Moving to 100% pension phase – why is it so hard to explain my actuarial %?

31 Aug 2020

Meg Heffron

Managing Director

In our article “Why isn't my actuarial % as high as I thought it would be?" we highlighted a number of scenarios where an actuarial certificate may appear to give an odd result. One of these was the situation where a fund moved to 100% pension phase during the year.

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A simple version of this is where a fund is 50% pension phase up until 31 December and then 100% pension phase from 1 January.

Instinctively, it feels like the actuarial % for this fund should be something like 75% - the fund was 50% pension phase for half of the year and then 100% for the remainder of the year. So the actuarial % should be somewhere in the middle – around 75%.

But in fact, some funds in this position will indeed have an actuarial % of 75% while others will have only 50%. Why?

It all depends on whether or not this fund is allowed to claim exempt current pension income (ECPI) using the “segregated method”.

If the fund cannot claim ECPI using the “segregated method”.

That would be the case if at (say) 30 June 2020 the fund had:

  • At least one member with a retirement phase pension (either in the SMSF or another fund); and
  • That member had a total superannuation balance of more than $1.6m.

In this example it’s easy to see how that might happen – perhaps the fund has two members (John & Grace) with roughly equal balances. John started a retirement phase pension a few years ago with $1.6m and at 30 June 2020 it stood at $1.62m. Grace’s super is entirely in accumulation phase and is about the same size. During the first half of the year, John takes regular pension payments and Grace withdraws some of her super as lump sums. By 31 December they both have $1.6m in their accounts. Grace starts a retirement phase pension with the full amount in her account at 1 January 2021 – moving the fund entirely to pension phase.

This fund would meet the two conditions outlined above and would not be allowed to claim ECPI using the segregated method. This is because John had a pension in place at 30 June 2020 and his total superannuation balance at that time was also more than $1.6m.

The actuarial % for this fund (the entirely unsegregated version) would be approximately 75%.

If the fund could claim ECPI using the “segregated method”

In this case the actuarial % would be completely different – it would be around 50%.  This is because:

  • the balances between 1 January 2021 and 30 June 2021 will be ignored completely (from an actuarial % perspective, it’s as if all the money had been transferred out of the fund at that time), and
  • the actuarial % will be 50% (the ratio that applies to the only balances that actually count – the balances in place at the start of the year).

How could this happen? Again, it’s deceptively simple.  The fund would have been able to segregate (resulting in an actuarial % of 50%) if:

  • John’s pension had not started until 1 July 2020 – in this case, while he would have had a total superannuation balance of more than $1.6m at 30 June 2020, he would  not have met the first leg of the two conditions – he would not have had a retirement phase pension in place at the previous 30 June. (Of course, for the fund to move to 100% pension phase from 1 January 2021, John would have needed to cash out his small accumulation balance before that time); or
  • John’s account had dipped below $1.6m at 30 June 2020 (even if it had previously been more than $1.6m, it is only the value at 30 June 2020 that matters for this purpose).

The actuarial calculation will be something like the following:

  • average value of the pension accounts (excluding any that are segregated) :
    ½ x ($1.62m + $1.6m) (the average balance of the pension account before it became segregated)
    x 50% (for half of the year)
    = $0.805m

Divided by:

  • average value of the whole fund (excluding any segregated accounts) :
    ½ x ($3.24m + $3.2m) (the average balance of the whole fund before it became segregated)
    x 50% (half of the year)
    = $1.61m

In other words, the actuarial % would be approximately 50% under this scenario (the segregated version).

Note that in both cases, it is important to check any other superannuation funds to which John and Grace belong. For example, if either of them had a small retirement phase pension in an industry fund at 30 June 2020 (and that same person had a combined total superannuation balance of more than $1.6m) that would be enough to make their SMSF unable to claim ECPI using the segregated method during 2020/21.

Does it really matter?

Even though the actuarial percentages are wildly different, the outcome (in terms of how much income is exempt from tax) might actually be the same in both cases.

For example, imagine the fund’s only income is $10,000 per month in interest or rent.

The first scenario (the entirely unsegregated version) would see the fund’s ECPI calculated as follows:

75% x $10,000 x 12 = $90,000

The second scenario (the segregated version) would see the fund’s ECPI calculated in two parts as follows:

50% x $10,000 x 6 (the income received in relation to unsegregated assets – ie during the first 6 months)

+

100% x $10,000 x 6 (the income received from segregated assets – ie during the second 6 months)

= $90,000

In other words, it’s not just the actuarial % that is important but also the income to which it will be applied.

In this case, John and Grace probably don’t really care how their actuarial % is calculated or what it is, they would just want to be sure their accountant applied it to the correct income.

But where John and Grace might care – passionately – would be where the income was not earned evenly throughout the year. For example, what if their SMSF’s income was received entirely in June 2021? This is entirely feasible where most of the fund’s income is received as a trust distribution or a capital gain at a particular time.

If the income amount was still $120,000 but received in June, the calculations would be as follows:

Under the first scenario (the entirely unsegregated version), the exempt current pension income would be:

75% x $120,000 = $90,000

Under the second scenario (the segregated version), the exempt current pension would again be calculated in two parts as follows:

50% x $nil (the income received in relation to unsegregated assets – ie during the first 6 months)

+

100% x $120,000 (the income received from segregated assets – ie during the second 6 months)

= $120,000

John and Grace would definitely prefer that the fund was able to claim ECPI using the segregated method. In fact, the trustee of their SMSF could choose not to get an actuarial certificate at all in this situation – its only purpose is to permit the fund to claim a tax exemption on some of the income earned on unsegregated assets. If there is no income from unsegregated assets, there will be no exemption claimed and hence no certificate is required for tax purposes. NB: A different type of actuarial certificate would still be necessary if the fund had defined benefit pensions.

Could John and Grace have controlled the outcome?

Absolutely. Let’s imagine John & Grace know that a large part of the fund’s assessable investment income will arrive in May / June 2021.  They could:

  • Start Grace’s pension earlier if possible – so that even on the entirely unsegregated scenario the actuarial % is higher, or
  • Stop John’s pension on 30 June 2020 and not re-start it until 1 July 2020.  Assuming all their super is in their SMSF, this would ensure that none of the fund’s members had a retirement phase pension in place on 30 June 2020 so the fund could use the segregated method.

As is often the case with SMSFs, there are choices providing they are planned in advance.