Issue 03 - Self Managed Superannuation Fund (SMSF)
The timing of your retirement is an important decision for many reasons, including taxation. The reason for this is that the rules regarding the commencement and cessation of a pension from your superannuation fund can be complex to apply. Before reducing your work hours to take advantage of a potentially tax-free income stream, or creating tax savings within your superannuation fund, you must first consider whether you can access your superannuation under the preservation rules.
Preservation is a superannuation concept based around the principle that super savings should be preserved for retirement. You can not have access to the funds until you have reached your preservation age, which is 55 years if you were born before 1 July 1960. This concept is a trade off for the concessional tax rates associated within super.
When considering your options for retirement not only do you need to meet the age requirement, but if you want unrestricted access to your superannuation balance, you must also retire from work completely and be prepared to declare this in writing and possibly come under ATO scrutiny. Retiring one month and then going back into the workforce months later, after accessing your super, is not looked upon favourably by the ATO.
Timing of when to commence a pension can be important too. For example, consider a self-managed superannuation fund in which there are two members. One member has reached preservation age and retired. Their balance within the fund represents 60% of the total fund. Once the fund commences a pension, approximately 60% of the earnings and capital gains will become tax exempt. The fund's tax liability will be significantly reduced.
However, if that member reached preservation age and retired part way through the year, the percentage of the fund's tax exempt income would need to be pro-rated. Based on the example above, if the member now started a pension on 1st April, only approximately 15% of the fund's earnings would be tax exempt for that year.
We will now discuss how you can access part of your super balance without having to retire after reaching your preservation age.
In the previous edition of Considered Wealth, we highlighted the differences between preservation age and pension age and what this would mean in relation to accessing your super benefits. To recap, once you reach your preservation age you have met what is known as a 'condition of release' and are eligible to commence accessing your super benefits through a transition to retirement (TTR) account based pension. If you were born before 1 July 1960, your preservation age is 55. Your preservation age is higher if you were born after this date.
Under a TTR, the amount you can withdraw is subject to minimum and maximum thresholds. The minimum amount is equal to 4% of your superannuation account balance as at 1st of July or on the date in which you commence a pension. The maximum amount is 10% of your super account balance. The maximum threshold rule ceases when you satisfy another condition of release such as permanent retirement after the age of 55 or reaching the age of 65 years
Below are some reasons why you may wish to commence a TTR:
- Gaining partial access to your super without having to retire
- Reducing your work hours without affecting your net cash flow
- Salary sacrifice more of your pre-tax salary to increase your super while not affecting your net cash flow
- Receive a tax free income stream reducing your overall tax position
As highlighted above, there are opportunities to reduce your tax liability not only in your personal name but also within your super fund. The outcome will depend on your personal super account, taxable position and your age.
By commencing a TTR, all income and capital gain earned on the assets of the super fund that support the pension become tax free.
The tax treatment of the pension income itself will depend on the age of the member. If under the age of 60, the taxable component of the pension will be taxable at the member's marginal tax rate. However, a 15% rebate will be available to offset against the associated tax. If a member is 60 years and over, any pension received from super is tax-free and not reportable.
Please note: Constitutionally Protected Funds, such as Super SA Triple S Fund, have different tax treatments when starting a pension.
Let's say Sally is 58 years old, works full time with a salary of $95,000. She would like to salary sacrifice more into super. Currently, her Self Managed Superannuation Fund (SMSF) account balance is $350,000 made up of 47% tax free and 53% taxable components.
Sally has reached her preservation age and therefore can start a TTR. She is under the age of 60 so the tax component of any pension withdrawn from super will need to be reported and taxed in her personal return at her marginal tax rate (plus medicare levy).
The maximum concessional super contribution that Sally can make into her SMSF is $35,000. Therefore, she could potentially contribute an additional $25,975 into super via salary sacrifice as her employer would be contributing 9.5% superannuation guarantee already on her behalf.
If Sally chooses to salary sacrifice an additional $15,000, $20,000 or $25,000 while withdrawing a pension of the same amount from her SMSF to maintain her net cash flow, the outcome will be as follows:
*taxable pension is calculated at 53% of total pension of $15,000, $20,000 or $25,000 respectively.
In the above example, there are significant tax savings when Sally salary sacrifices more into super and supplements her income with a TTR. The net tax effect could increase considerably if the superfund is investing in blue chip shares paying fully franked dividends. Our financial modelling process can assist you in determining what impact a TTR could have on your personal retirement goals.
There are not many SMSFs that own collectible assets, but those that do have until the 1 July 2016 to comply with the new rules that were introduced in 2011.
Regulation 13.18AA(1) of the Superannuation Industry (Supervision) Regulations (SISR) commenced on 1 July 2011 and specifies that the following assets are taken to be collectables and personal use assets:
- coins, medallions or bank notes
- postage stamps or first day covers
- rare folios, manuscripts or books
- memberships or sporting or social clubs?
From the 1 July 2016, trustees of the super fund must ensure that these assets are not leased to, or used by a related party and must not be stored at the private residence of a member or related party. The decision on where the assets are stored must be documented in writing and maintained for 10 years. Each asset must also be insured in the name of the super fund.
Some trustees have divested themselves of these assets. If you have not and would like to, you may be able to transfer these assets to a related party in some circumstances. Where an asset is being sold or transferred to a related party it must be at market value as determined by a qualified independent valuer.
Super fund auditors will be focusing on this during the completion of the 2016 financial year SIS compliance audits so take action now.