The transfer balance cap applies from 1 July 2017 and places a $1.6 million limit per person on the amount of savings that can be moved into the tax-free retirement phase of superannuation.
This means retirees who have balances in excess of $1.6 million will likely have both a retirement phase pension and a non-retirement phase accumulation account in superannuation unless they withdrew the excess from the superannuation system.
For some SMSF retirees, this may be the first time since moving into retirement that their fund has had an accumulation interest. It may also be the first time the fund has had a mix of pension and accumulation balances.
Here are eight things you need to think about when running an SMSF that is not solely in retirement phase due to the transfer balance cap.
- Separate accounts need to be maintained for pension and accumulation
Where a member has both pension and accumulation accounts in the SMSF, the trustee must allocate fund income and expenses on a fair and reasonable basis between the two accounts and members in the fund. They also need to keep track of an accumulation account and a pension account balances for the members. This does not mean the trustee needs to allocate specific assets to belong to each member or account, and indeed, from a tax perspective the trustee is not allowed to segregate assets.
- The fund may be eligible to claim a tax deduction on some fund expenses
General fund expenses that must be apportioned can only be claimed as a deduction in the annual return to the extent they were incurred in producing assessable income. Now the SMSF has an accumulation interest, it is likely to have assessable income and so the trustee may be eligible to claim part of those expenses as a deduction to offset taxable income in the annual return. A common industry approach is to use (1 – actuarial exempt income proportion) as the deductibility proportion. Tax Ruling 93/17 also provides another method and further information on apportioning expenses.
- Capital losses can be carried forward
Capital gains and losses on assets solely supporting retirement phase income streams are generally disregarded. This means gains are exempt from tax but also that capital losses cannot be carried forward to offset future capital gains. Where an SMSF with an accumulation interest realises a capital loss that is first offset against any current year capital gains, and if the result is a net loss this can be carried forward to future years to offset against future gains.
- Strategic thinking is required when taking benefit payments from the fund
When a payment is taken from the SMSF, the trustee will need to identify what interest the withdrawal was taken from, either pension or accumulation. There are pros and cons to each option:
- A minimum payment must be made from each pension as a pension payment in order to meet the legal requirements of having an income stream eligible for an exemption from income tax. So at least one payment in the year needs to be a pension payment and it must be enough to meet the minimum payment standards.
- Where a member wishes to draw above their minimum requirement in a year then they should consider taking that additional amount as a lump sum from their accumulation interest. This means a larger balance stays in the tax-free retirement phase, reducing the SMSFs future tax bills. For members under age 60 lump sums paid up to the lifetime low rate cap ($205,000 for 2018-19) are tax free.
- Payments can also be taken as a lump sum payment from a retirement phase pension. This payment does not count towards minimum pension requirement and is treated as a lump sum for tax purposes. Lump sums paid from pension accounts will be debited form the individual’s transfer balance account, meaning more room under the $1.6 million cap if needed in the future (e.g. receiving a death benefit income stream). Lump sums paid from retirement phase pension must be reported under the transfer balance account reporting requirements.
- Consider opportunities to even up retirement phase balances to reduce taxable accumulation interests in the fund
Each member in the SMSF has the lifetime transfer balance cap of $1.6 million. Where one member has a large balance which exceeded the $1.6 million cap resulting in an accumulation interest, but the other member has a balance in retirement phase under $1.6 million, consider moving some of those accumulation assets into retirement phase for the other member. The member would need to be eligible to make/receive contributions and consideration needs to be given to whether it is appropriate for the first member to give up their entitlement to those assets. That is, as part of the other member’s interest, those monies would be payable to their beneficiaries on death not those of the original member. But for some couples looking to maximise exempt income in their SMSF, this may be a strategy to help maximize the value of superannuation in retirement phase. Take care not to fall foul of the complicated contributions and transfer balance cap rules.
- Accumulation accounts will still form part of your superannuation death benefit but cannot be taken as a reversionary income stream
An accumulation account is a separate interest to any retirement phase pension in the SMSF. As such, a separate superannuation death benefit will be payable when a member passes away. It can be documented as such so that the accumulation interest is paid to a different beneficiary to the retirement phase pension if so desired upon death. However, an accumulation interest can only be taken by beneficiaries as a death benefit income stream or lump sum. It will not form part of a reversionary income stream, even if the pension from which the accumulation balance was commuted was a reversionary pension. The beneficiary will also not have the 12-month grace period under the transfer balance cap rules like that received from reversionary income streams. The beneficiary will need to decide as soon as practicable whether to take the death benefit as a lump sum and withdraw it from super, or as a death benefit income stream subject to their own transfer balance cap.
- Franking credits can be utilised
Under the Labor Party proposal, franking credits would be lost if fund assets were solely supporting retirement phase income streams producing exempt income. However, where a member has an accumulation account, franking credits can be used to offset the tax liability on the remaining assessable income.
- Income earned on fund assets will not be 100% exempt from tax
The SMSF is likely to have disregarded small fund assets and as such be required to use the proportionate method to claim exempt current pension income (ECPI). This means that an actuarial certificate is required prior to completing the SMSF annual return. The actuarial exempt income proportion will identify what proportion of the fund’s assessable income will be exempt from income tax.
A fund has disregarded small fund assets where it has a retirement phase account in an income year and so is eligible to claim ECPI, however at the prior 30 June any member in the SMSF had a total super balance in excess of $1.6 million. This total super balance includes accumulation and retirement phase accounts both in the SMSF and elsewhere in superannuation.
Written by: Melanie Dunn, SMSF Technical Services Manager at Accurium