Expert SMSF insights
Minimising tax with SMSF pensions
By Mark Ellem
When an SMSF is paying a retirement phase pension, for example an account-based pension (ABP), it is eligible to claim an amount of its assessable income as being exempt from tax. This is commonly referred to as “exempt current pension income” or “ECPI”.
For many years, working out a fund’s claim for ECPI has been regarded as the domain of actuaries and accountants, as it is generally seen as a retrospective calculation done as part of preparing the previous year’s annual financial statements. However, with the new ATO approach to calculating ECPI, focus will change from looking back over past transactions to looking forward to future asset sales and how much of any capital gain will be exempt from tax.
For an outline of the two methods used to claim ECPI, refer to my previous article Claiming ECPI – Which method to use?
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So, which SMSFs will be affected by the ATO’s new approach to ECPI?
SMSFs that consist wholly of retirement phase pensions for only part of the income year, rather than the whole income year, will be affected by the new approach. This could result in a much different tax outcome than in previous financial years.
Let’s consider the example of Lizzie & Phil and their SMSF, the Windsor Super Fund. At 1 July 2017, Phil was retired and all of his benefits were in a retirement phase ABP, with Lizzie still working and all her benefits in accumulation. In November 2017 Lizzie turned 65 and retired, then commenced a retirement phase ABP on 1 January 2018 using her entire accumulation account.
Their SMSF is eligible to claim ECPI in 2017/18, however, under the new approach it will be required to use both methods to claim ECPI:
- For the period 1 July to 31 December 2017 it will use the unsegregated method. The fund will be required to obtain an actuarial certificate with an ECPI% applicable for that period and apply it to the eligible income received during that same period.
- For the period 1 January to 30 June 2018 the fund consists wholly of retirement phase pensions, therefore it will use the segregated method, claiming 100% of eligible income as ECPI with no requirement for an actuarial certificate for that period.
The fund will add the two ECPI calculations, for each relevant period and claim the total ECPI amount in the fund’s annual return.
If this occurred in the 2016/17 or earlier year, industry practice was to simply use the unsegregated method for the entire financial year. That is, obtain an actuarial certificate for the whole financial year and apply the ECPI percentage to eligible income for the entire financial year.
This new approach could result in a different tax outcome for the fund. Let’s say the fund sold an asset in the second half of 2017/18 with a substantial capital gain. Under the new approach the entire gain would be exempt from tax as it occurred in the period the fund consisted wholly of retirement phase pensions. In prior years, applying industry practice, the actuarially determined ECPI percentage would be applied to the gain, leaving a portion of it assessable. So, the new approach provides a good outcome – but not always.
What if the asset was sold in the first half of the financial year? Also, what if in the first half there were no retirement phase pensions? Applying the new approach, 100% of the gain would be assessable, whereas in prior years, again applying industry practice, a portion of the gain would have been tax exempt.
And, just to add one further twist – what if this same fund is prohibited from using the segregated method to claim ECPI? Under the new approach the fund effectively applies the old industry practice approach, that is, obtain an actuarial certificate and apply the ECPI percentage to eligible income for the entire income year.
Understanding the new ECPI claim rules for asset sales
Calculating and determining the method for claiming ECPI is no longer just the province of the accountant. When an adviser is making a recommendation to sell a fund asset, they will need to be aware of the tax outcome of the sale. In making such a recommendation they will need to understand which ECPI claim method the fund will be using, not just for that financial year, but for that period of the financial year that the asset was sold.
So, working out an SMSF’s ECPI is not just a retrospective calculation to be done by actuaries and accountants – there’s benefit in understanding the future plans of SMSF clients so you can provide advice on the most tax effective manner to sell a fund asset.
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