Exempt pension income
What SMSF trustees should know on taxation.
Until the 2017 super changes when all the members of a superannuation fund are in pension phase no income tax is payable on the income generated by the fund. When a fund has members that are both in accumulation phase and pension phase a portion of the income will be tax exempt.
When a fund has members in both accumulation and pension phase the trustees have a choice between two methods for calculating what the exempt income will be. The first requires the trustees of an SMSF to have an actuary conduct a review and calculate what percentage of the total income is exempt.
The second method requires the trustees to allocate the assets of the fund between accumulation and pension-phase accounts. Once the investments have been allocated, or segregated as the legislation puts it, the trustees need to keep track of the amounts added to and paid from the investments in each category.
For the accumulation-phase assets this includes income, contributions, profits on sale and the amounts paid for such things as administration expenses, investment costs, lump-sum payments and tax.
The exempt income will be what is being generated by the pension phase assets after allowing for their fair share of the administration and investment costs.
The New Transfer Balance Cap/Limit applying to pension accounts
From July 1, 2017 there will be a limit placed on the amount that a member can have in superannuation pension accounts. This limit will apply to all superannuation pension accounts and not just a pension account with each superannuation fund.
For limit effectively applies from the date that the legislation was passed in November 2016 because any member that exceeds the $1.6 million in pension accounts on July 1, 2017 by more than $100,000 faces higher penalties and taxes.
The new limit will apply in two ways. The first will be those members with superannuation pension accounts at June 30, 2017, and the second will apply to those people commencing a superannuation pension from July 1, 2017.
Those members currently in pension phase will be required to either withdraw the excess of their superannuation pension accounts over the $1.6 million limit all roll over the excess back into an accumulation account.
Anyone commencing a superannuation pension from July 1, 2017 will be limited to rolling up to $1.6 million into a pension account from that date.
Capital Gains Tax relief for members rolling pension accounts back into accumulation
Superannuation members with pension account balances over $1.6 million, that are required to commute the excess portion of the pension balance and roll it back into accumulation, could have been disadvantaged with regard to capital gains tax for the investments that would no longer support a superannuation pension.
In recognition of this there will be transitional CGT relief for superannuation funds that reallocate already apportioned investments between November 9, 2016 and June 30, 2017. The CGT relief will differ depending on whether an SMSF uses the segregation method or the unsegregated actuarial method for identifying pension assets and accumulation assets.
For super funds that segregate their pension assets from their accumulation assets, and a member rolls back into accumulation the estimated excess pension account balance before July 1, 2017, those assets being reallocated to the accumulation account will effectively have their cost base re-set.
To benefit from the resetting the cost base of these investments the superannuation fund must have segregated current pension assets at November 9, 2016, in other words it must have been using the segregation method before the changes were legislated.
In addition, the investment asset must either cease to be segregated pension asset and become a segregated accumulation asset before July 1, 2017, or the fund chooses to use the unsegregated actuarial method for determining exempt income for the 2017 financial year, and the fund chooses to apply for CGT relief by notifying the ATO.
The CGT relief will effectively mean the cost base for all segregated pension assets, that are reallocated to support an accumulation account, is reset to the market value at the time of the transfer. As a result capital gains tax will only be paid upon the sale of those investments on any increase in value from July 1, 2017.
Where CGT relief is claimed for assets care needs to be taken because the ownership period for the one third CGT discount available to SMSFs is also reset. This means if an SMSF member reallocates segregated asset at March 31, 2017, and claims the CGT relief for that asset, if it is sold before April 1, 2018 the one third CGT discount will not be available.
Super funds that use the unsegregated actuarial certificate method for differing between pension and accumulation assets can also apply for CGT relief on the pension assets reapportioned to accumulation assets.
In this situation the cost base of all investments of the superannuation fund are reset at June 30, 2017 to the market value, by there being a deemed sale and buyback occurring on that date. A notional capital gain will be calculated as having been made by the fund on all of its investments at June 30, 2017.
Where an SMSF currently has both accumulation and pension accounts before the roll back of the excess pension transfer limit, the proportion of the notional capital gain relating to accumulation assets can either be included in the 2017 tax return for the SMSF with tax being paid then, or the notional gain can be deferred and declared in the tax return of the year when the asset is sold.
This effectively means any assets that had previously been supporting pension accounts, which have now been classed as supporting an accumulation account, will not be paying capital gains tax on any unrealised gains at June 30, 2017.
An SMSF will not be eligible for the CGT relief unless the amount that a member's pension account exceeds the new pension transfer limit is less than $100,000 at June 30, 2016. There are other concessions available to members that are proactive and make sure that their pension account does not exceed the transfer limit by more than $100,000.
These include no deemed notional earnings being calculated on the excess that would normally be required to be transferred back to accumulation, and no excess transfer balance tax will be payable if the excess is rectified within six months.
To labour a point the best advice I can give for the coming year is don't ignore the superannuation changes. Unless action is taken by members with pension accounts in excess of $1.6 million during the 2017 year they could miss out on capital gains tax relief, have a larger amount be classed as in excess due to deemed earnings, and pay the excess transfer balance tax.
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