Understanding when a fund is "segregated" for tax purposes is critical in applying the tax rules to SMSFs providing pensions. An important rule change from 1 July 2017 means that some funds are no longer classified as segregated even if they very much look like it - for example, they are entirely in pension phase. In this article we explain which funds are actually no longer allowed to segregate for tax purposes and what that means when it comes to their tax exemptions.
So what are the new rules?
From 1 July 2017, a fund cannot have any assets classified as segregated at any time during a particular financial year if, at the previous 30 June:
- any member had a total superannuation balance of more than $1.6m (and remember, total superannuation balance includes not just the balance in the SMSF but all superannuation in every fund to which the member belongs); and
- any of those members with more than $1.6m also had a retirement phase pension from any fund (not necessarily the SMSF).
If a fund cannot be classified as segregated it simply means that it cannot claim its tax exemption (ECPI) on the segregated basis. The fund is still eligible for an exemption but under the "pooled" method.
Mary and John both have $1.6m retirement phase pensions at 30 June 2017 and small accumulation balances. They have no other superannuation. During 2017/18 they fully withdraw their accumulation balances and their pension balances grow slightly during the year because their fund's investment earnings exceed their pension payments. At 30 June 2018 their balances are $1.65m each (all in pension phase).
Their SMSF cannot be classified as "segregated" for tax purposes during 2018/19 even if it remains entirely in pension phase throughout the year (ie no new contributions are made for either of them). The fund will instead claim its tax exemption for 2018/19 under the normal rules for "pooled" funds. These are found in Section 295-390 of the Income Tax Assessment Act 1997. The SMSF will need an actuarial certificate to say that the fund is 100% exempt from tax. This is because only funds that are segregated (and covered by Section 295-385) are allowed to claim a tax exemption without obtaining an actuarial certificate.
If Mary and John both withdraw large amounts from their pension accounts during 2018/19 and by 30 June 2019 their balances are under $1.6m, the situation will change again for 2019/20. For 2019/20 their fund will be allowed to be classified as segregated. It can claim a tax exemption on all of its investment income for the year without needing an actuarial certificate if no further contributions are made. If contributions are made during the year (or the fund has a mixture of pension and accumulation accounts for some other reason) the Fund will need to claim its tax exemption in two parts - on the segregated basis while it is entirely in pension phase and via an actuarial certificate during the "mixed" phase.
Stacey and Mark both belong to the Stacey & Mark Superannuation Fund (an SMSF) and their entire balances will provide retirement phase pensions throughout 2017/18. Their total superannuation balances have never been more than $1m. Stacey's mother Anne is also a member of the fund. She has a small accumulation account ($100,000) in their fund and traditionally the trustees have invested Stacey and Mark's balances quite separately to Anne's. They have treated the fund as segregated for tax purposes. Unfortunately Anne had $2m in another SMSF at 30 June 2017, of which $1.6m was providing a retirement phase pension. This means that the Stacey & Mark Superannuation Fund is not allowed to be segregated for tax purposes any more. It doesn't matter that Anne's large balance is in another SMSF, nor does it matter that Anne doesn't have a pension in the Stacey & Mark Superannuation Fund. Simply the facts that:
- she is a member of the Stacey & Mark Superannuation Fund;
- she has more than $1.6m in total superannuation balances at 30 June 2017; and
- she has a retirement phase pension "somewhere"
is enough to compromise the ability of the Stacey & Mark Superannuation Fund to segregate its assets for tax purposes.
The trustees could still invest the money separately and allocate investment earnings on the basis of the different assets chosen for each member. However the fund's tax return would be prepared as if all the assets are shared. The tax exemption would be based on an actuarial certificate.
Feel free to add your own scenarios to the comments box and we'll let you know whether or not the fund can segregate from 1 July 2017.