News 06/07

Super Concepts e-SuperUpdate provides you with technical tips and updates on Self Managed Superannuation Fund topics of interest. 

Splitting Super Benefits into two funds before 1 July 2007

In this e-SuperUpdate we look at the advantages of splitting your superannuation benefits into two funds and transferring the tax exempt amount to another fund.

Why Split the Super Benefit

Under the rules that apply until 30 June 2007 your superannuation benefits consist of many components, some of which are taxable and some which are not.  If you wish, you may elect to draw down just the tax free component or the taxable component of your benefit.  However, from 1 July 2007 that opportunity will not be available and benefits withdrawn from the fund will combine the tax free and taxable component in accumulation and pension phases, if they exist.

By splitting your superannuation benefit into its tax free and taxable components prior to 1 July 2007 and transferring the tax free components into another fund you can  receive a tax free pension if you are between 55 and 60 or should you die your non-dependants can receive a tax free death benefit.

How Does it Work?

Frances, who is 57, has a large benefit in her self-managed superannuation fund which she has accumulated over many years.  The current balance is $2million and consists of $1,500,000 in undeducted contributions.  She wishes to commence a pension from 1 July 2007 and would like to do it as tax effectively as possible.

If Frances was to commence an account based pension on or after 1 July 2007 from her self-managed fund then 25% of any pension payment would be taxable.  However, if Frances was to transfer her undeducted contributions to a second self-managed superannuation fund by 30 June and then commence an account based pension on 1 July 2007 then it will be totally tax free.  This also provides estate planning advantages if a death benefit is paid to a non-dependant child over 18.

Let’s assume that Frances wishes to use $1million of her superannuation account balance as at 1 July 2007 to commence an account based pension.  As she is age 57 she will be required to draw a pension equal to 4% of the account balance, $40,000.

If the pension was paid from her current self-managed superannuation fund then 25% of the pension, that is, $10,000 would be taxable.

However, if Frances decided to transfer all of her undeducted contributions to another fund by 30 June 2007 and commence a pension on 1 July 2007 then all of it would be tax free.  If she was to die any lump sum paid to non-dependants over 18 from the amount supporting the pension would also be tax free.

Is it worthwhile to have two super funds?

Believe it or not, it can be useful with the new super rules to use two superannuation funds.  Two funds allow you to make non-deductible contributions to one fund and tax deductible contributions to the other or have tax exempt components in one and taxable components in the other.  This can be an advantage to anyone younger than 60 or where it could be expected that death benefits will be paid to a non-dependant child older than 18.

Why do the funds need to be different?

Under the rules that apply until 30 June 2007 your superannuation benefits consist of many components, some of which are taxable and some which are not.  If you wish, you may elect to draw down just the tax free component or the taxable component of your benefit.  However, from 1 July 2007 that opportunity will not be available and benefits withdrawn from the fund will combine the tax free and taxable component in accumulation and pension phases, if they exist.

By making non-deductible and deductible contributions to separate funds the effect of requiring you to proportion your benefit over the taxable and tax free parts of your benefit can be reduced or even eliminated.  The advantage is that if you have a fund which only has tax free amounts, such as non-deductible contributions, and you commence a pension then the pension will always be tax free.  This applies irrespective of your age.  It also means that any payment on your death to a non-dependant child over 18 will also be tax free.

How Does it Work?

Let’s look at Mark who is 56 and has decided to commence two superannuation funds.  He makes non-deductible contributions after 1 July 2007 to the first fund of $450,000 and deductible contributions of $100,000 to a second fund. 

If Mark commences a pension from non-deductible contributions as soon as they are made he will be required to draw down a pension for the year equal to 4% of his account balance or $18,000.  At the end of the year Mark’s account balance will be about $470,000 assuming the fund earns 7% on its investments.

In the next year Mark will be required to draw a pension of $18,800 which is equal to 4% of his account balance of $470,000.  All of pension paid to Mark will be tax free even though he is under 60. 

Once Mark reaches age 60 he could commence a pension with the amount accumulated in the second fund which will provide a pension to him which will be tax free due to his age.

If Mark was to die then he may nominate the payment of a death benefit from the first fund to be received by his non-dependant children over 18.  As the death benefit comes from a pension which commenced wholly from a tax free amount then any death benefit to non-dependants will also be tax free.  The amount in the second fund could be paid tax free to Mark’s surviving spouse and/or dependants.

Commencing the pension does not require you to receive payments immediately.  An account based pension can be paid once a year.  For example, the whole amount of Mark’s pension could be paid at the end of the financial year on 30 June.

By making deductible and non-deductible superannuation contributions to two funds provides greater flexibility and can provide tax advantages for those who draw a pension prior to age 60 or for death benefits paid to non-dependants who are over 18.

We recommend you seek structural planning advice tailored to your own SMSF and personal situation to ensure that you make the most of the benefits available.