Calculating ECPI – The Lifecycles of Running Pensions in an SMSFPeter HoganNational Manager SMSF Advice, MLC

Agenda

1. Pensions – tax and related issues

2. Segregated & non-segregated calculations

3. Capital gains tax

4. Issues around reserves

5. Other pension issues

6. Practical application of rules

1. Pensions – Special Tax Features

• Transfer of member to pension phase:

• Not a taxable event

• Unrealised capital gains liability reversed

o Tax effect accounting being used?

• No tax on income or capital gains on assets supporting the pension provided pension liability continues

• Reserves are generally taxable as do not form part of assets supporting pension

• Refund of unused franking credits

1. What if both accumulators & pensioners in same SMSF

• One member in pension phase & one not

• Member in pension phase & also contributes to SMSF

• Member elects not to use all SMSF member account to commence pension

• One member fails pension standards for year

• SMSF reserving strategy adopted

• Member elects to commute pension in full or in part during the year

• Member elects to rollover to another superannuation arrangement

1. What if both accumulators & pensioners in same SMSF

• Some part of income & realised capital gains taxable & some part exempt

• Segregated or non segregated method used to identify exempt income & realised capital gains

• Interchangeable from year to year

• SMSF treated as single tax entity

• CGT free movement of assets between pools

• Beware Part IV A implications

• Franking credits & other tax credits not apportioned & can be fully used to offset any tax liability of SMSF (including tax on contributions)

2. Tax issues around pension and accumulation mix

• Segregated & non segregated methods

• Calculation of capital gains

• Application of capital losses

• Appropriate valuation of assets

2. Segregated & non segregated

• Tax device to determine exempt pension income

• Interchangeable from year to year

• Does not require physical separation of pension assets from other assets

• Does not relate to separate account for different investment strategies being undertaken

• Is not a substitute for appropriate risk analysis & asset allocation

• Is independent of asset allocation decisions of members

2. Segregated & non segregated

• S295-385 ITAA 97 exempt income from segregated current pension assetso Assets invested or held in reserves at the time to enable fund to discharge all or part of its

liabilities re super income stream benefits payable at the timeo Any excess difference between market value of identified assets & member’s account balance

supporting benefit not treated as segregated current pension assets• Applies to allocated pensions, market linked pensions or account based pensions

2. Segregated & non segregated

S295-390 ITAA 97 exempt proportion of income from current pension assets which are not segregated (either current or non current)

- Average value of current pension liabilities Average value of superannuation liabilities

• Value of particular liabilities signed off by actuary- Based on fund’s assets, future contributions & expected earnings

• Certificate obtained before tax lodgement date

S295-390 ITAA 97 exempt proportion of income from current pension assets which are not segregated (either current or non current)

- No current certificate- No segregated current or non current assets- Last value of superannuation lilabilities X Current value

Last value of assets of assets

2. Segregated & non segregated

• Excluded from definition of ordinary & statutory income

o Assessable contributions -s295-385(2) ITAA 97

o Non-arm’s length income -s295-390(2) ITAA 97

• Segregated assets

o 100% of income & realised capital gains are exempt

• Non segregated assets

o Proportion percentage applied to assessable income & net realised capital gains

• Deductions applied only after this calculation

2. Segregated & non segregated

Actuarial certificate must be obtained each year prior to lodgement of tax return –ss295-385(3)(b) & ss295-390(4) ITAA 97

No actuarial certificate is needed if:

o Segregated method is used

o Pension is one defined by Regulation – ss295-385(4) ITAA 97

• Reg295-385.01 ITAR 97 defines these pensions to be:

o Allocated pensions

o Market linked pensions

o Account based pensions

• No equivalent regulation for s295-390(7) ITAA 97

2. Segregated - Pros & Cons

Advantages

• Can i.d. 100% of specific assets with large accumulated capital gains

• Can i.d. high income producing assets leaving growth assets in accumulation

• Both income & realised gains completely exempt from tax

• Income & gains accounted for separately & so easy to identify & allocate to specific pensioner account

2. Segregated - Pros & Cons

Disadvantages

• Need to separately identify assets from accumulation assets

• Separate bank accounts needed for practical purposes

• Sub-set of financial accounts maintained?

• All income on segregated assets identified separately & pension only paid out of this account

• Realised losses are lost & cannot be carried forward

• All expenses kept separate that relate specifically to pension assets

• Apportionment of general fund expenses only

• Not possible to segregate large lumpy assets

• Assets in segregated pool must be identified before start of pension & at beginning of each year

2. Non Segregated - Pros & Cons

Advantages:

• All assets kept together for accounting & admin purposes

• Only one set of financial accounts maintained & audited

• Relatively simpler to administer

• Proportion of income tax free

• Proportion of all expenses deductible

• Can cater for large indivisible assets easily

• Net capital losses carried forward in full

Disadvantages:

• Proportion of income earned on assets assessable

• Proportion of net realised gains assessable

• Proportion of expenses non deductible

• Actuarial certificate required each year regardless of pension type

3. Pensions and CGTApplication of CGT rules when determining exempt income

• Segregated method

o Capital gains & capital losses are ignored on assets in segregated pool only

o Capital losses not “revived” to be carried forward if return to accumulation

• Non segregated method

o Net Gain added to assessable income 1st, then exempt percentage applied to that assessable income

o Net capital losses carried forward in full until used in later years

4. Reserves• Are unallocated amounts of money belonging to the Fund

• Not part of any member retirement or death benefit entitlement

• Are taxable even if fund is in pension phase

• S115 SISA allows reserves unless prohibited by governing rules

• Only two types of reserves can be established for SMSFs

o Investment reserve (Smooth returns)

o Contribution reserve – must be allocated within 28 days of end of month contribution paid

• Reserves need an investment strategy

o Like having another accumulation account in SMSF

• S52B&C(2)(g) SISA trustee obligations to manage reserves consistent with:

• SMSF investment strategy & SMSFs capacity to discharge its liabilities

Allocation from reserve may be subject to concessional conts cap• S292-25(3) ITAA 97, IF to accumulation account &• Assessable contribution Subdiv 295-C ITAA 97

Exclusions to concessional cap

• Reg292-25.01(3) ITARo Personal contributions, Rollover amountso Foreign super fund transfers, Conts to constitutionally protected funds

• Reg292-25.01(4) ITARo Allocated in a fair and reasonable manner

• To every members’ account• To every member of a class of members

o Amount allocated is less than 5% of member’s interest in fund

4. Reserves Allocation

5. Other pension issues• Financial Reporting ATO SC 2003/1

o SMSFs should use market value for:

• Financial reports

• Valuation at commencement of pension

o Market value should be determined by:

• Qualified valuer where value of asset is significant

• Trustees or others on reasonably objective & supportable basis

o Valuations should be undertaken:

• At reporting date annually

• Most recent valuation within 12 months for pensions & in house assets

• Payment of pension in cash – TR 2013/5 & APRA Circular No I.C.2 Payment Standards

• In specie payments can be made in lieu of cash for lump sum payments

• Pension payments cannot be in specie

• Part 6, SIS Regs only refers to lump sum payments in specie

• Common law definition of “annuity”

• SMSFD 2014/1 – partial commutation of a pension can count towards the minimum pension requirements where lump sum benefit is paid either in cash or in specie

5. Other pension issues

6. Practical application of rules• Cessation of pension determined by

o Fund rules, SISR and particular circumstances

o While member is alive

• Member elects to commute pension back to accumulation phase either full or partial commutation

• Minimum pension payments fail to be paid

• Payments will not be pension payments

• Member rolls over entitlement to another fund

• Cessation of pension determined by

o Fund rules, SISR and particular circumstances

o On members death unless

• The pension is reversionary or

• There is binding nomination to pay a pension to person entitled to be paid (but not where trustee has discretion)

• Note s59(1A) BDBN cannot bind type of benefit payment

6. Practical application of rules

6. Practical application of rules

Pension

commences

1/12/2011 30/6/2012

Minimum pension

not paid

30/6/2013

What are the pension payments?

-Super lump sum

-Transition to retirement payments?

Requirements met –

new pension

commenced

6. Practical application of rulesFull commutation

Sell assets – CGT may be payable, reduces payment

Pension

Accumulation

Partial commutation

Problem: payment from full commutation cannot count towards minimum pension

payment – pro rata pension payment must be made

Pension Pension

Sell assets while still in pension phase

Payment

Problem: payment from partial commutation counts towards minimum pension

payment BUT what about CGT at fund level?

6. Practical application of rules

Death benefit – no reversionary or BDBN (discretion applies)

No tax on income

Pension

Accumulation

Death benefit –automatic reversionary or automatic BDBN

Pension Pension

Pension

Automatic continuation of same pension

6. Practical application of rules

Death benefit – no reversionary or death benefit dependant

Pension

AccumulationDeath benefit lump

sum paidNo tax on income

Thank youQ&A

Disclaimer

© SMSF Association 2016

This presentation is for general information only. The material and opinions in this presentation are those of the author and not those of the SMSF Association. Every effort has been made to ensure that it is accurate, however it is not intended to be a complete description of the matters described. The presentation has been prepared without taking into account any personal objectives, financial situation or needs. It does not contain and is not to be taken as containing any securities advice or securities recommendation.

Furthermore, it is not intended that it be relied on by recipients for the purpose of making investment decisions and is not a replacement of the requirement for individual research or professional tax advice. This presentation was accompanied by an oral presentation, and is not a complete record of the discussion held. No part of this presentation should be used elsewhere without prior consent from the author.