May 2018 – Tax exemption on income of retirement pension assets

There seems to be a bit of confusion about which method to use when calculating the tax exemption on income from assets supporting superannuation retirement pensions. The sources of the confusion are the changes to the superannuation law that took effect from 1 July 2017 and, the Tax Office’s interpretation of the tax law as to which method must be used when calculating the tax exemption. Let’s see if I can clear this up.

If an SMSF has a member with a total superannuation balance in excess of $1.6 million across all of their superannuation funds (as at 30 June of the previous financial year) and:

  • the person is in receipt of a retirement pension (whether in or outside of the SMSF); and,
  • the same person has superannuation savings in the SMSF (accumulation account or a retirement pension account); and,
  • the SMSF has at least one member in retirement phase;

then, the SMSF can only calculate the tax exemption using the unsegregated or proportionate method.  This is regardless of whether the SMSF’s pension assets were segregated at any time during the current financial year.

If an SMSF has members in receipt of retirement pensions and each of these member’s total superannuation balance does not exceed $1.6 million across all their superannuation funds at 30 June of the previous financial year, then the SMSF can claim the tax exemption using the relevant segregated and/or unsegregated method.

For fund members with a total superannuation balance not exceeding $1.6 million, the Tax Office’s interpretation of the tax law is based on whether the SMSF had pension assets that were segregated at any time throughout the financial year. If an SMSF had segregated pension assets at any time throughout the financial year, then it must calculate the tax exemption using the segregated method for that time period.

What this means is that if, during a financial year, an SMSF did have pension assets that were segregated but at a later time it no longer had segregated pension assets, then it must use the segregated method to calculate the tax exemption for the time period where the pension assets were segregated; and, use the unsegregated method to calculate the tax exemption for the period the SMSF’s assets were no longer segregated.

Prior to 1 July 2017, SMSF trustees and professionals were simply using the unsegregated method to calculate the tax exemption when SMSFs had segregated pension assets at some time during the financial year, and unsegregated assets at other times during the same financial year. They did this to simplify the tax exemption calculation. Unfortunately, the Tax Office has stated that using the unsegregated method for those situations is no longer an option from 1 July 2017.

Example 1: Assume an SMSF has two members in the accumulation phase on 1 July 2017.  On 1 October 2017, both members commenced retirement pensions with their total superannuation balance of $1 million each.  Then on 1 December 2017, one of the members makes non-concessional contributions into the SMSF and on 1 February 2018 commences a second retirement pension account.

This means, the SMSF was completely in the retirement pension phase during the periods 1 October 2017 to 30 November 2017 and 1 February 2018 to 30 June 2018. However, the SMSF was not entirely in the pension phase during 1 July 2017 to 30 September 2017 and 1 December 2017 to 31 January 2018.  The SMSF trustee will need to take into account four accounting periods and apply the segregated method of a 100% tax exemption on investment earnings of pension assets during the period the SMSF was completely in pension phase and apply the unsegregated method to the other periods when the SMSF was not totally in pension phase.

Example 2:  Jack and Jill are members of their SMSF. At 30 June 2017, Jack has an accumulation account of $800,000 in his SMSF and a retirement pension account of $900,000 in another superannuation fund.   Jill has a retirement pension account of $700,000 in their SMSF.

In this example, Jack has a total superannuation balance of $1,700,000 (i.e. $800,000 accumulation account in the SMSF + $900,000 pension account with another super fund).  Jack has a superannuation interest with the SMSF (i.e. his accumulation account).  Jill is receiving a retirement pension from the SMSF.  The SMSF is ineligible to use the segregated method and must use the unsegregated method to calculate the tax exemption.  An actuarial certificate will be required and must apply to the full year of income.

The calculation of the tax exemption is certainly more complex now and it is most important that SMSF trustees and professionals are aware of this.

Disclaimer

Monica Rule is an SMSF specialist and author.  Her advice is general in nature and you should seek advice that relates to your specific circumstances before making any decisions. www.monicarule.com.au