26 April 2022
By Colin Lewis, Head of Strategic Advice, Fitzpatricks Private Wealth
Thankfully, superannuation was not meddled with in this year’s Budget. It was silent on super except for the Government announcing (days earlier) that it was extending the 50 per cent ‘temporary’ reduction in minimum pension drawdown rates for another year – good news for retirees not needing income to live off from their account-based pensions and similar income streams, as it means they can retain more in super’s tax-exempt environment for longer.
But last year’s Budget was different – it contained many important changes to super. The most significant being the ability for people aged 67 to 74 to make non-concessional contributions (NCCs) and salary sacrifice contributions from 1 July this year without having to meet the work test, together with the NCC bring-forward rule being extended to this age group subject to their total superannuation balance (TSB).
Another little-publicised, less sexy but nevertheless important change affecting self-managed superannuation funds (SMSFs) and small APRA-regulated funds (SAFs) also came into play – the way trustees determine their fund’s exempt current pension income (ECPI). This is the income a fund earns from assets supporting account-based pensions and other retirement phase income streams, which is exempt from tax.
It means less red tape and lower administrative costs for funds which have a member (or members) in both accumulation and retirement phases at one time, but retirement phase only at another time, during the year.
This change will help SMSFs and SAFs where one member is in retirement phase and another in accumulation phase starts an account-based pension part way through the year, or where an SMSF or SAF is 100 per cent in retirement phase and receives a contribution or rollover which goes into an accumulation account – even if that accumulation interest is then used to commence an account-based pension.
Exempt Current Pension Income
It’s widely known that when you commence an account-based pension and move into retirement phase in super that fund earnings, including capital gains, are tax-free. But this doesn’t just happen. It’s through the calculation of the fund’s ECPI that its tax-exempt income is determined and claimed in the SMSF’s annual return each year.
There are two methods for calculating a fund’s ECPI – the segregated method and the proportionate (unsegregated) method.
Before 1 July 2017, it was pretty straightforward as the established industry practice for SMSFs partly in pension phase and partly in accumulation phase during the year was to calculate ECPI using the unsegregated method for the entire year – even if there were periods where the fund was 100 per cent in pension.
But since then, it’s been more complicated and costly as the Australian Taxation Office (ATO) has applied strict guidelines – effectively removing a trustee’s choice of ECPI method.
Now, the good news is that from this financial year, SMSF trustees have the opportunity to use the proportionate method for calculating ECPI for the whole year – making it simpler – where they have member interests in both accumulation phase and retirement phase for part, but not all, of the income year.
Put in context
Up until now, two measures – the disregarded small fund assets (DSFA) rule and ATO guidance on ECPI – have significantly affected how funds claim ECPI.
The DSFA rule: this precludes SMSFs from claiming ECPI under the segregated method where any member of the fund who is in retirement phase – in any fund – has a TSB of $1.6 million or more at the previous 30 June.
Funds caught by this rule cannot – for tax purposes – assign specific assets to the fund’s pensions and can only claim ECPI under the proportionate method – even where the fund is 100 per cent in retirement phase for the entire year.
Sensibly, an actuarial certificate is not required when calculating ECPI where all members are wholly in retirement phase for the entire year– even where a fund has DSFAs.
The DSFA rule continues to apply – there has been no change here.
ATO guidance on ECPI: Since 1 July 2017, the ATO has required SMSFs to calculate ECPI – and obtain actuarial certificates – using the segregated method for any period the fund is 100 per cent in retirement phase, unless the DSFA rule applies. Where a fund uses the proportionate method for part of a year, an actuarial certificate is required to claim ECPI for that period.
The ATO’s view on ‘deemed segregation’ has created extra work for those funds caught by its guidance which are not subject to the DSFA rules – as it forces them to calculate ECPI based on multiple discrete ECPI periods.
Now, where an SMSF has a member (or members) in both accumulation phase and retirement phase at one time, but retirement phase only at another time during the year, there is the opportunity for the trustee to streamline its administration by using one approach for calculating the fund’s ECPI for the entire year
So, where a fund has a period of ‘deemed segregation’ and does not have DSFAs, the trustee can choose to treat all the fund’s assets held during this period as not being segregated current pension assets. Doing this means a trustee can use the proportionate method for calculating their fund’s ECPI for the entire year – minimising complexity and reducing reporting costs.
It also overcomes the ridiculous lengths some funds have gone to with the intent of preventing ‘deemed segregation’ – that is, maintaining a small accumulation balance for a member in retirement phase.
Trustees will be able to make this choice retrospectively as part of the preparation of the annual financial statements and SMSF annual return.
Before making a decision, a trustee should consider the timing of any CGT events as capital gains are disregarded if segregation is maintained for periods of ‘deemed segregation’.
If a trustee does not make a choice, then – consistent with the ATO’s view – the fund’s ECPI will be calculated using the segregated method for any period (less than the whole year) of ‘deemed segregation’, provided it does not have DSFA.
SMSFs which are 100 per cent in retirement phase for the whole year continue using the segregated method unless they’re subject to the DSFA rule.
Trustees are once again allowed to apply the pre-1 July 2017 industry approach to calculating ECPI.
Fred and Wilma are members of the Rubble SMSF. Both have TSBs of less than $1.6 million.
On 1 July, Fred’s super is entirely in retirement phase and Wilma has an accumulation account only in the fund.
On 1 December, Wilma retires and commences an account-based pension with her entire account balance.
On 15 January, a Superannuation Guarantee contribution of $5,000 is received by Fred’s employer for work performed in the previous quarter and on 1 February, he makes a NCC of $100,000.
On 1 March, Fred commences a second account-based pension with his entire accumulation account in the fund.
With this change, the trustee of the Rubble SMSF can choose to treat the fund’s assets as being not segregated current pension assets for the two periods the fund is fully in retirement phase. This choice is available for each ‘deemed segregation’ period because the fund is not entirely in retirement phase for the whole year and the fund is not subject to the DSFA rule.
If the trustee makes this choice, an actuarial certificate will be obtained covering the entire income year and all exempt income can be claimed using the proportionate method.
The trustee should consider the timing of any CGT events before making its decision as gains are disregarded if segregation is maintained for periods of ‘deemed segregation’.
Prior to this change, the Rubble SMSF would have needed to calculate its ECPI based on the four ECPI periods – period 1 from 1 July to 30 November when the fund was unsegregated; period 2 from 1 December to 14 January when the fund became segregated; period 3 from 15 January to 28 February when the fund ceased to be segregated and period 4 from 1 March to 30 June when the fund became segregated again.
An actuarial certificate would have been required for the two unsegregated periods – periods 1 and 3 – whereas no actuarial certificate was needed for the two segregated periods – periods 2 and 4.
The neglected super changes
Last year’s Budget contained many important changes to super and all bar two of those proposals have been legislated. The two that haven’t come into play are the relaxation of the residency requirements for SMSFs and SAFs, and the legacy pension amnesty.
Going overseas and have an SMSF or SAF?
The Government’s proposals in last year’s Budget to extend the central management and control (CM&C) test safe harbour from two to five years for SMSFs and remove the active member test for both SMSFs and SAFs, was good news for people moving overseas.
Heading overseas for more than two years requires you do something with your SMSF to avoid having a CM&C compliance problem with the fund.
You can appoint a trusted Australian-based person who holds your enduring power of attorney to act in your place as trustee (or director). However, you must resign as a trustee (or director) and be prepared to relinquish control to them.
Alternatively, you can wind-up your fund, or convert it to a SAF by appointing a professional trustee.
Extending the safe harbour means people moving overseas wouldn’t have to worry about doing any of this unless they were going for more than five years.
Moving overseas may also mean having to stop contributing to your SMSF (or SAF) if you cannot comply with the active member test which requires that while the SMSF is receiving contributions, at least 50% of the fund’s total asset value attributable to actively contributing members is attributable to resident contributing members.
Removing the active member test would allow SMSF and SAF members to continue contributing to their fund whilst temporarily overseas – ensuring parity with members of large APRA-regulated funds, such as retail and industry super funds.
So, these proposals would have given more people moving overseas greater flexibility to keep their SMSF and continue contributing to it, but they haven’t got off the ground – yet.
Trapped in an old pension or annuity?
In last year’s Budget, the Government announced that people locked into non-commutable income streams started back before 2007 to manage the old reasonable benefit limits or improve Centrelink entitlements, would finally be allowed to get out of them – a godsend for many – but this opportunity was only going to be temporary.
If you have a market-linked income stream – commonly known as a term allocated pension (TAPs) – complying lifetime or life-expectancy pension or annuity, you would have had two years starting from 1 July this year (if it had gone to plan) to fully commute your income stream – together with any reserves – back to accumulation phase. From there you’d be able to commence a new pension, withdraw the funds, or retain them in the accumulation account.
Any reserve transferred to accumulation phase would not count towards your concessional contributions (CCs) cap and thus wouldn’t result in excess CCs. Instead, the transferred reserve was going to be treated as an assessable contribution taxed at 15 per cent – recognising the concessional tax treatment received when the reserve was established to fund the pension.
Any favourable social security treatment applying to the existing income stream would be lost – wouldn’t transfer over – but there would have been no re-assessment of it.
This legacy pension amnesty should not be confused with the Government’s new laws impacting the commutation of legacy pensions which came into play earlier this month – they bear no relationship. The new laws address the excess transfer balance tax issue for legacy pensions.
New pension laws
Capped defined benefit income streams (CDBISs) are lifetime pensions commenced any time and certain old income streams – lifetime annuities, life expectancy pensions/annuities and TAPs/annuities in existence before 1 July 2017.
CDBISs are non-commutable income streams and thus have severe restrictions on when they can be commuted. For this reason, they cannot exceed a person’s transfer balance cap (TBC) – the limit on the total amount that can be moved into retirement phase – and modified TBC rules apply to them to ensure this does not happen.
The way the system works, CDBISs by themselves cannot result in an excess transfer balance but they can limit the ability to commence other non-CDBISs, such as account-based pensions.
However, a problem could have arisen where a CDBIS was restructured into a new TAP since 1 July 2017. This is because the new TAP, not being in existence before that date, is not a CDBIS and thus the modified TBC rules for CDBISs won’t have applied to it – potentially resulting in an excess transfer balance.
So, people who have restructured a CDBIS and ended up with an excess transfer balance but no ability to commute that amount from their new TAP, have an ongoing issue.
The new laws solve this problem by allowing these income streams to be commuted to resolve the excess transfer balance issue. Importantly, a TAP can now be commuted to comply with an ATO commutation authority to resolve an excess transfer balance.
Other important tax, social security – yet to be legislated – and succession planning issues may need to be considered here.
Unfortunately, the changes to the residency requirements for SMSFs and SAFs, and the legacy pension amnesty have not been legislated – and won’t be with the election. They had not even progressed since last year’s Budget – no draft legislation or exposure drafts from Treasury.
It will be interesting to see – depending on the outcome of the election – whether these changes are reintroduced or not.
*This information is prepared by Fitzpatricks Private Wealth Pty Ltd (Fitzpatricks) ABN 33 093 667 595 AFSL No. 247 429 and, where relevant, its related bodies corporate. The information in this publication is of a general nature only. All information has been prepared without taking into account your objectives, financial situation or needs. Because of this, we recommend you consider, with or without the assistance of a financial adviser, whether the information is appropriate for you.