Avoid a tax liability

The strategy: To avoid leaving my loved ones with a super tax bill when I retire.

The strategy: To avoid leaving my loved ones with a super tax bill when I retire.

How do I do that? You may have seen the fuss generated by a recent Tax Office draft ruling on retirement pensions - specifically when they start and end. Those dates are important as the investments backing a retirement pension get some tasty tax benefits.

Most notably, investment and other earnings on pension funds are tax-free - unlike other super funds, which are taxed at up to 15 per cent.

The Tax Office has now spelt out that when you die, your "pension fund" ceases to exist unless you've organised for your pension to revert to your spouse or another eligible dependant.

The upshot is the fund will now have to pay capital gains tax on any investments it holds before the proceeds are paid out to your beneficiaries as a lump sum.

Many self-managed super fund investors follow a popular strategy of carrying investments with capital gains from their super fund to their pension fund in the expectation that any tax liability will disappear thanks to the pension fund's tax-free status.

If the draft ruling becomes official, that expectation won't be quite true. While no capital gains tax will be payable if your fund sells the investments while you're alive, the minute you die without a reversionary pensioner, the tax liability will come back to life again.

But that's unfair! How can they do that? While there has been plenty of noisy indignation about this, it is not new. Money has heard from several advisers who say it has always been the case.

It simply hasn't emerged as a key issue because not everyone was aware of it and it doesn't become a concern until people die without someone else being able to carry on their pension.

So what can I do? A financial planner at Halcyon Wealth Advisers, Phil Clinton, says the first message is not to panic. So far, this is only a draft ruling and the most contentious part, that it applies from 2007, may prove too difficult to administer. Clinton says many retirees will not be affected, or the effects will be minimal, as the extent of the potential problem depends on the level of unrealised capital gains in your fund. He says he has been looking at clients' pensions since the ruling came out and in some cases the potential tax liability was small in relation to the size of the fund.

"You need to go back and do a quick calculation of what the tax liability could be," Clinton says. "It may not be a huge monetary issue."

He says one area where it could be a problem is where a self-managed fund has invested in a large asset, such as business property, and held it for a long time in the fund. If the gains are high, he says, you might want to consider selling the property before you die - or at least seek advice on your options.

He says the future tax hit can also be minimised by selling investments and replacing them to refresh the cost base of the investments. But don't sell on Friday and buy it back on Monday, he warns, as that could be regarded as tax evasion.

He says if you have health problems you should take particular care to get your super in order as part of normal estate planning, alongside things such as having a valid will and power of attorney.

And, as this ruling only affects funds that stop paying a pension, it makes sense for retirees to organise a reversionary pension to their spouse or minor child if there is someone to receive it.

"It's purely a matter of being aware of the situation," Clinton says. "It's not something you should panic about but something to manage as part of reviewing your financial arrangements."

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