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Self Managed Super Fund (SMSF) Article
How taxable and tax-free components are worked out

By Tony Negline.

This article may be out of date.

26th March 2008

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Under Peter Costello's Better Super changes all super benefits have at least two components – tax-free and taxable.

As you might expect the tax-free component is not taxed when it is paid regardless of the age of the person when it is paid to them.

The taxable component is a very different beast altogether.  It may be tax-free if the recipient is over 60 (most super benefits become tax-free once a superannuant reaches 60).  But it may be taxed even for those over 60.

There are two parts to the taxable component called taxed-in-the-fund and untaxed-in-the-fund benefits.  Untaxed benefits are paid to some public sector employees and a small group of other people and we will not look at how these are calculated here.

Taxed-in-the-fund benefits are paid to everyone including members of Self Managed Super Funds.

The best way to think through the process that works out the tax-free and taxable components is to think initially about someone who was a member of a super fund before 30 June 2007 and continues to be a member.  Using 30 June 2007 as the calculation date super fund administrator have to divide all member’s super benefit into Tax-free and Taxable Components.

The Tax-free Component is made up of a range of old super benefits including personal undeducted contributions made after 30 June 1983 and the pre-July ’83 component.  It might also include an invalidity benefit and the Small Business CGT exempt proceeds.  The government has given super funds until 30 June 2008 to do this calculation.

For example, on 30 June ’07 Sally Humble had $1.5m in her super fund.  $1m of it was undeducted contributions which she made to take advantage of the $1m contribution opportunity that finished at the end of June ’07.  Two-thirds ($1m / $1.5m) of her super fund account is classed as Tax-free Component.  The remainder is the Taxable Component.  From 1 July 2007 this portion of Tax-free Component sits in what is called the "Crystallised Segment".

Let's assume that at the start of April '08 she had not made any contributions and wants to know what her Component split is.  Her account balance has fallen to $1.1m.  In this case her Tax-free proportion will be 90.9% ($1m / $1.1m) and therefore 90.9% of any money she withdraws from the fund at that time will be Tax-free Component.

Now we need to change this case a little.  Assume that Sally adds additional personal undeducted contributions of $150,000 into her super fund in January '08.  In April '08 the account balance is $1.2m (yes, like us all Sally's super fund has had woeful investment performance since October ‘07).  The tax-free component is $1.15m ($1m + $150,000) which means the Tax-free proportion is 95.8% when that calculation is done.

The $150,000 contribution is placed into a “Contributions Segment” which contains all contributions made to a fund after June '07 that have not been taxed by the fund in the financial year they were made.  The "Contributions Segment" also contains the Tax-free Components from benefits rolled into a super fund after June 2007.

The Crystallized Segment and the Contributions Segment are not adjusted for investment earnings but they are reduced by the Tax-free Component withdrawals made from a fund.  The Taxable Component always acts as the balancing item in these calculations.

Rollovers from other super funds do cause quite a lot of confusion under this new system.  Suppose on 1 April Sally transfers into the fund $200,000 from another fund and $60,000 of this is the Tax-free Component.  This amount immediately goes into her "Contributions Segment" which would have a value of $1.21m ($1m + $150,000 + $60,000).

What happens if instead of rolling money into this super fund Sally took $200,000 out when her account balance is $1.2m before the withdrawal?  Her Tax-free Component is $1.15m or 95.8%.  This means $191,666 of the amount removed from the fund is Tax-free and the balance ($8,333) is Taxable Component.  After this is withdrawn her Tax-free Component in the super fund would be reduced to $958,334 ($1.15m – $191,666).

These calculations are done whenever a member wants to take a lump sum out of a super fund.

The Taxable Component for those under 55 will be taxed at 21.5%.  For those aged between 55 and 60 it will be taxed at 16.5% if the total Taxable Component that a person has received over their lifetime has exceeded $140,000.

Now you might be wondering how you are meant to keep track of the value of your Tax-free and Taxable components.  Under new laws, super funds must provide you with a "Lump sum Pre-payment Statement" before you take out any money.

Pensions are a whole different ball game.  The components are worked out on the day the pension commences.  Once they are worked out they are never changed.

For example suppose Sally commences a pension with $1.5m and a $1.21m Tax-free Component.  If she is over 60 then 80.6% of each pension payment will be deemed to be tax-free.  These percentages will remain the same throughout the life of the pension.

If Sally died and the benefit was to be paid to her non-dependant children then the taxable component of the death benefit would be taxed at 16.5%.

Pensions which commenced before July 2007 for anyone under 60 have their own unique set of rules which we will leave to another time.

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