Australian Financial Review
13 December 2016
Putting into practice the new super rules that will apply from next July – especially what happens when you have a pension balance of more than $1.6 million – will require some careful planning.
It’s planning that involves knowing how to split the pension balance between a $1.6 million pension account (where the investment returns are tax free) and an accumulation account (where future investment earnings will be taxed).
Along with the practical aspects of this big change, another significant pension-related modification that needs to be understood is that from July 1, funds with a combination of pension and accumulation accounts and members with more than $1.6 million worth of pensions will no longer be allowed to segregate the returns from selected investments.
Segregation is a tax strategy where returns from particular investments are specifically allocated at the fund level to either pension or accumulation accounts.
An SMSF, for instance, with an investment property or shares that have sizeable capital gains will prefer to own such assets in pension accounts as any returns when they are sold will be exempt from tax.
In most cases a fund will have both pension and accumulation accounts because a member was eligible to start a pension and did so. They have an accumulation account because they are still working and saving super.
Eventually all the super ends up in one or more pensions.
In future, however, this won’t be the case where members have $1.6 million in pensions as they will automatically have a pension and an accumulation account.
With the introduction of the $1.6 million pension limit from July 1 and the increasing number of funds with a combination of pension and accumulation accounts, Meg Heffron of Heffron SMSF Solutions says a reason why segregation will be banned is because of the potential for tax manipulation.
There is concern that members might seek to manipulate their investments by switching them from the taxable accumulation side to the pension side shortly before a sale or large income distribution.
With this in mind, the future rule that will apply where a fund has a $1.6 million pension account and an accumulation account will be to proportion the investment returns according to the percentages of the fund in pension and accumulation.
The investment return allocated to the pension account will be tax-free, while the accumulation proportion will be taxable.
As far as the practical application of these new rules is concerned, a reader writes: “I am currently in pension phase but come July 1, I will exceed the $1.6 million cap and understand that some of my SMSF assets must be put into an accumulation account.”
These assets, he says, are mostly shares and managed funds. But how can he identify which shares or funds to put into accumulation by June 30, he asks, when the value of his SMSF is not determined until a tax return is lodged? Further, the tax position of some managed funds is not received until late September or early October.
On top of all this, his SMSF tax return is not lodged for at least six months or even longer after the financial year and the share value used is determined by closing prices on June 30.
Another question is who is notified which assets are identified as being put back into accumulation by June 30?
According to Peter Crump, a private client adviser with ipac South Australia, the new cap of $1.6 million is essentially a restriction on the amount that can be held in tax-free pensions.
To determine their tax entitlements at the moment, most SMSFs use what is called an unsegregated approach where there is a single pool of investments supporting member account balances within the fund. This could be a fund where there are two members or where a member has both an accumulation and pension account in place.
The other approach, the segregated approach, has different pools of investments in place for different members or for pension and accumulation accounts.
This has enabled different assets to be held in the pension process, and therefore be fully exempt from tax on investment income.
Under the unsegregated approach, only a portion of the overall fund investment income is exempt from tax, depending on a certificate from an actuary who calculates that proportion.
Essentially, the tax-exempt proportion is the percentage of the overall fund that is supporting pension accounts throughout the year.
The new arrangements from July 1 require an unsegregated investment approach to be used at all times where a member of the fund has a balance in excess of $1.6 million.
This is a protective feature, says Crump, to ensure that investment sales cannot be manipulated between the different asset pools.
So in response to the last bit of the question, says Crump, there is no need to specifically tag investments that relate to the pension account balance or the accumulation account balance from July 1.
That’s because the balance of the respective pension and accumulation accounts is an accounting or book entry, and the total of these account balances is always equal to the total fund balance.
A most important issue as far as funds with pension accounts of more than $1.6 million is concerned, says Crump, is ensuring that the June 30, 2017 balance is shaved off at $1.6 million and any surplus moved across to an accumulation account.
Fortunately this can be achieved in a fairly straightforward way through an instruction recorded as a minute before June 30 next year from the member to the fund trustee (a corporate trustee or individual member trustees).
This will request as a simple instruction that a pension account balance be established with no more than $1.6 million and any surplus be transferred to an accumulation account.
At the pre-June 30 stage, there is no need to stipulate how much must move into the accumulation account as this won’t be known for some time for different reasons, including the ones the reader has mentioned.
In an SMSF, says Crump, the administration process is often completed in arrears but what is important is that the trustee has a minute that records the need to adjust any pension balance.