This has become a common question since pensions and exempt current pension income (ECPI) got more complicated from 1 July 2017. In theory, we should also be asked why the actuarial % looks too high. Funnily enough we don’t get many of those!
The question is rarely asked in the simple cases where a fund has (say) one pension account and one accumulation account all year. If the two are roughly equal in size the actuarial % is exactly as expected – roughly 50%. This is because the maths behind the calculation is relatively straightforward: average value of the pension account(s) throughout the year divided by the average value of the whole fund throughout the year.
Where life gets more complex is where that ratio changes during the year. Particularly if, say, the fund is 100% pension or accumulation phase at some point during the year.
There are a number of common scenarios to look for if you’re confused by the number on your client’s actuarial certificate.
In most cases, the complication is created by the fact that these days:
- Some funds are not allowed to claim their ECPI using the segregated method, while
- Other funds are allowed to do so. And in fact, if they are 100% in pension phase during any part of the year they are actually obliged to claim their ECPI using the segregated method for this part of the year.
The SMSFs that are not allowed to use the segregated method are those where, at the previous 30 June (so 30 June 2019 for 2019/20 annual returns that are currently being prepared):
- At least one member had a retirement phase pension in place (either in the SMSF or another fund), and
- That member had a total superannuation balance of more than $1.6m.
As a general rule, these funds (that cannot use the segregated method) have actuarial % that are simple and intuitive.
The complexity arises when a fund can.
So what are some of the most common points of confusion and what are our tips for accountants and advisers?
Moving 100% to pension phase during the year
Remember that if the fund falls into the category of funds that can claim ECPI using the segregated method, any part of the year where it only has pension accounts will effectively be ignored in the actuarial calculations.
For example, a fund that is roughly evenly divided between pension and accumulation accounts for the first few months of the year but entirely in pension phase from (say) September onwards might have an actuarial % of only 50%.
This doesn’t mean only 50% of the fund’s investment income is exempt from tax. Instead, it means that the fund’s ECPI will be calculated in two parts:
- 50% of the income earned while the fund wasn’t segregated will be exempt from tax (ie the income in July and August) using the actuarial % method; and
- All of the income earned while the fund was segregated (September onwards) will be exempt from tax using the segregated method.
See our article “Moving to 100% pension phase – why is it so hard to explain my actuarial %?” for more on this scenario.
Moving in and out of 100% pension phase during the year
These cases can become extremely tricky. Again those funds that can claim ECPI using the segregated method must do so for the periods when they are 100% in pension phase. Consider the case where:
- July – August: the fund is roughly 50% in pension phase (only one member has converted their account to a retirement phase pension),
- September – April: the fund is entirely in pension phase, and
- May – June: the members make a downsizer contribution on 1 May and both have an accumulation account for the remainder of the year.
In this case, the actuarial % will be based on the members’ account balances in two periods (July – August and May – June). Depending on the relative sizes of the accumulation and pension balances at the time, the actuarial % could be quite small despite the fact that the fund was entirely in pension phase for most of the year.
Again, remember that the actuarial % is only applied to income earned on “unsegregated” assets. Since the fund was entirely in pension phase from September to April, all income earned during that period will be ECPI under the segregated method regardless of the size of the actuarial %.
Moving from 100% accumulation phase
Very few SMSFs are prohibited from using the segregated method in the first year of providing pensions. This is because one of the conditions for prohibiting segregation is that at least one member had a retirement phase pension at the previous 30 June. In the first year of providing pensions, this condition will only be triggered in the unusual case where a member had a pension in another fund.
Hence funds that move neatly from 100% accumulation phase to 100% pension phase will not need an actuarial certificate at all in the first year – they will simply claim all income as exempt from tax under the segregated method once the pension(s) commence.
Where the move to pension phase involves at least some of the year in a “hybrid” phase (where the fund has both pension and accumulation accounts), it will need an actuarial certificate.
The actuarial % can sometimes be confusing here because of the way in which the accumulation phase is taken into account.
For example, consider the following case:
- July – September: 100% accumulation accounts
- October – June: 50% pension & accumulation accounts.
It is tempting to assume that the actuarial % will be 50% and will apply to the income earned after 1 October.
In fact, it will normally be less than 50% (very roughly 37% in this case), reflecting the fact that for a quarter of the year, there were no pension accounts at all.
It will, however, apply to the whole year’s investment income – not just the period after 1 October. This can also be unexpected – a large capital gain in August, for example, would be at least partly exempt from tax despite occurring at a time when the fund was entirely in accumulation phase.