentation is not clear.

Q3. It has been said that “segregation for investment purposes is NOT the same as for tax purposes”. Could you elaborate on this and provide some examples?

In order to segregate assets for tax purposes a fund must meet the conditions set out in the relevant legislation (s295-385 or s295-395 of ITAA 1997). Income earned on assets that trustees elect to segregate, or that are deemed to be segregated by virtue of a fund solely supporting account-based type pensions, is exempt from tax and capital gains and losses disregarded. The new rules around disregarded small fund assets means some funds will not be able to use the segregated method from 1 July 2017 onwards.

Despite this, it is still possible for these (and other) funds to notionally allocate certain assets to support specific member interests. While the fund’s overall income tax liability would need to be calculated using the unsegregated method, post-tax income can still be allocated to member interests according to the notional allocation of assets.

For example, consider an SMSF with three members. Bill and Jenny are the parents of Alfred who is an adult child. Bill and Jenny have both pension and accumulation interests, and Alfred is in accumulation. If the trustee assigned a pool of assets to support Bill and Jenny’s interests in the fund, and a separate pool of assets to support Alfred’s interest, then this would typically be segregation for investment purposes but not tax purposes. This could perhaps occur where the parent’s wanted to invest differently to Alfred, but they did not want separate SMSFs.

To have segregation for tax purposes the fund would need to document that specific assets are set aside solely to support retirement phase income stream liabilities in the fund. Any income from those assets is then ECPI claimed using the segregated method. If the trustee was to specify a property as belonging solely to Bill and Jenny’s pension interests, then there would be grounds for that asset to be treated as a segregated pension asset when claiming ECPI. All other assets would remain unsegregated for tax purposes.

Q4. In relation to a commutation made to comply with the transfer balance cap, does this need to happen on 30 June 2017 or can it happen on 1 July 2017? As long as there was a minute in place at 30 June 2017 to ensure that there was no excess transfer balance cap could the commutation could happen on 1 July 2017?

In order to avoid an excess transfer balance at 1 July 2017, commutations to comply with the $1.6 million pension cap must be done prior to 1 July 2017 which is the date at which members will begin to have a transfer balance account. If a commutation is completed on 30 June to bring a member’s balance in pension phase to $1.6 million then no excess will occur when the pension interest is assessed for the first time on 1 July 2017. If the commutation is done on 1 July 2017, the member will have an excess transfer balance on that day.

The commutation documents were therefore generally completed at 30 June 2017 or prior in order to facilitate commutations prior to 1 July 2017. In line with the ATO’s PCG 2017/5 these did not need to specify the actual commutation value as it is understood the amount of the commutation required may not be known until post 1 July 2017 when the fund accounts have been finalised.

It is also worth noting that to be eligible for the CGT relief the member should have taken an action to comply with the transfer balance cap prior to 1 July 2017. Effecting the commutation on 1 July 2017 may not meet this requirement.

 

Melanie Dunn is the SMSF Technical Services Manager at Accurium Pty Limited. This is general information only and is not intended to be financial product advice. It is based on Accurium’s understanding of the current superannuation and taxation laws. Examples are illustrative only. No warranty is given on the information provided and Accurium is not liable for any loss arising from reliance on or use of the information.

9 Comments
Frank V
June 05, 2019

RE- Q2
"For example, if the documentation identifies that the pension is to commence immediately upon receipt of the contribution with the total value of that contribution, then this may provide sufficient evidence that there was no period where the fund was unsegregated."

If a member has an accumulation account with a nil balance at beginning of the day and then a contribution is made and within a few hours a pension is commenced with the total value of that contribution, so that the accumulation balance is nil at the end of that same day, would this provide sufficient evidence that there was no period where the fund was unsegregated ??

Brian
December 03, 2017

Hi Melanie -- a related complexity of the new transfer balance cap is the situation that will arise for many older couples on the death of one partner.
Where the deceased's super interest flows to the surviving partner such that their TBC would be exceeded, they must remove the excess from super.

My understanding is that where a reversionary pension provision is in place, the surviving partner has up to 12 months to take the necessary steps, but otherwise these steps must be taken reasonably promptly after the death.

Two basic questions:
1. Can reversionary pension provisions be added when a SMSF is already paying account-based pensions, assuming that the Trust Deed allows them?

2. Do binding death benefit nominations also result in this 12 month grace period? If yes, does the BDBN path offer a simpler implementation?

Regards, Brian

Stephen H
December 06, 2017

Brian:

I’ll leave Melanie to answer your specific queries, but can I take issue with your assumption “where the deceased’s super interest flows to the surviving partner such that their TBC would be exceeded, they must remove the excess from super”.

We are on common ground that the survivor’s TBC cannot exceed $1.6M, but that doesn’t mean that any excess can’t stay in super, albeit in an accumulation account (income taxed at 15%).

Assume that both spouses have a TBC of $1.6M, and that at the time of death investment earnings have increased each pension balance to $1.8M. Total SMSF assets $3.6M. Remember that investment earnings and pension payments don’t impact the TBC balance. On death of first party, survivor could commute his pension back to accumulation account, which would result in his TBC having a negative balance of $0.2M, because his TBC must be debited by the capital value of the commutation. $1.6M - $1.8M = ($0.2M). He could then accept his late wife’s reversionary pension (and the related $1.8M credit to his TBC), because his TBC would still be within the $1.6M limit ($0.2M) + 1.8M = $1.6M. Total funds within SMSF still $3.6M, of which $1.8M in pension mode (tax free) and $1.8M accumulation mode (15% tax).

Brian O’Flynn
January 16, 2018

Thanks Stephen.
Belated Happy New Year!

You are quite right, as I oversimplified my “must remove” statement by thinking ahead to my two questions! Your illustrative example should help others.

I’m hoping that Melanie or other knowledgeable folk can shed light on my two questions.

Cheers, Brian

AlanB
December 02, 2017

I am a retiree and a SMSF trustee/member. I don't understand this stuff.

Our savings were once in joint names invested in shares. Then I was persuaded to transfer these shares into a SMSF.
Now I am supposed to know about transfer balance caps, exempt current pension income, pension commencement documentation, tax-free and taxable components, type of income stream, reversionary status, segregated or unsegregated contributions; segregation strategy, relevant legislation (s295-385 or s295-395 of ITAA 1997), notional allocation of assets.....

And I thought retirement was supposed to be about fishing, travel and walking the dog.

The government, with the connivance of the accounting and legal profession, has added layers of unnecessary complexity necessitating accountants to prepare more detailed tax returns and financial statements, lawyers to interpret regulations, auditors to ensure I comply with legislation before accessing my own savings, specialists in annual trust fund updates, tax audit insurance companies and other providers of services I did not know I needed.

I thought the sole purpose of a SMSF was to provide for my retirement. Now I understand the sole purpose of a SMSF is to provide the accounting and legal profession with a stream of lucrative fees as they implement a wealth transfer from retirees to themselves.

A SMSF is no longer a self-managed superannuation fund. A more accurate description is an AMSF: accountant-managed superannuation fund.

Cester
December 03, 2017

Insightful comments by AlanB. The government is failing us yet again by introducing this complexity.

mr.auspicious
December 07, 2017

Couldn't agree more - paying tax on a portion of super income is one thing - why has it
become necessary to impose layers of mindless bureaucratic complexity such as additional reporting requirements ??

All smsf's have been subject to an annual compliance audit from suitably qualified practitioners which, to the best of my knowledge, was a straightforward, effective and relatively inexpensive process.

Apparently that regime was not operating satisfactorily for politicians seeking to
justify their existence by introducing a " reform " agenda. What is obvious, judging by uncertainty that persists in the smsf industry, is that certain misguided members in government have attempted to fix a problem, that by my reckoning, never existed .



,

Being Frank
November 30, 2017

Thanks but gosh, it's all so difficult to remember and confusing – how many people, advisers or trustees, actually understand this stuff! It's our retirement money!

Peter
November 30, 2017

If you or your advisor do not understand this stuff, then perhaps a SMSF is not for you.

Perhaps a very low cost fund that uses an indexing strategy is the way to go.

There are a few not for profit funds that have indexing options available with tiny management expense ratios.

 

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