Tax with Max: Tax-free gains in pension mode

Tax-free gains in pension mode, franking credits, and more.

Summary: This article provides answers on whether all gains are tax-free in pension mode, how to access franking credits from dividends and how to get the benefits of franking credits when added to income, binding death benefit nominations in pension phase, whether to hold or sell a Brisbane property investment, and calculating tax on a past investment property.
Key take-out: The Tax Office supports a network of volunteers across Australia who can prepare a simple tax return at no charge.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Are all gains tax-free in pension mode?

If a self-managed super fund is in pension mode, it pays no income tax and no capital gains tax. Does this also apply if a share is bought and is sold two days later at a gain?

Answer: When a superannuation fund is in pension mode it does not matter how long an investment is held. A share can be owned for as little as one hour and then sold, or it could be owned for 15 years and sold, any gain made on the sale while it is in pension phase is not taxable.

Accessing franking credits from franked dividends

A subscriber recently asked a question about how someone under the current tax-free threshold can access franking credits from franked dividends.

Answer: You should be aware that the Australian Tax Office supports a network of volunteers across Australia who can help with the preparation of simple tax returns including franking credit reimbursement returns at no charge. The main test of eligibility is a taxable income of less than $50,000. If a retiree is not obliged to lodge a tax return they can file an Application for refund of franking credits for individuals. This form can be downloaded from the ATO website.

Getting the benefits of franking credits

Your response to franking credits leads me to ask, how do we get the benefits of franking credits when it’s added in as income?

Answer: The main benefit of earning fully franked dividends from share ownership is that unlike other investments it does come with the franking credit that can increase the investment return. For example $100,000 invested in a term deposit at 4% will produce $4,000 in income. If the investor has income below $18,000 they have a net return of 4% after tax. If they are on the bottom tax rate they will have an after tax return of 3.18%. This return drops with each increase in the marginal tax rate to the point where someone on the top tax rate has an after tax return of 2.14%.

By comparison $100,000 invested in a company earning 4%, after adding the franking credit, earns $7,000 before income tax. If an investor has total taxable income of less than $18,000 they are earning after tax 7%. On the lowest tax rate the after tax return is 5.56%. On the top tax rate the after tax return is 3.74 %.

Whether to hold or sell a Brisbane property investment

I have a three-bedroom rooftop unit in the Brisbane CBD and am concerned that there are many investment advisers saying that residential property is overvalued and a downward correction will occur very soon. I am also concerned about the rental market; many say it will soften significantly. What do you think?

Answer: From my limited understanding of the Queensland market there have already been some major corrections in the value of residential property. It is very hard to make general comments that will apply to all sectors and regions of the property market.

The final determinant of property values always comes down to supply and demand. In booming economic times with easy to obtain finance property values usually increase due to there being more buyers than sellers. In economic downturns, when banks tighten their lending criteria, the reverse will often happen where there are more sellers than buyers and property values decrease.

When advising clients, I always ask them to apply a sleep test to any investments they have or that I recommend. If owning an investment is going to cause them to be nervous and suffer sleepless nights, the investment is not worth owning. In your case you should seek advice from real estate agents that specialise in the area where your unit is to assess its value and, if you have made a profit and are worried about the future, you should consider selling it.

Binding death benefit nominations in pension phase

My wife and I are both over 60 and in the pension phase of our SMSF. We are about to complete the new non-lapsing binding death agreement in favour of each other. Are there any implications whether we nominate the other to receive the benefit as a lump sum or pension? Can a lump sum be paid directly to the surviving member’s super account or does it have to be withdrawn and re-contributed subject to the normal contribution limits.

Answer: When there is a binding death benefit nomination in place the trustees of an SMSF have a choice between paying out the death benefit as a lump sum, or it can be paid as a death benefit pension. Because of the limits placed on being able to make super contributions once a person is older than 64 it does not make sense, from a taxation and superannuation point of view, to have the death benefit paid out.

Rather than having non-lapsing binding death benefit nominations you should consider converting your account based pensions to a reversionary account based pensions. This will mean upon the death of one of you the pension will automatically pass to the survivor. If they want to continue with the pension they can, or they can commute all or part of the pension and take a lump sum payment.

Calculating capital gains on a past investment property

We bought an investment property, rented it for five years, and then lived in it for five years.

Is my capital gains tax calculated by deducting the purchase price from the selling price, then regarding 50% of the gain as taxable? Or is it worked on the value of the house after it stopped being an investment property? If so, what happens if we didn’t get a valuation then? A further complication in our case is that we did a major extension when we moved back in. How does the value of this get used in the calculations?

Answer: The correct way to calculate the capital gain you have made on the property is by deducting the purchase costs from its value at the time it ceased to be a rental property. It does not matter that you did not obtain a value at that time. A professional valuer should be able to look back through the property sale records at the time you ceased to rent the property and place a value on it.

As you will be paying tax on the increase in the value for the time of the property was rented, the fact that you did a major extension does not complicate things. If you had originally owned the home for five years and then rented it out, the value at the time it started to be rented would be taken as the cost for when it was eventually sold. If an extension had been done during the rental period the cost of the extension would be added to its starting value.


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.

Do you have a question for Max? Send an email to askmax@eurekareport.com.au