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Self Managed Super Fund (SMSF) Article
Drawing on super while still paying out
By Tony Negline.
This article may be out of date.
21st May 2008
Roger, a regular DIY Super reader has asked the following excellent questions: “I would like to commence a pension (age 62) from my SMSF [Self Managed Super Fund] but at the same time, I want to continue making contributions that I claim as a tax deduction. I would put my current super into pension phase and then switch the contributions made during a year over to a pension at the end of the year in which they are made. What are the mechanics that make this work within my SMSF? Do I have to create a new pension each year? What sort of tax work would need to be done?”
The advantage for this reader is that the income payments from the super pension are paid to him tax-free each year because he is over 60. The ability to claim a tax deduction for personal super contributions is important because it will reduce the amount of income tax paid on any other income he has to declare for income tax purposes.
If our reader has not retired then he will need to begin a Transition to Retirement pension. This means that the assets he uses to pay this pension will not be payable as a lump sum until he either retires permanently or turns age 65.
A Transition to Retirement pension must pay him an income between 4% and 10% of the market value of assets. The market value of assets is worked out on every 1 July for the whole financial year. A special rule is used in the first financial year of the pension.
The 4% minimum applies for all super pensioners aged under 65. The minimum income increases from that age onward.
Once the super investor satisfies the super retirement definitions or reaches age 65 the 10% income limitation disappears and all the money could be paid as a lump sum. The only requirement is that income payments must meet the minimum required.
Roger wants to claim a deduction for his personal super contributions. He will need to satisfy a particular test which says that less than 10% of his total assessable income and reportable fringe benefits can be paid by an employer who, in the ordinary course of events, would make Super Guarantee contributions for him. If he is not employed then he would satisfy this rule automatically. Voluntary contributions after age 65 will only be allowed if a gainful employment test is satisfied.
As he is over 50 during the five financial years between 1 July 2007 and 30 June 2012, Roger will be allowed a deduction for personal super contributions of up to $100,000. Contributions under this limit are taxed at 15%. Contributions above it, which is not indexed for this five year period, are taxed at 46.5%.
The deduction that he claims for these contributions cannot put his personal tax situation into a loss. For example suppose this financial year Roger has assessable income for income tax purposes of $75,000. The maximum deduction he can claim for his personal super contributions is $75,000. Because of the way the whole tax system works it may not be the most tax effective strategy to use the personal super tax deduction system to create $0 in tax assessable income.
Our reader has mentioned that with the proceeds from the contributions made he would start a pension each year. Ideally most people at this point would want to take that contribution money and simply add it to the pension they already have. It is very important to point out that this cannot happen because once a pension commences no new capital can be added to it.
At the start of year 2 of this strategy, Roger would have two pensions, in year three he would have a third pension and so on.
To implement this strategy correctly the next step is vital. In order to claim a tax deduction for personal super contributions there must be an exchange of paper-work between the super fund and the member. This paper-work must be done before each pension starts otherwise the tax deduction is not allowed.
Within the accounts of the fund there will need to be separate accounts for each pension showing the outstanding account balance. The super fund trustees have a choice if they wish to use the 'segregated' asset system or the 'unsegregated' asset system.
Unsegregated means that no particular fund asset belongs to a particular member or pension. Segregated means that particular assets are deemed to be 'owned' by a member. The unsegregated system is much simpler to administer which probably explains why most pension paying SMSFs elect to use it. A fund which implements this strategy will need an actuary to sign a certificate. Without this certificate the pension assets will not be exempt from tax.
The accounts for a fund implementing this system will be fiddly because there will be a portion of the assets in pre-retiree phase (and hence subject to 15% tax) as well as contribution tax liabilities. There will also be the pension assets which are not taxed. Allocating net investment earnings can be painful. It will cost more to prepare these accounts and to have them audited.
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