Tax with Max: Super contributions in pension mode

Making super contributions in pension mode, the 15% rebate, and more.

Summary: This article provides answers on making super contributions in pension mode, the 15% rebate, SMSFs buying shares in a unit trust, changing income or deductions, the tax rules for rental properties that become the principal residence, and super assets and the assets test.
Key take-out: A member can continue making super contributions once in pension mode by depositing funds into their SMSFs bank account. This effectively creates either a new accumulation account or further contributions to an existing accumulation account.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Can further super contributions be made once in pension mode?

I was motivated by a recent Bruce Brammall article, but somewhat confused by the section “tax-free income stream”. He wrote: “If you are still working and you convert the whole of the super fund balance ($500,000) to a pension fund, then you cannot make any further contributions. You must set up a separate accumulation fund for the TTR system to work”.

Wouldn’t it better to convert most of the fund to a pension fund and leave the balance in the existing accumulation fund? What tax is payable in the pension fund and on the income stream if you are between 55 and 60. Is the Medicare levy payable on the income stream?

Answer: The process of starting a pension starts with making a contribution or contributions to an accumulation account within a super fund. These could be employer contributions, self-employed contributions, salary sacrifice contributions, or non-concessional after tax contributions.

When a pension commences a member’s accumulation account either ceases altogether, where the total value of the member’s account is used to start a pension, or the accumulation account stays in existence and a pension account within the superannuation fund is created.

In an SMSF where the whole value of a member’s account has been used to start a pension, and the member wants to continue making contributions to the SMSF, they just deposit the money into the bank account of the SMSF. The act of depositing amounts in the SMSF bank account effectively creates either a new accumulation account or further contributions to an existing accumulation account.

How is the 15% rebate applied for taxation purposes?

Having recently retired, but still short of my 60th birthday, I have triggered a transition to retirement pension through my self-managed super fund. Hopefully you can clarify for me exactly how the 15% rebate is applied for taxation purposes. I intend to draw $40,000 as a pension this year and should have $6,000 of additional rental income. By my calculations, my tax liability (before applying the rebate), would be $6,497, excluding a 1.5% Medicare levy. Am I correct in assuming that the 15% tax rebate would equal $6,000 (15% of $40,000) and thus reduce my tax liability to $497, plus the Medicare Levy. I also assume I would have my tax bill further reduced by the low income offset, which I calculated at $310 in my situation.

Answer: I am confused why, if you have met a condition of release such as retirement – in other words that you are not planning to work more than 10 hours a week – that you have not started an account-based pension. A transition to retirement pension is only needed where the superannuation member is continuing to work.

You are spot on with your calculations as to how the 15% superannuation pension rebate works and its interaction with the low income tax offset. This will mean your income tax payable will be reduced to $187 and you will have a Medicare Levy payable, on the $46,000 of taxable income, of $690.

If you have retired you should consider a re-contribution strategy to increase the value and percentage of your tax-free superannuation in your SMSF. By doing this you will decrease the amount of pension that will be taxable and possibly get to the point where you are not paying any Medicare Levy or income tax. Before taking action you should seek professional advice.

Can a SMSF buy shares held personally in a unit trust?

I am an equal shareholder in a unit trust with my sister. Currently we both own 50% each in our personal names. The unit trust owns commercial properties that are leased to various commercial/retail tenants.

We both want our individual SMSFs to buy out each of our personal shares in the unit trust but have been told that because my sister and I are related SMSFs do not allow related parties to be involved, even though the tenants in the properties are completely non-related in anyway. Is there any way that our SMSFs can own shares in this unit trust?

Answer: One of the few assets an SMSF can buy from members is business real property. Where problems are encountered is when there are borrowings involved. Even in this situation, as long as the limited recourse borrowing requirements are met, a super fund can borrow to invest in property.

The ability for your SMSFs to buy the units in the trust will depend on whether there are borrowings in existence related to when the commercial properties were originally purchased. You should seek advice from an SMSF specialist, who will be able to advise both of you as to whether your SMSFs can purchase the units in the trust.

Can the nature of income or deductions be changed to achieve a better tax result?

I have received a couple of distributions from a property trust, which are partly tax-deferred. This of course reduces the cost base of the units, and is likely to create a capital gains tax liability when I sell those units sometime in the future.

I am entitled to the Senior Australians Tax Offset, which in this year I cannot fully utilise. It would therefore be advantageous for me to declare the entire distribution as income in this year, including the tax-deferred component, and thus avoid the reduction in the cost base of the units. I would like to know if this is permissible?

Answer: Unfortunately what you were planning to do is not allowed under the Income Tax Act. Taxpayers are not able to change the nature of income and/or deductions to achieve a better tax result. This will mean you will unfortunately have to prepare for a capital gains tax liability at sometime in the future. You should seek advice on ways to reduce this tax, possibly using self-employed super contribution strategy.

What are the tax rules for rental properties that become a principal residence?

Have the CGT rules recently changed? In recent years I sold a property that was first rented for a while before becoming my principal residence. At the time, the tax rules were pretty clear that if you rent first before the property changed to a principal resident then the time proportion of the full (net) capital gain was used over the entire ownership period.

However, in the reverse order where a property was a principal residence before being rented out the, CGT was assessed on the valuation gain over the actual period of renting as assessed by ‘start’ and ‘end’ market valuations over the income producing period only.

Answer: The main residence capital gains tax exemption is one of the most complicated areas of the Tax Act. There have been several changes to the law over the years. Where a home becomes a rental property, the market value method must be used. The information related to the treatment of when a rental property becomes a home is not as straight forward.

There is some conflicting information on the ATO website. Despite this, I believe you are right. When a rental property becomes a home, the days of ownership method is used to calculate what proportion of the gain is taxable.

Are superannuation assets counted in the pension assets test?

Would you please confirm if assets in an SMSF that is in pension mode form part of the asset base that Centrelink would calculate to assess eligibility to a full or part pension?

Answer: When a member is in pension phase in a super fund the value of their superannuation is counted by Centrelink in the assets test, whether they are of pension age or not. Where one member of a couple has reached age pension age, and their partner has not, if the superannuation is still in accumulation phase its value is not counted in the assets test.

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

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

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