An actuarial certificate may be required if a beneficiary draws on a pension or income stream that is in retirement phase from their SMSF. The actuarial certificate forms an important part of maximising the fund’s tax-exempt income. Actuarial certificates are also necessary in the rare situation that an SMSF is paying a beneficiary a lifetime, life expectancy or flexi pension that would need to meet the superannuation rules. An actuarial certificate may also be required if a person wishes to qualify for Centrelink benefits and needs to prove the pension they are receiving is solvent.
Segregated or proportionate method?
To work out the tax/-exempt and taxable income of an SMSF that is paying pensions, two methods can be used – the segregated and proportionate method.
The segregated method allocates the fund investments to members’ accounts that are in accumulation phase and those providing pensions in retirement phase. The general rule is that income and taxable capital gains from investments allocated to accumulation-phase pensions are taxed at 15%, and the income and capital gains from investments allocated to retirement-phase pensions are tax exempt.
The proportionate method assumes that the income and taxable capital gains earned from the fund investments are pooled. That is, the fund investments are not allocated specifically to the members’ accumulation and retirement-phase accounts. To work out the proportion of the fund’s income that is taxable and tax exempt, the actuary will calculate the average of members’ account balances that were in accumulation and retirement phases on average over the year. This is determined as a percentage and is applied to the net income of the fund to work out the proportion that will be taxable and tax exempt. Where a fund is wholly in accumulation phase at any time during the year, there is no requirement for the actuarial certificate to cover that period.
Let’s assume that an SMSF has a balance of $1.2 million. The sole member of the fund has an accumulation balance of $240,000 and is receiving an account-based pension from the fund with a balance of $960,000. For simplicity, let’s also assume that the income earned by the fund, as well as the pension drawn down by the member, does not take place until 30 June in the financial year.
If the SMSF uses the proportionate method, on average, 20% of the income and capital gains earned on the fund’s assets will be taxed at 15% and 80% will be tax exempt, and an actuarial certificate is required. However, if we were able to use the segregated method and the fund had only two investments, a bank account with a balance of $240,000 allocated to the accumulation-phase accounts and shares in a ASX-listed company valued at $960,000 allocated to retirement-phase accounts, then the outcome could be different. The income earned from the bank account and allocated to retirement-phase investments would be taxed at 15%, and the dividends and taxable capital gains would be tax exempt. Also, any franking credits from the listed shares would be used to reduce the tax payable by the SMSF.
Which method to use?
While it may appear beneficial to use the segregated method and allocate investments so the SMSF will be entitled to a larger tax-exempt result, not all funds can use the segregated method.
In the situation where the members of an SMSF have a total super balance as at 30 June in the previous financial year of less than $1.6 million, then either the segregated or proportionate method can be used. The total super balance of a member is the balance of accumulation accounts and pensions they have in all funds to which they belong; amounts being transferred between funds on 30 June in the previous year; and could include a proportion of the outstanding balance of any limited recourse borrowings at that time.
If there is at least one member of an SMSF who is receiving a pension from any superannuation fund and has a total super balance of more than $1.6 million, the proportionate method is the only option for the fund. This will require the SMSF to obtain an actuarial certificate and the income of the fund will be proportioned by the actuary between the accumulation accounts and pension accounts that are in retirement phase.
Actuarial certificates for solvency purposes
In addition to the requirement to obtain an actuarial certificate to determine the SMSF’s taxable and tax-exempt income, actuarial certification may be also be required for some types of pensions, or for Centrelink purposes.
Prior to 1 January 2006 it was possible to commence a defined-benefit pension from an SMSF which was payable for the member’s lifetime, or for their life expectancy, and could provide reversionary pensions to a surviving spouse. There are relatively few of these pensions in existence in SMSFs these days. However, if the fund is paying one of these pensions the actuary is required to provide a certificate that the amount set aside to provide the relevant pension is reasonable. These are referred to as solvency certificates and are not required for account-based pensions.
Defined-benefit pensions can also qualify for certain Centrelink income and assets test concessions. To obtain the concessions, a solvency certificate from an actuary is required to be completed each year by 29 December and submitted to Centrelink by 19 January.
Actuarial certificate – a necessity for some SMSFs
Any SMSF which is paying pensions that are in retirement phase should consider whether an actuarial certificate is required or is a necessity. In some cases, it may be optional and a choice between using the segregated or proportionate method may be available. But once at least one member is receiving a pension in retirement phase and has a total super balance of $1.6 million, an actuarial certificate is essential if the fund wishes to have part of its income tax exempt.
For those SMSFs which are paying defined-benefit pensions, an actuarial certificate concerning the solvency of the pension is also required to prove the fund is complying for superannuation, and in some cases, where Centrelink concessions are being claimed.
While every care has been taken in the preparation of these articles, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in them including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. Performance goals are merely goals. There is no guarantee that the strategy will achieve that level of performance. The information in this document contains statements that are the author’s beliefs and/or opinions. Any beliefs and/or opinions shared are as at the date shown and are subject to change without notice. These articles have been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. They should not be construed as investment advice or investment recommendations. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs.
This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.