As most people now know, from 1 July 2017 the amount a member can have in a pension account will be capped at $1.6 million. For members already in pension phase and with balances exceeding this cap, they will need to transfer assets out of pension phase and back into accumulation phase to get under the cap.
This change will directly impact all retirees who have super fund assets over $1.6 million. For those retirees operating self-managed super funds, they will need to be careful to ensure they are not stung by unexpected tax on and from 1 July 2017. Potential issues arise at the time of transitioning to the new measures, as well as for income and gains thereafter.
There has been a lot of general commentary on these changes, but little deeper analysis of the details.
CGT relief on asset transfer
As part of the introduction of the new cap, the government is providing capital gains tax (CGT) relief to reset the CGT cost base of the transferred assets. The pension assets left in pension phase under the cap will continue to qualify for tax-free treatment.
The CGT relief works by deeming that an asset was sold for its market value (out of the pension account) and repurchased for that value (in the accumulation account). The cost base of the asset will therefore be reset to market value, and only gains going forward will be taxed in the accumulation account.
The sale is deemed to occur:
- Immediately before the asset ceased being a segregated current pension asset in the pre-commencement period; or
- Immediately before 1 July 2017, if the fund uses the proportionate method.
The cost base reset can occur on some or all assets. The trustee must elect which assets will be the subject of the cost base reset. The only reason we can see for not electing to reset the cost base is if the asset carries an inherent loss.
CGT relief is only available if the fund holds the assets throughout the period from 9 November 2016 to 30 June 2017.
How does the CGT relief work?
If all the fund’s assets are currently supporting pensions, then moving part of the pension assets back to accumulation to get under the CGT cap will trigger a cost base step up for those assets. However, if the fund has both pension and non-pension assets, then how the CGT relief applies will depend on whether the fund applied the segregated or proportionate method of accounting for assets.
If the fund was using the segregated method, the cost base reset works by resetting the cost base to each elected asset that is moved out of the segregated pension account and into accumulation phase as at 30 June 2017. The trustee must review each asset held in pension phase on or before 9 November 2016 and held at 30 June 2017, and elect whether to choose the cost base reset as at 30 June 2017. A decision can be made by the trustee to reset all assets, some assets or no assets. Where an asset’s cost base is reset in the segregated method, the trustee must decide to bring the asset out of segregation for that asset to be eligible.
If the fund was using the proportionate method of accounting for pension and accumulation assets, and elects to reset the cost base of an asset, a proportion of the capital gain on the asset will be taxable to the accumulation account. As a transitional relief, the fund can elect to either pay tax in the 2016/17 tax year, or defer the taxable gain until the assets are sold.
Accessing the CGT relief
To access the relief, the trustee of the fund must elect for the cost base reset, and the reset must be done in the approved form. The ‘approved form’ at this stage entails preparing an updated CGT schedule and reporting correctly on the election and effect of the CGT relief.
Taxation of fund earnings after 1 July 2017
If all the fund’s assets are in a tax-free pension account after 1 July 2017 (and the pension accounts are under the cap), then all the fund’s income and gains on those assets will be tax-free. This is the straightforward scenario. All the trustee will have to do is elect which assets to transfer to accumulation account, and comply with the ‘approved form’ requirements.
However, if the fund has both pension accounts and accumulation accounts after 1 July 2017, and at least one retiree member has super interests over $1.6 million (across all funds), then the fund will need to apply the proportionate method to calculate the extent of tax-free pension income and taxable accumulation income. The fund will not be able to use the segregated method to determine the tax-free portion of the fund’s earnings applicable to the pension account.
The sting comes if a fund has income-generating assets supporting a pension account, and growth assets supporting an accumulation account. Under this scenario, a portion of the tax-exemption for the pension account will be diluted by the accumulation account balance – because the total earnings are apportioned across both accounts proportionally when determining the extent of tax-free pension income. Without proper planning, this means retirees are leaving themselves open to pay more tax on the fund’s assets than would otherwise be levied if the non-pension members exited the fund prior to 30 June 2016.
Another thing to note in this regard is that members may still require a segregation of assets for investment purposes (i.e. it is still possible for someone in pension phase to have one asset allocated to them, and another asset allocated to the accumulation account holder). This will impact investment earnings, but the proportion of tax-free income to the fund will be determined on the relative account balances.
What should you do?
As always, preparation is the key to success. If you take proper advice and plan for the changes, you can avoid being hit with unexpected tax as at 1 July 2017 and for the years afterwards.