The impact of the total superannuation balance (TSB) on a person’s ability to make non-concessional contributions or access to other superannuation measures are now reasonably well understood. But Tracey Scotchbrook asks: What about the impact of TSB on our pension clients?
Member TSBs will determine whether a SMSF reports for TBAR purposes on either a quarterly or an annual basis. However, there is one other area where TSB impacts pension funds that has perhaps slipped through a little unnoticed. That is the disregarded small fund asset rules (“DSFA”) and how that impacts the calculation of ECPI for affected pension funds.
These provisions will already impact our larger clients. However, for many clients the DSFA rules will not become an issue until after a fund member dies and benefits are then paid to the spouse as a death benefit pension. It is these clients that create a potential exposure for advisors where an unexpected liability arises from incomplete advice.
What is it?
The assets of a superannuation fund will be DSFAs where:
- The Fund is a SMSF; and
- The SMSF has at least one retirement phase income stream at some time during the year; and
- Just before the start of the income year:
- A member of the Fund has a TSB that exceeds $1.6m; and
- That member is the recipient of a retirement phase income stream (whether that pension is in this fund or another)
SMSF’s with DSFAs cannot be segregated funds for exempt current pension income (“ECPI”) calculation purposes (ITAA97 s.295-385(7)). Instead, an actuarial certificate is required to determine the taxable/tax free percentage of the fund. This is then applied against the fund income for the full financial year, including any periods where the fund held wholly pension interests.
What does that mean?
Couples whose member accounts are wholly retirement phase income streams and individually have TSBs below $1.6m are considered to be segregated funds. The income on these funds will be wholly tax free, including capital gains, where the fund is a retirement phase pension fund for the full financial year.
Problems can arise with the death of one of those members where the benefits are to remain in the fund and be paid to the surviving spouse as a death benefit pension.
If at 30 June in the year of death, the surviving spouse has a resulting TSB of more than $1.6m, the fund will be subject to the ‘DSFAs rule’ in the following financial year (e.g. from 1 July). It will no longer be treated as a segregated fund.
This can create income tax liabilities in particular where assets need to be sold and the surviving spouse will have an accumulation interest for the first time. The accumulation interest arises due to the need to roll back pension balances to accommodate the receipt of the death benefit pension.
In this scenario, an actuarial certificate is required and will be applied to the income received for the whole of the income year. This applies even though the sale occurred before the accumulation interest was created.
It is important to remember that a reversionary pension commences to be paid to the beneficiary from the date of death of the pension member. This will result in an immediate increase in the member balances for the surviving spouse. As a result, the reversionary pension will form part of the member’s TSB calculation at 30 June.
A non-reversionary death benefit pension becomes the beneficiary’s interest on the date the pension commences. The legislation requires that a death benefit is paid ‘as soon as practicable’ after the death of the member. However ‘as soon as practicable’ is not defined and will depend on the specific circumstances applicable to the fund. The pension will form part of the member’s TSB calculation at 30 June in the year in which the pension commences to be paid.
Here is one example on how clients can impacted
John died in September 2018. His pension is reversionary to his wife Patricia. As at date of death both their member balances were $1m each. Patricia has 12 months to comply with the transfer balance cap. As at 30 June 2019, Patricia’s TSB exceeds $1.6m as she is now in receipt of John’s pension. From 1 July 2019, the DSFAs rules apply to the calculation of ECPI for the fund.
In August 2019 a property (a significant asset of the fund) was sold resulting in the realisation of a significant capital gain. Patricia rolls back part of her pension to accumulation to comply with the transfer balance cap requirements in September 2019, one year after John’s passing.
Although the property was sold at a time the fund was wholly in pension mode, the fund meets the definition of a DSFA. An actuarial certificate is required and must be applied to the fund income for the entire year, including the capital gain on the property.
In contrast, if the property sold on or before 30 June 2019, the whole of the capital gain would be tax free as the DSFA rules have not yet been triggered and there was no accumulation interest during the year.
Pension planning and advice for clients is now a more complicated affair. The DSFAs is one area that is tripping up many advisors. Often the first thought is that if a capital gain is realised whist the fund is still wholly in ‘pension phase’ no income tax liabilities will be incurred.
It is important that clients are made aware of the potential for income tax liabilities to arise. Do include the potential income tax consequences in your written advice and discussions with clients to avoid any nasty surprises.
Tracey Scotchbrook is a SMSF Specialist Advisor and Director of Superology Pty Ltd with 15 years’ experience. Early in her accounting career Tracey had the opportunity to work with self-managed superannuation funds, setting her on the pathway to specialisation. She is actively involved in the SMSF Association (“SMSFA”) and is the former WA Chapter Chair and National Membership Committee Member. Her accreditations include: SMSF Specialist Advisor (SSA) with the SMSF Association, CA and CPA SMSF Specialist, and Charted Tax Advisor with the Tax Institute. Tracey is a regular presenter to industry professionals and trustees, commentator, educator, and writer. In 2009 Tracey was awarded the Praemium Scholarship by the SMSFA. Contact Tracey at [email protected] or connect via LinkedIn or Twitter