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Self Managed Super Fund (SMSF) Article
SMSFs & Actuarial Certificates

By Tony Negline.

This article may be out of date.

26th October 2005

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Earnings on super fund assets backing pensions are tax exempt.

Without this tax exemption and some other significant tax concessions, such as the 15% rebate on all income payments, superannuation might not be a worthwhile retirement income vehicle for most people.

However using current tax policy as the principal reason for investing in anything is not very clever.  Tax concessions are the Parliament's prerogative to give and to withdraw without much warning.

Tax is not the only reason the superannuation fund structure might suit an investor's needs and requirements.  Estate planning might be one because the super structure offers some levels of simplicity and flexibility not provided by other investment vehicles.

To gain access to the tax exemption for pension assets, a super fund's trustees may need to obtain an actuarial certificate.

But what is an actuary?  According to the Institute of Actuaries of Australia website “actuaries apply mathematical, statistical, economic and financial analyses, which involves adding risk assessment to longer term financial contracts, in a wide range of practical business problems ... [and] many actuaries participate in the operational management of financial institutions.”

So why must an actuary be involved in handing out this tax exemption?  The answer to this question is found in the historical development of the taxation of super funds.  Defined benefit lifetime and term pensions cannot operate without an actuary.  With these types of pensions, actuaries perform many tasks but perhaps the most important is predicting the likelihood that all future pension payments will be paid as promised by the fund trustees.  When super fund tax was introduced 17 years ago super funds could only provide lump sums or defined benefit pensions and the government needed to ensure that super funds didn't put too much money into their pension accounts thereby avoiding tax.  It solved this problem by forcing funds to get actuaries to formally certify the results of some of the work they were probably doing anyway.

However in the early 1990s allocated pensions which contain no guarantees began to appear.  An allocated pension is a bit like a bank account from which you are paid an income stream.  The  account balance increases with investment income and capital gains and decreases with pension payments and costs.  The word “allocated” is meant to show that the pension's money is kept in its own account.  Once that account has no more money no more income payments are made.  Clearly these types of pensions are much more transparent than defined benefit pensions and the need for actuarial review is not obvious.

For many years industry associations asked the government to automatically make allocated pension assets tax exempt and remove the need to get actuarial certificates.  In February 2004 the government finally agreed to this and said “where a fund only pays an allocated pension and holds no other pension assets, an actuarial certificate is not needed as the fund's entire pension assets are being used to support pensions.  The Government will remove the requirement for a superannuation fund to obtain an actuarial certificate for assets supporting allocated pensions, and the new complying market-linked pensions [that is, Term Allocated Pensions] from the 2004-05 financial year.  This will reduce compliance costs for pension providers.”

However when the government finally got around to formalizing the rules to put this worthwhile amendment in place, it only exempted super funds that are segregated from all other fund assets.

What is asset segregation?  Assets in a super fund can be segregated at a number of levels.  The two most common is at the member level or benefit level.

Assets are segregated at the member level when specific assets are identified as belonging to specific members.  Assets are segregated at the benefit level when they are split between one class of benefit type and all others.  For example between assets backing pensions and assets for pre-retiree members.

If assets are segregated then it is essential to identify and allocate specific assets so that income and expenses are allocated appropriately.  Most funds run separate accounts for each level of segregation.

Funds which segregate assets between pension and non-pension assets do not need to get actuarial certificate from the 2004/05 year onwards if the fund only provide allocated pensions or term allocated pensions.

Super fund assets are unsegregated when assets are not identified as belonging to a particular part of the fund.  When this occurs there has to be some mechanism for working out what notional amount of assets belong to pensioner members and what belongs to pre-retiree assets so that the amount of tax can be worked out.  The tax laws require the involvement of an actuary to work this split out.

Most small funds use the unsegregated asset approach because it is easier and cheaper to administer.  These funds still need an actuarial certificate if they want to get a tax exemption for their pension assets.

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