In this week’s episode of the SMSF Academy podcast (episode 23), Aaron explores how the introduction of the total superannuation balance definition impacts a range of measures including:
- the ability to make non-concessional contributions,
- eligibility for determining a fund’s tax exemption using the segregated method; and
- the application of the catch up concessional contribution measures starting on 1 July 2018.
This new total superannuation balance (TSB) definition impacts a range of strategies employed across SMSFs, and in this podcast Aaron discusses how to navigate around key opportunities such as with re-contributions, the use of contribution reserving and the unused catch up concessional contribution rules.
Furthermore, in this podcast, he discusses the ATO’s approach to the use of reserves as a tool to try and circumvent a member’s transfer balance cap and total superannuation balance.
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Hi, you’re listening to The SMSF Academy Podcast, this is episode 23.
Welcome to The SMSF Academy Podcast, the show designed to help professionals stay ahead of the curve. Now, here’s your host, the man that’s in the know and shows you how SMSF is done right, Aaron Dunn.
Hi there, Aaron Dunn here and thank you for joining me for today’s session. We did have a couple of weeks where we’re offline just due to some travel commitments including where we were up at the ATSA conference in Sydney and had a great event there. Let’s move on to today’s session where we’re going to take a bit of a look at the total superannuation balance requirements and in particularly here, how not only we need to calculate that member’s total superannuation balance but just how much it can influence a range of strategies and concepts from the 1st of July 2017. Because when we look at this definition of a total superannuation balance, we are looking at much more than just what a member’s balance actually is. We’ll cover this a little bit further in today’s podcast the definition of a total superannuation balance.
First of all, we’re going to discuss just what areas this total superannuation balance impacts. The first area is around the unused catch-up concessional contributions. Now, of course, this is something that doesn’t come into effect until the 1st of July 2018, but what we do see here is that the eligibility for a member to be able to use this catch-up concessional contribution amounts where they have a carry forward unused concessional contribution post 1 July 2018, they will be able to use that unused concessional contribution where they have a total superannuation balance that is less than $500,000 just before the start of the financial year.
Now, this is a really important distinction when we look at these unused catch-up concessional contributions because it is the only segment of these reforms that is linked to a flat rate, a flat dollar amount being the $500,000. When we look at this as a concept, it means that progressively over time, we will see individuals only be able to use those catch-up concessional contributions where they can have either a dollar balance that is ordinarily below $500,000 or where they may be able to manufacture an arrangement where that balance is under $500,000 as well.
A good example of that process may be where they have eligibility to able to withdraw those amounts out of superannuation and therefore, they could reduce that value down as at the 30th of June in the previous financial year and then, by virtue of reducing that value under that flat $500,000, they will then be able to use any of those unused amounts that they have subsequent to how much they have not used with their unused concessional contribution. If we have three or four years down the track in respect to these reforms having been introduced and they have the capacity to use $75,000 or maybe more, we can actually take it up to $125,000, they would be able to do so. But, of course, like I said, we need this flat $500,000 to ordinarily qualify.
Now, on the flip side, when we look at all of the other measures that impact a total superannuation balance, these are linked to the general transfer balance cap. And the general transfer balance cap is really important here as the marker that we need to stake in the ground because it will index over time. We do know that the general transfer balance cap starts at $1.6 million, but when we see that indexation occur, it will occur in $100,000 increments. The first area that this does impact is around our non-concessional contributions, and our non-concessional contributions we knew changed and changed quite substantially from when the government announced back in May of 2016 when we saw these new measures where they were going to introduce this $500,000 lifetime limit.
Now, what obviously unfolded as part of the negotiations here was, in essence, areduction in the eligibility to bring forward and also a linking of the non-concessional contribution cap to being four times the concessional contribution cap. As concessional contributions reduced down to $25,000, four times the cap gave us a $100,000 non-concessional contribution cap. We will see over time those non-concessional contributions increase again because the concessional contributions are going to index in a smaller increment of $2,500 rather than previously where they were in $5,000 increments.
But what is important here with this total superannuation balance definition is that if an individual immediately before the start of that financial year has a balance in excess of the $1.6 million, they are now going to be prohibited from making any further non-concessional contributions for that particular income year. And it’s when we look at balances that a member may have that are lower than $1.6 million, we have what I call this red zone. And the red zone is really going to determine the level of bring-forward that an individual have available to them. Where we have the general transfer balance cap and the gap space that exists between that individual’s total superannuation balance and the transfer balance cap, this is where we are influencing the level of bring-forward.
Let’s just go through this quickly to help give you some understanding as to how this works. Where we have in the first instance no bring-forward period, the first year’s cap space needs to be less than one times the general non-concessional contribution cap. We know that the transfer balance cap, the general transfer balance cap is $1.6 million. If an individual here has, say, a total superannuation balance at 30 June of the previous financial year, they have $1.55 million, well that cap space difference is less than one times the cap. On that basis, they are eligible to do one times the non-concessional limit but there’s no eligibility to bring forward any future years.
On the flip side, if we have a member that has a total superannuation balance of, say, $1.45 million, then what we have here is a difference between the general transfer balance cap and that total superannuation balance of being greater than one times the cap but less than two times the cap. In that instance, the individual will be able to bring forward two years’ worth of contributions or make non-concessionals of $200,000. Whilst they’re at $1.45 million, they could take them up to $1.65 million.
Then, finally, we have this three-year bring-forward period where the total superannuation balance of that member is greater than two times the cap, and therefore, off the back of that, they would be eligible to make a three-year bring-forward period. The optimum figure there that we’re looking at is $1.399 million because the amount of cap space that they have available to them is greater than two times the cap which will avail them to use the three-year bring-forward period.
This is really important not only when we test the year-one assessment as to whether that bring-forward can be used or not, but it also means we need to test this on the year-two basis and also in respect to year-three if we have a three-year bring-forward period. Because if the total superannuation balance on the 30 June of the financial year before the start of the second year is less than the general transfer balance cap in that second year and there are non-concessional contributions for the first year fallen short of the cap, then the individual will be able to use that unused portion from the first year. Otherwise, the amount that they will be able to get into the fund is actually nil. If in the second year, say for example, we now have a total superannuation balance at the end of that first year of, say, $1.62 million, they will be ineligible to make any further contributions even though we have a gap from that first year because theirtotal superannuation balancehas exceeded the $1.6 million general transfer balance cap.
Again, we look at this in the context of year three. In year three here, the total superannuation balance on the 30th of June of the financial year before the start of year three, less the general transfer balance cap in that third year. In addition to that, their non-concessionals for the second year fall short of their cap for that first year or if their cap for the second year was nil and their NCCs for the first year fell short of the cap for that year, then we will be able to apply a non-concessional contribution based upon that short fall.
However, if their cap was nil in that second year, we would also be able to and we fell short in that first year, again, we could make a contribution in respect to the amount of that short fall but if they are over the $1.6 million at the end of that second year, again, that third year would result as being nil. The non-concessionals is really important that you actually track through, not only the initial stage in determining the level of bring-forward but just how important it will be to see what an individual will qualify for in year two and year three based upon the total superannuation balance of that individual at the end of the preceding financial year as well.
The other couple of areas that this is impacting is also around government co-contributions. We would have the ordinary requirements that exist for co-contributions but importantly, eligibility for the government to make that co-contribution is going to be subject to that individual having a total superannuation balance that is less than the general transfer balance cap for that particular financial year.
This also extends to spouse contributions and whilst we have seen an increase in the ability to use spouse contributions because the threshold for qualification for spouse contributions has increased from $10,800 up to $37,000 and the phase out is increased from $13,800 to $40,000. It is now also going to be a function of the spouse’s total superannuation balance being less than the general transfer balance cap for that year. If we have a situation where the spouse’s total superannuation balance is less than the general transfer balance cap, we would ordinarily be able to apply the 18% tax rebate on the first $3,000 worth of NCCs that have been made into the fund.
Now, the final area that this does impact is around the definition of disregarded small fund assets, and this was something that we saw the government introduce from the 1st of July that will prohibit certain SMSFs from applying the segregated method to determine exempt current pension income. Where we have a fund that has assets that are disqualified by virtue of section 295-387 (ITAA 1997), we need to therefore look to apply the proportionate method to determine a fund’s tax exemption.
Funds here will not be able to use the segregated assets method for an income year if at a time during that income year there was at least one superannuation interest in the fund that was in retirement phase. And just before the start of the income year, a member of the fund has a total superannuation balance that exceeded the $1.6 million and they are a retirement phase recipient of a superannuation income stream. This importantly doesn’t need to be an income stream being received from their SMSF or small APRA fund as it could be from another provider that they have externally, say, public offer fund.
Finally, here at a time during that income year, this member has a superannuation interest in accumulation or in retirement phase inside that fund. Again, we have a linkage back to the total superannuation balance here that will preclude that self-managed super fund from being able to apply earnings tax exemption on the segregated method, and there will be circumstances whereby the fund is going to need to claim a 100% tax exemption where it would ordinarily be segregated but for the fact that this section 295-387 will apply and they will have to get the extra certificate to determine a 100% tax exemption.
Let’s now move on to the definition of a total superannuation balance because when we look at this requirement, it is really the sum of the accumulation phase value that sits for individual at that particular point in time. And then we look at the transfer balance account, so we’re not simply looking at a function of the retirement phase value of an individual’s account but rather an assessment of that member’s transfer balance account or more importantly for SMSFs, a modified transfer balance. And the reason why, say, for SMSFs, we’re looking at a modified transfer balance is because where an individual is in receipt of certain account based income stream, so there, we’re looking at account based pensions, market linked pensions, or the old allocated pensions. We are, therefore, needing to look at modifications through that member’s transfer balance account to ensure that it reflects the current value of that specific income stream.
When we look at the current value of that income stream, we need to go through a process of adjusting certain debits and credits off that transfer balance account and then reflect the current value based upon what the value is of that superannuation interest if the individual had the right to involuntary cease paying that income stream inside the fund.
Now, before we move on to some of the other areas here in this definition, I just wanted to go back and look at what gets included in the accumulation phase value here because whilst we have accumulated benefits ordinarily, there are also some other areas of superannuation income streams that we do need to include inside this definition. Because the law now specifically excludes the use of transition to retirement income streams ordinarily being in the retirement phase, and whilst we do have some exceptions once that TRIS has met a condition of release with a nil cashing restriction, what the laws, in essence, is saying is that a TRIS prior to this point in time so where they are either under 65 or they have not met that condition of release with a nil cashing restriction, that value is deemed to be in the accumulation phase for the purposes of a total superannuation balance.
Importantly though, the TRIS is a superannuation income stream when we look at the requirements of tax ruling 2013/5. There has been some conjecture as to whether that pension is in accumulation benefit. It is still an income stream, so the proportioning rule still applies. The attribution of it being a separate superannuation interest still applies. It is only deemed to be an accumulation (value) benefit for the purposes of the total superannuation balance definition. That’s an important distinction there that I just wanted to ensure we understood was the case.
What we then need to calculate once we go beyond the accumulation phase value and the modified transfer balance as it relates to a self-managed super fund is that we need to factor in any roll-over components that may not be accounted for either within the accumulation phase or against the member’s transfer balance account. Then, finally, this last component is we look to reduce the sum of the member’s total superannuation balance here by any structured settlement contributions that have come into the fund as well. The effect of this is to exclude those structured settlement contributions from counting towards the member’s total superannuation balance.
We’ve talked about the impact now of the total superannuation balance across a range of areas and how we need to define that total superannuation balance definition. What I think is important to now look at is revisiting how strategies that we’ve employed over the journey are impacted by this specific requirement. And one of the most common strategies that we have employed over the past decade or so has been around recontributions. We’ve used recontributions in a variety of context in particular from an estate planning point of view where we’ve taken the opportunity to withdraw that benefit from the individual’s pension account or accumulation interest and being able to recontribute that money back into the fund, and in many instances have established a second income stream or third or fourth potentially subject to the way in which pensions have been established, and have in essence locked in that non-concessional contribution as a 100% tax-free proportioned income stream or something that was very high subject to the value that sat within the accumulation interest at that point in time.
Now, recontributions are still going to be very advantageous here because it provides the opportunity to even up balances between couples given that we have a $1.6 million transfer balance cap that we need to contemplate. But it also means that we need to address this total superannuation balance to determine our eligibility for being able to make non-concessionals in the first place but also to the extent in respect to how much we can actually bring-forward those non-concessional contributions.
What’s important to understand here is that if we have a situation where a member has an excess amount or a total superannuation balance that exceeds the $1.6 million, we’re clearly not going to be able to facilitate this type of arrangement in one particular year. What we’re going to need to do is amortise the strategy over multiple years that will enable us to withdraw a particular benefit down and ensure that that member’s total superannuation balance has reduced to an amount below the $1.6 million and it may be as low as $1.399 million, for example, so that we can then make that contribution in the following year but still take advantage of the principals that we have known for some time around how a recontribution strategy would work.
Let’s say we’ve got a member that might have $1.65 million inside their fund. Now they may be made up of taxable components. They’re not ordinarily going to be able to get that money back into or do a recontribution strategy in that one particular financial year. However, as we approach June, well, what we could do subject to the age of that individual, we could actually look to do a withdrawal of that benefit out of their account.
Now, if that has already started as an income stream, we’re going to have to make sure that we trigger that as a partial commutation that strikes the debit against that individual’s transfer balance cap as well so that when that money comes back in, we can then have that amount credited back towards that member’s transfer balance cap as well. But if we take that money out, we can come up with what we would have as an optimal figure to ensure that we can trigger the bring-forward rule and avail ourselves for that individual to get the money back into the fund. If we were at $1.65m, maybe it’s grown over that period to say $1.7m, we then take a withdrawal out of, say, $301,000, it would take our balance at 30 June down to the $1.399 million.
Because the gap space against the transfer balance cap is more than two times the non-concessional limit, we would be eligible to use a three-year bring-forward period and in essence, be able to get that money back into the superannuation fund, have established a second income stream with that $300,000 and therefore, lock in that tax-free proportion going forward. That is a very important strategy that we can still use going forward around re-contributions.
Now, it equally applies when we think of things like contribution reserving as well. Now, we have as we know from the first of July 2017, the removal of the 10% rule when it comes to concessional contributions being made by a particular member. Let’s say we’re at $1.3 million for that member at the 30th of June 2017. As we get through the year, we’ve made say $20,000 worth of concessional contributions and the member is going to look to make it further $5,000 in the month of June. It doesn’t matter where that’s coming from because the 10% rule has now been abolished.
But if we attribute the value of that contribution to the member along with investment earnings, we’re going to be left with about $1.405 million at 30 June 18. If the member is then looking to make non-concessional contributions in the following year, then we’re going to be limited to a two-year bring-forward period because the gap space between the total superannuation balance and the general transfer balance cap is greater than one times but less than two times.
However, if we have a scenario whereby we decide for that payment in June to be held over in accordance with that tax determination, TD 2013/22, we don’t have to allocate that amount until 28 days after the end of the month in which that contribution was made. It will mean that we can keep that total superannuation balance below the $1.4 million which then will avail us in that following income year to apply a three-year bring-forward period rather than a two-year bring-forward period. They are just a couple of examples there that show the clear benefits of where a total superannuation balance can be altered to give a specific outcome as a result of the timing of when benefits may be taken out of the fund and also allocated by way of contribution.
Now, one of the more controversial issues that the ATO is going to look at providing us with some updated information is around the use of reserves. I found this quite interesting that when the legislation was initially drafted, that we had no attribution of reserves towards the calculation of a member’s total superannuation balance. Back in 2013, when Labor was in government, they were proposing at that time an extension to the $25,000 cap of concessional contribution by enabling individuals to make an additional $25,000, so in essence, $50,000 where their balance was less than $500,000. It sounds very similar to what we have been proposed to start from 1 July next year.
Interestingly, within the explanatory memorandum and the draft regulations there, they did include this concept of if you are trying to apply reserves here as a means to circumvent the $500,000, what they (government) were looking to do in those regulations was to apply a proportionate approach of the investment reserves that are inside that fund to this specific member’s account. We ended up with an attribution of reserves to those specific members.
Now, what we’ve seen in recent times by the ATO around a month ago is some updated guidance through their super changes FAQ on the use of reserves because there has, or quite clearly, it appears to be an opportunity to set up a reserve because the reserve if the benefits are not attributed to the member, then the member, that balance doesn’t get calculated, or those earnings don’t get calculated towards that individual’s total superannuation balance.
The ATO has initially responded to this through this FAQ that in essence, that they are reviewing and monitoring the use of reserves as a result of the introduction of these measures both around the transfer balance cap and also the restrictions with the total superannuation balance themselves. What we do understand and make very clear is that the law does not preclude the establishment of a reserve within an SMSF like it can be applied generally through Section 115 of the SIS Act.
However, the ATO sees very limited circumstances when it may be appropriate for a reserve to be established and maintained inside an SMSF and in essence, what the ATO are going to be looking at are circumstances that are created that would suggest that the adoption of a reserve and the way in which that reserve has been managed, in particular, we would need to establish a separate investment strategy for the prudential management of that reserve and how it’s being used more broadly to circumvent any of the new limits and restrictions.
Where the trustees cannot explain increases through the creation of a new reserve or in the increase in the balances of those reserve maintained by the fund, then the ATO says, “Expect us to take a close look at those arrangements.” The ATO has said that they intend on issuing further guidance in this area about where it may be appropriate for an SMSF to establish and maintain reserves in that point in time. They said if you do have any questions at this stage, they strongly recommend that you seek some advice or approach them prior to doing so.
The industry is on notice in respect to this as a strategy. I think it is more a legislative issue where this should have been nipped in the bud in the drafting of the legislation in the first place. Unfortunately, we don’t have that, so it certainly opened up some opportunity, I guess, but quite clearly the ATO is going to be targeting this and having a very close look at how reserves are being maintained in this respect in order to potentially get additional contributions in the fund (e.g. NCCs).
When we look at the tax consequences of this, in essence, the use of the reserve has no difference than an accumulation phase benefit. In that sense, the tax impact is ultimately one and the same. I get the understanding here that there could be ways in which we may circumvent the total superannuation balance like we’ve been speaking about here, but on the flip side, the tax outcome of it is going to be clearly different here.
The bigger issue, I think, with the reserves is that, where the government if we go back to this objective of super, is that they introduced these measures to ensure that it wasn’t used as an estate planning vehicle where, quite clearly, we could be building reserves here to build what could be a hugely powerful succession vehicle for superannuants and passing it down through generations by building large amounts of reserves rather than having them in the accumulation phase. And then, for example, being able to attribute certain investments to that reserve such as the business real property so that we get a succession through where the son or the daughter or whatever it’d be in that family business would in essence be able to continue to have that income producing asset, the business real property being paid inside the fund.
This is clearly something that the ATO is going to look at and spend some close attention on. I guess, from this point of view, just be warned that it is something that once we see some further information from the ATO, if you’re going to look at the application of reserves, have a very sound basis for the operation of those.
That’s it from today, when we look at this concept of a total superannuation balance, it is something that we need to … It’s another acronym, I guess, in the first instance, but it’s something that we need to start to incorporate and understand the impact of what a total superannuation balance means by way of definition but how it impacts the ability to do things like non-concessionals, apply segregation, qualifications for spouse contributions tax offsets and much, much more. If you’ve got any further questions in respect to this topic, you can reach out to me at firstname.lastname@example.org get in contact with us through many of our social media channels. Other than that, I look forward to you joining me for next week’s podcast. Have a great day and I look forward to speaking with you soon.
Thanks for listening to The SMSF Academy Podcast. Please note that the podcast provides general advice only and is based upon our understanding of the law at the time of the recording. If you have any comments or questions from this podcast or wish to subscribe to the series, you can find us at thesmsfacademy.com.au. Tweet us @thesmsfacademy. Like us on Facebook or connect with us on LinkedIn.