SMSF: How super rule change affects tax exemption on pension assets

The calculation of the tax exemption on pension assets is more complex now and SMSF trustees must come to grips with this.

There is some perfectly understandable 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 July 1 last year and the Australian Taxation Office’s interpretation of the tax law as to which method must be used when calculating the tax exemption. Let’s see if we can clear this up.

If a self-managed superannuation fund has a member with a total superannuation balance of $1.6 million (as at prior June 30), across all their superannuation funds, and the person is in receipt of a retirement pension, 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 is less than $1.6m across all their superannuation funds at June 30 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 of less than $1.6m, the ATO’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 July 1 last year 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 ATO has stated that using the unsegregated method for those situations is no longer an option from July 1, 2017.

Let’s look at an example. ­Assume an SMSF has two members in the accumulation phase on July 1, 2017. On October 1, 2017, both members started retirement pensions with their total superannuation balance of $1m each. Then on December 1, 2017, one of the members makes non-concessional contributions into the SMSF and on February 1, 2018, starts a second retirement pension account. This means the SMSF was completely in the ­retirement pension phase during the periods October 1, 2017, to ­November 30, 2017, and February 1, 2018, to June 30, 2018. However, the SMSF was not entirely in the pension phase during July 1, 2017, to September 30, 2017, and December 1, 2017, to January 31, 2018.

The SMSF trustee will need to take into account four accounting periods and apply the segregated method of a 100 per cent 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.

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.

Monica Rule is an SMSF specialist and author.

www.monicarule.com.au