Finding CGT relief in an SMSF

Summary: Clarifying what the new segregation-proportional method changes mean for SMSFs and how to navigate these from a tax perspective, determining which assets can be revalued under CGT concessions, and shedding light on life insurance policies.

Key take-out: If an SMSF uses the proportionate method, where an actuary calculates how much of the fund's income relates to pension fund members and is therefore not taxable, the SMSF may choose to claim the CGT relief on any or all of its assets.

Question. My wife and I are in our seventies, members of an SMSF, and each have entitlements in excess of $1.6 million. One of our assets returns more than 30 per cent per annum and the balance 6-7 per cent. Can we elect to have the high-performing asset in a pension fund, with the income there being tax-free, and place our poorer performing assets in accumulation?

Answer. Unfortunately one of the reforms brought in as a part of the $1.6 million pension transfer balance cap (PTBC) was stopping SMSFs from using the segregation method. From July 1, 2017 an SMSF, which has a member with a superannuation balance of more than $1.6 million, cannot use the segregation method when calculating how much income relates to accumulation fund members and how much relates to pension fund members.

An item related to this reform has not yet been widely understood. As part of super funds being able to claim the Capital Gains Tax (CGT) relief for assets transferred back to accumulation, is that a fund must cease using the segregation method and use the proportional method at the latest of June 30, 2017.

This means from July 1, 2017 all the income from your SMSF is subject to the proportional method when assessing how much of the income earned relates to pension fund members and is therefore not taxed.

For example, if your pension accounts were both worth $2.4 million, and you each rolled back $800,000 to an accumulation account, all the income of the fund would be combined and then split between the pension accounts and the accumulation accounts under the proportionate or actuarial method.

In rough terms, one-third of the income earned by the fund would be taxed at 15 per cent, with the remaining two-thirds untaxed due to it being related to the pension accounts.

If you wanted to maximise the amount your pension accounts increase, you could consider rolling over the total value of your accumulation accounts into another super fund. As part of this process, you would leave the asset earning 30 per cent per annum while converting the lower earning assets into cash to be rolled to the other super fund.

From doing this, the income earned in your SMSF would be allocated to the pension accounts, including the income earned on the asset returning 30 per cent, and not taxed in your SMSF. This should result in your pension account increasing above the $1.6 million limit and being able to remain in pension phase.

Before taking any action you should seek professional advice to make sure the strategy of rolling your accumulation accounts into another fund would be suitable for your personal circumstances.

Question. Is there a limit placed on the value of assets that can be revalued under the CGT concessions? If so, what is measured – is it the total value of the assets at June 30, or is it the difference in value between the purchase price and valuation at June 30, or something else? And is it limited to the amount that is transferred between pension and accumulation, assuming this is greater than the minimum, or the minimum that must be transferred?

Answer. The first thing to establish when assessing the value of assets, which will be eligible for the CGT concession, is whether the SMSF is using the segregation method or the proportionate method for assessing the tax payable on income earned by the fund.

If all the fund's members are in pension phase for the entirety of fiscal 2017, it will be classed by the ATO as automatically subject to the segregation method. Under the segregation method, the CGT concession is only available on the value of the assets transferred back to accumulation account. That's so the member does not breach the $1.6 million PTBC.

If the fund uses the proportionate method, where an actuary calculates how much of the fund's income relates to pension fund members and is therefore not taxable, the fund may choose to claim the CGT relief on any or all of its assets.

In other words, under the segregation method the fund can only claim the CGT concession on the value of assets that exceed $1.6 million. Meanwhile, under the proportionate method, a super fund can choose to revalue and claim the CGT relief on all its assets, not just the excess over the $1.6 million.

The value of the assets rolled back to accumulation is used, and not the unrealised capital gain (being the difference between its cost and market value at June 30, 2017). This is the rule regardless of whether a super fund is forced to use the segregation method, or is using the proportionate method and selecting those assets be eligible for the CGT concession rather than claiming the concession on all assets.

It is clear from the explanatory memorandum related to the introduction of the Fair and Sustainable Superannuation bill that CGT relief cannot be abused to gain a tax advantage for an SMSF. It states, “The CGT relief arrangements are only intended to support movements or re‑proportioning of assets and balances necessary to support compliance with the transfer balance cap and changes to the TRIS.  It would be otherwise inappropriate for a fund to wash assets to obtain CGT relief or to use the relief to reduce the income tax payable on existing assets supporting the accumulation phase”. 

Question. I am 55 and have an insurance policy for $1 million in my SMSF. At my age the policy premiums are increasing rather steeply. I didn't mind so much when I was able to put in $35,000 a year, but it obviously makes up a bigger portion of the $25,000 that we are limited to putting in now. What are my options?

Answer. One of the first things you should assess is whether you need $1 million in life insurance. The amount of life insurance a person should have should firstly be enough to pay out all liabilities and loans, and then to provide extra capital for the fund if the super fund can't sufficiently provide an income, in the event of death of the member.

If it turns out you need the $1 million in life insurance you should assess whether the current policy is the best value for money. Sometimes policies are sold by financial advisers who work for just one company.

If the cost of the insurance to your SMSF is still extremely high, you could consider becoming an accumulation fund member with an industry fund which has lower insurance costs due to its buying power. You would then have your compulsory superannuation contributions made to the industry fund with any excess contributed to your SMSF.

You should seek independent professional advice to assist you in assessing how much insurance you should have and determining the most cost-effective alternatives.