Background
It might not be top of the barbecue chat list yet, it is rapidly becoming the hot topic for superannuation savers. Members are finally realising they do have control over their savings destiny due to extreme volatility in the market. But it is possible to control tax on income which is earned by your superannuation fund. The catch is that you must be at least preservation age which is 55 years for those born before 1st July 1960.
Once you reach preservation age, you can access your superannuation benefits and convert your balance in super from accumulation phase to pension phase. To change your superannuation benefit to pension phase means a whole lot of documents need to be executed by the member including a pension agreement.
The trustee of the fund must follow the trust deed and pension agreement to commence a pension and make pension payments (income stream) to the member. The member must withdraw a minimum amount of pension from their super fund account to maintain the pension as a complying pension.
Click here to learn how to commence a pension
The minimum withdrawal amount is a percentage of the account balance at the start of the financial year or if the pension commences during the year, the purchase price of pension with adjustments for the number of days left in the financial year.
Once pension commences, income earned by assets supporting a pension is tax free to the fund (Section 295 F of ITAA 1997). All income of the fund may not be tax free, as some members could still be in accumulation phase or the member withdrawing the pension could still be working and the employer contributing to the same fund in accumulation account of the member.
Once a pension commences, SIS Regulation1.06(1)(a)(ii) of the SISR 1994 do not allow trustees to add more money's to the pension account, all these contributions then go to a newly created accumulation account. Each pension is a separate superannuation interest of the member (Section 307-200.05 of the ITAR 1997).
A lid is put on the pension account for additions however the pension account of member can increase by allocation of yearly income. Since there is no income tax charged to the account, the pension account can reduce by pension payments to the member or in case of court order split due to a marriage breakdown.
If your trust deed allows, you can roll over the pension back to accumulation phase (internal roll over) where the pension money's will mix with other money's in accumulation account (if any) and commence a new pension (Section 307-125(3) of the ITAA 1997). This is usually done on 1st July each year, when members are in Transition to retirement pension, this is called "refreshing your pension".
Click here to update your trust deed
Need for Actuarial Certificate
Any income from assets which are held to provide for super income stream benefits to members is exempt from income tax. This is referred to as exempt current pension income (ECPI). A SMSF cannot automatically claim ECPI, it must either have segregated pension assets or if the assets are not segregated, it must obtain an actuarial certificate before lodging its income tax return.
If fund assets are considered mixed or un-segregated, some of the income of the fund is tax free (belonging to pension accounts) and some income is taxable (belonging to accumulation accounts). When assets are mixed, then trustees, members or accountants cannot determine what percentage of income is tax free and what is taxable. As per section 390 of ITAA 1997, an Actuarial certificate is required to determine these proportions.
You will need an Actuarial certificate only if your SMSF is paying a pension. All member balances must represent all assets of the fund which are valued at market value: Assets = Member liabilities. Hence member liabilities are counted by an actuary and not mixed assets when calculating ECPI percentage.
Once you commence an income stream (pension) for the member, you can keep the pension assets separate (segregated) from non pension assets of the fund. This way, whatever the pension assets earn can be clearly identified and pay no tax.
Segregation of assets can be difficult as trustees will have to maintain two bank accounts, one for collecting income from pension assets and the other for banking contributions and income from accumulating assets (or reserve account).
The ATO's view of what is segregation as set out in the NTLG Superannuation Technical Minutes of March 2010 is very strict. A part of the asset cannot be considered to be segregated for example a property or a bank account.
If income of pension assets is banked in the wrong account, even once, then trustees will be considered not to have maintained "segregation of pension assets" to the true sense. As per legislation, pension & non-pension assets would be considered mixed. The choice, trustees will then have to use the un-segregated, actuarial certificate percentage of income method.
Learn how to add a member to your smsf
Segregated Assets
SMSF has "segregated assets" if the trustee have set aside certain assets so that the income from these assets can be specifically identified as having the sole purpose of paying a super income stream benefit (pension)
If SMSF is on pension phase only for part of the year (converted accumulation account to pension account during the year) then you will need an actuarial certificate even if the all assets of the fund are segregated for pension members for the rest of the year because the income is deemed to be earned for the whole year. Hence any capital gain on sale of an asset after commencement of pension during the year can also be partially assessable.
If two members are on pension phase and two members are in accumulation phase, then segregation is between pension assets and accumulation assets, which mean that within the pension pool the assets of the two member's assets can be mixed.
If your SMSF is paying an allocated pension, market-linked pension or account-based pension in addition to other types of super income stream benefits, such as complying pension and the assets of the fund are segregated, you will still need an Actuarial certificate.
When you commence a pension and where capital gain is likely on some assets, segregation of assets which are expected to rise in value should be segregated to the pension pool in anticipation for future exempt capital gain.
For example: A SMSF had $250,000 on 1st July 2011 of which $170,000 was the market value of shares and managed funds and the balance in a bank account. If $191,000 belonged to the member who was converting his account to pension phase, in anticipation of future exempt capital gain, all shares and managed funds should be allocated to the pension pool and another bank account should be set up $21,000 for the pension member.
Note that in the above example, if the pension member had only $125,000 it would be very difficult to create a pool of assets totalling to the exact balance (some shares and managed funds to be segregated) for this member. Further any segregation of assets should also be allowed by the fund trust deed.
By segregating the fund's assets the trustee may save actuarial certificate fee but it can involve two funds operating within one SMSF and extreme care is needed in depositing income to the correct pool.
Click here to set up a SMSF
Un-segregated assets
Where assets supporting accumulation and pension accounts are not segregated, assessable income are determined on a proportional basis. This concept simplifies the preparation of the fund accounts but requires an actuarial certificate.
The advantage of this method is that it reduces the amount of extra accounting work regardless of the number of different investments and it is relatively simple and cheap to obtain an actuarial certificate.
Click here to apply for an Actuarial Certificate
How is Percentage of exempt income calculated?
The principal is relatively simple; assets earn income, to determine how much income is ECPI, we need to know quantity of pension assets at the beginning/ during and at the end of the year = compared to total assets = average pension assets / total average assets.
To work out this percentage, what the actuary needs to know, opening balance of the year of pension members as compared to accumulating members and during the year what were the movements in these two accounts, like contributions, deductions (such as life insurance etc), pension payments and end balance.
Accumulating accounts can have new contributions but no withdrawals, whereas pension accounts can have only withdrawals but no new contributions, extreme care is required in providing fund data to the actuary.
The date and amount of contributions and pension withdrawals can play a significant part in determining exempt percentage. As any large amount of either two (contribution or pension payment) at either the beginning or at the end of the year can skew the percentage in any direction.
For example a small accumulation account on 1st July can become a big account with new large contributions similarly a big pension account on 1st July can become a small account with huge amounts of withdrawal early in the year. Hence to work out "average balance" of each account, correct method is to track movement of the pension / non-pension accounts on daily balance basis.
The tax exemption is based on the proportion of the SMSF's average value of current pension liabilities compared to its average value of super liabilities. These calculations do not include assets which are segregated current pension assets.
If the fund has income tax losses, not capital losses, the loss amount is reduced by the net ECPI amount. Any remaining tax losses can be offset against the SMSF's assessable income
Click here to learn how your SMSF can borrow
How to increase Exempt Current Pension Income
There are strategies available to increase ECPI, such as;
1) Commence pension early : If condition of release (age of member) for the pension has been reached and the minimum pension requirements are satisfied, then making the pension commencement date as early as possible will improve the tax free percentage.
2) Minimum pension not withdrawn: The fund is not entitled to claim any amount for exempt pension income under either Section 295-385 or 295-390 if the minimum prescribed amount is not withdrawn. If no amount is withdrawn then exempt percentage cannot be claimed, then the only alternative is convert the fund back to accumulation phase. However, if the member is above 55 years below 59 years of age it is possible to include the minimum withdrawal amount as PAYG withholding amount and issue a PAYG payment summary with the same amount as payment withheld.
For example Smith Family Super fund has only one member, Rodney Smith who was 56 years old as on 1st July 2010 and had $1,000,000 amount in pension phase; there is no accumulation account as on that date. In the 2010 / 11 year, his employer contributed $50,000 as employer contributions and as salary sacrifice by quarterly instalments. The fund earned $200,000 as capital gain, interest and dividend income. Rodney was supposed to withdraw minimum of 4% (half minimum allowed) before 30th June 2011 but he forgot to withdraw any amount.
The advisor can issue a PAYG certificate with a gross and tax amount of $20,000 and remit $20,000 to ATO for PAYG withholding after 30th June 2011 and still have the fund in pension phase and claim a percentage of ECPI instead of paying income tax @ 15% on $200,000 income.
3) Less than minimum amount withdrawn: It is possible to roll back part of the purchase price of pension back to accumulation phase to ensure that minimum withdrawal is in sync with the pension amount.
Assume the same example above, but this time Rodney is over 62 year old and instead of withdrawing no amount, he has withdrawn only $10,000.
The way to fix this problem is to roll back $1,000,000 pension amount to accumulation account as on 1st July 2010 and commence a pension with only $500,000 and leave the balance in accumulation account. This strategy will at least save half the tax as some balance would be in pension phase and the minimum pension payments will now be satisfied as it is sync with the pension amount withdrawn ($10,000 is 2% of $500,000). Extreme care is required for this strategy as the trust deed must allow for internal roll over.
4) Payment of death benefit: The ATO has issued a draft ruling that the pension mode stops on date of death of the pensioner. Any income or realised gains on assets sold to pay lump sum superannuation death benefits will be fully assessable if assets are segregated for the pensioner. If assets are un-segregated, some of the capital gain may become tax free if the assets are sold quickly after death.
Further the longer the assets are in accumulation phase (after death), the more income the fund is going to earn. Hence it will be advisable to payout the lump sum as early as possible.
5) Time of withdrawal: The higher the pension account, the favourable the ECPI percentage. This means that pensioner should delay, if circumstances permit, to withdraw the minimum amount till the last week of the financial year.
Click here to learn how to change corporate trustee of your SMSF
Can expenses be claimed where the fund is paying a pension?
Where an expense is incurred which relates to both accumulation and super income stream based income, the expense must be apportioned so that only the proportion of the expense relating to the production of assessable income is claimed.
Some specific expenses can be claimed in full, whether they provide exempt or assessable income, such as supervisory levy and death and disability premiums, these expenses should be paid out accumulation accounts.
When you do not need an Actuarial Certificate
- Funds that have all members in pension phase and no accumulation accounts, as they are considered to be 100% tax free and segregated.
- When no pensions are being paid by the SMSF, Which means that all members are in accumulation phase.
- When all pension assets are segregated from non-pension assets.
Click here to apply for an Actuarial Certificate
When do you need to apply for an actuarial certificate?
You need an actuarial certificate before you can prepare the SMSF Annual return for the income year. Once the income tax return is prepared with correct claim of ECPI, you will need to get the fund audited before lodging the return with ATO. The auditor must check that ECPI is correctly calculated and reported.
SMSF income tax return form requires you to declare all income of the fund; however you can claim exempt pension income as a deduction to arrive at taxable income of the fund. Note that contributions are always taxable and if there is any special income (such as related party dividends) it cannot be exempted.
How our system works
Our internet based question and answer style Actuarial certificate data collection system has been designed for accountants and trustees of a self managed superannuation fund to provide sufficient accounting and transaction data for the Actuary to provide an actuarial certificate to support exempt current pension income under Section 390 of ITAA for the fund to claim exemption from income tax in the funds annual tax return for only Allocated Pension, Market Linked and Account based pensions.
Our Actuary can directly (not automated) supply actuarial certificates where the fund is paying complying pensions. Please phone our office on 02 9684 4199.
Our online Actuarial Certificate application process should not take you more than 10 minutes to complete and not more than 3 minutes if you are applying on our system for the second year for the same fund as the data of the fund can be rolled over from the previous year.
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