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Retirement

SMSFs: Claiming tax exemptions on pension assets

  • January 11 2018
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Retirement

SMSFs: Claiming tax exemptions on pension assets

By Louise Chan
January 11 2018

Exempt current pension income (ECPI) is the tax relief that the Australian Taxation Office (ATO) provides for self-managed super funds (SMSFs) that pay out retirement benefits. Regulations state that income from SMSF assets that support retirement benefits are typically exempt from tax.

SMSFs: Claiming tax exemptions on pension assets

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  • January 11 2018
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Simply making pension payments, however, doesn’t automatically qualify SMSFs for tax exemption.

There are some conditions that SMSFs need to meet before lodging their annual tax return in order to become eligible for ECPI.

Here’s a quick guide on what trustees need to know about SMSF pension payouts and the ECPI before filing taxes.

When can SMSFs claim pension tax exemptions?

There are two conditions that SMSFs must meet before claiming a tax exemption for the financial year:

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  • An SMSF member in their pension phase must have receive retirement benefits for a part of or in the full tax year; and,
  • The SMSF should be a complying fund.

Condition 1: An SMSF member in their pension phase must have received retirement benefits for a part of or the full tax year
An SMSF should pay out pension before gaining eligibility for pension tax exemption. 

The member must receive their retirement benefit through an allocated, market-linked or account-based pension at all times they were in pension phase.

Defined-benefit pension accounts do not fall under any of these, so it’s best to ensure that the member’s account is qualified for ECPI.

Condition 2: The SMSF should be a complying fund
Problematic or delinquent SMSFs don’t get rewarded with tax breaks. The SMSF should be a complying fund for the tax year they intend to claim ECPI. If there are any issues that arose during the financial year, they must all be cleared before filing the tax return.

Note: When claiming ECPI, trustees should remember to have SMSF assets revalued to reflect current market value. SMSFs must ensure that they are using current values in their tax return for a more accurate ECPI computation.

Requirements for claiming ECPI

An actuarial certificate is the main requirement to claim ECPI; however, it is also possible to gain eligibility without one if the SMSF makes arrangements to segregate its underlying assets.

ATO implements regulations with regard to how ECPI should be calculated, depending on whether the SMSF is considered as a segregated or unsegregated fund.

Segregated funds: Actuarial certificate is NOT needed if applied correctly
Segregated funds are SMSFS which have allocated assets specifically for pension payments. SMSFs are also considered segregated funds if it is 100 per cent in accumulation phase (with 0 per cent allocated pension assets) or 100 per cent in pension phase (with 0 per cent accumulation assets).

These types of funds do not need an actuarial certificate to compute for the ECPI, because income from pension assets may already be considered as wholly tax-free.

For example, SMSF BxB has a current market value of $3 million composed of the following:

  • $1 million rental property
  • $1.25 million business property (originally purchased for and fully paid by Bill’s company)
  • $100,000 fixed-term deposit account
  • $250,000 managed investment funds
  • $100,000 worth of shares each in companies A, B, C and D ($400,000 in total)

If member Bill retires with an account balance of $1.6 million, the SMSF can allocate the business property, managed funds and all company B shares for his pension payments—a total of $1.6 million. If Bill receives $50,000 in total pension for the tax year, the full amount will remain untaxed.

In this example, the trust can claim ECPI for all payments made to Bill without presenting an actuarial certificate.

There are some exceptions wherein an actuarial certificate will be required despite having a segregated fund. These are:

  • If the asset’s current market value exceeds the member’s account balance
    ATO would consider the assets as unsegregated since only a portion of it is supporting the retirement benefits. 

  • If the asset’s market value is less than the member’s account balance
    The SMSF would be required to use a portion of the income from non-pension assets to supplement retirement benefit payments. 

In both cases, an actuary would need to certify the portion of the affected assets used to pay benefits.

Unsegregated funds: Automatically requires an actuarial certificate
Most SMSFs are unsegregated because it makes management simpler and triggers fewer fees. This means that both accumulation phase and pension phase members contribute to and receive funds from the same asset pool.

When SMSFs don’t segregate assets for the sole purpose of supporting retirement income streams, they must use the ‘proportionate method’ to compute for ECPI.

SMSFs are required to obtain an actuarial certificate every time they intend to claim ECPI, in order to indicate the proportion of assets used to fund retirement benefits.

The proportionate method should also be used on the following circumstances:

  1. The fund member exceeds the $1.6 million transfer balance cap immediately prior to the start of the income year; and,
  2. The member is in receipt of a retirement income stream from other sources (i.e., annuity or another super fund).

The remaining portion in accumulation phase must be taxed at 15 per cent, as stipulated by superannuation and tax laws.

For example, if the actuary indicates that only 45 per cent of the total assets with a $300,000 annual income is used to pay pension, then the ECPI is only $135,000. The SMSF must pay a $24,750 tax for the remaining $165,000, which is the 55 per cent still in accumulation phase.

What happens when pension assets trigger capital gain or loss?

Assets that are sold trigger capital gains or losses and come with capital gains tax (CGT), but ATO has a different treatment for assets that are sold in order to support retirement benefits.

CGT, just like the actuarial certificate requirement, depends on whether the SMSF assets are unsegregated or segregated.

For unsegregated assets, capital gains and losses must be included in the SMSF’s assessable income. 

As a rule:

  • Capital loss may not be deducted but it may be used to offset future capital gain.
  • Capital gain is added to assessable income before deducting any tax exemptions.

For segregated assets, any capital gain or loss resulting from the sale of an asset to pay pension must be ignored. Capital gains do not need to get paid and capital loss may not be used to offset non-pension asset gain.

Knowing how SMSF assets are allocated is the most basic consideration when it comes to tax exemption, so it’s important to be aware of this before calling up an actuary and paying unnecessary costs.

Explore Nest Egg for more information on correct SMSF management.

SMSFs: Claiming tax exemptions on pension assets
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About the author

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Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

About the author

Louise is a content producer for Momentum Media’s nestegg who likes keeping up-to-date with all the ways people can work towards financial stability in 2019. She also enjoys turning complex information into easy-to-digest, practical tips to help those who want to achieve financial independence.

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