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Will I be able to reset?
That is the question many retirees who will be hit by the $1.6 million ceiling on the amount of money that can be held in a tax-free pension – known as the transfer balance cap – are asking themselves about the ability to claim capital gains tax relief on any investments in their pension that will become taxable from July 1.
It's a question that has either simple or complicated answers depending on your circumstances, super experts say.
If you have more than $1.6 million in an account-based pension and you choose to transfer any surplus into a taxable accumulation account, your CGT relief decision is pretty straightforward.
If you have $2 million of super that is all in a pension the simplest way to claim CGT relief is to roll back $400,000 of excess pension into an accumulation account on June 30 and opt for CGT relief by resetting the cost base of any investments that show a capital gain, says Meg Heffron of Heffron SMSF Solutions.
That way when you sell these investments – hopefully for a profit in the future – any tax the fund pays will be based on a higher cost base rather than the original purchase price.
Tax will only be paid on the capital profit gain generated after July 1, 2017, and even then it will be based on the proportion of the super allocated to the accumulation account at the time of sale.
If the accumulation amount was now $600,000 in a $2.4 million overall fund – which assumes that the size of the pension has risen over time – it would be 25 per cent of the combined pension-accumulation account.
These proportions can also apply when calculating the annual investment earnings. In this case, 25 per cent of earnings are taxable and 75 per cent are tax exempt.
Time to get house in order
One reader has asked whether CGT relief will be available in future years?
"If we started a pension in 10 years time, say in 2027, can we reset the CGT cost base of pension investments then?"
The answer is "no", says Chris Malkin, a senior consulting auditor with Baumgartner Superannuation. CGT relief is only available this year up to June 30 so if you want to be eligible you need to get cracking, he says.
The importance of getting your house in order before the new super rules apply from July 1 is emphasised by Stuart Forsyth, a director of McPherson Super, in response to a scenario presented by a reader.
He has one SMSF in pension mode that expects to have a member balance of a little under $1.6 million on June 30 that he plans to keep that way. He also has a second SMSF, with $1 million and also in full pension mode that will be rolled back to accumulation. Will the investments in the second completely separate SMSF be entitled to CGT relief?
Forsyth, a former Australian Taxation Office super deputy commissioner, says that on the basis of the law and Tax Office comments in relation to a Draft Law Companion Guideline (LCG 2016/D8) his view is that CGT relief will be available.
This means that where the SMSF investments in the second fund have a capital value greater than their original cost, their CGT cost base can be reset to this higher value that can then be used to calculate any future CGT obligation on accumulation assets when the investments are sold. But it is important that the pension is stopped on or before June 30.
Also essential is that the decision to stop the pension must be recorded along with the date, and that the fund has paid the required minimum pension for the year up to the time it stops.
A record must also be kept of the investments that CGT relief is claimed on through an approved ATO form, which at this stage is not yet available.
More complex when there's two
Claiming CGT relief can be more complex where a fund has two members , says Graeme Colley, executive manager SMSF technical and private wealth with Super Concepts. Take a fund with a male retiree with $2 million in an established pension and another female member who is still working with $1 million of super in an accumulation account. The second member may be some years away from retirement.
Under the transfer balance cap, his pension must be reduced by $400,000 to $1.6 million which means the fund will have $1.6 million in pension phase on July 1 and $1.4 million in accumulation.
This will need to happen by June 30. Also by this date the fund has the option of resetting the cost base of any investments and having the notional capital gain included in its 2016-17 financial year assessable income, or deferring this until the assets are actually sold.
This CGT rule applies to funds that operate on a pooled or unsegregated basis where any taxable income is split in proportion to the value of a fund's investments in pension and accumulation phases.
Let's assume the original cost of all the fund's investments was $2.75 million on June 30, resulting in an overall notional capital gain of $250,000.
If the members decide to take up the option to re-set the cost base on all the investments, the capital gain that would be included in the fund's assessable income for the 2016-17 financial year would be one third of $250,000 (or $83,333): because that is how much of the fund was in accumulation in 2016-17 ($1 million of $3 million).
Assuming the investments have been held for longer than 12 months, the super tax rules allow a one-third capital gains tax discount, reducing the gain to about $55,555 on which tax of 15 per cent would be levied. Therefore the tax payable in the 2016-17 financial year is $8333, although this can be deferred until the investments are sold.
Making a choice not to re-set the cost base is an option for members who think it is likely the fund will have a higher proportion in pension phase when the assets are sold.
This could be because the second member is considering retiring in the next few years which would have the effect of increasing the tax exempt proportion of the fund. Withdrawing benefits from accumulation accounts could also achieve this.
If you want a more detailed illustration of Graeme Colley's example please email me at John.Wasiliev@fairfaxmedia.com.au
AFR Contributor