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Combining contribution splitting and reserving strategies - the devil is in the detail

Apr 5, 2021, 11:39 AM
By Anthony Cullen
SMSF Technical Specialist

SuperConcepts Author - Anthony CullenThe concept of splitting contributions with one’s spouse has been around for some time now.  In the pre-Transfer Balance Cap (TBC)/Total Super Balance (TSB) world it may not have been overly popular, but it still served a purpose.  

Given there was no limit on how much you could start a pension with, there was little incentive to split balances to spouses.  Having said that, splitting was useful for some couples to redirect benefits to the spouse that was either going to reach their preservation age first or entitlement to Centrelink benefits last.  Ensuring the spouse had enough of an interest to cover insurance premiums was another reason to use splitting.  

While these strategies still hold true today, since 1 July 2017, limitations associated with TBC and TSB have created further reasons to look at the splitting strategies. But, don’t get caught out when combining contributions splitting with reserving strategies as it may not work.

In a recent article, Nicholas Ali pointed out that due to indexation, concessional contributions are set to rise to $27,500 from 1 July 2021. He went on to say, this may provide opportunities for some individuals to utilise the contribution reserving strategy and claim a tax deduction of $52,500 this financial year.  To find out more on the strategy and opportunities, you can find the article here.

Continuing on from the case study in Nick’s article, let’s further explore what amount Trevor can potential split to his spouse (Patricia, aged 63) in the 2022 financial year. 

The basics

The rules associated with contribution splitting can be found in Division 6.7 of the Superannuation Industry (Supervision) Regulations 1994 (SISR).  Regulation 6.40 states the maximum splittable amount, in relation to a financial year, means:

• For taxed splittable contributions* – the lesser of:
i. 85% of the concessional contributions for that financial year: and
ii. The concessional contribution cap for that financial year.
*Although there are also definitions for untaxed splittable contributions and untaxed splittable employer contributions I will only be considering taxed contributions in this article.

The definition of ‘taxed splittable contribution’ can be found in r6.41, which further creates a link with the 1997 Income Tax Assessment Act (ITAA).  Section 295-160 of the ITAA requires concessional contributions to be included in the assessable income of a super fund, in the year in which they are made.

This is unlikely to be anything new to most readers of this article but stay with me.  When it comes to reserving strategies, it’s accepted the deduction to the contributor and the assessable income of the fund are accounted for in the year in which the contribution is made (in the month of June).  The key to the strategy is not allocating the contribution until the next financial year (no later than 28 July), as was demonstrated in Nick’s article. This works, in our case study, as the reserved amount will not count towards Terry’s cap until the 2022 financial year.  

If we return to the SISR, r6.44 tells us that the amount that can be split is based on the splittable contributions made to that fund by, for, or on behalf of the member in:

• The last financial year that ended before the application; or
• The financial year in which the application is made – where the member’s entire benefit is to be rolled over, transferred or cashed in that year.

This all points to the fact that we need to consider the actual contributions to the fund in any given year when determining the splittable amount, and not the amount that has been allocated to the member in that year.

In Nick’s example, Terry will make $52,500 worth of concessional contribution in the 2021 financial year.  Looking at the maximum amount splittable under r6.40, his options are, the lesser of:

i. 85% of his concessional contributions for the year i.e. $52,500 x 85% = $44,625, and
ii. His cap for the year i.e. $25,000
You will note that I have not calculated 85% of the cap to come up with the value at ii.  This is an area we often receive questions on.  Under the provisions of r6.40 there is no requirement to apply 85% to the concessional cap when determining the lesser value that can be split.  If a member only contributed the cap, then yes, you would factor this in, but it would be based on calculating the value at i, not ii.

Assuming Terry is able to split his contributions to Patricia in the 2022 financial year, the maximum he could split would be $25,000, being the lesser calculated in options i and ii above.

The amount allocated to Terry, via the reserving strategy, in the 2022 financial year would not meet the criteria to be considered a splittable contribution in that year.  This amount will effectively be lost to the splitting strategy.  
Before splitting to Patricia, Terry will also need to consider r6.44.  Amongst other criteria, the application to split will be invalid if, at the time of the application:
• the member’s spouse is aged 65 years or more: or
• both

o the member’s spouse is aged between the relevant preservation age and 65 year: and
o the member’s spouse satisfies the condition of release specified in item 101 of Schedule 1.

Given Patricia is 63 years of age, her employment/retirement status must be considered.  As a side note, despite the recent increase to the work test age, there has been no corresponding age increase for splitting purposes. 

Another area that often comes up in conversations, for somebody in Patricia’s age bracket, is the concept of retirement per item 101 of Schedule1 of SISR.  What would happen if Patricia had previously declared retirement in order to gain access to her benefits, but would no longer be able to satisfy the definition (maybe she has returned to work or maintained a second employment after ceasing another after the age of 60)?

Per r6.44(3), if at the time of the splitting application from Terry, Patricia provides a declaration that she would not be deemed to be permanently retired (i.e. would not satisfy item 101 of Schedule 1) the trustees of the fund could consider Terry’s application.  Notwithstanding the fact Terry is aged 66 and has full access to his benefits, the purpose of limiting the ability to split to someone who has met a condition of release is to stop access to benefits that would otherwise be preserved with the original recipient.  By Patricia declaring she wouldn’t meet a condition of release at the time of the splitting application, the integrity of the system is maintained.  

Catch up concessional contributions

In more recent times, it’s not just the interaction between splitting and contribution reserving that needs to be considered.  From 1 July 2018 onwards, members are able to accrue unused concessional contributions and carry them over to future years, for up to five years.  Whether a member can access them and make larger contributions will be dependent on their TSB in those future years.

Let’s consider Franklin, he is 54 and as at 30 June 2020 has a TSB of $400,000. Taking advantage of the current year cap as well as fully utilising his unused caps for prior years, he makes a personal concessional contribution to his SMSF of $40,000 in the 2021 financial year.

Franklin will be looking to split what he can to Elisa in the 2022 financial year.  When considering the maximum splittable amount, his personal cap for the 2021 financial year includes the rolled forward unused portions from prior years.  As such, in accordance with r6.40, he can split the lesser of:
• 85% of the contributions made i.e. $40,000 x 85% = $34,000, and
• His cap for the year i.e. $40,000
If a member is unable to utilise the catch up provisions due to their TSB exceeding the threshold, their cap will remain at the general concessional cap.

Timing of the split

In accordance with r6.44, the majority of splitting transactions occur in the year after the contributions are made.  However, there are provisions to allow for a split in the year in which the contributions are made – where the member’s entire benefit is to be rolled over, transferred (i.e. to commence a pension) or cashed in that year.  We have seen situations where member’s have made contributions to an APRA fund, then set up an SMSF and rolled their benefits over, before attending to the split.  Unfortunately, the application to split cannot be made to the SMSF as the contributions were not made to that fund, nor are they counted towards the assessable income of that fund.  In these circumstances, the application to split should be made to the APRA fund prior to the transfer request.  

If we concentrate on the more common split in the subsequent year, when should we split Franklin’s contribution to Elisa in their SMSF?  I’ve heard many an argument to suggest it is practical to process it on 1 July.  Common arguments are along the lines of; ‘It’s a fresh year and it’s an easy process to account for at the being of the year’, ‘it increases Elisa’s balance early and she can then benefit from an increase in allocation of earnings’, ‘the split needs to occur early to cover Elisa’s pending insurance premium payment’.

My concern with such arguments, regardless of how compelling they may seem, is what is the trigger that enables the split to be considered in the first place?  Franklin must request the trustees to split his contributions to Elisa.  The split cannot happen prior to the request.  When was the request form completed, dated and supplied to the trustees?  

In addition to this, Franklin cannot split non-concessional contributions.  Given he made personal contributions, he will need to supply the trustees with a notice of intent to claim a deduction for the trustees to classify his contributions as concessional.  As with my question in relation to the splitting request; when was the notice form completed, dated and supplied to the trustees?  Prior to this, how do the trustees know they have valid concessional contributions to split?

The idea of splitting seems an easy concept to understand.  But, like many laws and rules, we need to consider the devil is in the detail.  As highlighted above, ever evolving laws in other areas of contributions have flow on effects to splitting that need to be considered.  

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