Tax with Max: More pension cap questions

Q. I don't understand the concept of selling shares to crystalise capital profits prior to the introduction of the $1.6 million cap. Why would this need to be done, as the shares are shown at their market value each year and as a result the gains have already been recognised?

ANSWER: Just because the shares held in an SMSF are shown at their market value each year does not result in the gain being recognised for tax purposes. The increase or decrease in the market value of shares results in an unrealised gain or loss that does not affect the tax paid by a super fund.

This means if the shares in your fund had a cost of $500,000, and over time have been revalued to a market value of $1m, your fund has unrealised capital gains of $500,000. The strategy to sell shares while still in pension phase, before assets are allocated to an accumulation account due to exceeding the $1.6m pension transfer cap, would result in a tax-free gain being made.

Thankfully, the legislators when drafting the legislation introducing the $1.6m pension transfer balance cap included capital gains tax concessions. The CGT concessions mean, where a member has to transfer assets back to accumulation to reduce their pension account balance to below $1.6m, the member can choose to have the value of the assets reset to their market value at that time.

This means the strategy of selling shares while still in pension phase is not necessary. As a result of the CGT concession, the shares in a fund transferred back to accumulation will have protected any unrealised capital gain that has built up over the time the shares were held.

Q. I am not sure how an SMSF should process the Transfer Balance Cap and Transfer Balance Account? For the accumulation account receiving the excess over $1.6m, are we expected to have a different HIN and separate cash holding account? Given that segregation ends on June 30, I am presuming that the old system of having an accumulation sub-account under the main pension account is no longer acceptable.

ANSWER: There are no extra actions that trustees need to take when assets are transferred back to an accumulation account due to a member exceeding the $1.6m limit. Just because a fund has been in pension phase for many years there is nothing stopping the excess being commuted back to a new accumulation account set up to receive the excess.

There will not be a need to change share registrations such as a HIN, and also there will be no requirement to set up a new bank account that would be linked to the accumulation account. Super funds have always been able to have members in both accumulation and pension phase.

Because SMSFs with a member that has exceeded the $1.6m cannot use the segregation method, this requires them using the proportional method. Under the proportional method an actuary calculates what portion of the income each year relates to the pension accounts and what relates to accumulation accounts.

Q. I receive two pensions from my SMSF. One is account based and the other is a market linked pension with an initial term of 20 years. I am now halfway through that term meaning that, in the current financial year, the payment factor will be 9.0. How will my market linked pension be valued for the $1.6m cap?

ANSWER: The legislators have thought of everything when it comes to assessing whether someone will exceed the $1.6m pension limit. For lifetime pensions the annual pension receivable is multiplied by 16 to arrive at a value for the pension limit.

For market linked pensions the value is calculated by multiplying the annual pension receivable by the number of remaining years for the defined benefit period, rounded up to the next whole number. This means in your case if your pension will be $100,000, and with 10 years to go, the value of your defined benefit pension for the $1.6m pension limit will be $1m.

Q. My wife and I have equal 'proportions' in our SMSF and are both in pension phase. The assets of the fund consist of a share portfolio, a corporate bond portfolio and cash. Because I also have another pension, to comply with the $1.6m transfer balance cap, I will have to roll back from my pension account to accumulation one-third of the SMSF assets.

Rather than complicate matters by trying to identify individual assets to roll back to accumulation, can we simply say that a 'proportion' – i.e. one-third – of all the assets are rolled back?

On June 30, 2017, would we need to reset the cost base for CGT on all shares and bonds that have made a capital gain, recognising that when an asset is sold one-third of any subsequent capital gain will be subject to CGT? Of course a third of all income will be subject to 15 per cent tax. Also, will we need an actuarial certificate for this year and subsequent years?

ANSWER: There are two options available to trustees that must roll back that part of a pension account that exceeds the $1.6m limit. The first is to not claim a CGT exemption on assets transferred back to an accumulation account, and the second is to claim the exemption.

If the decision is made not to claim the CGT concession, any unrealised gains on assets transferred back to the accumulation account could be taxed if they are subsequently sold for more than their original cost.

If the trustees decide to claim the CGT concession there are two ways in which the concession will be calculated depending on whether the fund uses the segregation method or the proportional method.

A super fund that has all members in pension phase will be classed as using the segregation method. Where a fund has members in both accumulation and pension phase they can choose what method is used.

A segregated fund chooses what assets allocated to the accumulation account will be subject to the CGT concession. For each of those assets their cost will be reset to the market value at the time the excess is rolled into the accumulation account. This will mean tax will only be paid if the investments allocated to the accumulation account are sold for a value greater than their transfer value.

Funds that use the proportional method, and want to claim the CGT concession, will have all assets of the fund revalued to market value at June 30, 2017. That portion of any gain made on the value of the fund supporting pension accounts at the time of the transfer will not be taxable.

Where a fund has existing accumulation accounts before the transfer of the excess, the percentage of the gain related to those accumulation accounts will be taxed. Trustees will have a choice of paying tax when lodging the 2017 tax return for the SMSF, or can defer paying the tax until the investment is sold.

In some cases SMSFs could be worse off by choosing to use the CGT concession. Before taking any action you should seek advice from an SMSF professional.

Max Newnham is a partner with TaxBiz Australia, a chartered accounting firm specialising in small businesses and SMSFs.

Got a question for the Tax with Max column? Email: askmax@eurekareport.com.au

General Advice warning: Eureka Report Pty Ltd: ABN: 84 111 063 686 AFSL No: 433424. This article may contain general advice and has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider if it is appropriate for your circumstances. Where the information relates to the acquisition of a product, you should obtain the PDS and consider this before making your decision