Since the first self managed superannuation funds (SMSFs) were established, this sector of the financial services industry has seen steady growth year after year. The latest Australian Taxation Office (ATO) figures show that there are now over 600,000 SMSFs managing the retirement savings of more than 1.1 million Australians.
There are several benefits to establishing an SMSF, including the amount of control the trustees have over their investments when compared to industry and retail superannuation funds. However, the major benefit is the generous tax concessions that compliant SMSFs can access.
For example, SMSFs that comply with the superannuation legislation have their member contributions and fund earnings taxed at the concessional rate of 15% in Australia. This is called the accumulation phase. Once you are over 60 years of age you can access your superannuation tax free, but if you move your super into retirement phase to get a pension rather than taking it as a lump sum, the earnings on the investments supporting your income stream are also tax-free.
Of course, there are rules and conditions attached to achieving this tax-free status for eligible SMSF members, and not understanding or complying with these rules and conditions could see you jeopardise this key benefit. The tax exemption on earnings in retirement phase is called exempt current pension income (ECPI), and you must claim it correctly or miss out.
ECPI is claimed in your SMSF’s annual return when your fund starts paying one or more retirement phase income streams. There are two methods that can be used, the segregated method and the proportionate method. Where the SMSF’s assets supporting retirement income streams are clearly held separate from any other assets, the segregated method should be used.
The proportionate method is used where the SMSF does not set aside specific assets to support retirement income streams and it is the one most commonly used by SMSFs. This method applies when the fund has a member or members in both the accumulation and the retirement phase, and the assets have not been segregated but are all pooled in together.
An actuarial certificate is required from an actuary who calculates the exempt proportion and applies it to income earned in that period, which forms part of the fund’s total ECPI for the year. This is a complex area that can easily confuse fund trustees who are more conversant with investment strategies than they are with actuarial calculations.
Many trustees engage companies such as SMSF Assure to help them navigate the complex administration and reporting requirements of running an SMSF. There are several more issues involved in calculating a fund’s ECPI other than those already mentioned. Getting additional professional expertise for these calculations is preferable to making a mistake and suffering a financial penalty.
The lure of a tax-free status in retirement has been a large part of the growth of SMSFs. Successive federal governments have encouraged this growth so that working Australians can provide for their own retirement rather than rely on the government-funded Aged Pension. Superannuation is one of the best vehicles Australians have to reduce their tax payments while creating wealth for their retirement.