Superannuation - Study Notes

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Unformatted text preview: Specialist Knowledge: Superannuation (924) DISCLAIMER These materials are issued by Kaplan Education on the understanding that: 1. Kaplan Education and individual contributors are not responsible for the results of any action taken on the basis of information in these materials, nor for any errors or omissions; and 2. Kaplan Education and individual contributors expressly disclaim all and any liability to any person in respect of anything and of the consequences of anything done or omitted to be done by such a person in reliance, whether whole or partial, upon the whole or any part of the contents of these materials; and 3. Kaplan Education and individual contributors do not purport to provide legal or other expert advice in these materials and if legal or other expert advice is required, the services of a competent professional person should be sought. The views expressed by presenters delivering course material by lecture or workshop may not necessarily be those of Kaplan. COPYRIGHT © Kaplan Education, 2008. All rights strictly reserved. No part of these materials covered by copyright may be reproduced or copied in any form or by any means (graphic, electronic or mechanical, including photocopying, recording, taping or information retrieval systems) without the written permission of Kaplan Education. Kaplan Education makes every effort to contact copyright owners and request permission for all copyright material reproduced. However, despite our best efforts, there may be instances where we have been unable to trace or contact copyright holders. If notified, Kaplan Education will ensure full acknowledgement of the use of copyright material. ACKNOWLEDGEMENTS All ASX material is © ASX Limited. All rights reserved. All ASX material is reproduced by the publisher with the permission of ASX Limited. No part of this material may be photocopied, reproduced, stored in a retrieval system, or transmitted in any form or by any means, whether electronic, mechanical or otherwise, without the prior written permission of ASX Limited. Kaplan Education acknowledges the support of Aspect Huntley Pty Ltd Morningstar, Dow Jones, EBSCO Australia and ProQuest in the development of its course material. Contents Introduction Unit 1 Introduction to retirement planning and the superannuation industry Unit 2 Contributions Unit 3 Tax Unit 4 Superannuation benefits Unit 5 Income streams Unit 6 Social security Unit 7 Death benefits Unit 8 Divorce, bankruptcy and complaints Unit 9 Self-managed superannuation funds Introduction About this Specialist Knowledge module This module provides the Specialist Knowledge component of the Tier 1 (Diploma level) training and assessment required for individuals who provide personal financial advice to retail clients in superannuation. It addresses the ASIC RG146 competency requirements in relation to FNSASIC503UB Provide Advice in Superannuation. You are referred to the ASIC website at <www.asic.gov.au> for further information on compliance obligations. Overall program structure The Tier 1 Compliance Program has three components: Generic Knowledge, Specialist Knowledge and Adviser Skills. This module must be completed in conjunction with the Generic Knowledge and Adviser Skills components to achieve a Statement of Attainment for the competency FNSASIC503UB Provide Advice in Superannuation. Note: The Generic Knowledge and Adviser Skills components only need to be completed once. If you are undertaking more than one advice area you only need to undertake the Specialist Knowledge assessment for each additional advice area. Generic Knowledge Assessment 40 multiple-choice questions Specialist Knowledge area Adviser Skills Statement of Attainment Assessment Case study assignment Role of experience and prior learning If you have significant industry experience (five years in the past eight years) relevant to the area in which you advise or you have undertaken recognised programs of study relevant to the advice area, you may request assessment only options in both ‘knowledge’ and ‘skills’ areas to demonstrate competency. © Kaplan Education 2 Specialist Knowledge: Superannuation (924) How knowledge will be assessed Assessment in each knowledge area is an online examination of 60 minutes duration and comprises 40 multiple-choice questions. The examination is delivered via Kaplan’s Online Learning centre. A pass mark of 70% is required for the examination which is open book. The examination assesses the knowledge requirements in the Evidence Guide for FNSASIC503UB Provide Advice in Superannuation set out below. Evidence guide — Provide Advice in Superannuation Superannuation — Specialist Knowledge Operation and management of the superannuation industry • • • • • • • • • • • • • • characteristics and structure of a superannuation product roles played by intermediaries and issuers types of superannuation products fee structures/administration and management costs types of contribution annuities/pensions, allocated pensions and income stream products associated risks structure of superannuation plans management and administration of superannuation products preservation rules investment strategies within superannuation funds (i.e. investment concepts and strategies) restrictions on investment strategies Retirement Savings Accounts Act (RSA) 1997 SIS Act 1993 Superannuation Guarantee Act 1991 and other relevant legislation Superannuation Contribution Tax (Assessment and Collection) Act 1997 Income Tax Assessment Act 1936 Taxation • • • • • • • • • • • • impact on investment earnings employer and employee contributions benefit payments and expenses tax deductions capital gains tax treatment roll-overs reasonable benefit limits superannuation surcharge social security pension eligibility retirement planning death benefits franking credits Legal environment — disclosure and compliance • • the role of the representative/adviser relevant legal principles (e.g. SIS Act, Australian Taxation Office (ATO), Corporations Act, ASIC Act, Privacy Amendment (Private Sector) Act) the relationship between ethics and regulatory requirements (e.g. good faith, utmost good faith, full disclosure of remuneration/fees and any other conflicts of interest which may influence the adviser) relevant industry standards and codes of conduct regulators’ guidelines including our requirements in this policy complaints resolution procedures (external and, if relevant, internal) • • • • • • 924.SM1.9 Introduction Superannuation — Specialist Knowledge Small funds • • • • • • • • • • characteristics of self-managed superannuation funds and small APRA funds establishment of self-managed superannuation funds special investment rules associated risks roles played by advisers trustee appointment/duties/responsibilities fee structure/administration/management costs income streams self-managed superannuation funds’ relationship with the ATO in specie contribution This module also addresses the underpinning knowledge requirements for the following industry competencies: FNSICCUS506B Determine client requirements and expectations FNSICADV502B Provide appropriate and timely information and advice to clients FNSICPRO502B Conduct research to support recommendations FNSICCUS507B Record and implement client instructions. Recognition of competence Once you have successfully met the assessment requirements for the Specialist Knowledge component, you will also need to satisfy the assessment requirements for the Generic Knowledge and Adviser Skills components to receive a Statement of Attainment for FNSASIC503UB Provide Advice in Superannuation. Pathway to qualifications The Tier 1 competencies identified on your Statement of Attainment will be recognised for advanced standing into FNS50804 Diploma of Financial Services (Financial Planning). Getting the most from these resources This module has been designed as a self-study resource to prepare candidates for the Specialist Knowledge examination in this advice area. It also provides a reference for the practical application of concepts and principles in the workplace. © Kaplan Education 3 4 Specialist Knowledge: Superannuation (924) Further resources A list of further resources is identified in each unit. These resources are designed to enable you to research beyond the module notes and required readings to further your understanding of the material. Further resources may be textbooks, journal or newspaper articles, websites or other relevant material. These items are not assessable. You will be given clear instructions in each unit on how to access these resources. ‘Reflect on this’ Some units contain the activity ‘Reflect on this’. This activity is designed to enable you to reflect on matters beyond the module notes and required readings to further your understanding of the material. These activities are not assessable. Other competency units in the Tier 1 Compliance Program • Provide Advice in Derivatives • Provide Advice in Securities • Provide Advice in Managed Investments • Provide Advice in Life Insurance • Provide Advice in Financial Planning • Provide Advice in Foreign Exchange. Administrative queries For information about logins, exams, results or program information contact: Student Advice Centre Australia Tel: 1300 135 798 (free call) Tel: 02 8248 6799 [email protected] 924.SM1.9 International Tel: +61 2 8248 6799 [email protected] 1 Introduction to retirement planning and the superannuation industry Overview 1.1 Unit learning outcomes ....................................................................1.1 Further resources ............................................................................1.2 1 1.1 1.2 1.3 1.4 1.5 Retirement planning 1.3 Stages of retirement planning..................................................1.3 The ageing population.............................................................1.4 The role of superannuation in retirement planning .....................1.5 The role of social security in retirement planning .......................1.6 How much money is needed in retirement?...............................1.7 2 2.1 2.2 2.3 2.4 2.5 2.6 Overview of the superannuation industry 1.8 Brief history of superannuation ................................................1.8 Superannuation industry overview ............................................1.9 Types of superannuation benefit schemes ..............................1.10 Sole purpose test .................................................................1.11 Types of funds .....................................................................1.12 Retirement savings accounts.................................................1.14 3 3.1 3.2 3.3 3.4 3.5 Superannuation funds management 1.15 Operations of superannuation funds.......................................1.15 Investment options ...............................................................1.16 Obligations to members ........................................................1.16 The corporate trustee and trustee directors ............................1.17 The trust deed......................................................................1.17 4 4.1 4.2 4.3 4.4 4.5 4.6 Regulation of superannuation funds 1.17 Trust law..............................................................................1.17 State trustee acts ................................................................1.18 Corporations Act and Trade Practices Act................................1.18 Superannuation Industry Supervision (SIS) regime ...................1.18 Concessional tax treatment compliance status .......................1.22 Role of government agencies.................................................1.23 5 5.1 5.2 5.3 5.4 5.5 5.6 Choice of fund 1.24 Eligibility ..............................................................................1.24 The default fund ...................................................................1.25 Penalties for non-compliance .................................................1.25 Employer obligations under superannuation choice..................1.26 Adviser obligations when switching funds................................1.27 Portability ............................................................................1.27 References Appendices 1.28 Unit 1: Introduction to retirement planning and the superannuation industry Overview Few people commencing their first job are thinking about retirement. They might be aware that their employer pays money into superannuation on their behalf, but they rarely think about how this money is working for them. With an ageing population, however, there is an ever-increasing need to fund our own retirement. This is why the federal government structures superannuation as a tax-effective vehicle to encourage Australians to save more for retirement. This unit outlines retirement planning and looks at the role of superannuation and social security in the context of the complex issues facing clients approaching retirement including which type of fund the client will use, and which particular fund they opt for under choice of fund. It provides information about superannuation and social security needed to advise clients on how to make the best of their retirement plans. Later units in Specialist Knowledge: Superannuation (924) examine superannuation and the social security system in greater detail. The regulatory environment for superannuation funds is also discussed. This unit specifically addresses the following subject learning outcome: • Critique available superannuation structures and contribution strategies for different client situations. Unit learning outcomes On completing this unit, you should be able to: • outline the different stages in retirement planning • discuss the role of social security and superannuation in retirement planning • describe the main types of superannuation funds • explain how the superannuation industry is regulated • distinguish between defined benefit and accumulation superannuation schemes • explain the choice of superannuation fund provisions. © Kaplan Education 1.1 1.2 Specialist Knowledge: Superannuation (924) Further resources • AMP 2008, ‘How much super is enough’ [online]. Available from: <http://www.amp.com.au> by selecting ‘Superannuation’ [cited 23 June 2008]. • APRA 2008, ‘Superannuation statistics’ [online]. Available from: <http://www.apra.gov.au> by selecting ‘Superannuation’ then ‘Statistics’ [cited 23 June 2008]. • ASIC 2005, ‘Regulatory Guide 84 Super switching advice: Questions and answers’ [online] June. Available from: <http://www.asic.gov.au>. Under ‘Publications’ select ‘Regulatory documents’ then ‘Regulatory guides (RG)’ [cited 23 June 2008]. • ‘Superannuation professionals’ [online] ATO. Available from: <http://www.ato.gov.au> by selecting ‘For Superannuation’ and then ‘Superannuation Professionals’ [cited 23 June 2008]. • Nielson, L & Harris, B 2008, ‘Chronology of superannuation and retirement income in Australia’ [online]. Available from: <http://www.aph.gov.au> by selecting ‘publications’ then ‘library publications’, then ‘Background Notes’ [cited 23 June 2008]. • Productivity Commission 2005, ‘Economic implications of an ageing Australia — Productivity Commission research report’, [online] April. Available from: <http://www.pc.gov.au> by entering ‘ageing Australia’ in the search box [cited 23 June 2008]. • State Super 2007, ‘Choose you investment strategy’ [online]. Available from: <http://www.firststatesuper.com.au> by selecting ‘Talking super’ and then ‘Choose your investment strategy’ [cited 23 June 2008]. • The Treasury 2007, ‘Intergenerational Report 2007’ [online] April. Available from: <http://www.treasury.gov.au> by entering ‘intergenerational report’ in the search box [cited 23 June 2008]. • Westpac/ASFA 2008, ‘Retirement living standards’ [online]. Available from: <www.superannuation.asn.au> by selecting ‘Advocacy & Research’ then ‘Research Centre’ and then ‘Westpac/ASFA Retirement Standard’ [cited 14 October 2008]. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry 1 Retirement planning Retirement planning is about prudent investment to help people lead the lifestyle of their choice in retirement. For some people, the goal for retirement is a sea change. For others, it is accumulating adequate resources to help their children. Whether they have sufficient money for retirement is an issue for most people. This will impact when they can retire. Whatever the goal, good retirement planning should be tax effective and investment effective. It should consider ways to maximise social security benefits, and both superannuation and non-superannuation assets. 1.1 Stages of retirement planning Retirement planning has two stages. First, it is the accumulation and protection of wealth to provide income and financial security in retirement. For many people, wages (and the ability to earn wages) provide income and financial security during their working lives. Both are lost at retirement. Once wealth is accumulated the second stage of the retirement planning comes into play. During retirement, the income previously received from employment has to be replaced by income drawn from the individual’s savings. Social security provides some income in retirement for those who are unable to self-fund their retirement. However, this is generally insufficient as a sole source of income for many people. Retirement planning is best seen as a rolling program rather than a one-off event. Changes in legislation and changes in client circumstances make it necessary to regularly review the retirement plan within each stage and, where appropriate, update the plan so it continues to be effective and relevant to your client’s objectives. The two stages of retirement planning will now be addressed in more detail. Stage 1: Wealth accumulation The first stage of retirement planning is employment savings and wealth accumulation phase. It generally begins when someone commences work, as superannuation contributions are compulsory under the Superannuation Guarantee Charge Act 1992 (Cth). Employees are also encouraged to contribute to superannuation through voluntary contributions which can attract tax concessions. Many people also have in place savings and investment plans outside superannuation. The combination of superannuation and non-superannuation assets provides a wellbalanced portfolio to meet long-term, medium-term and short-term savings goals. Changes in employment bring important wealth accumulation decisions that will impact upon retirement planning. The investment of payouts from previous employment and the tax implications should be managed carefully. Payments received on leaving employment include accumulated superannuation and employer payments. Prior to 1 July 2007 some of these payments could be rolled over to superannuation. Employer payments can now only be rolled over if they meet the transitional rules which apply until 30 June 2012. © Kaplan Education 1.3 1.4 Specialist Knowledge: Superannuation (924) Reflect on this: Personal experience of retirement planning Think about your retirement plans and compare them with other students. What are some of the common issues? Stage 2: Retirement The retirement stage concerns wealth protection and spending with a focus on ensuring a steady income stream throughout retirement. Decisions are made on how to invest superannuation benefits to meet lifestyle needs. Consideration should be given to the clients’ additional spare time. In the early years of retirement, retirees are generally very active, but in their seventies may scale back their more expensive leisure pursuits. In the eighties-plus age group they may experience reduced physical capabilities. This does not necessarily mean reductions in living expenses as it can be a time when medical costs increase. Access to public health facilities help to control costs, and retirees qualify for concessional entitlements. It is important to ensure that estate planning issues are reviewed and updated regularly. 1.2 The ageing population Like the rest of the developed world, Australia has an ageing population. As a result of this shift, there has been greater attention paid on the needs of this expanding group. The proportion of the population age 65 and over is expected to grow from 13% in June 2004 to 26% to 28%% in 2051 and 27% to 31% in 2101(see Figure 1). Figure 1 Projections of the populations of Australia, States and Territories, 2004 to 2101 (Series B assumptions) A ge group (years) 85+ 80–84 75–79 70–74 65–69 60–64 55–59 50–54 45–49 40–44 35–39 30–34 25–29 20–24 15–19 10–14 5–9 0–1 5 4 3 Source: ABS 2008. 924.SM1.9 2 Males 1 0 2004 2051 2101 0 1 2 Females 3 4 5 Unit 1: Introduction to retirement planning and the superannuation industry The ageing population has led to a focus on self-funding of retirement. This raises the issue of Australia’s low level of savings (see Figure 2). Figure 2 Household saving ratio March 1994 to March 2008 % HOUSEHOLD SAVINGS RATIO, current prices 10.0 7.5 5.0 2.5 0 –2.5 Trend 08 06 M ar 20 20 ar M ar M ar M 20 20 04 02 00 M ar 20 98 19 ar M ar M M ar 19 19 96 94 –5.0 Seasonally adjusted Source: ABS 2008. The objective of superannuation initiatives over recent years has been to raise the level of long-term retirement savings across the entire labour force. Further resources Commonwealth of Australia 2007, ‘Intergenerational Report 2007’, [online] April. Available from: <http://www.treasury.gov.au> by entering ‘intergenerational report’ in the search box and selecting ‘Intergenerational Report 2007’ from the results [cited 23 June 2008]. 1.3 The role of superannuation in retirement planning Superannuation plays a prominent role in retirement planning at several levels. Primarily, superannuation is a tax-advantaged means of saving for retirement. However, it also provides tax-effective income and growth after retirement. Finally, superannuation plans may offer advantages as a means of securing death and disability insurance cover. Taxation Superannuation is taxed in three ways: • contributions • investment earnings • when benefits are withdrawn, but only if under age 60 or when the benefit is paid from an untaxed scheme (such as some public sector superannuation schemes). © Kaplan Education 1.5 1.6 Specialist Knowledge: Superannuation (924) To make superannuation attractive, a low tax rate applies to earnings within the fund and a range of tax deductions and offsets are offered on contributions. With the ability to take tax-free withdrawals or pensions from taxed funds from age 60 since 1 July 2007, most people will not pay any tax on benefits received. Strict laws govern the superannuation industry. Violation of these laws could mean the loss of tax concessions, and a risk of incurring both tax and criminal penalties. The trustees of superannuation funds must be careful to comply with all the regulatory requirements. Further resources Australian Taxation Office, ‘Superannuation professionals’ [online]. Available from: <http://www.ato.gov.au> by selecting ‘For Superannuation’ and then ‘Superannuation Professionals’ [cited 23 June 2008]. The Australian Taxation Office’s ‘Superannuation professionals’ pages contain large amounts of definitive information on superannuation. Superannuation most commonly operates as a regular savings plan with contributions tied to the payment of salary and wages. The intention of superannuation is to set these savings aside until retirement. Superannuation laws require that superannuation investments are generally preserved (i.e. remain in superannuation savings) until meeting a condition of release such as retirement or prior death. Today all full-time and many part-time employees have superannuation contributions paid on their behalf by their employers under the Superannuation Guarantee Charge Act. Some employees make additional contributions from their after-tax income or through salary sacrifice arrangements with their employers. Self-employed people may contribute to superannuation funds and receive tax deductions. Limits apply to both after-tax and pre-tax contributions. Anyone under age 65 can contribute to a superannuation fund. 1.4 The role of social security in retirement planning Social security benefits alone are insufficient to provide for the lifestyle that many people desire in retirement. However, a growing number of people use the social security system to supplement the income available from their superannuation and other savings. Social security provides income in the form of the age pension to retirees over age 65 (currently age 63–65 for females) and in the form of Newstart allowance to people under age pension age who might be out of work. There are also disability support pensions, parenting payments and Department of Veterans’ affairs entitlements. Eligibility for social security benefits is means tested against income and assets. Therefore, it is important in retirement planning to consider the impact that investment decisions might have on these means tests. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry 1.5 How much money is needed in retirement? How much money is needed in retirement has been the subject of many studies and publications. The following are just a few examples. Further resources • AMP 2008, ‘How much super is enough’ [online]. Available from: <http://www.amp.com.au>) by selecting ‘superannuation’ [cited 23 June 2008]. • Productivity Commission 2005, ‘Economic implications of an ageing Australia’, [online] April. Available from: <http://www.pc.gov.au> by entering ‘ageing Australia’ in the search box [cited 23 June 2008]. • Westpac/ASFA 2008, ‘Retirement living standards’ [online]. Available from: <www.superannuation.asn.au> by selecting ‘Advocacy & Research’ then ‘Research Centre’ and then ‘Westpac/ASFA Retirement Standard’ [cited 14 October 2008]. The Westpac/ASFA outlines research conducted into the income required in retirement and the June 2008 updates showed: • a ‘comfortable’ lifestyle required $50,086 p.a. for a couple or $37,452 p.a. for a single person • a ‘modest’ lifestyle required $27,151 p.a. for a couple and $19,399 p.a. for a single person. The required level of income will vary for each individual based on their lifestyle expectations, expenses, the area they live in, their life expectancy and health etc. Therefore, experts provide a range of amounts of income needed in retirement. Many financial advisers quote 7–8.5 times the final average salary to provide an income in retirement of about 60% of the final salary per annum. Table 1 provides a guide to the amount of capital needed to provide pre-tax income on a per annum basis, assuming a 6% rate of earnings. Table 1 Capital required to maintain income throughout retirement Level of income (excluding family home) Capital required $15,000 $250,000 $20,000 $333,333 $25,000 $416,666 $30,000 $500,000 $35,000 $583,333 $40,000 $666,666 $45,000 $750,000 © Kaplan Education 1.7 1.8 Specialist Knowledge: Superannuation (924) 2 Overview of the superannuation industry Since 1983 there have been significant changes to superannuation rules to improve prudential regulation, encourage investment from a broad base of Australian workers and capture the funds invested so that they can only be used in retirement years. 2.1 Brief history of superannuation Superannuation in Australia has gone through three main phases (as set out in Figure 3): • Before 1988, superannuation was primarily the preserve of government employees, senior executives and workers in certain corporations. • In 1988, superannuation became part of the award-based employment structure, which broadened the franchise. Under this system, unions traded off award wage increases for increased superannuation coverage. • On 1 July 1992, the superannuation guarantee (SG) scheme was introduced and superannuation became part of most Australians’ savings. Legislation to allow choice of fund commenced on 1 July 2005. Figure 3 Three main phases of superannuation regulation Prior to 1988 Superannuation limited mainly to government employees and corporate executives 1988 Superannuation extended via award provisions 1992 Superannuation made universal via SG In addition to these changes, the superannuation system has undergone enormous changes in regulation, tax rules and social security assessment. In 1994, the Superannuation Industry Supervision (SIS) Act 1993 was introduced in addition to the reform of taxation on end benefits. The changes introduced on 1 July 2007 boost the tax effectiveness of superannuation in retirement but also have implications for how money will be accumulated in superannuation. Appendix 1 contains a time line summarising important stages in the development of the regulation of superannuation in Australia between 1987 and 2008. Further resources Nielson, L & Harris, B 2008, ‘Chronology of superannuation and retirement income in Australia’ [online]. Available from: <http://www.aph.gov.au> by selecting ‘publications’ then ‘library publications’, then ‘background notes’ and selecting ‘Chronology of superannuation and retirement income in Australia’ from the results [cited 23 June 2008]. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry 2.2 Superannuation industry overview The assets of the Australian superannuation industry totalled $1.1 trillion at March 2008. This section describes key trends in the industry, as reported by the Australian Prudential Regulation Authority (APRA), in its Annual Superannuation Bulletin to 30 June 2007. Key features of the superannuation industry noted in APRA’s annual report to June 2007 published in March 2008 include: • Superannuation contributions for the year to June 2007 were $123 billion, an approximate increase of approximately 44% on contributions for the previous 12 months. Employer contributions increased by 30% and member contributions increased by 64%. The very large increase in member contributions was the result of members taking advantage of the special $1 million transitional cap on non-concessional contributions to 30 June 2007. • The number of people covered by superannuation has increased markedly. At June 2007, there were 30.4 million member accounts (many members have multiple accounts). • Self-managed superannuation funds (SMSFs) continue to increase with around 3500 new funds created per month. • Despite the general growth, other funds such as corporate funds) have declined. Over the 12 months to 30 June 2007, the number of funds (other than SMSFs) decreased by 34%, while the number of SMSFs increased by 13%. • The number of funds with fewer than five members (small APRA funds and SMSFs) reported by APRA to June 2007 was 365,992 with a total of 702,000 members (just over 2% of all superannuation fund members). • Despite representing only 2% of all superannuation member accounts, small superannuation funds are the second largest category measured by assets (behind retail funds), with $286.6 billion in assets. Further resources APRA 2008, ‘Superannuation statistics’ [online] Available from: <http://www.apra.gov.au> by selecting ‘Superannuation’ then ‘Statistics’ [cited 23 June 2008]. APRA is the regulatory authority responsible for supervising fund compliance, and APRA publishes both annual and quarterly reports. © Kaplan Education 1.9 1.10 2.3 Specialist Knowledge: Superannuation (924) Types of superannuation benefit schemes The two types of superannuation benefit schemes are defined benefits, and accumulation. Additionally, retirement savings accounts (discussed in section 2.6 below) offer capital guarantee but generally a low rate of earnings. Defined benefit schemes Defined benefit schemes are traditionally associated with large corporate and public sector superannuation funds. Essentially, the final benefit is a function of a number of variables, including age, length of membership and salary. Because the benefit is not subject to fund performance, it provides members with a degree of certainty. Generally, the benefit is a multiple of the person’s final salary at retirement, for example 75% of the average of the last three years’ salary. The benefits may be made in the form of a pension or lump sum. Pensions are often indexed to retain their value in real terms. How payments are made will be specified in the trust deed or governing legislation. Investment risk inherent in defined benefit schemes is borne by the employer who has made a promise to pay a designated amount. Defined benefit funds require actuarial funding calculations and regular financial adequacy reviews. Accumulation benefit schemes Under an accumulation style of benefit scheme, money is contributed to the fund by a member or on a member’s behalf. Expenses are debited from and investment earnings are credited to the member’s individual account balance and the net accumulated balance provides the benefit to that member. In an accumulation fund, there is no guarantee or even presumed likelihood that the ultimate amount of the benefit will be adequate or sufficient for the member’s financial needs upon retirement or other benefit contingencies. The size of the benefit depends on the amount of money contributed and the fund expenses and investment earnings. The benefits may be paid in the form of a pension or lump sum, as specified in the trust deed. The investment risk within an accumulation fund is borne by the member. Accumulation fund members will generally need financial advice on how much money to contribute and on which superannuation vehicles provide the most cost-efficient and flexible avenues for those superannuation accumulations. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry 2.4 Sole purpose test Superannuation funds must meet the sole purpose test. This means the primary purpose must be the provision of retirement (or death) benefits. To do this, it must have one of the core purposes listed below, and may have one or more ancillary benefits. Core purposes The core purposes of a complying superannuation fund are: • to provide benefits to members on or after the prescribed age (65) • to provide benefits to members on retirement from employment • to provide benefits on the death of members. Ancillary benefits Superannuation funds may provide ancillary benefits, such as death and disablement benefits. Many complexities can be built into a superannuation fund’s overall benefit design, particularly in employer-sponsored funds where considerations such as staff attraction and retention might come into play. However, these complexities are beyond the scope of this subject. Ancillary benefits include: • disability benefits • benefits on termination of employment • death payments (defined as an ancillary benefit when death occurs after retirement) • other benefits permitted by APRA in writing. © Kaplan Education 1.11 1.12 2.5 Specialist Knowledge: Superannuation (924) Types of funds APRA (2008) reports on five different types of superannuation fund arrangements, as shown in Table 2. Table 2 Superannuation assets at 30 June 2008 (amounts in $ billion) Fund type Jun 2004 Jun 2005 Jun 2006 Jun 2007 Jun 2008* Corporate 50.5 52.2 52.2 69.2 61.5 Industry 94.0 119.4 150.3 197.3 199.3 Public sector 112.1 129.0 152.7 177.6 170.2 Retail 207.5 244.5 298.9 369.7 341.5 Small funds** 136.7 171.9 220.3 286.6 362.4 Subtotal 600.7 717.0 874.4 1,100.4 1,134.9 40.3 42.2 43.4 42.8 37.0 6,41.0 759.3 917.8 1,143.2 1,171.9 Directly invested 227.6 263.4 327.9 411.1 Placed with an investment manager 249.1 317.9 388.6 506.8 Invested in life office statutory funds 166.4 181.5 201.3 225.4 Total assets 643.0 762.9 917.8 1,143.2 Balance of statutory funds*** Total superannuation assets Manner of investment * Estimate. ** Small funds include small APRA funds and SMSFs. The ATO reported the balance held in SMSFs to be $282.7 billion at June 2007. ***The balance of statutory funds is the remaining superannuation assets residing in life office statutory funds after the assets explicitly known to reside in the other fund types have been allocated. These assets include products (e.g. deferred annuities) that are regulated solely under the Life Insurance Act 1995. Source: APRA 2008, Tables 9 and 12. Broadly, these types of funds are defined as follows: • Corporate funds are employer-sponsored funds where membership is restricted to employees of the enterprise and only according to the membership rules set by the employer-sponsor. Corporate funds are now generally accumulation funds although in the past many provided defined benefits. • Industry funds are funds originally designed for employees in a particular industry or range of industries. The union system, in conjunction with employer bodies, has set up around 60 schemes, to accept productivity payments paid under industrial awards. These funds became the nominated funds for many workers at the outset of compulsory superannuation. Many of the larger of the industry funds have adopted public offer status, allowing them to accept contributions from any person. With very few exceptions, industry funds are accumulation funds. Industry funds are described in Appendix 2. • Public sector schemes are established by legislation for government employees. These funds were traditionally defined benefit funds, but government financial pressures have forced the closure of many of these defined benefit funds, to be replaced by more modest accumulation funds. Public sector schemes are described in Appendix 3. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry • Retail funds. As well as superannuation retail funds, there are: – Life office retail funds which include personal superannuation and annuity products held in the statutory funds of life companies. – Other retail funds which include personal superannuation products sold through public offer pooled superannuation products and master trusts operated by financial institutions and professional advisers such as accountants and actuaries. • Small funds have fewer than five members. They are also known as DIY funds, ‘mum and dad’ funds, small APRA funds and SMSFs. The relative size of member accounts in the different types of funds in June 2007 and superannuation assets per member are shown in Figure 4. Figure 4 Superannuation assets of funds and per member at 30 June 2007 450 Assets of fund ($bn) 400 Assets per member ($’000) 350 300 250 200 150 100 50 ds il al lf un ta st du Re Sm Co In Pu ry e at or rp bl ic 0 Source: APRA 2008. Derived from Key Statistics table presented in Table 3. Table 3 Assets by types of funds Corporate Assets of fund ($bn) Assets per member ($’000) Industry Public Retail Small funds 69.2 197.3 177.6 369.7 286.6 102.4 18.5 60.7 23.9 408.3 © Kaplan Education 1.13 1.14 Specialist Knowledge: Superannuation (924) Public sector funds showed the slowest growth in the year to June 2007, with assets managed increasing by 16%. Retail funds grew by 24% and small funds grew by 30%. Corporate funds increased by 33% and industry funds increased by 31%. Table 4 below shows the number of member accounts in each fund type. You can see that the general reduction in the number of members in corporate funds was reversed in 2007. Table 4 Number of member accounts by fund type June 2004 (000) Corporate funds June 2005 (000) June 2006 (000) Jun 2007 (000) 774 697 605 676 Industry funds 8,946 9,270 9,948 10,654 Public sector funds 2,707 2,758 2,891 2,925 Retail funds 13,764 14,434 14,970 15,437 Small funds 552 585 621 702 26,744 27,744 29,035 30,394 Total Source: APRA 2008, Table 3. 2.6 Retirement savings accounts Retirement savings accounts (RSAs) are designed to provide a low-cost alternative to other superannuation products. RSAs are offered by banks, credit unions, life insurance companies and others. RSAs do not require a trust structure. RSAs must comply with rules and regulations applying to other superannuation funds. In addition, RSAs: • must be capital guaranteed • can be opened and maintained only in the name of the individual beneficiary • can offer life and disability cover • are fully portable, and are owned and controlled by the member • are subject to complaints review by the Superannuation Complaints Tribunal • are subject to SIS standards, including the preservation rules. RSAs are not particularly suitable for long-term investment because: • they are run similarly to bank accounts in that there is no connection between the rate earned on members’ money and the rate they receive • there is no trustee looking after members’ benefits • earnings rates will be low and will not allow for the growth of members’ funds required to fund a satisfactory level of retirement savings • there is no exposure to growth assets or diversification of assets. According to APRA, June 2008, RSAs held $1.2 billion in assets, approximately 0.1% of total superannuation assets. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry Use of retirement savings accounts Retirement savings accounts can be useful for clients with very small superannuation balances which do not meet the minimum balance requirements of larger superannuation funds, e.g. teenagers age 15 to 18, young adults, itinerant workers or those doing casual work. The advantages for this group are: • accounts can be opened with $1 • deposits can be made at any time • there are no management fees (but there are administration charges) • the savings are guaranteed • if they are working at least part-time and submitting an annual tax return, they may be eligible for the government co-contribution. Clients should be careful in choosing an account fund as there is a large variation in the interest rates paid, and some institutions may pay no interest on smaller amounts. RSAs can also be useful for clients who: • wish to amalgamate a number of very small superannuation accounts • need a short-term transitional vehicle to hold their superannuation • are very close to retirement and want their superannuation in a short-term capital-guaranteed deposit. 3 Superannuation funds management Superannuation funds are trusts that operate under a trust deed. The trustees have a range of obligations to their members. Funds are generally structured around receiving contributions, managing the moneys of the trusts and paying out funds to the members. 3.1 Operations of superannuation funds The basic operation of a superannuation fund is that it: • receives contributions from the members, employer(s) and/or Government co-contribution • invests these moneys • receives investment earnings and/or capital gains • pays tax and expenses • pays lump sum and/or pension benefits to the members according to the rules of the trust deed. Traditionally, services provided to superannuation funds have tended to be bundled together. For example, a life office would provide actuarial services, investment management, member administration and insurance. Increasingly, these services have been sold individually rather than as a package. Appendix 4 gives a brief summary of the professionals who help run superannuation funds. © Kaplan Education 1.15 1.16 3.2 Specialist Knowledge: Superannuation (924) Investment options In many cases superannuation funds offer their members the choice of investment options. This can range from high return–high risk (volatility), to capital guaranteed low return–low risk. An investment option can include a mixture of asset classes or single asset class. For example, the industry fund AustralianSuper offers six ‘premixed’ investment options: • high growth • balanced • sustainable balanced • conservative balanced • capital guaranteed. It also offers ‘DIY mix investment options’ of: • Australian shares • international shares • Australian sustainable shares • international sustainable shares • property • Australian fixed interest • international fixed interest • diversified fixed interest • cash. Further resources State Super 2007, ‘Choose you investment strategy’ [online]. Available from: <http://www.firststatesuper.com.au> by selecting ‘Talking super’ and then ‘Choose your investment strategy’ [cited 23 June 2008]. The site above provides descriptions of various investment options. Visit the web sites of other superannuation providers for more. 3.3 Obligations to members Superannuation funds manage the retirement savings of the members of the fund. SIS legislation requires the trustee of a superannuation plan to provide members with all the information they might reasonably require to understand the management and operation of their superannuation fund. Notwithstanding the protection of the legislation and APRA, it is the members who must be satisfied that their interests are being properly served. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry 3.4 The corporate trustee and trustee directors SIS legislation requires that an incorporated trustee administer regulated superannuation funds. The directors of the corporate trustee are often referred to as ‘trustees’. While this is not technically accurate, it is appropriate as the SIS legislation deems the trustee directors to be personally bound by the same covenants (duties) as the corporate trustee. The corporate trustee and its directors have the duty of managing the superannuation fund according to the rules set out in the trust deed and relevant legislation. However SMSFs might have individual trustees. 3.5 The trust deed The trust deed sets out the rules by which the superannuation fund is run. These rules include who is eligible for membership, what the benefits are, how the money may be invested and other similar operational terms. Unlike a company director, the discretions available to a trustee are very few and very limited: the trustee must act in the manner prescribed in the deed. Therefore, it is very important that the trustee directors know the terms of the deed. 4 Regulation of superannuation funds There are frequent changes to superannuation and as a result it comprises a complex set of rules. This section covers superannuation funds regulated by APRA. The regulation of SMSFs by ATO, while generally similar, does have some differences. 4.1 Trust law Most superannuation funds are established under a trust deed or life policy. The exception is some public sector schemes for government employees, which are established by statute. Under common law, a trust exists where money is held, invested, administered and/or applied by one person (the trustee) for the benefit of another (the beneficiary). Broadly, trust law imposes obligations on superannuation fund trustees and other fiduciaries: • to act in the interest of beneficiaries • to act impartially between beneficiaries • not to act according to the instructions of, or at the dictation of, another person • to observe the terms of appointment, such as the provisions of the relevant trust deed. A wide range of remedies are available under common law for breach of fiduciary duty, including recovery of damages, injunctions and the setting aside of improper transactions. Trustees obligations under trust law are discussed further in Appendix 5. © Kaplan Education 1.17 1.18 4.2 Specialist Knowledge: Superannuation (924) State trustee acts Each state and territory of Australia has its own legislation on the trusteeship of trusts. A detailed examination of such legislation is outside the scope of this subject, but such legislation commonly deals with the: • limits on the number of trustees • appointment and removal of trustees • authorised trustee investments • powers of trustees, particularly powers to delegate, appoint agents, mortgage, sell and insure property, and borrow • power of a trustee to seek advice from a court • liability, indemnification and reimbursement of a trustee. 4.3 Corporations Act and Trade Practices Act Where regulated superannuation funds have an incorporated trustee, they are subject to the Corporations Act 2001 (Cth) and the Trade Practices Act 1974 (Cth). The Corporations Act specifies how directors will be elected, how records are to be kept and what returns are required. Importantly, it also sets the rules for public offer by prospectus which must be followed if a superannuation fund seeks to raise moneys from the public. The Trade Practices Act prohibits misleading and deceptive conduct in dealing with the public. 4.4 Superannuation Industry Supervision (SIS) regime The SIS regime regulates superannuation and protects fund members by making trustees responsible for prudently managing funds and meeting detailed regulatory retirements. The SIS regime takes its name from the principal Act, the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act). For most funds, SIS legislation commenced from the 1994/95 year of income. A regulated superannuation fund that elects to be regulated under the SIS Act and Regulations is entitled to taxation concessions and may accept superannuation guarantee (SG) contributions. (Note: Taxation concessions are also subject to conditions discussed in section 4.5.) There are, however, situations where a fund decides not to become regulated because it prefers not to comply with SIS requirements. These funds are not eligible for the superannuation tax concessions. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry Election to become a regulated fund The Australian Government has no direct constitutional powers over superannuation funds. The SIS regime relies on constitutional powers over corporations and pensions. To become a regulated fund under SIS legislation, trustees must lodge an election with APRA to become a regulated superannuation fund via one of two routes: • Corporations route — the fund must have a corporate trustee and its trust deed must require the trustee to be a corporation (i.e. a company incorporated under the Corporations Act). • Pensions route — the fund’s trust deed must provide that the fund’s sole or primary purpose is the provision of age pensions. In this case, the trustees may be individuals. Election forms that do not clearly select one of these routes are invalid, since there is no separate constitutional power to protect fund members. Funds lodging invalid election forms will not be entitled to concessional tax status. Once a superannuation fund has lodged a valid election, it is required to follow the SIS regime of duties and obligations. SIS legislation also requires that investment managers of regulated superannuation funds and pooled superannuation trusts (PSTs) must be incorporated. Trustee accountability The cornerstone of the SIS regime is the principle that trustees have prime responsibility for managing superannuation funds. Section 52(2)(b) of the SIS Act says the trustee must exercise: the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with the property of another person for whom the person felt morally bound to provide. While trustees may seek expert assistance from professional advisers, they remain ultimately responsible and may not surrender control of their fund. SIS legislation protects trustees from threats made by employers or other parties. In addition, APRA encourages trustees to have contracts with service providers specifying what they expect from them. For example, outsourcing is often used both to devise an investment strategy and then to implement it. © Kaplan Education 1.19 1.20 Specialist Knowledge: Superannuation (924) SIS requirements Regulated funds must follow the SIS Act and Regulations, which aim to ensure that funds are managed prudently and are used for genuine retirement purposes. In broad terms: • Member benefits are protected. – Member benefits are subject to vesting, preservation and portability rules. – Member benefits must be fully secured and not restricted by a lien (i.e. not used as a security for a debt). – Accrued member benefits can be reduced only with the approval of fund members and APRA. • Members can become involved in managing their fund. – Trustee boards must generally have equal employer/employee representation. • Members are informed about their fund. – Members must be sent annual reports detailing their current benefits, fees and charges plus the fund’s financial position, investment and management strategies. • Superannuation must be managed prudently. – Trustees must formulate and implement an investment strategy. – Investments must be on commercial terms (i.e. at arm’s length). – Loans to, and investments in, an employer-sponsor are strictly limited. – Funds must not make loans to, or acquire assets from, members, with specified exceptions. – Funds must not borrow, except for short-term financing to pay member benefits. APRA annual returns Funds lodge annual APRA returns certifying that they have complied with SIS requirements, together with a certificate from an approved auditor. This self-assessment approach is supplemented by an APRA fund program review. While APRA will prosecute major breaches, for minor breaches, APRA auditors will work with trustees in identifying possible weaknesses in the running of a fund. Non-compliance with SIS The SIS regime has resulted in the better targeting of penalties for breaches of the superannuation provisions. For example, the in-house asset rule protects fund members by limiting the amount that a fund can invest in or lend to the employer-sponsor of a fund. In a worst case scenario, where the in-house asset rule is breached and the employer subsequently fails, the fund members can lose in three ways: • lose their jobs • retirement savings are reduced because their fund has invested a large proportion of its assets in a failed business • their fund loses eligibility for concessional tax treatment. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry Sanctions under SIS Sanctions under SIS legislation focus on the responsible parties and can be set at appropriate levels. SIS legislation gives APRA powers to take court action directly against the persons responsible for intentional or reckless breaches — usually the trustees. The sanction of loss of concessional tax status is retained under SIS legislation, but is limited to instances where an offence under the SIS Act has been committed or a civil penalty provision contravened. SIS offences Offences under SIS legislation include failure to comply with the following provisions: • lodgement of prescribed annual returns with APRA • prohibition on acquisition of certain assets from members of regulated superannuation funds • prompt remittance of authorised deductions from salary and wages by employers to the trustee of a regulated superannuation fund • establishment of an enquiries and complaints procedure • retention of certain minutes and records • establishment of a procedure for appointing member representatives of a standard employer-sponsored fund (i.e. a regulated superannuation fund to which employer-sponsors contribute wholly or in part under an agreement between the employer-sponsor and the trustee of the fund) • retention of certain accounting records and accounts • written appointment of investment managers • duty of actuaries and auditors to tell the trustee of a fund, in writing, about a contravention of SIS legislation by an entity, or the unsatisfactory financial position of an entity, related to the actuary’s or auditor’s functions. SIS civil penalty provisions The following provisions are civil penalty provisions under SIS legislation: • the purposes for which a regulated superannuation fund may be maintained (referred to as the sole-purpose test) • prohibition on lending to members of a regulated superannuation fund • prohibition on a trustee of a regulated superannuation fund borrowing money or maintaining an existing borrowing of money • in-house asset requirements by regulated superannuation funds • prohibition on avoidance schemes in respect of the in-house asset requirements • notification of APRA of significant adverse events regarding the financial position of a regulated superannuation fund • investments of a regulated superannuation fund to be made on an arm’s length basis • payment of an amount of a fund to an employer-sponsor, in circumstances other than those prescribed. © Kaplan Education 1.21 1.22 4.5 Specialist Knowledge: Superannuation (924) Concessional tax treatment compliance status Not all SIS-regulated superannuation funds receive concessional tax treatment. The Income Tax Assessment Act 1997 (Cth) provides for concessional tax treatment of funds that comply with particular requirements. To be a complying superannuation fund, and therefore receive concessional tax treatment in a particular year of income (normally 1 July–30 June), a superannuation fund must: • be a regulated superannuation fund under SIS legislation (see section 4.4) • either: – the trustee must not have contravened the SIS Act or Regulations in respect of the year of income, or – the trustee did contravene the SIS Act or Regulations but the fund did not fail the culpability test. For the purpose of determining whether a fund is a complying fund: • a contravention of SIS legislation will be ignored unless it constitutes an offence under the SIS Act or is a contravention of a civil penalty provision under the SIS Act • a fund will fail the culpability test if either: – all of the members of the fund were in any way directly or indirectly knowingly concerned with, or party to, the contravention, or – one or more (but not all) members of the fund were in any way directly or indirectly knowingly concerned with, or party to, the contravention and the ‘innocent members’ would not suffer ‘any substantial financial detriment’ if the fund were to be treated as a non-complying superannuation fund in relation to the year of income concerned. APRA, after considering the taxation consequences that would arise if the fund were to be treated as a non-complying superannuation fund in relation to the year of income concerned, the seriousness of the contravention and all other relevant circumstances, believes that notice should be given to the fund stating that it is not a complying superannuation fund in relation to the year of income concerned. For the purposes of the culpability test, the question of whether a person was in any way directly or indirectly knowingly concerned with, or party to, a particular contravention will be decided on a balance of probabilities. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry 4.6 Role of government agencies There are four government agencies involved in superannuation: • Australian Securities and Investments Commission (ASIC) • Australian Prudential Regulation Authority (APRA) • Australian Taxation Office (ATO) • Superannuation Complaints Tribunal (SCT). Australian Securities and Investments Commission (ASIC) ASIC’s primary role in the superannuation arena is to protect fund members’ interests and promote saving for retirement by: • supervising public offer superannuation funds (examining prospectuses, approving trustees and conducting reviews) • Details of whether ASIC or APRA is responsible for various regulations can be found at <www.asic.gov.au>. Australian Prudential Regulation Authority (APRA) APRA is responsible for prudential regulation functions, including supervising fund compliance with SIS provisions (processing annual returns and levy payments, and conducting audits and investigations). APRA’s superannuation activities are funded by a levy on regulated superannuation funds. There are more than 300,000 superannuation funds in the private sector, and they are not guaranteed by the Government or APRA. Australian Taxation Office (ATO) The main responsibilities of the ATO with respect to superannuation are: • supervising SMSFs • processing superannuation fund tax returns and tax collections — regulated funds that comply with SIS legislation are entitled to tax concessions • monitoring compliance with other superannuation tax laws, such as deductions, contribution rebates and the taxation of benefit payments • administering the SG system (monitoring employer compliance with their obligations to make contributions for their employees, imposing the superannuation guarantee charge and remitting it to employees) • keeping a register of lost members benefits. Superannuation Complaints Tribunal The Superannuation Complaints Tribunal (SCT) is an independent tribunal set up by the Commonwealth Government to deal with complaints about superannuation funds, annuities and deferred annuities, and retirement savings accounts. © Kaplan Education 1.23 1.24 5 Specialist Knowledge: Superannuation (924) Choice of fund The ‘choice of fund’ legislation — the Superannuation Legislation Amendment (Choice of Superannuation Funds) Act 2004 (Cth) — came into force on 1 July 2005, giving most employees in Australia the choice of superannuation fund into which their compulsory 9% superannuation guarantee contributions will be paid. Previously, most employees had to accept the fund nominated by their employer. Employers retain the right to decide where other contributions will be paid (such as voluntary employer and salary sacrifice contributions). However, most employers will direct these additional contributions into the same fund to keep administration simple. The impact of the choice of fund legislation was overstated before its introduction. The majority of employees have not changed their fund and still contribute to the employer default fund. 5.1 Eligibility The initial choice of fund legislation took effect on 1 July 2005 (estimated to have affected about 5.2 million employees) and eligibility was extended further from 1 July 2006. Employee entitlement to choose depends on whether the employer is incorporated or not. Who is eligible for choice of fund? Employers must offer superannuation fund choice to employees who are paid under: • federal awards • another award or agreement that does not require superannuation support • neither an award nor industrial agreement (including individuals contracted principally for their labour). If the employer is an incorporated business (e.g. a company) they must also offer choice to employees who were paid under former state awards, now known as ‘notional agreement preserving state awards’. New Commonwealth Government employees and those who are members of the PSS (Public Sector Superannuation) Scheme are also offered choice of superannuation fund. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry Who is not eligible for choice of fund? Currently the following employees do not have access to choice of fund: • Employees for whom contributions are being made under or in accordance with an Australian workplace agreement (AWA) or a certified agreement (CA). • Employees of a non-incorporated business for whom contributions are being made under or in accordance with a state industrial award or registered industrial agreement. These are now known as a ‘preserved state agreement’. • People for whom contributions are being made under a prescribed law (such as where the contributions are made to an unfunded public sector scheme), i.e. a scheme where the government does not contribute funds regularly, but pays entitlements when required. An employee who is a member of a defined benefit scheme is not entitled to choice of fund if: • they have reached their maximum benefit in their scheme and there is no need to make further SG contributions • on their termination of employment they would be entitled to the same amount of benefit from the defined benefit scheme whether or not they chose a new fund • the defined benefit is in surplus — that is, an actuary has provided documentation: – stating that contributions need not be made for the quarter – that covers all periods since 1 July 2005 – stating that the assets of the defined benefit scheme are, from 1 July 2005, equal to or greater than 110% of the defined benefit scheme’s liabilities. 5.2 The default fund If the employee does not choose a fund, or the nomination is invalid, SG contributions must be paid into the employer’s default fund. The default fund must be one of the following: • a complying superannuation fund or scheme • a retirement savings account • a scheme for which there is a certificate under s 24 or s 25 of the Superannuation Guarantee (Administration) Act 1992. The default fund must offer a minimum level of life insurance cover. 5.3 Penalties for non-compliance Penalties will apply if employers fail to offer their eligible employees choice of fund or if they pay SG contributions into the incorrect fund. The penalty is linked to the superannuation guarantee charge (SGC) and will increase the SG liability by 25%, up to a maximum of $500 per quarter for each employee. This penalty cap includes penalties for any SG shortfall as well as failure to comply with choice of fund provisions. Penalties will apply each quarter until the problem is corrected. © Kaplan Education 1.25 1.26 Specialist Knowledge: Superannuation (924) Example: Choice of fund breach Tristan is the only employee of Traction Pty Ltd. As he does not fall into any of the categories excluded by the legislation, he is entitled to choice of fund. Tristan makes a valid choice. On 25 October 2007, Traction Pty Ltd makes an SG contribution into a fund not chosen by Tristan. Tristan’s employer has breached the choice rules and a penalty will apply. Tristan’s SG earnings base is $8000 per quarter. The SG contribution is $720 ($8000 × 9%). The penalty charge for paying to the incorrect fund will be $180 (25% × $720). The cost of this penalty is non-deductible. 5.4 Employer obligations under superannuation choice The ATO has published a Guide for employers, which recommends a three-step process to implement choice of fund rules: Step 1 — Identify eligible employees Employers initially should determine whether each employee is eligible for choice of fund. Step 2 — Provide a standard choice form to eligible employees Employers must provide a standard choice form: • to all eligible new employees within 28 days of commencing employment • within 28 days of an eligible employee’s request for a form. On the standard choice form, employers must include details of the fund (the ‘default fund’) to which they will make SG contributions if a choice is not made or the choice is invalid. If an employee is a member of a defined benefit fund and eligible for choice, the employer will need to provide additional information to the employee highlighting the issues that they should consider before choosing a fund. Step 3 — Act on the employee’s choice • An employer has two months from the date of receiving an employee’s choice form to start making future contributions to the new chosen fund. • If an employee’s written notice does not contain all the required information, the employer does not have to accept it. • An employer only has to accept one choice request in any 12-month period. 924.SM1.9 Unit 1: Introduction to retirement planning and the superannuation industry 5.5 Adviser obligations when switching funds Where superannuation switching advice is recommended, such as when a recommendation is made to switch superannuation funds, advisers are subject to additional obligations. ‘Superannuation switching advice’ is not a technical or legal term. It is used by ASIC to refer to personal advice given to a retail client relating to either (or both): • the transfer (in whole or part) of an existing superannuation account balance from one superannuation fund to another superannuation fund • the redirection of future contributions away from one superannuation fund to another superannuation fund. These situations go beyond cases of product replacement. In these situations, advisers must: • compare a client’s existing fund with the recommended fund • specifically disclose the costs, loss of benefits (including insurance) and other significant consequences of making a switch • specify how any recommendation on change of fund is appropriate for the client • ensure that advice given to setup SMSFs is appropriate. The following publication specifies the requirements for advisors when advising clients about switching superannuation. Further resources ASIC 2005, ‘Regulatory Guide 84 Super switching advice: Questions and answers’ [online] June. Available from: <http://www.asic.gov.au>. Under ‘Publications’ select ‘Regulatory documents’ then ‘Regulatory guides (RG)’ [cited 23 June 2008]. 5.6 Portability Choice of fund legislation only relates to future SG contributions. However, existing balances can be transferred to a new account by requesting a transfer through the superannuation fund trustee. Prior to 1 July 2004, this ability was limited for many people in employer funds. However portability legislation which came into effect on 1 July 2004 now allows existing balances in any fund (except some public sector funds) to be transferred to any other fund chosen by the member. Reflect on this: Superannuation portability Why is portability important for the clients of financial advisers? What are the advantages of portability of superannuation for a client? Why would a client want to move their superannuation? © Kaplan Education 1.27 1.28 Specialist Knowledge: Superannuation (924) Planning opportunities Choice of fund and portability provisions give financial advisors the opportunity to advise employees on their superannuation benefits, including: • the level and type of voluntary contribution • an appropriate superannuation fund • appropriate investment options • levels of death and disability cover. References ABS 2006, Population Projections, Australia, 2004 to 2101 cat. no. 3222.0 [online] Australian Bureau of Statistics, Available from: <http://www.abs.gov.au>. Select ‘Australia’s population’. ABS 2008, Australian national accounts: National income, Expenditure and Produce, mar 2008 — cat. no. 5206.0 [online] Australian Bureau of Statistics. Available from: <http://www.abs.gov.au>. Under ‘National Statistics’, select ‘National Accounts’ [cited 23 June 2008]. APRA 2008, Annual superannuation bulletin June 2007 [online] Australian Prudential Regulation Authority. Available from: <http://www.apra.gov.au>. Under ‘Superannuation’ select ‘Statistics’ [cited 23 June 2008]. 924.SM1.9 1 Appendices 1 Main developments in regulation of superannuation 1987–2007 2 Industry funds 3 Public sector funds 4 Role of professionals in running a fund 5 Trustees’ fiduciary duties 1 Unit 1: Appendix 1 Main developments in regulation of superannuation 1987–2007 1987 Nov. Insurance and Superannuation Commission (ISC) established to assume overall responsibility for supervision of the insurance and superannuation industries. Dec. Occupational Superannuation Standards (OSS) Act comes into operation. Regulations made under the Act provide standards for occupational superannuation funds and approved deposit funds. 1988 May Treasurer announces significant changes to taxation of superannuation. 1990 July New administration arrangements for reasonable benefit limits (RBLs) commenced. 1991 May Superannuation Supervisory Levy Act and regulations impose a levy on superannuation funds from the 1990/91 income year. June Senate select committee on superannuation established to inquire into a range of superannuation issues. 1992 June Accounting Standard AAS 25 ‘Financial Reporting by Superannuation Plans’ takes effect for most funds. Commonwealth Treasurer issues a major policy statement, ‘Security in Retirement’, announcing measures to streamline the rules for superannuation, including simplified RBLs. July Commencement of the superannuation guarantee scheme, designed to ensure employers provide minimum levels of superannuation support for their employees. Oct. Commonwealth Treasurer releases the statement, ‘Strengthening Super Security’, announcing a package of measures aimed at strengthening the prudential framework for superannuation. 2 1993 June Commissioned by the Commonwealth Treasurer, Dr FitzGerald presents a report on national saving containing a number of proposals relating to superannuation, taxation and national saving. Administration of RBL system transferred from APRA to the ATO. Dec. Superannuation Industry (Supervision) (SIS) legislation passed. The SIS legislation aims to strengthen the framework of prudential supervision of the superannuation industry and give effect to the Treasurer’s October 1992 statement. 1994 Jan. New disclosure regime for single and regular premium life insurance products (including personal superannuation) takes effect — ISC Circular No. 304. Mar. SIS regulations gazetted. July Commencement of the new SIS regime for most funds. Superannuation Complaints Tribunal commences operation in Melbourne. Flat dollar reasonable benefit limits replace salary-linked RBLs. Dec. Gazettal of transitional RBL regulations. People had until 31 December 1996 to apply for a transitional RBL where this was higher than the new flat rate RBLs (this cut-off date has since been removed). 1995 May Treasurer announces the introduction of compulsory employee contributions from 1997/98 in his Budget speech. Lower paid employees and self-employed people will also be eligible for matching Government contributions. July ATO Superannuation Holding Accounts Reserve is established to collect superannuation payments. SIS regulations implementing ‘member protection’ for superannuation balances under $1000 take effect. 1996 Aug. Treasurer announces introduction of: • superannuation surcharge on high income earners • retirement savings accounts (RSAs). 1997 May Treasurer announces: • abolition of previous Government’s co-contribution proposal • employee choice as to fund or vehicle to which compulsory employer contributions are to be made announced • tighter preservation rules. 3 1998 Mar. Employee choice legislation is introduced for the first time. May Changes are announced to alter the definition of excluded superannuation funds and their regulation. Aug. Tax Reform Package is announced, including GST. Sept. Change to the assessment of income streams by social security and the definition of complying pensions and annuities for pension RBL purposes. Dec. Choice legislation is reintroduced. 1999 Apr. FBT reporting changes commence (to include reportable fringe benefits in income definition). July Preservation rules change so all contributions and earnings from 1 July are fully preserved. Oct. Change to taxation of capital gains to replace indexation method with discount method and remove averaging provisions. 2001 Mar. Self-managed funds have to meet new definition, so that all members must be trustees and all trustees must be members (exception for single-member funds). Regulation for SMSFs moved to the ATO. July Tax reform initiatives become effective. 2002 Mar. The Financial Services Reform Act commences. July Contributions age increased to 75. Contributions allowed on behalf of a child, under age 18. The deductible limit for self-employed and unsupported individuals increased to allow for a full deduction on the first $5000. 2003 July SG contributions not required to be paid quarterly. Surcharge rate reducing, with a maximum rate for 2003/04 of 14.5%. Co-contribution scheme replaces rebate for low income employees. 4 2004 July Proposal to split superannuation contributions to spouses due to come into effect (introduction subsequently deferred). Start date for some of Treasurer Costello’s February 2004 announcements including: • all people under age 65 to be eligible to contribute to superannuation • annualised work test for people aged 65–75 years • employer ETPs rolled over to be fully preserved. Surcharge rate reduces to 12.5% for 2004/05. Co-contributions scheme expanded with increased thresholds and co-contribution up to $1500. Sept. Term allocated pensions introduced. Asset test reduction reduced to 50% for new complying income streams purchased on or after 20 September. 2005 July Choice of fund commences 1 July. Surcharge abolished from 1 July. Transition to retirement rules commence. 2006 Jan. SMSFs unable to commence new defined benefit pensions (i.e. lifetime guaranteed and term certain pensions). Contribution splitting commences. May A transitional cap of $1 million applies to non-concessional (post-tax) contributions made until June 2007. A person 65 years of age and retired no longer has to compulsorily cash out their superannuation. Federal Budget announces major reforms to superannuation ‘Simple Super package’. July Choice of fund extended from 1 July to cover employees of corporates. Superannuation holding account closed to new contributions from 1 July. Sept. Consultation period ends for Budget proposals and final decisions published by Treasury. 5 2007 Feb. ‘Simple super’ legislation passes Parliament. Mar. ‘Simple super’ legislation receives Royal Assent. Apr. A member can no longer split a non-concessional (previously known as undeducted) contribution with his or her spouse. June ‘Simple Super’ rebranded as ‘Better Super’. Superannuation funds must calculate pre-July 1983 and other balances and re-classify funds into tax-free and taxable components. July RBLs abolished. Concessional contributions limited to $50,000 per annum, replacing age-based limits. Non-concessional contributions limited to $150,000 per annum, with ability to average over three years if under age 65. No tax on lump sum payouts from taxed superannuation funds for those age 60 and over. No tax on superannuation income stream payments for those age 60 and over. New account-based pension type, as well as life and term pensions. Government co-contribution is extended to the self-employed. Employment termination payments cannot be rolled over unless they satisfy the transitional rules. Changes to eligibility for capital gains tax (CGT) small business concessions and introduction of CGT contributions cap. New lower minimums for allocated pensions and no maximums (except transition to retirement (TTR) pensions which have a maximum of 10%). Self-employed people can become eligible for co-contribution and invalidity component. ETPs are changed to superannuation lump sums. Components merged into two — tax-free and taxable — and new proportioning rules apply. Sept. The assets test exemption for income streams purchased on or after 20 September is removed and the assets test taper rate reduces to $1.50 per fortnight for every $1000 above the lower threshold. No assets test exemption allowed for new income streams purchased on or after 20 September. Notes 1 Unit 1: Appendix 2 Industry funds Industrial background of industry funds Industry superannuation refers to accumulation plans that, in the main, draw members from multiple employers, either on an industry, occupation or geographic basis. The term ‘industry superannuation fund’ was coined in the mid-1980s to describe the funds established for the 3% award contribution. However, the precursors to industry funds have been around for a long time. Industry superannuation had its genesis as long ago as 1941 in the NSW coal industry, but development remained relatively slow until the 1980s. The early industry funds were born out of the industrial relations process, by unions seeking to improve the lot of their members in their retirement, and providing for the families of members who died or were disabled. In 1967, the waterfront unions advanced claims for an industry superannuation scheme. The Waterside Workers and the Stevedoring Employers established a fund, The Stevedoring Employees Retirement Fund (SERF). SERF was a defined benefit fund and only a single employer contributed. SERF was followed in 1973 by the Seafarers’ Retirement Fund (SRF), again a defined benefit fund, for members of the Seamen’s Union. SRF was arguably the forerunner of the multi-employer industry funds of today. SRF had employers from the seagoing trading fleet, the offshore industry, tugs and, later, dredges. It provided portability between employers, and benefits were preserved in the fund for seafarers not working for a participating employer. These members were called non-contributory members. SRF arose out of a log of claims served on employers by the Seamen’s Union to deal with technological change. Amongst other things, the union claimed a pension scheme. This was countered by an employer’s claim for compulsory retirement at age 65 years for all seamen. The maritime industry established long service leave under a national award in 1968 and in the early 1980s the building industry did likewise. It was then a short step to industry superannuation as we know it today. Schemes, like the Building Unions’ Superannuation Scheme and Metal Unions Superannuation Trust, were established in 1984. These schemes, although preceded by the storemen’s scheme LUCRF (1978), were the forerunners of today’s major industry accumulation funds. Since the 1980s, they have become some of the largest retirement vehicles in Australia, in both member numbers and assets. According to APRA, in June 2006, 91 industry funds held $150 billion in funds in 9.7 million accounts. Some, such as C+BUS (Construction and Building Unions’ Superannuation) and STA (Superannuation Trust of Australia), are now large financial institutions in their own right. Today C+BUS has over 320,000 members, 26,000 participating employers and assets of over $3.4 billion. It is a national fund covering the entire construction and building industry. Other major industry funds include Australian Super, Retail Employee’s Superannuation Trust (REST) and Health Employees Superannuation Trust of Australia (HESTA). 2 Distinctive features of industry funds While industry funds have some similarities to master trusts (they are multi-employer funds operating under a single trust structure) there are some very important distinctions. Industry funds are not established as commercial ventures designed to operate at a profit. They were generally created by agreement between the representatives of employees (unions) and employers (industry and trade associations) to allow employers to provide superannuation on a consistent and cost-effective basis. Accordingly, industry funds are fiercely proud of their heritage as ‘not-for-profit’ funds, so much so that many hail themselves as the ‘new mutual companies’ in an era when mutual life insurers such as the AMP, National Mutual and Colonial have all converted to listed public companies. They aim to provide services at a very low cost. Typically, they charge between $0.50 and $2.00 per week to each member for the provision of administrative services including record keeping, benefit payments and member communication materials. Investment management fees incurred by the funds and other costs not met by the weekly per-member charge are passed on to members by deducting them from the investment earnings credited to member accounts. The largest funds have been able to negotiate competitive fees with fund managers and these savings are passed on directly to members. Most of the funds outsource all of the key services including administration, investment management and insurance. They usually employ an in-house team to provide some member and employer services and to be responsible for the overall management of the fund. In many respects this means they operate in a similar way to large corporate funds. The low-cost superannuation and strong member focus have been powerful recruitment and retention aids. Most industry funds provide accumulation-style benefits plus insurance for TPD/death. Some also offer temporary disability/salary continuance policies and lump sum benefits for certain trauma events. Industry funds also play a major role in unbundling services at lower costs for their members. The reason for this focus in the earlier days was the low average account balance of members who could not afford high charges. This approach of keeping costs, and therefore fees, under control continues to give them a competitive advantage when companies are considering options to outsource their fund. 3 Like smaller corporate and public sector funds, smaller industry funds have seen the benefits to members of mergers to achieve economies of scale and improve the quality of service. This rationalisation has led to an overall reduction in the number of industry funds. Trustees of industry funds have also embraced outsourcing to gain access to external expertise and achieve competitive prices for services such as asset management, custody and insurance. With this increasing trend to outsourcing, trustees must ensure that their compliance framework extends to cover external service providers, both in the quality control of service standards, and in meeting legislative requirements such as privacy. Increasingly, the trustees of industry funds are also seeking ways to increase the value of their offering to their members in order to retain them. In most cases, members have joined an industry fund either as a result of an industrial award or through a workplace agreement. This is a different situation to that faced by the trustees of a corporate fund, where, until the introduction of fund choice, there was a strong association with the funds through the workplace and hence less need to add additional features or services to build loyalty. One emerging feature of industry funds is their use by younger people to consolidate their superannuation benefits from previous employers (who may have had a corporate fund or used master trusts), into a low-cost and convenient environment with good investment returns. Services to members One successful initiative introduced by industry funds in this area has been the offer of discount home loans to members. This resulted from a small number of industry funds providing seed capital to a mortgage originator in order to give their members access to home loans which were substantially cheaper than those offered by traditional providers. While the gap between the home loan rates of trading banks and other providers has narrowed over the last few years, other new initiatives in products and services are being offered. Brand recognition While there has been some significant product in industry funds designed to increase their appeal to current and prospective members, one challenge remaining for this sector is the limited ‘branding power’ that they have compared to traditional providers of superannuation (life companies and banks). The increased use of television advertisements by a group of industry funds can be seen as an attempt to enhance the recognition of this type of superannuation fund among both employers and members. 4 How industry funds describe their advantages Industry funds describe their advantages as: • all profits belong to members • no sales commissions paid to agents • no dividends are paid to shareholders • no entry or exit fees • low administration fees for members • no fees for employers • a wide choice of investment strategies • a history of strong, long-term investment returns • regular communication with members and participating employers • many offer access to low-cost banking, home loan and pension products • free retirement and financial planning seminars • simple, efficient administration • fee-for-service financial advice from planners. Industry funds emphasise their low fees and high returns In their advertising, industry funds emphasise their low fees and link a low fee structure to a higher return over time. According to <http://www.industryfunds.org.au>, industry Funds held the top 10 positions for returns for balanced options, as sourced from the SR 50 Balanced Index from the SuperRatings Fund Crediting Rate Survey, 31 August 2006’. In April 2007 The Age newspaper published SuperRatings findings that industry funds held eight of the 10 top positions for balanced options. As reported by <www.industrysuper.com>, ‘over the five year period to 31 March 2007, SuperRatings net benefit testing showed that Industry Super Funds on average delivered $13.70 in earnings for every dollar taken out in fees, while Retail Master Trusts on average delivered only $5.60’. 1 Unit 1: Appendix 3 Public sector funds In most respects, public sector funds can be viewed as corporate funds established by governments and government bodies for their employees. As the majority of defined benefit funds within the public sector are closed down and replaced by accumulation schemes, public sector funds are taking on many of the characteristics of industry funds. In this case the ‘industry’ is the relevant segment of the public sector. However, there have been a number of key historic differences between public sector and private sector funds: • While most public sector funds were originally defined benefit funds, like the original corporate funds, they were much more likely to provide benefits in pension form than corporate funds. • Most governments did not fund benefits in advance. Member contributions were commonly (but not always) accumulated in the fund, but the employer did not pay its share of the benefit until it actually fell due. As the liabilities for future benefits became greater and greater, governments came under pressure from ratings agencies and the public to control the growth of these liabilities by funding benefits as they accrue. • Public sector funds were not governed by the Commonwealth’s superannuation regulatory regime (the Occupational Superannuation Standards Act (OSSA) and now the SIS Act) until 1 July 1990. Generally they operated under rules set up by Acts of Parliament rather than trust deeds. Nowadays, public sector funds comply either explicitly or with the spirit of the SIS Act. • Public sector funds have often come under greater public scrutiny than private sector funds and the governance of the funds often reflects this. Some state governments impose constraints on the investment powers of the funds or mandate that they use state-owned investment corporations, e.g. VFMC in Victoria or QIC in Queensland. The superannuation arrangements in different jurisdictions have evolved differently. Commonwealth The Commonwealth government operated a single fund, the Commonwealth Superannuation Scheme (CSS), for all permanent Commonwealth sector employees. In 1990 it closed the CSS and opened a more modern defined benefit fund, the Public Sector Superannuation Scheme (PSS). However some Commonwealth-owned employers, notably Telstra and Australia Post, were allowed to set up funds for their own employees. The Commonwealth also set up arrangements for temporary and casual staff to receive ‘3% productivity benefits’ and later superannuation guarantee contributions. The 3% productivity benefit was also paid to Defence Force members in the Military Superannuation Benefits Scheme (MSBS). 2 Victoria Victoria had a myriad of different schemes until major rationalisation in the 1980s under Labor and the 1990s under the Coalition resulted in five main schemes. These are the State Superannuation Fund, which covers closed defined benefit arrangements for teachers and public servants; the Emergency Services Superannuation Scheme for police, fire brigade and ambulance service employees; HealthSuper for employees in the public health system; VisionSuper (formerly the Local Authorities Superannuation Scheme) for employees in local government; and VicSuper, an industry-style accumulation fund for teachers and public servants. New South Wales Until recently, New South Wales ran almost all of its defined benefit superannuation arrangements through one very large fund with four sub-funds. In 1997 it split out separate funds for the electricity industry and local government. New South Wales has maintained a separate accumulation fund since it closed the defined benefit schemes to new members in the late 1980s. Funds held by public sector funds at 30 June 2006 According to APRA, at 30 June 2006, 44 public sector funds held $152 billion in 2.9 million accounts. 1 Unit 1: Appendix 4 Role of professionals in running a fund The actuary In the superannuation field, actuarial firms measure fund performance and value fund liabilities. The primary role of the actuary in a defined-benefit fund is to assess whether the assets will be sufficient or to advise what contributions an employer must make over time so that there is certainty that benefits can be paid. The actuary must prepare an actuarial report every three years for these funds. Actuaries are also involved in advising superannuation funds on their benefit design, investment strategy and choice of investment manager(s). The administrator, accountants and auditors The administrator maintains all the contribution, membership and benefit records of the fund. This administration may be done by the employer’s staff, an external accounting firm or a professional administration firm. Accountants may be in-house or external. They provide bookkeeping services, prepare financial statements, provide taxation advice and prepare and lodge tax and APRA returns. Financial statements for superannuation funds are prepared in accordance with accounting standard AAS 25 ‘Financial Reporting for Superannuation Plans’. Auditors examine a fund’s financial controls and verify its financial statements and compliance with government legislation. Asset consultants Asset consulting refers to advice on a fund’s investment objectives, the choice of investment sectors (equities, property, etc.) and the choice of investment managers and investment vehicles. Asset consultants generally do not act as investment managers or get involved in individual stock selection decisions. 2 Investment managers Management of the investments of a superannuation fund may be undertaken internally or by appointing one or more external fund managers. In all cases, the investment manager(s) has/have a responsibility to manage the assets of a fund in a way that meets its risk and return objectives. In practice, funds (other than excluded funds) contract out the investment management function to life offices or investment managers. This is because the trustee-directors have a duty of care to see that proper expertise is applied to the asset consulting and investment management activities. In the case of self-managed funds, the trustees and members are the same persons and might therefore be prepared to take on the direct responsibility of the investments. Investment managers can vary considerably in their areas of expertise and their investment style. Funds that invest directly are usually either very small (with few assets to manage) or very large (such as those funds operated for government employees or major corporates like BHP Billiton and Shell) ⎯ large enough to employ their own staff to manage their investment internally. Life companies Life companies write group cover for superannuation funds — enabling them to provide death and disability insurance for their members. They also provide investment management and administration services. Lawyers Lawyers assist superannuation funds in the preparation, amendment and interpretation of the trust deed that is the basic document establishing and governing the fund. Lawyers also advise on interpretation of legislation, and on contracts between the fund and its investment managers and other advisers. Other Other service providers, generally used by larger superannuation funds, are: • communication specialists who prepare reports to fund members • custodians who hold title to the assets of the fund • professional trustee companies that can be appointed to act as the trustee of a fund. 1 Unit 1: Appendix 5 Trustees’ fiduciary duties The main source of a trustee’s duties and responsibilities is the law of equity, developed over a long period of time through court decisions. These duties can be modified by trust deed provisions. The duties that equity imposes upon trustees include the following: To obey the terms of the trust deed The trustee is required to administer the fund in accordance with the particular terms and conditions of the trust deed unless it can satisfy the court that deviation is necessary or beneficial or, if the trustee had applied to the court, the deviation would have been authorised by the court. For example, a trustee can only pay benefits that are prescribed under the deed. This means that the trustee must become familiar with the trust deed. If uncertain about the meaning of any of its provisions, the trustee should seek appropriate professional advice. Not to disclose matters that are confidential The trustee has a duty of confidentiality. The duty of confidentiality is owed to each individual member, and the trustee cannot disclose confidential information without obtaining the member’s consent. In addition, a trustee cannot use confidential information for any extraneous purpose. As Lord Denning said: he who has received information in confidence ... must not make use of it to the prejudice of him who gave it without obtaining his consent. (Seager v Copydex [1967] WLR 932) A trustee may also owe a contractual duty of confidence in some circumstances. 2 Not to profit from the fund A trustee is not permitted to derive any profit or remuneration from its trust, except in circumstances where the trust deed specifically authorises the trustee to obtain such profit or remuneration or where the court is prepared to grant an application to amend the trust deed to allow such remuneration. For an example of a case where such an application was granted, see Re Queensland Coal & Shale Mining Industry (Superannuation) Fund SC Qld, unreported 26 June 1998 (Williams J). The prohibition against a trustee profiting from office applies even if there is no fraud on the part of the trustee. As a result, a professional trustee company will insist that the deed contain a clause allowing for its fees and charges. If a trustee gains financially through its position as trustee in an unauthorised manner, any such gain is held on trust for the fund on what is known as ‘a constructive trust’. This rule was strictly applied in the case of In Re Drexel Burnham Lambert UK Pension Plan [1995] 1 WLR 32 where the court noted that the trustees of the plan were unable to approve benefit augmentations because they were also members of the plan and would gain from the improvements, along with all of the other members. Therefore, the court had to approve the improvements. More recently, however, in Edge v Pension Ombudsman [1998] 3 WLR 466 it was held that the ‘no profit’ rule should not apply to prevent trustees who are also members benefiting from improvements if the trust deed specifically contemplates that members will be trustees. To exercise discretions for a proper purpose and in good faith There are two elements to this duty ⎯ that the exercise of discretion be for a proper purpose and that it be in good faith. To act in good faith means that a trustee must act honestly: Karger v Paul [1984] VR 161. A trustee must also exercise its discretion in accordance with the purpose for which the power was conferred. To do otherwise is to commit a fraud on the power, with the result that the purported exercise of the discretion is invalid. A trustee is not permitted to benefit either itself or a non-beneficiary of the trust. To do so would usually be an improper purpose. It might be, however, that to act in the interest of a non-beneficiary might actually further the beneficiaries’ interests in certain circumstances. In the case of Withers v Teachers’ Retirements System and the City of New York (1978) 1447 F.Supp 1248, for example, the trustees of a superannuation scheme covering municipal employees in New York (which was in a state of insolvency) decided to invest in special securities issued by the city as a vital part of its program to avoid bankruptcy — which would have led to the dismissal of a large number of members of that scheme. The terms of the investment were distinctly disadvantageous to the investor and beneficial to the city. The court held that, in all the circumstances, the trustees of the scheme had exercised their discretion properly, in that it was appropriate for them to balance the need to preserve the ongoing employment and other benefits of the members by supporting the continued existence of their employer, at the expense of an otherwise disadvantageous investment of the assets of the scheme. 3 However, in a recent case, Hillsdown Holdings PLC v the Pensions Ombudsman [1997] 1 All ER 862 it was held that the trustees of a pension scheme had acted in breach of trust in using a power to transfer benefits out of the scheme for the purpose of giving effect to a bargain that they had struck with the employer−sponsor. The trust deed of the scheme contained no power for the trustees to make any refund to the employer. In addition, the amendment power prohibited amendments that would result in the payment of any assets of the scheme to any of the employers. The employer therefore asked the trustees to transfer all of the assets of the scheme to another scheme, which did allow refunds to the employer. In return, the employer would agree to benefit improvements in the other scheme. The court held that the proper ambit of the transfer-out power was to enable transfers to other funds in order to secure rights for members, not to avoid the limitation in the amendment power. Therefore, the trustee had committed a fraud on the power. This does not mean that the trustee cannot cooperate with the employer. In Edge v Pension Ombudsman (see above) the court held that the trustee was entitled to consider the employer’s wishes in exercising its discretion to improve benefits for employed members, rather than pensioner members. In England there is also judicial authority for the proposition that a proper exercise of discretion means taking into consideration all appropriate matters and not taking into consideration inappropriate matters. This is known as the ‘rule in Hastings Bass’ [1975] Ch 25. According to Justice Warner in Mettoy Pension Trustees Ltd v Evans [1991] 2 All ER 513 this rule applies wherever it can be shown that the trustees would not have acted as they did if they had a proper understanding of their actions. The extent to which this rule applies in Australia is questionable (see Asea Brown Boveri Superannuation Fund No 1 Pty Ltd v Asea Brown Boveri Pty Ltd 1999/VR/144). Not to act under dictation The trustee must not act under the dictation of, or the instructions of, another person. It must not exercise any discretions or powers that it has been given as the puppet of another person. An extension of the duty not to act under dictation is the duty not to fetter the exercise of discretions. In Re Vestey’s Settlement [1959] Ch 209 the trustees were under a duty to distribute property of a fund among a class of beneficiaries and purported to bind themselves as to how they would exercise that discretion indefinitely into the future. The court held that, so far as it purported to control future distributions of property, it was an ineffective exercise of discretion and was therefore void. Although the SIS Regulations require balanced trustee representation on the boards of superannuation funds, once a person is appointed to the board of trustees, that person is not entitled to have regard to the interests of their particular representative group. It is fundamental that trustees not represent any sectional interest, regardless of who appoints them. 4 Mr Justice Street in the case of Bennetts v Board of Fire Commissioners of New South Wales (1967) 87 WN (NSW) 307 held that merely because a member of a board is elected by a particular group or sectional interest does not mean that they owe any overriding obligation or duty to that group. A trustee’s obligation to the members as a whole prevails over the interests of their electorate. His Honour said: it is entirely foreign to the purpose for which this or any other board exists to contemplate a member of the board being representative of a particular group or a particular body. Once a group has elected a member of the board he assumes office as a member of the board and becomes subject to the overriding and predominant duty to serve the interests of the board in preference, on every occasion upon which any conflict might arise to serving the interests of the group which appointed him. With this basic proposition there can be no room for compromise. (Also, under SIS, it is a breach of the legislation for any interested party associated with the superannuation fund to put pressure on a trustee by way of intimidation or coercion.) To act impartially, also known as the duty to act fairly and reasonably This duty is an extension of the duty to exercise discretions in good faith. However, it is not sufficient for the trustee to act in the interests of a majority of the beneficiaries. A trustee must act impartially as between beneficiaries and fairly as between groups of beneficiaries. Acting impartially requires that the trustee consider the interests of the beneficiaries as a whole. The case of Re Mulligan, Hampton v PGG Trust Ltd [1998] 1 NZLR 481 provides an example of the operation of this duty in terms of the trustee’s power of investment. There the trustees under a will invested to provide income returns for the income beneficiary at the expense of protecting the capital against inflation on behalf of the capital beneficiaries. The court held that the trustees (one of whom was the income beneficiary) had committed a breach of trust in failing to act impartially as between the income and capital beneficiaries. The duty to act fairly and reasonably is also relevant in the consideration by superannuation fund trustees of total and permanent disablement claims. In Chammas v Harwood Nominees Pty Ltd (1993) 7 ANZ Ins Cas 61-175 the court held that this duty involves giving the member an opportunity to respond to adverse medical opinion. In addition, the courts have said that the assessment of such claims is not an adversarial process — the trustee must act honestly and reasonably in considering the claim: Vidovic v Email Superannuation Ltd NSW SC (unreported, 3 March 1995). The trustee must remember the importance of these benefits to the member and give proper consideration to the matter: Maciejewski v Telstra Super Pty Ltd (1997–1998) 44 NSWLR 601. If an insurer is involved, the trustee cannot just ‘rubber stamp’ the insurer’s assessment. It must review the information and come to its own decision about the claim: Minehan v AGL Employees Superannuation Pty Ltd [1998] SC ACT 114 (Gallop A/CJ). 5 To act with reasonable care, skill and diligence Trustees are expected to exercise a reasonable degree of skill and care. Specifically, a trustee is required to act as a prudent person would act and to exercise the same degree of skill, care and diligence that a prudent business person would exercise in considering those for whom they are morally bound to provide. The standard of prudence is best described in Re Whitely (1886) 33 Ch D 347 by Lord Justice Lindley at p. 355, where he said: the duty of a trustee is not to take such care only as a prudent man would take if he had only himself to consider: the duty rather is to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide. That is the kind of business the ordinary prudent man is supposed to be engaged in; and unless this is borne in mind the standard of the trustee’s duty will be fixed too low. It can be seen that it is not sufficient for the trustee to allege that it has done its best. The standard of prudence is an objective one. Honesty and sincerity are not the same as prudence and reasonableness. In addition, a professional trustee has a higher standard of prudence and is expected to exercise the degree of diligence and the degree of knowledge of a specialist in trust administration: ASC v AS Nominees (1995) 133 ALR 1. To illustrate the standard expected of trustees, it has been held on various occasions that a trustee: • must not leave funds too long in the hands of others • must not lend to co-trustees or leave funds in another’s sole control • must not lend on contributory mortgage • must not mix trust funds with its own or with other funds • must recover trust property that is outstanding and convert it into an authorised investment • must keep securities and title deeds under its own control and in safe custody, except where a custodian trustee has been engaged • must insure trust property • must act promptly to rectify any deficiency in the fund • must make allowance for the payment of tax from the fund. 6 To act in the best interest of beneficiaries A trustee’s paramount duty is to exercise its powers for the benefit of its beneficiaries and to generally act in their best interests. The best interests of beneficiaries has been held to comprise their best financial interests: Cowan v Scargill [1984] 2 All ER 750. As a result, it is expected that the trustee will take advantage of tax concessions, as this will usually be in the best interests of beneficiaries: Attorney General v Breckler (1999) T3ALJR 981. But, when exercising a power given by a superannuation trust deed, the trustee may take into account that the interests of members will be better served if the employer continues to support the fund: Withers v Teachers’ Retirements System and the City of New York (see above). The extent to which such matters may influence trustee decisions arose in Lock v Westpac Banking Corporation (1991) 25 NSWLR 593. In that case it was held that the trustees were entitled to take into account the interests of the employer−sponsor when considering whether to consent to the amendment of the trust deed. Their consent was required so that the trust deed could be amended to allow a surplus of funds to be returned to the employer−sponsor. As a condition of their consent, the employer sponsor had agreed to a portion of the surplus being used to improve members’ benefits. The court held that the trustees had not breached their duty to act in the best interests of members if they consented after being satisfied on reasonable grounds that the proposal was fair to both the members and the employer−sponsor. In this sense, the trustee was like an impartial ‘umpire’. In Asea Brown Boveri (see above) the proposition that a trustee act in the interests of the employer-sponsor was firmly rejected. The court stressed that a trustee’s duty is to its beneficiaries. This would not seem to preclude a consideration of the employer’s interests, however: Edge v Pension Ombudsman (see above). To avoid conflicts of interest Trustees must avoid being placed in situations where they have a conflict of interest or where there is a potential for a conflict of interest: Chan v Zacharia (1984) 154 CLR 178. The conflict is usually that between the duty of trustees to act in the best interests of members and any personal self-interest. (See duty not to profit, above.) Examples of such situations are: • where a trustee is involved in assessing their own disablement claim • where a trustee allows an investment adviser exclusive access to members and accepts a commission for doing so • where a trustee invests trust funds in a property in which the trustee has a financial interest. Trustees in the superannuation context must also disregard any responsibilities they might have in any other capacity, e.g. as a director of the employer−sponsor (known as a conflict of duty). 7 To keep accounts and give information to beneficiaries Trustees have a duty: • to keep proper records of the fund • to keep proper accounts of the fund • to provide information to beneficiaries as and when it is appropriate to do so. Beneficiaries have a right to inspect accounts and trust documents at their expense (Re Londonderry’s Settlement [1964] 3 All ER 855), but do not generally have a right to require inspection of internal documents such as minutes or correspondence between trustees: Hartigan Nominees Pty Ltd v Rydge (1992) 29 NSWLR 405. The trustee should ensure that information provided to beneficiaries is accurate to avoid potential liability for negligent misstatement: Rennie v The Commonwealth of Australia and the Defence Force Retirement and Death Benefits Authority, Full Fed Ct (unreported, 17 November 1995). (The SIS Regulations increase the obligations of fund trustees to inform members of a superannuation fund on an ongoing basis.) To invest trust funds promptly and prudently in authorised investments. Trustees have a duty to invest trust funds in the best financial interests of the beneficiaries in such investments as are authorised by the trust deed, legislation or the court. Failure to invest promptly may require payment of interest by the trustee out of its own funds (see Hagan v Waterhouse (1992) 34 NSWLR 305). In most States the Trustee Acts include a power to invest in any form of investment, subject to an overriding standard of prudence and a requirement to have regard to a number of prescribed factors. The prescribed factors tend to support a ‘modern portfolio theory’ method of investment. Notwithstanding that an investment may be authorised, it is not necessarily prudent for the trustee to make the investment, bearing in mind the standard of prudence enunciated by Lord Justice Lindley in Re Whitely (and the similar standard now codified in the Trustee Acts of most States). It is the duty of trustees to exercise the power of investment in a manner whereby fund assets are not placed at risk. It is necessary to select investments that are secure from capital loss and yield an adequate return commensurate with their security. Investments that a trustee should avoid are the lending of moneys without interest (since a trustee should prudently attempt to maximise returns without undue risk) and speculative investments such as futures contracts (except perhaps for hedging purposes). In addition, superannuation fund trustees should generally avoid investments with unduly low liquidity factors, which may not easily be converted into cash in order to pay benefits. In Bartlett v Barclays Bank Trust Co Ltd (No 1) [1980] Ch 515 the court held that if the trustees were put on notice that the affairs of a company in which they had invested were not being conducted in a sound manner, the trustees should take appropriate action. This case supports the trend towards corporate governance. The case is also authority for the proposition that a trustee must not engage in speculative investment, again codified in the Trustee Acts of most States. 8 Notwithstanding the standard of prudence expected of trustees, courts are reluctant to judge investment performance with the benefit of hindsight. In Nestle v National Westminster Bank PLC [1993] 1 WLR 1260 Lord Justice Dillon said: what the prudent man should do at any time depends on the economic and financial conditions of that time — not on what judges of the past, however eminent, have held to the prudent course in the conditions of 50 or 100 years before. When exercising its investment duty, a trustee must be mindful of the balance between preserving the trust assets and obtaining the best possible return. For this purpose, a diversified portfolio is always recommended. As Justice Williams in Riddle v Riddle (1952) 85 CLR 202 said: the trust property … should be invested in investments which, having regard to the existing and future economy … are most likely to provide the best income … and the best security for the capital. The modern portfolio theory of investment requires diversification, because it focuses on the investment portfolio as a whole. The courts have endorsed this method of investment in recent times. For example in Nestle’s case (see above), at first instance Justice Hoffman stated: Modern trustees acting within their investment powers are entitled to be judged by the standards of current portfolio theory, which emphasises the risk level of the entire portfolio rather than the risk attaching to each investment taken in isolation … an investment which in isolation is too risky and therefore in breach of trust may be justified when held in conjunction with other investments. SIS also supports modern portfolio theory because it requires the trustee to have regard to the whole of the circumstances of the fund in formulating its investment strategy. A trustee must also keep the trust property separate from other moneys and property held by the trustee. As mentioned above, a higher standard of duty is imposed on a professional trustee than on a trustee with little or no investment experience. Nevertheless, trustees in this inexperienced class should seek the advice of experts and give that advice due and careful consideration before forming a reasoned decision. The duty to seek advice on investment matters is now codified in the Trustee Acts of most States. Trustees should formulate an investment strategy. This is a specific requirement of SIS, but it is also prudent practice. However, trustees must be sure not to impose investment policies on a selective political or social basis that are not in the best interests of all beneficiaries of the fund: Cowan v Scargill [1984] 2 All ER 750. In that case, it was held to be improper for the trustees of the Mineworkers’ Pension Scheme in the United Kingdom to seek to impose a blanket prohibition on investment in sources of energy other than coal, this being part of the policy platform of the union from which some of the trustees were drawn. The case of Harries v Church Commissioners of England [1992] 1 WLR 1241 provides some authority for including moral considerations in connection with the fund’s investment policy, but only if the financial merits of two investments are equal. 9 In addition to the general duty of prudence, there are a number of specific investment restrictions for superannuation funds imposed by SIS. Most of the SIS investment restrictions are civil penalty provisions. To act personally The trustee must exercise the powers that have been vested in it personally, and is not able to delegate those responsibilities or any discretions to another person in the absence of express authority in the trust deed or statute to do so. (This duty is related to the duty not to act under dictation — see above.) Most modern trust deeds provide a specific facility for delegation of various responsibilities, including specialist functions such as accounting, administration and investment. However, trustees must be sure that they are only delegating, and not abdicating their responsibility totally. They can only delegate powers that they themselves possess. For example, a trustee could not delegate to an investment manager a power to invest in futures contracts if such contracts are not ‘authorised investments’ in terms of the trust deed. Proper selection and supervision of the trustee’s agents are essential. The trustee must see that it engages a suitable delegate and must be diligent in seeing that delegated powers are properly performed: Dalrymple v Melville (1932) 32 SR(NSW) 596. The Trustee Acts of the various States also recognise that a trustee might, out of necessity, be compelled to act through agents in the performance of its duties. To act unanimously Under the law of equity, decisions of the trustees must be unanimous (see Attenborough v Solomon [1913] AC 76), although this rule may be modified by the terms of the trust deed. Where equal representation applies to a superannuation fund, SIS requires that trustee decisions must be by not less than a two-thirds majority. However, unless the trust deed has a provision relaxing the requirement of unanimity, this two-thirds rule is of no significance, since in equity the trustees must come to a unanimous decision. To seek advice A trustee has a duty to take advice on matters that the trustee might not understand, such as the making of investments. In Martin v City of Edinburgh District Council [1988] Scots Law Times, 329, the trustees failed to seek any necessary professional advice as to the effect that the sale of certain investments would have on the fund’s overall asset base. Lord Murray said: … the trustees … misdirected themselves in failing to comply with a prime duty of trustees, namely to consider and seek advice as to the best interests of the beneficiaries and so they are in breach of trust. SIS protects a superannuation fund trustee’s right to seek advice, by stating that any provision in a trust deed that limits the trustee’s right to seek advice is void. Notes 2 Contributions Overview 2.1 Unit learning outcomes ....................................................................2.1 Further resources ............................................................................2.2 1 Superannuation and financial advising 2.3 2 2.1 2.2 2.3 2.4 2.5 2.6 2.7 Making a superannuation contribution 2.4 Who can contribute? ...............................................................2.4 Types of contributions.............................................................2.5 Superannuation guarantee contributions...................................2.6 Salary sacrifice.......................................................................2.8 Deductible member contributions and the 10% rule .................2.10 Award superannuation ..........................................................2.10 Vesting and preservation.......................................................2.11 3 3.1 3.2 3.3 Limits on contributions 2.12 Concessional cap .................................................................2.12 Non-concessional cap ...........................................................2.13 Averaging of contribution limits ..............................................2.13 4 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 Taxation and concessions on contributions 2.15 Concessional contributions ...................................................2.15 Non-concessional contributions .............................................2.16 Government co-contribution ...................................................2.17 Personal services income......................................................2.19 Borrowing for superannuation contributions ............................2.20 Transfers from overseas funds ..............................................2.20 Personal injury payments ......................................................2.21 Employment termination payments.........................................2.21 No TFN and refund of excess .................................................2.23 5 5.1 5.2 5.3 5.4 Contributions splitting 2.24 What is contributions splitting?..............................................2.24 Preserved and taxable components........................................2.25 Requirements for splitting contributions..................................2.25 Advantages and disadvantages of contributions splitting..........2.26 6 6.1 6.2 6.3 6.4 6.5 6.6 Small businesses, capital gains tax and superannuation 2.28 Introduction to CGT concessions............................................2.29 Basic tests for entitlement ....................................................2.31 Fifteen-year active asset exemption........................................2.35 Fifty percent small business active asset exemption................2.37 Small business retirement exemption.....................................2.37 Small business rollover relief.................................................2.39 7 Contribution strategies Suggested answers 2.39 2.41 Unit 2: Contributions Overview This unit covers the rules, issues and strategies relevant to using superannuation contributions to accumulate wealth for retirement. Superannuation contributions are important from three perspectives: • the employee — on behalf of whom superannuation guarantee (SG) contributions are paid by their employer and who might voluntarily contribute additional amounts • the self-employed — who must fund their own retirement, but who receive taxation incentives to do so, and who may be able to make use of capital gains tax (CGT) concessions in order to contribute to superannuation • the employer — who is legally required to make compulsory superannuation contributions and who may promote arrangements such as salary sacrifice to encourage employees to increase contributions to superannuation. This unit looks at the types of contributions, who can contribute, the caps on contribution and the taxation treatment of contributions. This unit specifically addresses the following subject learning outcome: • Critique available superannuation structures and contribution strategies for different client situations. Unit learning outcomes On completing this unit, you should be able to: • describe the rules and limits (caps) for superannuation contributions • describe the tax treatment of superannuation contributions • describe the superannuation guarantee and its implications for employees and employers • describe the link between small business capital gains tax concessions and superannuation contributions • describe the treatment of overseas transfers, personal injury payments and transitional ETPs. © Kaplan Education 2.1 2.2 Specialist Knowledge: Superannuation (924) Further resources • ATO 2006, ‘Beware of illegal schemes to withdraw your superannuation early’ [online] May. Available from: <http://www.ato.gov.au> by entering ‘preservation’ in the search box, and selecting ‘Beware of illegal schemes to withdraw your superannuation early’ from the results. Select the ‘brochure’ PDF download [cited 11 June 2008]. • ATO 2006, ‘Key superannuation rates and thresholds’ [online] June. Available from: <http://www.ato.gov.au> by selecting ‘For Superannuation’, ‘Superannuation home page’, and ‘Key superannuation rates’. Select ‘Contribution caps’ from the right column [cited 11 June 2008]. • ATO 2007, ‘Superannuation contributions splitting — superannuation funds’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘superannuation contributions splitting’ in the search box, and selecting ‘Superannuation contributions splitting — superannuation funds’ from the results [cited 11 June 2008]. • ATO 2007, ‘Excess contributions tax — applying to have your contributions disregarded or reallocated’ [online] November. Available from: <http://www.ato.gov.au> by entering ‘excess contributions tax disregarded reallocated’ in the search box [cited 11 June 2008]. • ATO 2008, ‘Super and capital gains tax’ [online] March. Available from: <http://www.ato.gov.au> by entering ‘active assets’ in the search box, and selecting ‘Super and capital gains tax’ from the results. Read all the details using the menu on the right hand side [cited 11 June 2008]. • ATO 2008, ‘Superannuation guarantee: how to meet your super obligations’ [online] April. Available from: <http://www.ato.gov.au> by entering ‘nat 1987’ in the search box, and selecting ‘Superannuation guarantee — how to meet your super obligations’ from the results [cited 11 June 2008]. • ATO 2008, ‘Salary sacrifice’ [online] May. Available from: <http://www.ato.gov.au> by entering ‘salary sacrifice’ in the search box, and selecting ‘Salary sacrifice’ [cited 11 June 2008]. 924.SM1.9 Unit 2: Contributions 1 Superannuation and financial advising In relation to superannuation contributions, financial advisers are most likely to be asked questions like those listed below. Individuals • Is my employer contributing the correct amount of compulsory superannuation for me? • Can I make contributions into super? • Should I contribute more to super? • How can I get the government co-contribution? • How much can I put into super? • How does putting money into superannuation affect my tax? • What is salary sacrifice? • How should I make my superannuation contributions to maximise my position at retirement? Employers • Am I contributing the correct amount of compulsory superannuation for my employees? • What do I do if I am not paying enough compulsory superannuation for an employee? • Should I offer salary sacrifice arrangements to my employees? • What limits are there to employee contributions? Small business • Is it worth my while to contribute to superannuation? • When I sell my business, are there advantages in contributing to superannuation? How the practitioner deals with these questions can influence a client’s decision to place funds in certain areas and maximise their financial benefit and protect their interests. The detail of contribution to superannuation is subject to regular amendment, so financial advisers need to keep their knowledge up to date. This will ensure their advice is current and that it takes full advantage of the opportunities. © Kaplan Education 2.3 2.4 Specialist Knowledge: Superannuation (924) 2 Making a superannuation contribution For many years the Australian Government has provided generous tax concessions to encourage Australians to contribute to superannuation so they have income for their retirement. Superannuation is designed as a long-term investment and the tax concessions ensure that superannuation will normally form a significant part of any financial plan aimed at wealth creation and securing income for retirement. 2.1 Who can contribute? The provisions specifying who can contribute to superannuation are set out in the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SIS Regulations), summarised in Table 1 below. A person’s ability to make a superannuation contribution, or to receive a superannuation contribution made on their behalf, depends upon their age. A work test applies from age 65. Contributions generally cannot be made after age 75 unless paid under an award or certified agreement. Table 1 Eligibility to contribute to superannuation Concessional Non-concessional Age group SG Award Voluntary employer Member contributions Under 65 Yes Yes Yes Yes, even if not working 65–69 Yes Yes Yes, subject to work test Yes, subject to work test 70–74 No Yes Yes, subject to work test Yes, subject to work test 75 and over No Yes No No The work test is satisfied if the member has been gainfully employed at least 40 hours in a consecutive period of 30 days during the relevant financial year. For splittable contributions, if the receiving spouse is over preservation age but under age 65, they must not have retired from the workforce. For clients turning 75, the contribution must be received up to 28 days after the end of the month in which they turn 75. ‘Gainfully employed’ means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment. If the person is eligible to contribute, they can make personal contributions, or contributions can be made on their behalf by a spouse or employer. Residency and taxation status do not affect ability to contribute The eligibility criteria outlined in Table 1 are independent of a person’s residency or taxation status. For example, a person aged 60 gainfully employed overseas is eligible to contribute to an Australian superannuation fund. Similarly, the person’s tax status, and whether or not they will claim a deduction for their superannuation contribution, does not affect their ability to contribute. Residency and taxation status do, however, affect tax concessions on contributions. These are determined in line with the relevant Income Tax Assessment Act (ITAA). 924.SM1.9 Unit 2: Contributions Apply your knowledge 1: Who can contribute? Which of these four siblings can make contributions to superannuation? John, age 58, operates a plumbing business as a sole trader. Reg, age 61, is unemployed. Julie, age 63, is a manager in the Commonwealth public service. Sandra, age 66, works part-time 12 hours a week. 2.2 Types of contributions There are two types of superannuation contributions: • concessional contributions • non-concessional contributions. Limits apply to both types of contributions. These limits are described below. Concessional contributions Concessional contributions include: • employer contributions: – compulsory superannuation guarantee (SG) contributions – mandated employer contributions made under an award – additional voluntary contributions made by the employer – employee voluntary salary sacrifice contributions • personal contributions claimed as a tax deduction by a self-employed person or a person who is substantially self-employed under the 10% rule (see section 2.5) • personal contributions claimed as a tax deduction by a person who is not working and under age 65. Contributions can only be concessional if they are within the concessional cap (see section 3.1). Non-concessional contributions Non-concessional contributions are contributions for which a tax deduction is not claimed. They are often referred to as ‘undeducted’ or ‘after-tax’ contributions and include: • personal contributions for which a tax deduction is not claimed • spouse contributions • transfers from foreign superannuation funds, excluding amounts included in the fund’s assessable income • contributions in excess of the concessional cap (see section 3.1). © Kaplan Education 2.5 2.6 Specialist Knowledge: Superannuation (924) Exclusions from non-concessional cap The non-concessional cap (see section 3.2) does not include: • any government co-contribution • contributions relating to personal injury payments • rollover amounts from superannuation • proceeds from the disposal of assets that qualify for the small business capital gains tax (CGT) exemptions, up to a lifetime limit of $1 million (indexed). 2.3 Superannuation guarantee contributions The superannuation guarantee (SG) system began on 1 July 1992 as a system of compulsory superannuation for the majority of employees. Employers must provide a prescribed minimum level of superannuation support for eligible employees. Main features of the SG system The main features of the SG system are: • Employers must contribute 9% of each employee’s salary (normally ordinary time earnings) to avoid paying the SG charge (see below). (Lower rates applied prior to 1 July 2002.) • The system is administered by the ATO. • The SG percentage only applies to the amount of a person’s wage or salary that is below a maximum salary threshold. For 2008/09, the maximum is $38,180 per quarter ($152,720 p.a.). Thus, someone earning $45,000 per quarter will only receive the 9% SG contribution on $38,180 per quarter. The maximum wage or salary is indexed each year. • Certain employees are exempt (see below). • SG contributions must be fully vested in the employee (i.e. belong to the employee) immediately and they are fully preserved (i.e. they cannot be withdrawn from superannuation until a condition of release is met). • Employer contributions must be made to a complying superannuation fund. If the employee is eligible for choice of fund, the contribution must be paid to the employee’s chosen fund. • The level of employer support is measured quarterly, with the SG contribution also being paid at least quarterly. The SG contribution must be paid by the 28th day of the month following the end of the relevant quarter. • Failure to comply will expose employers to a non-tax-deductible SG charge (SGC). The SG system applies to all employers and almost all employees including full-time, part-time and casual. Only a small minority of employees are exempt. 924.SM1.9 Unit 2: Contributions Opting out before 15 March 2007 Prior to 15 March 2007, employees could elect to opt out of the SG system when their accumulated benefits exceeded the pension reasonable benefit limit (RBL) of about $1.3 million that applied at that time. With the removal of RBLs from 1 July 2007, this is no longer possible. Elections made after 15 March 2007 will not be valid and employers must continue to meet the SG requirements. Any elections made prior to 15 March 2007 are still valid and irrevocable, however affected members may decide to make voluntary contributions before tax as concessional contributions by salary sacrifice and after tax as non-concessional contributions. SG-exempt employees Employers are not required to pay SG contributions for certain exempt employees. The main types of exempt employees as specified under the Superannuation Guarantee (Administration) Act 1992 (Cth) (SGAA) are: • employees receiving salary and wages of less than $450 in a calendar month (s 27(2)) • employees who are 70 years or over (s 27(1)(a)) • employees aged under 18 who are employed part time (s 28) (Note: Less than 30 hours per week actual work is deemed to be part time.) • employees doing domestic or private work of not more than 30 hours per week (e.g. a part-time nanny or housekeeper) • non-resident employees, for work completed outside Australia (s 27(1)(b)) • employees temporarily working overseas and covered by a bilateral superannuation agreement (s 27(1)(c)) • employees who are prescribed employees under s 27(1)(d) (prescribed employees hold a particular class of migration visa) • employees receiving salaries or wages prescribed under s 27(1)(e) (these are payments made under the Community Development Employment Program, which is funded by the Australian Government for Indigenous Australians) • members of the Australian Defence Force Reserves for income that is exempt under s 23(s) of ITAA 36 (s 29). Penalties for SG non-compliance Employers who fail to comply with the rules of the SG system may have to pay a penalty tax called the superannuation guarantee charge (SGC). The SGC comprises: • the shortfall in superannuation contributions • an administration charge • notional earnings on unpaid contributions • possible penalties for late lodgements, not keeping records etc. The SCG is a penalty tax and not deductible to the employer, despite including the superannuation contribution. © Kaplan Education 2.7 2.8 Specialist Knowledge: Superannuation (924) The ATO will pay the shortfall in contributions and the notional earnings to the fund of the employee’s choice as a concessional contribution. Further resources ATO 2008, ‘Superannuation guarantee: how to meet your super obligations’ [online] April. Available from: <http://www.ato.gov.au> by entering ‘nat 1987’ in the search box, and selecting ‘Superannuation guarantee — how to meet your super obligations’ from the results [cited 11 June 2008]. Review your progress 1 An employer has four employees in 2007/08. Calculate the SG liability for each: (a) (b) Pete earns $600 gross income per month. (c) Lee earns $5000 gross income per month. (d) 2.4 Karen earns $400 gross income per month. Jane earns $15,000 gross income per month. Salary sacrifice Salary sacrifice is generally a tax-effective way of contributing to superannuation because the contributions are made by the employer from the employee’s pre-tax salary. The employer is then able to claim a tax deduction and the employee only pays income tax on the lower salary. The amount is counted towards the employee’s concessional cap. As an example, an employee aged between 35 and 50 may choose to forgo some of their salary of, say, $60,000. The employee may choose to ‘sacrifice’ $10,000 of this salary, and have the employer pay it directly into a superannuation fund. This is beneficial to the employee because the $10,000 is taxed at 15% on entry to the superannuation fund, instead of being taxed at the employee’s marginal tax rate. The employer can claim a tax deduction for the salary sacrifice contributions as an employer contribution. Salary sacrifice arrangements must be prospective, that is, they must relate to an earnings period that has not yet occurred. If a salary sacrifice arrangement is not prospective, the amount sacrificed will still be treated as salary and wages of the employee. This issue is dealt with in detail by the ATO’s Taxation Ruling 2001/10 ‘Income tax: fringe benefits tax and superannuation guarantee: salary sacrifice arrangements’. This ruling sets out the ATO’s view about when a salary sacrifice arrangement will be effective and the consequences if it is not. Care should be taken when dealing with year-end bonuses as they are deemed to be earned over the whole year. 924.SM1.9 Unit 2: Contributions Example: Salary sacrifice Horace (age 48) is an employee on a salary of $80,000 p.a. His employer allows him to salary sacrifice part of this salary. Horace is considering sacrificing $30,000 to superannuation. Table 2 presents the tax implications. Table 2 Salary sacrifice example 2008/09 No salary sacrifice Salary sacrifice $80,000 $50,000 nil $30,000 $19,200 $9,750 nil $4,500 Total net package $60,800 $65,750 Cash in hand $60,800 $40,250 Salary Superannuation contribution Income tax (incl. Medicare) Contribution tax to super Salary sacrificing $30,000 to superannuation has the following advantages for Horace: • His net package increases by $4950 because of less tax. • He has an additional $25,500 in the low tax superannuation environment. The salary sacrifice also has an important disadvantage: he has $20,550 less cash in hand. This amount becomes preserved in superannuation until he meets a condition of release. In making a decision, Horace should also consider that: • the salary sacrifice contribution will be counted towards his concessional cap of $50,000. Higher rates of tax apply to contributions above the cap • the superannuation benefit will be a taxable component and hence subject to tax if taken prior to age 60. (They will be tax-free if taken after age 60 from a taxed fund.) Limitations on salary sacrifice There is nothing in legislation which specifically prohibits a person from salary sacrificing their entire salary to superannuation. However, there are two key limitations on such a strategy: • An employee covered by an award cannot reduce their cash salary below the minimum salary specified in the award. • If a company excessively remunerates shareholders, or directors of the company or their associates, s 109 of ITAA 36 may deem the payment to be a dividend. The excess remuneration is not deductible to the company and is deemed to be an unfranked dividend. ‘Remuneration’ is not specifically defined in relation to s 109; however, it could be interpreted to include superannuation contributions. An example of potentially excessive remuneration would be a 51-year-old employee, who is also the wife of the managing director of a company, choosing to fully salary sacrifice to superannuation a salary of $85,000, if such an amount would be an excessive payment to a non-associated party doing a similar role. © Kaplan Education 2.9 2.10 Specialist Knowledge: Superannuation (924) Diminishing value of salary sacrifice Salary sacrifice works as a strategy because the taxation of contribution in superannuation (15%) is often less than the client’s marginal tax rate. There may be no value in salary sacrificing if it takes assessable income below $34,000 on 2008/09 tax scales (see Table 3 below), as the tax on earnings up to $34,000 is also 15%. Table 3 Taxable income scale (2008/09) Taxable income 2008/09 Tax rate $0 – $6000 Nil $6001 – $34,000 15c for each $1 over $6000 $34,001 – $80,000 $4200 plus 30c for each $1 over $34,000 $80,001 – $180,000 $18,000 plus 40c for each $1 over $80,000 Over $180,000 $58,000 plus 45c for each $1 over $180,000 Review your progress 2 Karen is an executive with a large bank receiving a salary package of $80,000 in 2008/09. The bank allows salary sacrificing as part of the employment package. Karen is considering sacrificing $15,000 into superannuation. Based on tax rates for 2008/09, what is Karen’s overall tax saving if she decides to salary sacrifice? How much less will Karen have in hand? Further resources ATO 2008, ‘Salary sacrifice’ [online] May. Available from: <http://www.ato.gov.au> by entering ‘salary sacrifice’ in the search box, and selecting ‘Salary sacrifice’ [cited 11 June 2008]. 2.5 Deductible member contributions and the 10% rule An ‘eligible person’ can claim a tax deduction for personal superannuation contributions if their assessable income plus reportable fringe benefits from employment as an employee is less than 10% of the individual’s total assessable income plus reportable fringe benefits. An eligible person generally refers to a self-employed individual or an individual who does not receive any employer superannuation support. The definition includes a person who is substantially self-employed with less than 10% of income coming from an employer. It also includes a person not working but who can contribute to superannuation because they are under age 65. 2.6 Award superannuation Superannuation is incorporated into many industrial awards (both state and federal) that require employers to make minimum contributions to superannuation on behalf of employees (usually 3%). Amounts contributed under award superannuation count towards an employer’s SG liability. Whether under an award, legislation or another scheme, the employer will not incur an SG liability provided the contributions are at least equal to the prescribed minimum level of support and made to a complying superannuation fund. 924.SM1.9 Unit 2: Contributions 2.7 Vesting and preservation Once contributions have been made to a superannuation fund, they form part of the benefits that will ultimately be paid back to the member. However, there are special rules governing: • benefits which are absolutely owned by the member (vesting) • when the benefits can be paid out (preservation). ‘Fully vested’ means that benefits arising from the contributions belong to the member at all times. The following are fully vested: • all personal contributions (concessional, non-concessional and salary sacrifice contributions) • spouse contributions • rollovers • compulsory (SG, award or enterprise agreement) contributions. Partial vesting in corporate funds prior to 1 July 2004 Prior to 1 July 2004, many employers who made additional voluntary contributions set in place their own vesting scales. The employees would become progressively entitled to the extra amounts based on measures such as years of service. For example, a fund might have a 10-year vesting scale, whereby members who leave the fund after one year receive 10% of the benefits from additional employer contributions, while those who leave after two years receive 20% of the benefits and so on. In this case, the member is not entitled to 100% of the benefits until after 10 years in the fund. Partial vesting typically applies only to corporate superannuation funds, to which the employer contributes more than the minimum legislative requirements. Any additional employer contributions made to a fund but not vested in a particular member form part of the reserves or surplus of the fund. Fully vested from 1 July 2004 From 1 July 2004, all contributions, including additional voluntary employer contributions, must be fully vested in the member unless the employer had existing arrangements before this date. Employers should seek advice from APRA if uncertain as to whether contributions are vested. Preservation Preservation is the compulsory retention of part or all of a superannuation benefit in the superannuation environment until certain criteria are met. The most common criterion, or ‘condition of release’, is reaching preservation age once a person has permanently retired. From 1 July 1999, all contributions to superannuation are fully preserved, regardless of contribution type or contributor. Before this date, some contributions were classified as restricted non-preserved and could be accessed before retirement in certain circumstances. © Kaplan Education 2.11 2.12 Specialist Knowledge: Superannuation (924) Review your progress 3 Ralph will be 64 years old on 15 July 2008. Ralph retired from full-time gainful employment on 15 March 2006 and has not worked for paid employment during the 2007/08 financial year. Ralph wishes to make contributions to his superannuation fund. (a) Can Ralph make contributions to superannuation on 29 June 2008? Why/why not? (b) Could Ralph claim a tax deduction for the contribution? Why/why not? Further resources ATO 2006, ‘Beware of illegal schemes to withdraw your superannuation early’ [online] May. Available from: <http://www.ato.gov.au> by entering ‘preservation’ in the search box, and selecting ‘Beware of illegal schemes to withdraw your superannuation early’ from the results. Select the ‘brochure’ PDF download [cited 11 June 2008]. 3 Limits on contributions From 1 July 2007, there are limits on superannuation contributions. The limits apply to the aggregate contributions for a person to all superannuation funds from all sources throughout the financial year. 3.1 Concessional cap The limit on concessional contributions, known as the ‘concessional cap’, is $50,000 per person per year in 2008/09. The annual entitlement will operate on a ‘use it or lose it’ basis. That is, if a cap is not fully utilised in any year, then the unused amount cannot be credited to a future year. Thus if concessional contributions for 2008/09 are $40,000, the unused amount of $10,000 at 30 June 2009 is lost and cannot be carried forward to 2009/10. The limit on concessional contributions is indexed to AWOTE (average weekly ordinary time earnings) on 1 July each year. However, the actual limit will only rise with each $5000 accumulated increase in the indexed amount. Transitional arrangements Transitional arrangements for those aged 50 or more increase the concessional cap to $100,000 per person per year from 1 July 2007 to 30 June 2012. This cap is not indexed. For a person who turns 50 between 1 July 2007 and 30 June 2012, the transitional limit will apply from the financial year in which they turn age 50. For example, a person turning age 50 on 1 February 2011 will be able to contribute $100,000 in the financial years of 2010/11 and 2011/12. 924.SM1.9 Unit 2: Contributions 3.2 Non-concessional cap The limit on non-concessional contributions, known as the ‘non-concessional cap’, is three times the concessional cap. This equates to $150,000 per person per year in 2008/09, as shown in Table 4 below. The non-concessional cap will rise with indexed increases to the concessional cap. The annual non-concessional cap will operate on a ‘use it or lose it’ basis. That is, if a cap is not fully utilised in any year, then the unused amount cannot be credited to a future year. Thus, if non-concessional contributions for 2008/09 are $40,000, the unused amount of $110,000 at 30 June 2009 is lost and cannot be carried forward to 2009/10. Table 4 Limits on non-concessional contributions Clients … Will be … Under 65 • • able to contribute $150,000 per year, or able to contribute up to $450,000 in a single year under the three year averaging rule (see below for further details) 65–74 • restricted to contributing $150,000 per financial year (they must also satisfy the contribution work test) 75 and over • generally unable to contribute to superannuation Further resources ATO 2006, ‘Key superannuation rates and thresholds’ [online] June. Available from: <http://www.ato.gov.au> by selecting ‘For Superannuation’, ‘Superannuation home page’, and ‘Key superannuation rates’. Select ‘Contribution caps’ from the right column [cited 11 June 2008]. 3.3 Averaging of contribution limits For those under age 65 at the start of a financial year, the cap on non-concessional contributions can be averaged over three years. This means that up to $450,000 can be contributed in any one year, based on the 2008/09 limit of $150,000. In contributing $450,000, a taxpayer would use all of the current year’s cap of $150,000 and bring forward the entitlement of $150,000 for each of the following two years. The three year averaging limits will rise with indexation in the individual years. The ‘bring forward’ option is automatically triggered when non-concessional contributions exceed the single year cap, $150,000 in 2008/09. People aged 63 and 64 who contribute $450,000 will not be required to meet the work test in the two years after they make the contribution. Example: Triggering ‘bring forward David, aged 62, contributes $180,000 to his superannuation in 2008/09. This triggers the ‘bring forward’ because the contribution is higher than the 2008/09 non-concessional cap of $150,000. David can contribute up to $270,000 over the next two years without exceeding his non-concessional cap. © Kaplan Education 2.13 2.14 Specialist Knowledge: Superannuation (924) Example: Contributing $600,000 James, aged 63, receives a $600,000 inheritance in May 2009. He would like to contribute it all to superannuation but knows of the $450,000 limit over three years. In June 2009, he could contribute $150,000, taking advantage of that year’s limit. In the next financial year, commencing the next month, he could contribute the remaining $450,000 to take advantage of the new year’s limit combined with the ‘bring forward’ limit of the two following years. Thus, James contributes the full $600,000 within weeks. Table 5 shows examples of how someone under age 65 can contribute the maximum allowable each year or use the three-year $450,000 averaging provision. Table 5 Examples of non-concessional cap Maximum annual contribution Maximum contribution using averaging Example 1 Maximum contribution using averaging Example 2 Maximum contribution using averaging Example 3 2008/09 $150,000 $450,000 $150,000 ? 2009/10 $150,000 $0 $450,000 ? 2010/11 $150,000 $0 $0 ? 2011/12 $150,000 $150,000 $0 ? Example 1 shows that the client with $600,000 could contribute $450,000 in the first year of a three-year period and then another $150,000 in the fourth year. Example 2 shows that a client with $600,000 could contribute it all to superannuation within 12 months by contributing $150,000 this financial year, and then bringing forward two years’ contributions on the next 1 July to contribute a further $450,000. Apply your knowledge 2: Averaging super Using Table 5 above, provide another example of how the person could contribute $600,000 over the four years. 924.SM1.9 Unit 2: Contributions 4 Taxation and concessions on contributions After determining whether a person is eligible to contribute to superannuation, the next step is to determine: • what type or types of contribution to make • what tax concessions are available • how much can be contributed before attracting higher tax rates. 4.1 Concessional contributions Employer contributions including SG, salary sacrifice and additional voluntary contributions are tax deductible in full to the employer with no limit for employees who are under age 75. Over age 75, the only contributions that can be made to superannuation are employer contributions that are mandated under an award or similar. Mandated contributions are tax deductible to the employer. Self-employed persons and those who are under age 65 and not working may claim a tax deduction for some or all of their personal contribution (see section 2.5). The amount that is claimed as a tax deduction will be a concessional contribution with the rest being a non-concessional contribution. Notice to superannuation fund A tax deduction for a personal contribution by those who are self-employed, substantially self-employed, or under 65 and not working, is only available if they have given a notice to the superannuation fund advising that they are claiming the deduction. The contribution will then be included in the taxable income for the fund. Excess concessional contributions Where a person’s total concessional contributions to all superannuation funds for a year exceeds the concessional cap, the excess is taxable at an additional 31.5% beyond the normal 15%. This brings the total tax on excess concessional contributions to 46.5%, which is the maximum marginal tax rate. The bill for excess concessional contributions tax will be sent to the member and they can pay it themselves or they can ask their superannuation fund to pay it out of their superannuation balance. Any excess concessional contribution for a year is counted under the non-concessional cap. Further resources ATO 2007, ‘Excess contributions tax — applying to have your contributions disregarded or reallocated’ [online] November. Available from: <http://www.ato.gov.au> by entering ‘excess contributions tax disregarded reallocated’ in the search box [cited 11 June 2008]. © Kaplan Education 2.15 2.16 4.2 Specialist Knowledge: Superannuation (924) Non-concessional contributions Non-concessional contributions include spouse contributions and personal non-concessional contributions. Non-concessional contributions over the contribution cap attract excess tax. Spouse contributions A contributing spouse may be eligible to claim a tax offset (rebate) for eligible spouse contributions made to a complying superannuation fund or RSA during a financial year. The spouse rebate is limited to 18% of the amount of eligible spouse superannuation contributions made, up to a maximum rebatable contribution of $3000 p.a. This equates to a maximum rebate of $540 p.a. To be eligible for the rebate, both the spouse and the contributor must be Australian residents and the contributor must not be able to claim a deduction for the contribution. This means that the spouse cannot be their employee. The spouse’s assessable income plus reportable fringe benefits must be less than $10,800 p.a. to claim the full rebate. The maximum rebatable contribution phases out if the spouse’s assessable income and reportable fringe benefits combine to be between $10,800 and $13,800 p.a. The maximum is reduced by one dollar for every dollar of income over $10,800. Example: Eligible spouse contribution Felicity contributes $10,000 as an eligible spouse contribution for Kenneth. Kenneth’s assessable income in the year of the contribution is $12,000. The maximum rebatable contribution is: $3000 – ($12,000 – $10,800) = $1800 The rebate Felicity can claim is 18% × $1800 = $324. Although the tax rebate is limited, the amount that can be contributed is not. Spouse contributions are treated as non-concessional contributions. No contributions tax is deductible from these amounts. Personal non-concessional contributions Personal contributions to a superannuation fund from after-tax income are included in non-concessional contributions if no tax deduction is claimed. No contributions tax is deducted by the superannuation fund on these contributions. When withdrawn from a superannuation fund, non-concessional contributions are included in the tax-free component — and hence will be tax-free if taken before age 60. (The tax-free component of a superannuation payout will also include spouse contributions and any government co-contribution.) Non-concessional contributions make the following more tax-effective: • lump sum payments and income from income streams taken before age 60 • death benefit payments to non-dependants, such as adult children. 924.SM1.9 Unit 2: Contributions Excess non-concessional contributions If total non-concessional contributions to all superannuation funds exceed the non-concessional cap, the excess is taxable at 46.5%. The bill for the excess contributions tax will be sent to the member, who must ask their superannuation fund to release money to pay it. The 46.5% tax rate is clearly a punitive rate aimed at enforcing the non-concessional cap, making excess non-concessional contributions unattractive. This is very severe because: • non-concessional contributions are made with after-tax money (money on which tax has already been paid) • excess concessional contributions included within the non-concessional cap have already been taxed at the highest marginal tax rate, currently 46.5%. Care is required to avoid accidentally exceeding the non-concessional cap over one or three years. Problems could arise from an employee making post-tax contributions involving: • excess concessional contributions from employer superannuation or elsewhere that are included in the non-concessional cap • transfers from overseas funds • spouse contributions. 4.3 Government co-contribution The government co-contribution supplements superannuation contributions by eligible medium-to-low income earners by up to $1500. Generally, employees with employer-sponsored superannuation support are not eligible for a tax deduction for any personal contributions if 10% or more of assessable income plus reportable fringe benefits is derived from employment as an employee. However, they may be eligible to receive the government co-contribution. The self-employed also may be eligible to receive the government co-contribution provided they earn 10% or more of their income from carrying on a business, eligible employment or a combination of both. Maximum contribution is $1500 Under the co-contribution scheme, the government will contribute $1.50 for every $1 eligible medium-to-low income earners contribute to their superannuation, up to a maximum government contribution of $1500. To receive the maximum $1500 contribution, a member must not only contribute $1000, but also have a total income (assessable income plus reportable fringe benefits) of $30,342 (from 1 July 2008) or less. The maximum co-contribution tapers off at the rate of five cents for each dollar of assessable income in excess of $30,342. All government co-contributions are treated as non-concessional contributions and, as such, are not subject to 15% contributions tax. However, they are not included in the non-concessional cap. © Kaplan Education 2.17 2.18 Specialist Knowledge: Superannuation (924) Eligibility criteria for co-contribution Individuals must meet all of the following criteria to receive a government superannuation co-contribution: • be aged less than 71 at the end of the financial year • make a personal non-concessional contribution (excluding spouse contributions) to a complying superannuation fund or RSA • receive at least 10% of total assessable income plus reportable fringe benefits from employment as an employee or from their business activities if self-employed • have total income less than $60,342. This includes assessable income and reportable fringe benefits. The person is not eligible for a co-contribution if: • their total income is $60,342 or more • they held an eligible temporary resident visa at any time during the relevant year and are therefore eligible to cash out their superannuation under the temporary resident rules. Co-contribution amount The government co-contribution is the lesser of: • $1500, reduced by 5c for each $1 of total income over $30,342 • the total amount of non-concessional contributions made by the member in the financial year multiplied by 1.5. Note: Where a taxpayer qualifies for at least $1 of co-contribution, the minimum amount that will be paid is $20. Non-concessional super contribution amount: $1,000 and your income is: $800 $500 $200 your government co-contribution will be: $30,342 or less $1,500 $1,200 $750 $300 $32,342 $1,400 $1,200 $750 $300 $34,342 $1,300 $1,200 $750 $300 $36,342 $1,200 $1,200 $750 $300 $38,342 $1,100 $1,100 $750 $300 $40,342 $1,000 $1,000 $750 $300 $42,342 $900 $900 $750 $300 $44,342 $800 $800 $750 $300 $46,342 $700 $700 $700 $300 $48,342 $600 $600 $600 $300 $50,342 $500 $500 $500 $300 $52,342 $400 $400 $400 $300 $54,342 $300 $300 $300 $300 $56,342 $200 $200 $200 $200 $58,342 $100 $100 $100 $100 $60,342 $0 $0 $0 $0 924.SM1.9 Unit 2: Contributions Example: Government co-contribution Joe, age 45 and working full time, contributes his Melbourne Cup winnings of $1200 into superannuation as a non-concessional (after tax) contribution. His total income for the financial year is $32,000. As shown above, the $1500 maximum co-contribution entitlement is reduced by five cents for every dollar of earnings over $30,342. Given that Joe earns $32,000, his maximum is worked out as follows: $1500 – [0.05 × ($32,000 – $30,342)] = $1500 – [0.05 × ($1658)] = $1500 – $82.90 = $1417 Therefore, the maximum co-contribution Joe is eligible for is $1417. Joe only needs to contribute $945 or more to receive his maximum co-contribution as the government will pay $1.50 for each eligible dollar of contribution. Apply your knowledge 3: Co-contribution Amanda is 41 years old and married to Marvin. Amanda earns an annual salary of $42,000. As a result of salary packaging a car, she also has reportable fringe benefits of $8000, and has investments that return an annual dividend (including any franking credits) of about $6000. Amanda also makes personal after tax contributions to her superannuation above the compulsory 9% from the employer. How would co-contribution be calculated by the tax office? 4.4 Personal services income From 1 July 2000, if an entity (such as a company, partnership, trust or individual) is deemed to derive personal services income, there are limitations on the deductions otherwise available for certain superannuation contributions, unless the entity is conducting a personal services business. The deductibility rules are outlined in Table 6. Table 6 Deductibility under personal services income rules Type of contribution Deduction applicable Contributions on behalf of the principal worker or a non-associated arm’s length employee Normal deductibility rules apply (i.e. under self-employed or employee rules as applicable) Contributions on behalf of an associate doing less than 20% of the principal work Deduction limited to amount of superannuation guarantee contribution Contributions on behalf of an associate not doing any of the principal work No deduction available © Kaplan Education 2.19 2.20 4.5 Specialist Knowledge: Superannuation (924) Borrowing for superannuation contributions Interest on borrowings by employees or self-employed persons to make either personal contributions or contributions for the individual’s dependants are not tax deductible. Interest incurred by employers on such borrowings for eligible employees continues to be deductible, but this type of borrowing is not common. Note: Interest on borrowings before 19 August 1992 was deductible under ruling IT 2678 made in May 1992. 4.6 Transfers from overseas funds Certain transfers from overseas funds are tax-free for new residents. The rules differ depending on whether the transfer is made within or after six months of the person gaining residency. Transfer from overseas within six months of residency Where a transfer payment from an overseas superannuation fund is received within six months of the person becoming an Australian resident, the payment is tax-free and can be credited to a superannuation fund. No tax will be payable by the fund provided: • the transferred superannuation comes from work undertaken overseas when the person was not an Australian resident • the benefit does not exceed the member’s vested benefit under the overseas fund at the time of payment. The payment is treated as a non-concessional contribution and counts towards the non-concessional cap. Transfer from overseas after six months of residency Where the transfer payment is received more than six months after becoming a resident, part of the benefit may be taxable income. The taxable component is the increase, if any, in the fund balance between the date of becoming a resident and the date of payment. The increase will be taxed as income at the taxpayer’s marginal tax rate. This applies even if the whole of the transfer has been paid into an Australian superannuation fund. However, if the transfer has been paid directly into an Australian superannuation fund, the taxpayer can elect in writing to have part of the transfer (e.g. the amount that is taxable) treated as a concessional (taxable) contribution in the Australian fund. The concessional contribution would then be taxed at 15% rather than the taxpayer’s marginal tax rate. Although it is a taxable contribution within the fund, it is not counted towards the concessional cap. The rest of the amount transferred would be a non-concessional contribution. This will be tax-free and counts towards the non-concessional cap. 924.SM1.9 Unit 2: Contributions Caution with overseas transfers Transfers from overseas require careful treatment because: • amounts can be substantial and will be counted in the non-concessional cap • some of the overseas pension funds do not transfer part-benefits or permit multiple transfers, a problem which may force a contribution over the cap • it can be difficult, if not impossible, to arrange transfers within six months • UK benefits must be transferred to a ‘qualifying recognised overseas pension scheme’ (QROPS) or face 40% tax in the UK • paying the 15% concessional tax on benefits transferred from the UK to Australia outside the six-month period could cause problems with UK authorities. UK regulations do not allow the payment of any part of the benefit before specified ages and/or retirement. The UK authorities may regard the payment of tax from the benefit as being a payment of part of the benefit in contravention of their regulations. This would trigger tax at 40% and could put the QROPS approval of the fund at risk. 4.7 Personal injury payments Certain payments from personal injury claims made into superannuation as non-concessional contributions can be excluded from the non-concessional cap. To be excluded the contributions must have been derived from: • a structured settlement payment • an order for a personal injury payment • a workers compensation payment taken as a lump sum. Two legally qualified medical practitioners must certify that, as a result of the injury, the person is unlikely to ever be gainfully employed in the capacity for which they are reasonably qualified. The approved form certifying that the contribution was derived from a personal injury payment must be given to the superannuation fund by 31 July following the end of the financial year in which the contribution was made. The exclusion only applies to the part of the payment that is compensation or damages for personal injury. 4.8 Employment termination payments An employment termination payment (ETP) is a lump sum payment made because of a termination of employment. It can include: • amounts for unused rostered days off • amounts in lieu of notice • a gratuity or ‘golden handshake’ • an employee’s invalidity payment for permanent disability, other than compensation for personal injury • certain payments after the death of an employee which are subject to their own tax rates. © Kaplan Education 2.21 2.22 Specialist Knowledge: Superannuation (924) ETPs are subject to their own tax and cannot be rolled over into superannuation, although some transitional provisions apply, as discussed below. Prior to 1 July 2007 these payments were able to be rolled over into superannuation and thus receive concession taxation. What is not an employment termination payment Certain components of an employee’s final payment are not ETPs under changes effective from 1 July 07. The following are not considered to be ETPs: • unused annual leave and long service leave • the tax-free part of a genuine redundancy payment or an early retirement scheme payment. Tax on ETPs Any invalidity or pre-1983 amounts, as calculated by the employer, will be tax-free. The balance of the ETP, if it is not transitional (see below), will be a taxable component with tax calculated as set out in Table 7. Table 7 Tax on taxable components of an ETP Age Tax on taxable component Under preservation age on the last day of the financial year • • Up to $145,000* taxed at 30% Amount over $145,000* taxed at top marginal rate plus Medicare levy Preservation age or over on the last day of the financial year • • Up to $145,000* taxed at 15% Amount over $145,000* taxed at top marginal rate plus Medicare levy * $145.000 for 2008/09 indexed. All payments within the year will be aggregated before the tax is calculated. Transitional arrangements for employer termination payments Transitional arrangements apply for people entitled, as at 9 May 2006, to the payment if the payment is made before 1 July 2012 on termination of employment under: • a written contract • an Australian or foreign law (or an instrument under such a law), or • a workplace agreement under the Workplace Relations Act 1996 (Cth). These documents must refer to the amount of the payment, or to a method or formula to work it out. It may allow you to choose how the payment is made — for example, as a payment made in kind, such as shares. The transitional arrangements do not apply to ETPs made on death. Transitional termination payments (TTPs) made before 1 July 2012 may be: • contributed in full or in part to a superannuation fund, or • used in full or in part to buy a superannuation annuity. 924.SM1.9 Unit 2: Contributions Transitional ETP not rolled over As with non-transitional ETPs, any invalidity or pre-1983 amounts (as calculated by the employer) are tax-free in a transitional ETP not rolled over. The balance of the transitional ETP will be a taxable component with tax calculated as set out Table 8. Table 8 Tax on transitional ETP not rolled over Age Tax on taxable component Under preservation age on the last day of the financial year • • Up to $1 million* taxed at 30% Amount over $1 million* taxed at top marginal rate plus Medicare levy Preservation age or over on the last day of the financial year • • • Up to $145,000* taxed at 15% Amount over $145,000* and up to $1 million* taxed at 30% Amount over $1 million* taxed at top marginal rate plus Medicare levy * $145,000 is 2008/09 figure and is indexed, the figure of $1 million is not indexed. All payments within the year will be aggregated before the tax is calculated. Transitional ETP rolled over A transitional ETP that is rolled over becomes a directed termination payment. This is tax-free to the former employee but the taxable component is subject to tax within the superannuation fund. The normal 15% tax rate on the taxable component is increased to the maximum marginal tax rate plus Medicare levy on any amounts above $1 million. The excess over $1 million is also included in the concessional cap. Apply your knowledge 4: Transitional ETP Gerry (aged 57) is leaving his employer on 30 September 2008 and will be receiving an employment termination payment of $600,000. The ETP is being paid under a written service contract dated in 2003. His employer has advised that the ETP would comprise: Tax-free (pre’83) component $50,000 Taxable $550,000 Total $600,000 • How would tax be calculated if Gerry took the ETP in cash? • Can he roll the ETP into his superannuation and how would the ETP be taxed if he rolls it over? 4.9 No TFN and refund of excess Superannuation funds are required to return any amounts of personal contributions: • that exceed the non-concessional cap. They are not required to aggregate the total of member contributions received for a person either within the fund or across other funds, rather the rule applies on a contribution by contribution basis • if the member has not quoted their tax file number (TFN) to the fund. © Kaplan Education 2.23 2.24 Specialist Knowledge: Superannuation (924) 5 Contributions splitting 5.1 What is contributions splitting? Contributions made to accumulation funds and to accumulation interests within defined benefit funds may be split with a member’s spouse. A spouse for these purposes includes a de facto spouse of the opposite sex, but not the same sex. Contribution splitting was introduced on 1 January 2006. Not compulsory for funds to offer Contributions splitting is a service that superannuation funds may offer to their members. They may, however, choose not to. Before advising a client to make contributions to a fund to take advantage of contributions splitting, advisers should make sure the fund allows it. Each fund offering this service may set its own rules to administer the process, as the regulations are not fully prescriptive. Reflect on this: Contribution splitting What are the pros and cons of contribution splitting? How important is it for clients? Would you not use a superannuation fund that did not offer the service? Further resources ATO 2007, ‘Superannuation contributions splitting — superannuation funds’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘superannuation contributions splitting’ in the search box, and selecting ‘Superannuation contributions splitting — superannuation funds’ from the results [cited 11 June 2008]. 924.SM1.9 Unit 2: Contributions 5.2 Preserved and taxable components Contributions that have been split will be a preserved benefit for the receiving spouse. Any amount split after 1 July 2007 will consist entirely of the taxable component and hence will be a taxable component within the receiving spouse’s benefit. Table 9 provides details about what contributions can be split with a spouse. Table 9 Splittable and non-splittable contributions Which contributions are splittable? Which contributions are not splittable? • • • concessional contributions made on or after 1 July 2007 and contributions made from 1 January 2006 to 30 June 2007 an amount allocated from a surplus within a fund to meet an employer’s contribution obligations on or after 1 January 2006 • • • • • non-concessional contributions made from 1 July 2007 and undeducted contributions made from 5 April 2007 to 30 June 2007 amounts rolled over or transferred amounts previously allotted to a spouse account using the contributions splitting provisions lump sums transferred from an overseas superannuation fund transitional termination payments CGT-exempt ETPs The amount to be split must not exceed the lesser of 85% of concessional (or taxable) contributions and, from 1 July 2007, the concessional contribution cap. Up to 100% of non-concessional contributions made before 6 April 2007 may be split. 5.3 Requirements for splitting contributions An application to split contributions may be made in two circumstances: • in the financial year following the year in which the contributions were made. Trustees may prescribe a limited ‘window’ within that year in which they will accept the application (e.g. from 1 July to 31 December) • just prior to a rollover of the entire benefit to another fund for any contributions made in that financial year. Age of receiving spouse The receiving spouse must be: • under preservation age (currently age 55), or • over preservation age but under age 65 and not retired from the workforce. The purpose of these criteria is to ensure that contributions split to the spouse are transferred as preserved amounts and not used as a means to gain early access to superannuation benefits via a non-working spouse who has already reached preservation age. Transfer of concessional contributions If the member has made a concessional contribution, the member must advise the superannuation fund that a tax deduction is being claimed. This is done with an s 290-170 notice which must be received by the trustee before the application to split is received. The 290-170 replaces the 82AAT notice used in past years. © Kaplan Education 2.25 2.26 5.4 Specialist Knowledge: Superannuation (924) Advantages and disadvantages of contributions splitting Tax-effective life insurance Contributions splitting can be an effective way to pay for a spouse’s life insurance cover when insufficient cash flow is available. To do this, contributions are split to a spouse’s superannuation account, and then used to pay premiums for life insurance within the superannuation fund. Those premiums will be tax-deductible within the fund, which they are not outside the fund. Reduced tax before age 60 By splitting contributions, couples who plan to retire or receive superannuation benefits (lump sum or pension) before age 60 can divide the superannuation to split taxable income between them. This can reduce their collective tax. Superannuation benefits from a taxed fund are tax-free from age 60. Insurance against legislative risk The superannuation rules from 1 July 2007 appear to give few advantages to contribution splitting with a spouse unless benefits are taken before age 60. However, some couples may be concerned about ‘legislative risk’, meaning future changes to the law that could result in them paying increased tax. Some of these couples may see contributions splitting now as a way to reduce tax in a possible future system. Independent income stream Where a spouse has little or no accumulated superannuation benefits, splitting contributions will allow the spouse to commence an income stream, or to increase the balance in an income stream, in their own name. If the member dies, the surviving spouse will continue to receive income payments from their own income stream. This will leave the surviving spouse with some income to meet living expenses and other needs until the estate is finalised. Reduce assets test effect If one spouse is considerably younger than the other, it can be beneficial to put the superannuation in the younger spouse’s name. Reducing amounts in the older spouse’s name can help maximise the older spouse’s age pension as income and assets tests for the older spouse would be reduced. Such a strategy will only be effective until the younger spouse reaches age pension age. A disadvantage of splitting superannuation to a younger spouse is that access to the benefits would be locked away until the receiving spouse has reached their preservation age and met a condition of release. Consider individual circumstances Every person’s circumstances and needs are different. These matters need to be taken into consideration by financial advisers when recommending contributions splitting for their clients. 924.SM1.9 Unit 2: Contributions Tips and traps • If a member is making a full rollover, they need to make an application to split before they roll over. In the new fund they will not be able to split contributions made to the old fund. • If superannuation benefits are taken in cash, there is currently no provision that allows clients to split contributions that they have made during the financial year in which they take their benefit. To take advantage of splitting, these clients could consider rolling over their entire benefit first, thus triggering the ability to split. However, they must not have already made an application to split in the current financial year. This includes an application in the current year to split the previous year’s contributions. Alternatively, they could wait until after the next 1 July to apply for the split and then take their benefit. They could take some of their benefit upfront and leave a sufficient amount in the fund to split contributions the following financial year. • If benefits are taken as a pension in the same fund, again there is currently no provision that allows clients to split contributions they have made during the financial year in which they start their pension. These clients have the following options: – They could leave enough in the accumulation stage to split in the next financial year. However, this could be complicated because investment earnings would accrue, leaving amounts to be paid out as ETPs. Another possibility is that the investment loses value, leaving the clients with less than the full amount of contributions. – They could roll over the entire benefit to another fund and split just prior to rollover. In some funds, this would trigger capital gains tax. As the rules currently stand, they could only split in these circumstances if they had not yet made an application to split in the current financial year. This prevents them from splitting even if the current year’s application was to split the previous year’s contributions. Note: It is expected that future amendments to the regulations will allow clients to apply to split contributions when a benefit is taken in cash, and when benefits are taken as a pension in the same fund. © Kaplan Education 2.27 2.28 Specialist Knowledge: Superannuation (924) Case study: Ken and Cynthia Ken Wong and his wife Cynthia both work for a mining company. Ken is age 66 and earns a salary of $55,000 p.a. and Cynthia is age 58 and earns a salary of $52,000 p.a. Both Ken and Cynthia have been salary sacrificing an additional 5% of their salary to superannuation for the past 10 years. Ken has a superannuation balance of $460,000 and Cynthia has $240,000. Ken is planning to retire in three months time, after 18 years of service for the company. The company wishes to keep him on their books and has offered him a few hours work a week as support, to a maximum of $400 a month. Cynthia is not thinking of retiring for another two years. In January 2008 Ken and Cynthia sold their apartment in one of Sydney’s suburbs for a profit of $400,000. Ken bought the property over 40 years ago before he met Cynthia. Reflect on this: Ken and Cynthia Ken and Cynthia want more money in their superannuation accounts. What are their options? Can the $400,000 be a non-concessional contribution? Should Cynthia salary sacrifice? Should Ken split some of his contribution? What would you recommend? 6 Small businesses, capital gains tax and superannuation As noted in section 2, the self-employed can contribute to superannuation and claim tax deductions up to the concessional cap. There are two additional benefits for small businesses: • If there is a pattern of regular contributions, assets in superannuation are protected in bankruptcy. • Up to $1 million can be contributed over a lifetime to superannuation from assets that have been subject to certain capital gains tax (CGT) exemptions. This $1 million does not count towards either the concessional or the non-concessional cap. Importantly, capital gains tax (CGT) exemptions are available when selling small businesses. Several concessions exist, with varying rules on eligibility. Also available is rollover relief, which allows small businesses to defer CGT liability when selling an asset to replace it or to improve another asset. 924.SM1.9 Unit 2: Contributions 6.1 Introduction to CGT concessions When a small business is sold at a profit, CGT would normally be payable. However, there are six concessions that may, depending on the circumstances, reduce or eliminate CGT. Two are two standard CGT provisions and four are specific to small business. Standard CGT provisions 1. Assets acquired before 20 September 1985 are exempt from CGT. 2. Individuals are taxed on only 50% of realised gains if the asset has been held for at least one year. CGT may, however, be lower under the indexed cost base method for assets acquired before 21 September 1999. The 50% reduction does not apply to assets owned by a company. Small business CGT provisions 1. The 15-year CGT exemption, which came into effect on 19 September 2000. This is 15 years after the introduction of CGT on 19 September 1985 (see section 6.3). 2. A 50% active asset exemption, which came into effect on 21 September 1999 (see section 6.4). 3. The small business retirement exemption (SBRE). This gives rise to the CGT-exempt component (CGTEC) of an ETP (see section 6.5). 4. The replacement asset rollover relief from CGT where sale proceeds are used to purchase a replacement active asset (see section 6.6). Effects of CGT provisions Standard provision 1 and small business provision 1 above give complete exemption from CGT and do not need to be used with any other concession. The other four concessions can be used in conjunction with each other, provided the appropriate conditions are met. Trusts generally operate on the principle of flow-through taxation. This allows them to pass on the 50% discount when distributions are made to individuals. Fifteen-year exempt monies may be contributed to superannuation Individuals can contribute to superannuation the proceeds from the disposal of assets that qualify for the 15-year exemption and the SBRE, listed above as small business concessions 1 and 3, respectively. From 10 May 2006, proceeds from the disposal of eligible small business assets that are contributed to superannuation do not count towards the cap on non-concessional contributions, up to a lifetime limit of $1 million. © Kaplan Education 2.29 2.30 Specialist Knowledge: Superannuation (924) Order of CGT concessions The order in which the small business CGT concessions must be taken is set out in Figure 1 below. Figure 1 Order in which CGT concessions must be taken Pre-20-September-1985 asset Yes Asset is exempt from CGT No 15-year exemption Yes 100% exemption applies No Individuals (trusts) 50% exemption Yes Reduce capital gain by further 50% No Active asset 50% exemption Yes Reduce capital gain by further 50% and/or Small business retirement exemption 924.SM1.9 Rollover relief Unit 2: Contributions Example: CGT concessions Jane has run a florist shop from rented premises as a sole trader for the past 10 years. She started the business from scratch and sold the goodwill of the business for $16,000 on 15 January 2000. • As an individual selling an asset after 21 September 1999, with the asset acquired before 21 September 1999, she can choose between using the frozen indexed cost base method or the 50% reduction method. As Jane started the business from scratch, the value of the goodwill was nil, therefore she has no cost base. In this case, she chose the 50% reduction method, which reduces the assessable gain to $8000. • Assuming the net value of Jane’s assets is less than $6 million, she is entitled to apply the small business concessions, as the sale of the goodwill is considered to be the sale of an active asset (see below). The 50% active asset exemption reduces the assessable gain to $4000. • With the remaining $4000, Jane can purchase a replacement active asset (small business rollover) or apply the small business retirement exemption. Alternatively, she can choose a combination of the two concessions. 6.2 Basic tests for entitlement Two basic conditions must be satisfied for entitlement to any of the small business CGT concessions: • a limit of $6 million on the net value of the business’s CGT assets (maximum net asset value test), or the taxpayer must be a small business entity for the income year • the CGT asset disposed of must be an active asset (active asset test). Additional conditions apply to interests in shares or assets. Maximum net asset value test To satisfy the maximum net asset value test, the total of the following amounts cannot exceed $6 million: • the net value of CGT assets of the taxpayer • the net value of CGT assets of the entities connected with the taxpayer • the net value of CGT assets of any small business CGT affiliates of the taxpayer and entities connected with any such small business CGT affiliate. The net value asset can take into account: • the negative value of assets • liabilities such as annual and long service leave entitlements, unearned income and future tax. Simplified tax system taxpayers are eligible for the small business CGT concessions without having to satisfy the maximum net asset value threshold. © Kaplan Education 2.31 2.32 Specialist Knowledge: Superannuation (924) Sole trader and partnerships The maximum net value asset test is applied to the value of assets of individual partners rather than to the partnership as a whole. For a sole trader or a partner in a partnership some assets are ignored for the purposes of the net asset value test. These include: • assets being used solely for the personal use and enjoyment of the individual or the individual’s CGT affiliate • rights to assets or amounts payable from a superannuation fund or approved deposit fund • life insurance policies. For individuals using their home to conduct a business, the net asset value test considers only the value of the portion used for business. Small business CGT affiliate A small business CGT affiliate is defined as an individual’s spouse, their child under age 18, or an entity that could reasonably be expected to act: • in accordance with the individual’s directions or wishes • in concert with the individual. However, a partner in a partnership is not included in the definition of a small business CGT affiliate. Small business entity An entity is a small business entity if it carries on a business and its aggregated turnover is less than $2 million, based on the: • actual figure for the previous income year • expected figure calculated on the first day of the current year, or • actual figure calculated on the last day of the current year. Active asset test A CGT asset may be an active asset if it is used, or held ready for use, in a business. The business may be: • carried on by the taxpayer • a small business CGT affiliate of the taxpayer, or • another entity connected with the taxpayer. In the case of an intangible asset, it must be inherently connected with the business. Assets remain ‘active’ if sold up to 12 months after the cessation of business, provided the asset was active for at least half the period of ownership or 7.5 years. 924.SM1.9 Unit 2: Contributions Types of active assets Active assets include: • goodwill • business premises • intellectual property, such as computer programs and data • fixtures and fittings, unless depreciated • restrictive covenants and other rights created • shares or trust interests (in limited circumstances). Assets that have been depreciated are no longer CGT assets and therefore do not give rise to a capital gain when sold. Not active assets Active assets do not include: • shares or trust interests, unless the 80% market value rule (see special conditions below) is satisfied • financial instruments, such as loans, debentures, futures contracts, currency swaps and derivatives • assets that are mainly used in the business to earn any one or more of: – an annuity – rent (unless only used to produce rent temporarily) – royalties – foreign exchange gains. Special conditions for shares and trust interests If the CGT asset is a share in a company or an interest in a trust: • the company or trust must have had a significant individual (defined below) • the taxpayer selling the asset must be a CGT concession stakeholder (defined below) in the company or trust. Shares and trust interests as active assets — The 80% rule A share or trust interest will only be an active asset if the market values of the active assets of the company or trust, combined with the cash or debt proceeds from the sale of any active assets of the company or trust during the previous years, make up more than 80% of the market value of all of the assets of the company or trust. Cash and financial instruments inherently connected with the business are counted as active assets. The legal personal representative or beneficiaries of a deceased estate can access the concessions to the same extent that the deceased could have just prior to their death. © Kaplan Education 2.33 2.34 Specialist Knowledge: Superannuation (924) Significant individual holds 20% A significant individual refers to a person with a stake of at least 20% in the company or trust. The definition is as follows: • For companies, it refers to an individual who legally and beneficially holds shares (not redeemable shares) with the right to at least 20% of: – voting power that the entity is entitled to exercise – any dividend payment that the entity is entitled to receive – any capital distribution that the entity is entitled to receive. • For fixed trusts, it refers to an individual beneficially entitled to at least 20% of the income and capital of the trust. • For discretionary trusts, it refers to an individual who was entitled to at least 20% of the total distributions of either income or capital from the trust during the year. (The discretionary trust must make a distribution in the relevant year.) Up to eight people operating a small business can access the concessions. The test can be satisfied on the basis of direct and indirect holdings through interposed entities. CGT concession stakeholder A CGT concession stakeholder is a significant individual of the company or trust or a spouse of the significant controlling individual, provided the spouse has an interest in the company or trust. In the case of a discretionary trust, the trust must have made a distribution to the spouse in the current year of income. Example: CGT concession stakeholder Consider again the scenario from the previous example in section 6.1, except with Jane running her florist business through a company rather than as a sole trader. The company has no other assets. Jane and her husband John each hold 50% of the shares in the company and they are directors and employees of the company. Both Jane and John are significant individuals as they each own at least 20% of the shares. As significant individuals they are both automatically CGT concession stakeholders. The only assets in the company are active assets relating to the florist business, so the company passes the 80% active asset test. The active assets of the company are likely to include goodwill and the business premises. If Jane and John decide to sell the shares in the company, the shares will be treated as active assets and the couple can claim the small business CGT concessions. Alternatively, Jane and John could get the company to sell the business directly to the purchaser, rather than Jane and John selling their shares in the company. In this event, the company could claim the small business CGT concessions on the sale of any active assets. The tax outcomes will be different for each of these scenarios. 924.SM1.9 Unit 2: Contributions 6.3 Fifteen-year active asset exemption The 15-year active asset exemption is the most generous of the small business CGT concessions. Where the exemption applies, 100% of the taxpayer’s capital gain will be entirely disregarded. Unlike the general 50% discount and the other small business CGT concessions, this exemption is applied before reducing the capital gain by the taxpayer’s capital losses. In order for it to apply, the basic tests set out in section 6.2 above must be met, as well as the additional conditions below. Fifteen years ownership The company must have had a significant individual for at least 15 years. However, this does not need to have been the same individual for the entire period of ownership. The period of ownership restarts if the asset is subject to a CGT rollover other than an involuntary rollover under compulsory acquisition or marriage breakdown rules. Disposal in connection with retirement or permanent incapacitation If the taxpayer is an individual, the disposal of the asset must have been connected with the individual’s retirement or permanent incapacitation. If the taxpayer is a company or trust, the disposal must be connected with the retirement of a significant individual, or a significant individual of the company or trust must be permanently incapacitated. The taxpayer may gift the business asset rather than requiring the asset to be sold. For example, a family farm can be gifted to the children. Shares and trust interests If the capital gain assets are shares or trust interests, the relevant company or trust must have had a significant individual, not necessarily the same individual, during the whole ownership period for the exemption to apply. However, a discretionary trust need not have a significant individual in a loss year. Flow-through exemption for taxpayers that are companies or trusts If the taxpayer is a company or trust, the capital gain will only be tax-free if the distribution is made within two years. In addition, tax-free distribution to a CGT concession stakeholder is limited to the exempt amount multiplied by the CGT concession stakeholder’s control percentage. CGT concession stakeholder’s control percentage × exempt amount = Maximum tax-free distribution to a CGT concessional stakeholder The excess will be an unfranked dividend, unless the company has excess franking credits. © Kaplan Education 2.35 2.36 Specialist Knowledge: Superannuation (924) Stakeholder’s control percentage for CGT concessions CGT concession stakeholder’s control percentage is their percentage of shares with voting/income rights or their percentage interest in the income and capital of the trust. In the case of discretionary trusts, the control percentage is 100% or 50%, depending on whether the trust had one or two CGT concession stakeholders. Example: CGT concession stakeholder’s control percentage John and his daughter Jane each own 50% of the shares in FAF Pty Ltd. John is age 60 and decides to retire. He will be retiring from directorship of FAF Pty Ltd. John will still own 50% of FAF Pty Ltd, but Jane will be sole director and run the company. To make a distribution from the company and help fund John’s retirement, they decide to sell a factory that has been owned by the company and used for its business operations since the factory was acquired in February 1996. On the factory’s sale in March 2007, FAF Pty Ltd makes a capital gain of $500,000. Eligibility for exemption Assume the company satisfies both the maximum net asset value test and the active asset test. • The active asset test is satisfied as the factory was used in the business for at least half of the 15 years before sale and at sale time. • As the taxpayer is a company, it must have had a significant individual at all times during the ownership period. As both John and Jane own more than 20% of the company, they are both controlling individuals. Assume this requirement is satisfied. • The sale is in connection with the retirement of John, a significant individual of the company. • The company can make a tax-free distribution to Jane and John, as they are both CGT concession stakeholders, within two years of the sale as set out below. Note: Jane would not be a CGT concession stakeholder if she owned less than 20% of the shares in FAF Pty Ltd as she would not be a significant individual or a spouse of a significant individual. The factory sale proceeds can be summarised as follows: Capital gain 15-year exemption Assessable capital gain $500,000 ($500,000) nil Tax-free distribution (John) $250,000 Tax-free distribution (Jane) $250,000 Both John and Jane must pay the distribution from the company within two years of making the capital gain and the distribution must be paid in proportion to each CGT concession stakeholder’s interest in the company. 924.SM1.9 Unit 2: Contributions 6.4 Fifty percent small business active asset exemption A general 50% discount is available to individuals for nominal capital gains made on assets owned for at least 12 months. It is also available to trusts if distributions of the capital gains are paid to individuals. For example, if you sell shares in a listed company you only need to pay tax on 50% of the gain, provided that you owned the shares for at least one year. Individuals selling shares in their small business or active assets can claim this exemption in addition to the small business CGT concessions. The 50% small business active asset exemption may apply to capital gains made on or after 21 September 1999. Only the basic conditions, described in section 6.2, need to be satisfied to be eligible for the 50% small business exemption. There are no additional conditions. If the 15-year active asset exemption applies to the capital gain, or if the asset is a pre-CGT asset, the 50% small business exemption will not be needed, as the capital gain would have been wholly exempted. If the 15-year active asset exemption does not apply, the 50% small business exemption applies after the capital gain has been reduced by the taxpayer’s capital losses and the general 50% discount. 6.5 Small business retirement exemption The small business retirement exemption (SBRE) is an important exemption as it can allow a taxpayer to reduce their assessable capital gain to nil. Many options are available to clients considering this exemption, but additional conditions must be satisfied. This is a good opportunity for advisers familiar with the operation of the SBRE and other small business CGT exemptions to add significant value for clients. The following special conditions apply. $500,000 lifetime limit An individual cannot exempt more than $500,000 of capital gains using the SBRE over their lifetime. If the taxpayer has previously used the retirement exemption applicable before 19 September 1999, those amounts will count towards the limit. The lifetime limit is not indexed for inflation. If the taxpayer is a company or trust, the exemption the company or trust may claim is limited to the total of the amounts paid as ETPs to, or rolled over for, its CGT concession stakeholders. The lifetime limit applies to the amount each CGT concession stakeholder can receive or rollover. See the other conditions for companies and trusts below. © Kaplan Education 2.37 2.38 Specialist Knowledge: Superannuation (924) Written irrevocable choice The taxpayer must choose for the retirement exemption to apply. The choice must be in writing and must specify an amount, not greater than the capital gain, as the asset’s CGT-exempt amount. The choice must be made by the day the individual lodges their tax return for the year in which they made the capital gain. At the later of the choice being made or the capital proceeds being received, the exempt amount will be taken to be an ETP. If the taxpayer is a company or trust and there are two CGT concession stakeholders, the written choice must specify the percentage of the CGT-exempt amount to be paid to each. Individuals aged under 55 years — Compulsory rollover If the taxpayer is under 55 years of age on the date they receive the capital proceeds of a sale, they must roll over the amount of the capital gain they wish to exempt. The rollover must occur immediately after receiving the capital proceeds or choosing to use the retirement exemption, whichever is later. Companies have an additional seven days to make the payment. According to SIS Regulations, the amount rolled over will be CGT-exempt and preserved in the rollover fund. Individuals aged over 55 years — Rollover or cash out If an individual is aged 55 years or over on the date they receive the capital proceeds of a sale, they may choose to receive the exempt amount as cash or to roll over the amount to a superannuation fund. If the individual decides to roll over the proceeds, the amount will become a preserved benefit in the fund until a condition of release is met. Further resources ATO 2008, ‘Super and capital gains tax’ [online] March. Available from: <http://www.ato.gov.au> by entering ‘active assets’ in the search box, and selecting ‘Super and capital gains tax’ from the results. Read all the details using the menu on the right hand side [cited 11 June 2008]. 924.SM1.9 Unit 2: Contributions 6.6 Small business rollover relief Unlike the other small business CGT concessions, the small business rollover does not exempt a capital gain, rather it defers liability until a later date, such as when the replacement asset is sold. Capital gains in two years A taxpayer can defer the capital gain in the year the gain is made, pending the reinvestment of the sale proceeds into a replacement asset. The capital gain arises after two years if the proceeds have not yet been reinvested. Rollover is also available to the extent that the sale proceeds are reinvested in a replacement asset or used to improve an asset already owned, rather than having to be wholly reinvested in a newly acquired asset. 7 Contribution strategies Contribution strategies described in this unit include: • salary sacrificing to a superannuation contribution from pre-tax dollars to reduce overall taxation • making a non-concessional contribution as a self-employed person to gain a tax concession • making a non-concessional contribution to gain the government co-contribution • splitting contributions with a spouse • using the small business retirement exemption to roll over profit from a business sale into superannuation and reduce CGT to nil. This final section provides further examples of where superannuation might be recommended to a client. Example: Business person with income outside superannuation Joe is aged 55 and earns $200,000 net business income each year. He also has $400,000 in a bank account generating 7% or $28,000 interest each year. Joe is keen both to make his money work harder and to pay less tax. A financial adviser can explain the advantages and disadvantages of adding the cash to superannuation. If the full $400,000 was contributed to superannuation, there would be a reduced tax rate on its earnings. Tax inside superannuation would be 15%, so the $28,000 earnings would be taxed at 15% rather than 46.5% resulting in a saving of $8820 per year. Further, given that Joe is 55, he could commence a transition to retirement pension (TRIP). As the tax rate in the pension fund would be nil, the tax saving could then increase up to $13,020 p.a. Joe would also be eligible for a pension tax offset on the TRIP he receives. The disadvantage is that funds would be preserved within superannuation and not able to be withdrawn unless Joe meets a condition of release. At this stage, he could only access the funds with a transition to retirement pension, which is capped at 10% of the balance. © Kaplan Education 2.39 2.40 Specialist Knowledge: Superannuation (924) Example: Retiree with shares with an unrealised capital gain Maria, a 61-year-old retiree, has a share portfolio valued at $550,000 with an unrealised capital gain of $200,000. Can she contribute the shares to super? Are there tax benefits in doing so? She could contribute the entire amount to superannuation in one year. The shares could be transferred as an ‘in-specie’ or off-market transfer (transferred to superannuation without selling). This can easily be achieved for clients with a self-managed superannuation fund but many wrap accounts can also facilitate this transfer. Alternatively the shares could be sold and the cash contributed. Either way the capital gain would be crystallised. The assessable income would be 50% of the realised gain or $100,000. $100,000 could be contributed as a concessional contribution and the other $450,000 would be a non-concessional contribution. The concessional contribution would be claimed as a tax deduction and the resulting personal assessable income would be nil. The contributions tax would be 15% of $100,000, resulting in a tax bill of $15,000. This is the effective cost of the transfer. If the superannuation fund is then converted to a pension, then all earnings within the superannuation fund are tax-free. If the shares are held outside of superannuation, the unrealised capital gain will continue to grow and will one day be taxed to Maria or her beneficiaries who inherit the unrealised capital gain. In addition, all the ongoing dividends are taxable in Maria’s personal name. It is up to the adviser to determine if the cost of transfer, in this case $15,000, is recouped by the current and future tax savings. The adviser will need to make some assumptions about future tax consequences. There are many clients with large non-superannuation portfolios, for which the adviser may need to design a long-term strategy gradually transferring assets to superannuation. If the client intends to hold the shares long term, then any dip in the share market provides an opportunity to incur a reduced capital gain. 924.SM1.9 Unit 2: Contributions Suggested answers Apply your knowledge 1: Who can contribute? John, Reg and Julie are all under 65 and can therefore make contributions to superannuation with no work test required. Sandra is over 65 and hence needs to meet the work test. As she works more than 40 hours per month (48 hours), she could contribute to superannuation. Apply your knowledge 2: Averaging super Possible options include: Maximum annual contribution Example 3a Example 3b Example 3c 2008/09 $150,000 $200,000 $150,000 $350,000 2009/10 $150,000 $200,000 $50,000 $0 2010/11 $150,000 $50,000 $250,000 $100,000 2011/12 $150,000 $150,000 $150,000 $150,000 Note that in example 3b non-concessional contributions would be limited to $50,000 before the cap was exceeded as the bring forward was only triggered in 2011/12 and $400,000 of the $450,000 cap has been used. Apply your knowledge 3: Co-contribution The co-contribution is calculated on total income determined by the ATO. In this case, total income is $56,000, comprising salary, fringe benefits and return on investments. With tax deductions of, say, $3000, taxable income is $45,000. However, the ATO calculates any co-contribution on total income. In the case of Amanda, with a total income of $56,000 and personal after-tax superannuation contributions of $1000, the $1500 maximum co-contribution entitlement is reduced by five cents for every dollar of earnings over $30,342: $1500 – [0.05 × ($56,000 – $30,342)] = $1500 – [0.05 × ($25,568)] = $1500 – $1278.40 = $222 The co-contribution payment is $222, which still represents a 22% return on investment within months. © Kaplan Education 2.41 2.42 Specialist Knowledge: Superannuation (924) Apply your knowledge 4: Transitional ETP Gerry’s ETP would qualify as a transitional employer termination payment provided the written service contract specifies the amount of the payment. He is over the preservation age. If the ETP was cashed out, tax would be: Component Tax rate* Tax Tax-free $50,000 Taxable $145,000 16.5% $23,200 Taxable Balance — $405,000 31.5% $127,575 Total – $600,000 – $150,775 • If rolled over, tax in his superannuation fund would be: Component Tax-free $50,000 Taxable $550,000 Total $600,000 924.SM1.9 Tax rate – 15% Tax – $82,500 $82,500 Unit 2: Contributions Review your progress 1 (a) There is no SG liability for Karen. (b) SG liability for Pete is 9% of $600, that is, $54 per month. (c) SG liability for Lee is 9% of $5000, that is, $450 per month. (d) Jane is above the threshold, so will receive 9% × $38,180 ÷ 3 (converting the quarterly threshold to a monthly amount) per month. SG = $1145.40 per month. (In each of the above, the SG can be paid monthly but must be paid at least quarterly.) Review your progress 2 Tax (including Medicare) on $80,000 salary: = $20,400 $3600 + (30% × $35,000) + (1.5% × $65,000) = $15,075 Tax (including Medicare) on $65,000 salary: Tax on $15,000 superannuation contributions: $15,000 × 15% = $2,250 = $17,325 = $3,075 = $59,600 = $49,925 = $9,675 Total tax for salary sacrifice: $15,075 + $2250 Difference (tax saving): $20,400 – $17,325 Cash in hand on $80,000 salary $80,000 – $20,400 Cash in hand on $65,000 salary $65,000 – $15,075 Difference in cash in hand $59,600 – $49,925 Review your progress 3 (a) Ralph is eligible to make contributions to superannuation on 29 June 2008 because he is under age 65. (b) Yes, Ralph would be classified as an ‘eligible person’ as he has not received, or does not expect to receive, any superannuation support from an employer during 2007/08. © Kaplan Education 2.43 2.44 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 3 Tax Overview 3.1 Unit learning outcomes ....................................................................3.1 Further resources ............................................................................3.1 1 1.1 Introduction 3.2 Relationship between tax and a superannuation fund’s members ...............................................................................3.3 2 2.1 2.2 Complying and non-complying superannuation funds 3.5 Complying superannuation funds .............................................3.5 Implications of losing compliance ............................................3.7 3 3.1 3.2 3.3 3.4 Taxable contributions 3.9 No-TFN contribution income ...................................................3.10 Member contributions ...........................................................3.11 Amounts excluded from taxable contributions .........................3.12 Transfer of tax liability on taxable contributions .......................3.12 4 4.1 4.2 4.3 4.4 4.5 4.6 4.7 Investment income 3.13 Superannuation fund assets..................................................3.13 Dividends ............................................................................3.14 Capital gains and losses .......................................................3.15 Non-arm’s length income.......................................................3.17 Trust distributions ................................................................3.17 Exempt current pension liability income ..................................3.18 Goods and services tax (GST) ................................................3.18 5 5.1 5.2 Changing residency 3.19 An Australian fund becoming a foreign fund ............................3.19 A foreign fund becoming an Australian fund ............................3.19 6 6.1 6.2 6.3 6.4 6.5 6.6 Rollovers 3.20 Advantages of rolling over funds ............................................3.21 Disadvantages of rolling over.................................................3.21 Rolling over employer ETPs....................................................3.22 Choosing a rollover fund........................................................3.22 Effects of rolling over an employer ETP ...................................3.24 Transitional rules for employer ETPs.......................................3.24 Suggested answers 3.27 Unit 3: Tax Overview The purpose of this unit is to provide an understanding of the taxation implications and tax concessions of superannuation at a fund level. This can help with decisions about the appropriateness of an investment strategy, especially when dealing with a self-managed superannuation fund (SMSF). These taxation principles generally apply to superannuation entities as well as life insurance companies to the extent of their complying superannuation business. The principles also apply to approved deposit funds (ADFs) and pooled superannuation trusts. Earnings generated within a superannuation fund are generally taxed at the concessional tax rate of 15%, with certain other special concessions and exemptions allowed. These concessions are only available to resident complying superannuation funds. Thus, residency changes may cause superannuation to be taxed at a much higher rate. The unit also considers rolling over an eligible termination payment (ETP) and the procedures for transitional employer termination payments. This unit specifically addresses the following subject learning outcome: ● Evaluate the taxation implications of superannuation strategies for contribution, withdrawal and insurance at the fund level. Unit learning outcomes On completing this unit, you should be able to: ● describe the relationship between a superannuation fund, its contributors and beneficiaries ● differentiate between complying and non-complying superannuation funds ● outline the consequences of a superannuation fund becoming non-complying ● list and identify items that are taxable for a superannuation fund ● list and identify those payments by funds that are generally deductible ● outline the effects of change in residency on a superannuation fund ● outline the advantages or disadvantages of rolling over superannuation fund assets ● outline the procedures for transitional employer termination payments. Further resources ● ATO 2007, ‘Tax file numbers and superannuation’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘superannuation tax file number’ in the search box, and selecting ‘Tax file numbers and superannuation’ from the results. Select the ‘Tax file numbers and superannuation’ PDF download. © Kaplan Education 3.1 3.2 Specialist Knowledge: Superannuation (924) 1 Introduction An understanding of how tax interacts with superannuation is important for financial advisers as they must be able to identify and discuss potential liabilities their clients may face. Tax and superannuation interact in many different ways with regard to: • tax on contributions • tax on fund earnings in the accumulation and pension phases (for example, franking credits are refunded during the pension phase, and gains accrued during the accumulation phase but realised during the pension phase are exempt from tax) • capital gains tax in accumulation • tax on pensions received by members age 55–59 • rebates of up to 15% on pensions received by members age 55–59. Another point to consider is that no tax is payable on lump sums or pensions received from a taxed fund after reaching age 60. The financial adviser must understand how the interaction of these provisions affects their clients. Crucial for this is knowledge of tax laws. Tax from 1 July 1988 From 1 July 1988, superannuation funds became liable to pay tax at 15%. The tax became payable on employer contributions, tax-deductible (now concessional) member contributions and any investment income and gains earned. Additionally, a tax rebate of 15% was introduced on the taxable portion of pension payments received by a member of a superannuation fund. This was subject to certain eligibility conditions. Gains realised on sale of assets by superannuation funds were generally made subject to the capital gains tax provisions. This means that funds do not usually pay tax on the portion of gains attributable to inflationary increases up to September 1999 (if applicable) or the gains are subject to a one-third discount. Tax-free benefits from a taxed fund at age 60 From 1 July 2007, lump sum benefits and pensions received from a taxed fund by a member after they reach age 60 are exempt from tax altogether. Different tax rules apply if the member receives benefits from a fund after reaching age 55 but before reaching age 60. Historical note: On 21 August 1996, the Australian Government introduced a contributions tax (surcharge) of up to 15% on employer and tax-deductible member contributions for high-income members. Superannuation funds generally paid this tax by deducting the surcharge from the relevant member’s account. This surcharge was additional to the tax on the fund’s taxable income (including taxable contributions). The surcharge was abolished from 1 July 2005. 924.SM1.9 Unit 3: Tax 1.1 Relationship between tax and a superannuation fund’s members A complying superannuation fund’s assessable income is determined on the basis that it is a resident taxpayer. Its taxable income is taxed at a standard rate of 15%. Different rates apply to some special or arm’s length income. Assessable income The assessable income of a complying superannuation fund includes taxable contributions made to the fund (e.g. concessional contributions), as well as taxable investment income. A fund’s taxable contributions comprise the following: • employer contributions, regardless of whether a tax deduction is allowed. This includes contributions for employees and non-employees (e.g. independent contractors) under an industrial agreement, an award, a law or a contractual obligation • tax-deductible personal superannuation contributions • payments of the shortfall component of a superannuation guarantee charge • amounts transferred to the fund from a person’s individual account in a superannuation holding account • part of any ETP rolled over into the fund from an untaxed source, such as an employer ETP (e.g. golden handshake or ex gratia retiring allowance), or from a government fund that is not a taxed fund. The taxable part of these amounts is the ‘post-June 1983 untaxed element’. A complying superannuation fund with investment in superannuation policies taken out with a life assurance company may, upon written agreement, transfer to the life insurance company its tax liability on any taxable contributions received by the fund. This is also the case for superannuation funds with investments in units of a pooled superannuation trust. The effect of the transfer is that relevant contributions are excluded from the fund’s assessable income, and included in the assessable income of the transferee for that year. Pension payments including allocated pensions A complying superannuation fund is entitled to an exemption from tax in respect of income it uses to pay current pensions. To determine the exempt amount, the trustee may either: • segregate some of the fund’s assets as specifically relating to such current pension liabilities, or • base the exemption on the proportion of current pension liabilities of the fund to its total superannuation liabilities (an actuarial certificate is required in such cases). © Kaplan Education 3.3 3.4 Specialist Knowledge: Superannuation (924) A fund, its contributors and beneficiaries The tax relationship between a superannuation fund, its contributors and its beneficiaries is shown in Figure 1. Figure 1 Relationship between a superannuation fund, its contributors and its beneficiaries Employer contributions Taxed at 15% up to the member’s concessional cap Accumulation income Lump sums After age 60, lump sums from a taxed fund are tax-free • Investment income taxed at 15% • Long-term CGT taxed at 10% • Short-term CGT taxed at 15% Government co-contributions Not taxed Contributions Member’s concessional contributions Taxed at 15% up to the member’s concessional cap Superannuation fund Pension income Not taxed Member’s non-concessional contributions Not taxed Benefit payments Pensions For pensions from age 55 to 59, up to 15% tax rebate. After age 60, pensions from a taxed fund are tax-free Figure 1 shows the four major types of contributions that go towards a superannuation fund, the way income in the fund is taxed, and the tax that is payable on benefits such as lump sums and pensions. Superannuation taxes To further demonstrate this process, Table 1 below outlines the impact of superannuation taxes at various stages (contributions, earnings and benefits). The table assumes the following: • the member commenced employment after 1 July 1983 • employer contributions are made regularly during employment • investment earnings consist only of interest earned at 10% • the member’s personal marginal tax rate is 45% (Medicare levy ignored for the purposes of the example). The table shows the tax situation both for members above and for members below the low tax threshold ($145,000 for the 2008/09 financial year). 924.SM1.9 Unit 3: Tax Table 1 Taxation on superannuation example Member reached age 55 but not 60 — benefit below $145,000 in 2008/09 Member reached age 55 but not 60 — benefit above $145,000 in 2008/09 Member reached age 60 $ $ $ Employer contribution 100 100 100 Contributions tax at 15% (15) (15) (15) Net (after-tax) contribution 85 85 85 8.50 8.50 8.50 Tax at 15% (1.275) (1.275) (1.275) Net (after-tax) earnings 7.225 7.225 7.225 Total benefit 92.225 92.225 92.225 0 13.834 0 92.225 78.391 92.225 15% 27.75% 15% Investment earnings 10% on $85 Tax at 15% on lump sum benefit (excluding Medicare levy) Net (after-tax) benefit Effective tax rate on employer contributions and investment earnings 2 Complying and non-complying superannuation funds Complying superannuation funds are Australian funds that comply with the SIS regime. These funds are subject to the concessional tax rate of 15% on most their income. A fund becomes complying after receiving a notice from APRA, or, for self-managed superannuation funds (SMSFs), the ATO. The notice states that the fund meets certain requirements for compliance. The fund remains complying until APRA (or the ATO for SMSFs) issues a notice revoking its complying fund status. If a fund becomes non-complying, the superannuation fund is subject to tax at 45%. 2.1 Complying superannuation funds The concessional tax rate of 15% applies only to Australian complying superannuation funds. A complying fund must meet the following conditions: • the trustee has elected that the fund be regulated under the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) • the fund meets the requirements of the SIS Act • the fund meets the requirements of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SIS Regulations). © Kaplan Education 3.5 3.6 Specialist Knowledge: Superannuation (924) Conditions to be an Australian fund An Australian superannuation fund is a fund that meets the requirements of sub-section 295-95(2) of the Income Tax Assessment Act 1997 (ITAA 97). A fund is an Australian superannuation fund at a particular time in an income year if it fulfils certain conditions. Broadly, these conditions are: • the fund was established in Australia, or any asset of the fund is situated in Australia • the central management and control of the fund is ordinarily in Australia • either: – the fund has no ‘active members’, or – if the fund has one or more active members, the market value of Australian resident active members’ superannuation entitlements is at least 50% of the total market value of the superannuation entitlements of all active members of the fund. Apply your knowledge 1: Australian fund Which of the following would be classified as an Australian fund? (a) A fund which invests directly in property, namely shopping centres in Australia. (b) A fund which invests directly in property, namely shopping centres in Australia, the UK and the US. (c) A fund which invests in a property trust that is listed on the Australian Securities Exchange and which invests in shopping centres in Australia, the UK and the US. (d) A fund whose trustees live in Melbourne. (e) A fund whose trustees used to live in Melbourne when the fund was established, but now permanently reside in the UK. Location of central management and control The ‘central management and control’ of a fund is generally located where the trustees of the fund ordinarily perform their trustee functions. For corporate trustees, the central management and control of the fund is generally located where the directors of the trustee company perform their function as directors. If the individual trustees (or directors) of a fund moved to permanently reside outside Australia, the fund would cease to be an Australian superannuation fund. However, where the trustee resides outside Australia temporarily for up to two years, the central management and control of the fund is deemed to be located in Australia. 924.SM1.9 Unit 3: Tax Active members An active member is a member who makes a contribution to the fund, or for whom another person makes a contribution to the fund. However, a member is not an active member if: • they are a foreign resident • they do not make a contribution to the fund while overseas • any contributions made for the member by other persons during the overseas stay relate to a period when the member was an Australian resident. If a fund does not have any active members, it can retain its resident status by meeting the ‘central management and control’ test. However, if it has any active members, the 50% superannuation entitlement test must also be met. Because SMSFs have fewer than five members, the 50% test is likely to be more significant for them. Example: Retaining complying status John is 25 and manages his own self-managed superannuation fund. He has an opportunity to work overseas for 18 months earning an excellent wage. He decides not to contribute to his fund while he is away. As result of this his fund remains complying and retains its 15% concessional tax rate. Apply your knowledge 2: Active members Which of the following describes an active member of an Australian fund? (a) (b) An Australian citizen working in France makes contributions to an overseas fund. (c) 2.2 An Australian citizen contributes to an Australian fund for his daughter while she is working overseas. An Australian citizen working in France since May 2008 receives a superannuation guarantee payment from a previous employer relating to employment in Australia for March and April 2008. Implications of losing compliance A non-complying fund pays tax on its taxable income at 45%. This tax rate negates the tax benefits of using superannuation as an investment vehicle. To avoid this tax penalty, a superannuation fund must remain Australian and complying at all times during the year of income for which the fund’s status is to be ascertained. If a fund loses its complying status in an income year, the net value of its assets (i.e. the gross market value of assets less non-concessional contributions i.e. undeducted contributions since 1 July 1983) at the beginning of that income year is included in the taxable income for the year of change in status. Not only does this mean that the 15% concessional rate is lost, causing future earnings to be taxable at 45%, it also means that the value of accumulated assets financed by tax-deductible contributions and investment income on all contributions is taxed at 45%. © Kaplan Education 3.7 3.8 Specialist Knowledge: Superannuation (924) The consequences of becoming non-complying are: • not being subject to SIS rules and regulations • not having to remain an Australian superannuation fund • losing eligibility for tax deductions for contributions • losing eligibility for government co-contributions for non-concessional contributions • becoming subject to fringe benefits tax for Australian permanent resident employees • becoming subject to a tax rate of 45% • not having contributions taken into account for superannuation guarantee purposes • not having to pay tax when paying benefits to recipients (as they have already been fully taxed at 45%) • potentially being subject to an asset-based tax. Apply your knowledge 3: Non-resident makes a contribution A single-member SMSF holds assets of $500,000 on 1 July 2008. These assets represent concessional contributions and accumulated investments (net of fund tax) totalling $450,000 and non-concessional (undeducted) member contributions of $50,000. During the year ended 30 June 2007, the fund’s only member takes up residence in Singapore for an indefinite period and thus becomes a non-resident of Australia. After the member becomes a non-resident, the fund receives a contribution of $20,000 from the member. What would happen to the fund and what amount of tax would the fund attract? 924.SM1.9 Unit 3: Tax 3 Taxable contributions Subdivision 295-C of ITAA 97 determines what contributions are taxable. Broadly, these are: • contributions made for the purpose of making provision for superannuation benefits for another person, regardless of whether the contributor is entitled to a tax deduction. This includes employer contributions. (Note, however, that eligible spouse contributions are specifically excluded from the definition, as are contributions made by another person not associated with the employer.) The rule holds regardless of whether a tax deduction is allowable for the contributions • contributions received under s 65 of the Superannuation Guarantee (Administration) Act 1992 representing an employer’s superannuation guarantee (SG) shortfall for an employee, that is, the shortfall component of the superannuation guarantee charge which is paid to the member’s account • the part of a rollover amount that constitutes the untaxed element of the post-June 1983 component of an ETP. In general, these amounts arise from termination or golden handshake payments by employers. From 1 July 2007, the ability to roll over eligible termination payments is restricted to those payments where entitlement to receive the payment was in place at 9 May 2006 • personal superannuation contributions made by a member of a superannuation fund where a tax deduction is claimed on the contributions. Typically, contributors who are self employed and wish to claim a tax deduction for concessional contributions are required to provide a s 290-170 notice. A section 290-170 notice replaces the 82AAT notice used in prior years. Personal contributions made by a member intending to claim a tax deduction are treated as taxable contributions of the fund upon receipt of the relevant s 290-170 notice • a transfer of an amount from the Superannuation Holding Account Reserve (SHAR) maintained by the ATO • a transfer of an amount from a superannuation fund to another superannuation fund, except where the transfer constitutes a ‘rollover superannuation benefit’. Generally, a benefit is a rollover superannuation benefit if it is paid from one complying superannuation fund to another complying superannuation fund • a transfer of an amount from a foreign superannuation fund when the member for whom the transfer is made elects that the whole or part of the amount transferred is to be treated as taxable contributions to the transferee fund • a transfer of an amount from a foreign superannuation fund for a member when the amount transferred exceeds amounts vested in the member at the time of transfer. In such a case the excess is included in the recipient fund’s assessable income. Special rules apply to contributions to foreign superannuation funds and to transfers from foreign superannuation funds. Taxable contributions are generally assessed on a receipts basis (i.e. when received) rather than on an accruals basis. © Kaplan Education 3.9 3.10 Specialist Knowledge: Superannuation (924) Special rules apply when the trustee of the fund receives an s 290-170 notice for contributions made in a prior year after the fund has lodged its income tax return for that prior year. Where the trustee receives a late s 290-170 notice, the fund’s taxable contributions for the year in which the late notice is received will include that part of the prior year contribution that the member has claimed as a tax deduction (ITAA 1997 s 295-190). This ensures the fund avoids having to lodge an amended income tax return for the year to which the contributions relate. 3.1 No-TFN contribution income From 1 July 2007, a new category of taxable contribution has been introduced, called ‘no-TFN contribution income’. Contributions will be classified as no TFN contributions if the members for whom the contributions were received do not provide their TFN by the end of the fund’s income year during which the contributions were made. No-TFN contribution income over $1000 will attract tax at 46.5%. The ATO will issue a separate assessment specifying the amount of the no-TFN contribution income and imposing the tax on that amount. If the member subsequently quotes their TFN to the fund within four years from the year in which the contribution was made, the fund will be able to amend the assessment previously issued and get a tax refund for the excessive tax previously paid. The balance of the taxable contributions received by a complying superannuation fund is included in its assessable income in the normal manner and taxed at 15%. A fund cannot accept non-concessional member contributions (personal contributions) if a TFN has not been quoted. Therefore the no-TFN contributions tax does not apply to undeducted member contributions. Example: Refund of excess tax on contributions Apart from his full-time job as a horticulturalist teacher for TAFE, Michael has been consulting for a small gardening firm on and off for five years. Michael has never given his TFN to the superannuation fund to which the gardening firm was contributing for his benefit. The contributions have been taxed at the 46.5% rate. When Michael is advised that his superannuation has been taxed at a higher level he provides his TFN and the fund gets a refund of the excess tax paid. Further resources ATO 2007, ‘Tax file numbers and superannuation’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘superannuation tax file number’ in the search box, and selecting ‘Tax file numbers and superannuation’ from the results. Select the ‘Tax file numbers and superannuation’ PDF download. 924.SM1.9 Unit 3: Tax 3.2 Member contributions Member contributions are personal, voluntary contributions to superannuation funds made independent of contributions by employers. With limited exceptions primarily for self-employed people, member contributions are not tax deductible and not taxed to the fund. Apart from the exceptions, member contributions are classified as non-concessional (undeducted) contributions. Where an employee is a member of a superannuation fund to which both the employer and employee make contributions, the employee does not receive a tax deduction for their personal contributions out of after-tax income (non-concessional contributions). The superannuation fund receiving the contributions is liable to pay tax only on the employer contributions, and not on the employee contributions. Member personal contributions for which a tax deduction can be claimed but not claimed are also treated as non-concessional contributions. Deductions for member contributions and the 10% rule Deductions for member contributions are available mainly to self-employed people. This is because the deduction generally does not apply for people who receive superannuation from an employer at any time during the year. Exceptions to this are employees whose ‘income from employment’ makes up less than 10% of their total assessable income and reportable fringe benefits. For this purpose, income from employment includes the employee’s total assessable income and reportable fringe benefits arising from the employment. Deductions can be claimed by people who are under age 65 whether or not they are working. If claiming a tax deduction, the member must provide written notification to the trustee of the fund under s 290-170 of ITAA 97. The notice must provide information specified in the ATO Taxation Determination 93/224. The trustee must acknowledge receipt of the notice before the tax deduction can be claimed. Amounts claimed as a tax deduction are taxable to the fund, i.e., treated as assessable income. © Kaplan Education 3.11 3.12 3.3 Specialist Knowledge: Superannuation (924) Amounts excluded from taxable contributions Apart from member contributions that are not tax deductible, certain other amounts are also not treated as taxable contributions. These are: • contributions covered by an s 295-180 election. This election refers to the untaxed portions of post-June 1983 components of ETPs and to non-rebatable pensions determined under subdivision 301-C of ITAA 97 • taxable contributions transferred to a life insurance company or a pooled superannuation trust (PST) under s 295-260 of ITAA 97. (These amounts are taxed to the transferees and, in general, the tax is recovered from the investor superannuation fund.) • employer contributions that are exempted by the application of pre-1 July 1988 funding credits available to a fund (ss 295-265 and 295-270 ITAA 97). Other contributions which are not taxable The following contributions received by a superannuation fund are not included in taxable contributions: • contributions made by a spouse for the benefit of the other spouse • contributions made for the benefit of a child (i.e. below 18 years of age) unless they are made by or on behalf of the child’s employer • non-concessional contributions, that is, undeducted contributions • contributions arising from CGT concessions for small business • co-contributions made by the federal government under the co-contribution scheme. Review your progress 1 What contributions to a superannuation fund are taxable? 3.4 Transfer of tax liability on taxable contributions The tax liability on the taxable contributions received by a complying superannuation fund may be transferred to: • a life insurance company carrying on a superannuation business • a pooled superannuation trust (PST). A transfer is effected by an agreement between the transferor and the transferee, and must be made on or before the lodgement of the tax return of the transferor for the transferor’s year of income. Once an agreement is made, it is irrevocable. Before the amount of taxable contribution to be transferred is determined, the trustee of a fund should assess the overall tax situation of the fund to ensure that no tax disadvantage arises from the transfer. For example, where the trustee of a fund incurs administration expenses or pays insurance premiums to insure the fund’s liability to pay death or disability benefits, these expenses are generally tax deductible to the fund. In these situations, the trustee should ensure that taxable contributions of an amount at least equal to such deductions are not transferred. This should ensure that the tax deduction can be claimed for the expenses. 924.SM1.9 Unit 3: Tax 4 Investment income A major component of the fund’s assessable income is income earned from the fund’s investments. The investment income of the fund is broadly represented by the following items: • gross interest • gross dividends (including franking credits) • trust distributions • other Australian income • the assessable part of realised capital gains • any refunds or rebates received for insurance premiums for which a deduction had previously been claimed. The net investment income (i.e. gross investment income less allowable deductions) of a complying fund is subject to the concessional tax rate of 15%. 4.1 Superannuation fund assets The trustee of a superannuation fund invests money in various assets. The trustee may directly acquire income-producing assets, such as bank accounts, debentures, shares, real estate and units in unit trusts, or may invest through life insurance policies or units in pooled superannuation trusts (PSTs). Direct investments Funds are liable to pay tax on the income and gains arising from direct investments. Gains from income-producing assets are divided in two categories: • ordinary income — for example rent, interest or dividends • capital gains — for example profit on disposal of shares or real estate. Rent and interest income is usually assessed on a receipts basis (i.e. when received or credited). Gains realised on the disposal of fixed interest securities (i.e. not shares in companies or units in unit trusts) are treated as ordinary income and are not subject to capital gains tax. Investments in life insurance and PST units Where investments are made in life insurance policies and PST units, tax on the investment income is paid by the life office or the PST. The superannuation fund receives the policy proceeds or unit proceeds free of any further tax. © Kaplan Education 3.13 3.14 4.2 Specialist Knowledge: Superannuation (924) Dividends Investment in shares of Australian companies paying franked dividends is particularly attractive for a superannuation fund. This is because franked dividends received from Australian companies generally carry a franking credit (tax offset) at 30%. Given that a complying superannuation fund pays tax at the lower rate of 15%, the excess tax offset of 15% (i.e. 30% – 15%) helps to reduce tax on other income. Additionally, from 1 July 2000, any excess franking credits not offset against the fund’s tax liability on taxable income can be claimed back as a cash refund from the ATO to boost the effective returns of the fund. Example: Fully franked divided Assume the taxable income of a complying superannuation fund excluding dividends is $9500 for 2008/09. The complying superannuation fund receives a fully franked dividend of $1000 (assume the franking credit is based on a corporate tax rate of 30%). The income tax position of the fund would be calculated as follows: $ Taxable income (excluding dividends) 9,500 Franked dividend received 1,000 Dividend gross-up for franking credit $1000 × 30/70 429 Total taxable income 10,929 Gross tax on taxable income @ 15% 1,639 Less franking credit offset (429) Net tax payable on total income 1,210 Tax payable on income (other than dividend income) 15% of $9500 = 1,425 Therefore, tax saving arising from fully franked dividends $1425 – $1210 = 215 Therefore, the complying superannuation fund pays less tax than it would have paid had it not received the franked dividend at all. 924.SM1.9 Unit 3: Tax Apply your knowledge 4: Interest and franked dividends Assume a complying superannuation fund receives interest income of $5000 and fully franked dividends of $7000 during the year ending 30 June 2009. Assume the franking credit is based on a corporate tax rate of 30%. The fund has incurred a $2000 administration expense for the year. Determine the tax position of the fund for the year: $ Interest Dividends: Franked Franking credit gross-up $ 5,000 7,000 Total assessable income Allowable deduction: administration expenses Total allowable deductions Taxable income Tax payable on taxable income Less franking credit offset Tax refund due Unfranked dividends are fully assessable. There is no gross-up of such dividends and no franking credit offsets are allowed. Dividends received from foreign companies are taxable as ordinary income, but a credit may be available for any foreign withholding tax paid. Remember that dividends might not always be received in cash. They might be automatically used to purchase additional shares under a dividend reinvestment plan. Dividends might also be received indirectly through unit trust distributions. These amounts are still assessable as ordinary income, and franking credit offsets are allowed, where applicable. 4.3 Capital gains and losses A complying superannuation fund must include in its assessable income any net capital gains derived by the fund. A net capital gain is the excess of realised capital gains over realised capital losses. When realised capital losses exceed realised capital gains, the resulting net loss is quarantined and carried forward to offset against future realised capital gains. In calculating the net capital gain for a particular year, no distinction is drawn between foreign assets and domestic assets. In other words, a loss on a domestic asset may be offset against a gain on a foreign asset, and vice versa. Capital gains are assessed under either the indexation rules (for assets purchased before 21 September 1999) or the one-third discount rule (for assets sold on or after 21 September 1999 irrespective of the date of purchase) (see below). Any asset owned by a complying superannuation fund as at 30 June 1988 is taken to have been acquired by the fund at that date. This effectively means pre-CGT assets (i.e. assets purchased by a superannuation fund prior to 19 September 1985) lose their tax-free status. Special rules apply for calculating the cost base of such assets. © Kaplan Education 3.15 3.16 Specialist Knowledge: Superannuation (924) Assets acquired before 21 September 1999 Where an asset acquired before 21 September 1999 has been held for at least 12 months, upon disposal, the complying superannuation fund can elect to pay tax on the lower of: • a capital gain calculated under the indexation rule using the indexed cost base method, or • two-thirds of the nominal capital gain (i.e. sale proceeds less unindexed original cost base) under the discount method. This discount method is also used for assets acquired on or after 21 September 1999 (see below). Indexation rule (indexed cost base method) The cost base can be indexed up to 30 September 1999. No indexation of the cost base applies from 1 October 1999. If the indexed cost base method is adopted, no tax is payable on that part of the gain that is attributable to inflationary adjustments. This means that any capital gain equals disposal price less indexed cost base of the asset. Assets acquired on or after 21 September 1999 (discount method) Where an asset acquired on or after 21 September 1999 is disposed of after being held for at least 12 months, the superannuation fund may claim exemption from tax for one-third of the capital gain under the one-third discount rule. The indexation rule does not apply to such assets. Example: CGT calculation — Indexed cost base method Assumed purchase price in December 1988 $100,000 Asset sold in September 2008 $140,000 Index — December 1988 quarter Index — September 1999 quarter (frozen quarter) Assessable capital gain — indexed cost base method Sale proceeds Less indexed cost base $100,000 × 92.00 123.40 $ $140,000 123.4 92.0 (factor of 1.341 rounded to three decimal places) Assessable capital gain ($134,100) $5,900 Apply your knowledge 5: CGT calculation Calculate the assessable capital gain/loss using the indexed cost base method if the asset in the example above was sold for: • $130,000 • $96,000. 924.SM1.9 Unit 3: Tax Example: CGT calculation — discount method Using the same information as the previous example, the assessable capital gain can be calculated as: Assessable capital gain — discount method $ Sale proceeds $140,000 Less original cost base ($100,000) Nominal capital gain $40,000 Less one-third discount ($13,333) Assessable capital gain under discount method $26,667 As the asset was acquired before 21 September 1999, tax would be determined based on the method that produces the lower assessable gain. The assessable capital gain thus is $5900 under the indexed cost base method. Apply your knowledge 6: Comparing CGT methods Using the above example, calculate whether a discount method or an indexed cost base method is the appropriate method to use to minimise CGT if the sale proceeds were $205,000. 4.4 Non-arm’s length income Non-arm’s length income comprises certain excessive private company dividends and distributions from non-fixed (i.e. discretionary) trusts. Non-arm’s length income is taxed at the highest marginal rate applicable to individuals (currently 45%) instead of the concessional rate of 15%. 4.5 Trust distributions Trust distributions received from all trusts other than fixed trusts by a superannuation fund are generally taxed at 45%. Further, distributions from unit (fixed) trusts in excess of an arm’s length amount are also taxed at 45% if the units in the fixed trust were acquired by a non-arm’s length transaction among the parties. Income arising from arm’s length investments in unit trusts continues to be taxed at 15%. © Kaplan Education 3.17 3.18 4.6 Specialist Knowledge: Superannuation (924) Exempt current pension liability income Where a complying superannuation fund is liable to pay a current pension, a portion of its assessable income is exempt from tax. The exemption does not apply to taxable contributions and non-arm’s length income. The exemption may be calculated in the following ways: • Where the fund assets are segregated for the purpose of paying current pensions, the income from such segregated assets is exempt (s 295-385 of ITAA 97). • Where the fund assets are unsegregated or segregated in respect of its non-current pension liability only, the exempt amount is to be calculated under a statutory formula set out in s 295-390 of ITAA 97. Other matters to note are: • An actuary’s certificate is required to determine the fund’s current pension liability and its superannuation liability if the fund has either segregated current pension assets or segregated non-current pension assets for a financial year. The certificate must be obtained before the return for that financial year is lodged. This certificate is not required if the fund is solely a pension fund. A certificate is also not required where the fund holds assets to pay pensions that are allocated pensions, marketlinked pensions and account-based pensions. • A fund with both pension and non-pension members might need to allocate some of its expenses to its exempt pension income. These expenses would not be tax deductible. 4.7 Goods and services tax (GST) Goods and services tax (GST) is payable as from 1 July 2000. Generally, the following rules apply to superannuation funds: • GST is payable for any administration service fees directly procured by the fund. • GST is payable on any investment management fees directly paid by a fund. • No GST is payable on employer and member contributions. • No GST is payable on investment earnings received by a fund. • No GST is payable on the life insurance premiums payable by a fund for its liability to pay death and certain disability (generally, total and permanent disability) benefits. In general, funds are entitled to receive a refund of up to 75% of the GST paid on investment management, trustee services and certain administration service fees, if the fund is registered under the GST Act. Detailed rules governing the application of GST are beyond the scope of this subject. 924.SM1.9 Unit 3: Tax 5 Changing residency A change in residency of a fund affects its tax status. An Australian fund that becomes a foreign fund will lose concessional treatment. On the other hand, a foreign fund that becomes a complying Australian fund may gain concessional tax treatment. 5.1 An Australian fund becoming a foreign fund If an Australian fund becomes a foreign fund, it will automatically cease to be a complying fund. The Australian Prudential Regulation Authority (APRA) or the ATO have no discretion in this matter. Upon becoming a non-complying fund, a fund will automatically be liable to pay 45% tax on its taxable income. Such taxable income would usually include all taxable contributions and assessable investment income derived during the year. It also includes certain income from previous years calculated in accordance with the formula set out in s 295-325. If the fund is required to pay tax on previous years’ accumulated assets, for the purpose of calculating any liability to capital gains derived in later years, the cost base of the assets held on the first day of the current year of income is taken to be their market value on that day. 5.2 A foreign fund becoming an Australian fund Compliance status can be granted to a foreign fund that becomes an Australian fund if it elects to be regulated under the SIS Act. The fund would remain a non-complying fund during the year in which it first becomes an Australian fund. Ordinarily, a foreign fund is liable to pay Australian tax only on income that is sourced in Australia. (Special rules apply to taxable contributions made to a foreign fund for persons who are Australian residents or who earn salary or wages subject to Australian tax.) However, upon becoming an Australian fund, the fund’s taxable income for the year would also include certain income arising in the previous income years calculated in accordance with the formula set out in s 295-330. If, upon conversion, the fund remains a non-complying fund, the tax payable on the previous net income would be calculated at 45%. If, on the other hand, the fund becomes a complying fund, it would be taxed at 15%. Note that in the year of conversion, such a fund would remain a non-complying fund for that year unless the conversion occurs at the beginning of the year. A credit is allowed for any foreign tax paid up to the amount of Australian tax payable by the fund. © Kaplan Education 3.19 3.20 6 Specialist Knowledge: Superannuation (924) Rollovers A rollover, or transfer, refers to the act of a member shifting superannuation benefits from one fund but keeping them with the superannuation system. The rollover can be to: • another superannuation fund • a retirement savings account (RSA) • an eligible retirement fund (ERF) • an approved deposit fund (ADF) • a deferred annuity (DA). When a benefit is rolled over or transferred between taxed funds, tax is deferred until the money is withdrawn as a lump sum or received as an income stream. If it was received from an untaxed fund, the roll over is treated as income. The most common source of untaxed money prior to 1 July 2007 was employer-paid ETPs. ETPs from unfunded government superannuation schemes can also be an untaxed source. Transfers from one superannuation fund to another retain their status within the superannuation system. Preserved benefits must be retained within the superannuation system if a member terminates employment before meeting an appropriate condition of release, such as reaching the applicable preservation age. Sometimes, members with unrestricted non-preserved benefits will be able to cash out their superannuation, paying lump sum tax if necessary. Alternatively, they may be able to roll-over their benefits to another superannuation fund. Funds may require specific information and proof of identity before effecting a rollover or transfer. Once all required information is supplied, the payment must generally occur within 30 days. Changes to employer payments on termination of employment As from 1 July 2007, significant restrictions have been imposed on the ability to roll-over lump sum payments received from an employer due to termination of employment. Limited transitional rules allow employees to roll over an employer lump sum termination payment where they were entitled to the lump sum termination payment before 10 May 2006 under a written contract or a federal or state law. In such cases, the relevant termination payment must be made by 30 June 2012. Deciding whether to roll over or not Rollovers can make significant tax savings. However, deciding whether to roll-over funds requires careful consideration of complex issues re advantages and disadvantages of such roll-over. 924.SM1.9 Unit 3: Tax Some superannuation funds allow members to retain their benefits within the fund after they terminate employment. Others might give an employee up to 90 days to consider their options or may require them to take the money out of that fund upon termination of employment. If the superannuation benefit cannot remain in the original fund, members can park their superannuation benefit in another fund while deciding what to do with their benefits. In these cases, it may be preferable to use superannuation funds with no entry and exit fees or a retirement savings account. A member must decide whether or not to roll over a particular superannuation benefit if they can access the benefit in cash and retain it. This is usually the case if the member has reached the relevant preservation age and the benefit is not required to be retained within superannuation. 6.1 Advantages of rolling over funds Rolling over superannuation benefits may offer advantages over taking the lump sum in cash and reinvesting it outside superannuation. The benefits of rolling over into superannuation include: • Lump sum tax deferral — because the investor does not take a lump sum, no lump sum tax is payable when rolling over. (Contributions tax at 15% is imposed on money received from an employer-paid ETP, such as a golden handshake or ex-gratia payment, or from an untaxed fund.) Deferring receipt of an ETP can allow the investor to take advantage of lower rates of lump sum tax applicable to ETPs for people aged over 55. Because no lump sum tax will be payable on benefits from a taxed fund received after age 60, deferring can result in substantial tax savings. • Continued investment in a tax-efficient environment — the fund’s earnings, including any capital gains, are generally taxed at no more than 15%. This rate may be further reduced by franking credits. Note: this benefit is still available for any lump sum withdrawn from superannuation and then re-contributed as a nonconcessional member contribution. • The money continues to be kept as a provision for retirement. • Rollovers allow investors to consolidate superannuation benefits on changing jobs. 6.2 Disadvantages of rolling over Rollovers are not an appropriate option in some situations. The major disadvantage is that the employee cannot access the money. This means that investors must weigh up accessibility against any tax payable on cashing it out. (From 1 July 2004, employer ETPs are fully preserved if rolled over, restricting access to these funds until a condition of release is met.) © Kaplan Education 3.21 3.22 6.3 Specialist Knowledge: Superannuation (924) Rolling over employer ETPs Prepayment stage The prepayment stage is when members are given information about an ETP and an opportunity to roll over. This stage usually takes place when the ETP is paid directly by an employer or from an employer-sponsored superannuation fund, and where the rollover decision has not been initiated by the investor. The aim is to provide the investor with the information necessary for them to decide whether to take the ETP in cash or roll it over. Many public offer superannuation funds dispense with this stage, as the investor has effectively made this decision prior to requesting payment of their benefit. Once a recipient has elected a rollover, payers have to provide information to receiving funds (i.e. the rollover fund) in an ETP rollover statement. 6.4 Choosing a rollover fund Section 243 of the Superannuation Industry (Supervision) Act 1993 sets out rules allowing certain member benefits to be paid to an eligible rollover fund (ERF). Generally, trustees of a superannuation fund must decide and advise the member the circumstances in which benefits are to be paid into an ERF. Being unable to locate the member is an example of an appropriate circumstance. Rollover vehicles currently available to investors are: • complying superannuation funds and retirement savings accounts (RSAs) • approved deposit funds (ADFs) • deferred annuities. In choosing a rollover fund, the client should consider: • investment objectives, strategy and performance • the level of investment choice • fees and charges • the ability to make further contributions • types of death benefit options • other benefits available from the fund. Lost and inactive members A benefit is defined as ‘unclaimed’ if: • the member has reached age 65 • no monies have been received from or for the member for at least two years • five years have expired since the last contact with the member, despite the trustee ‘making reasonable efforts’. Similar rules apply if the member has died and the trustee has been unable to pay the death benefit. In this instance, the time which needs to elapse is a ‘reasonable period’ rather than five years. 924.SM1.9 Unit 3: Tax Unclaimed benefits do not remain in the fund, as trustees are required to transfer them to the ATO or, in certain cases, the state or territory government. Under the SIS Act, a member is generally taken to be ‘lost’ if they are ‘uncontactable’ or ‘inactive’. A member is uncontactable if: • the fund never had an address for the member, or • two written communications have been returned unclaimed (or one returned communication if the trustee so determines). An inactive member is a member who: • has been a member of the fund for longer than two years • was an employer-sponsored member at the date of joining the fund, and • has not had a contribution or rollover received by the fund for them within the last five years. A fund must report the details of lost members to the ATO and, if the member is transferred, notify the transferee fund of the prescribed details of the lost member. The ATO keeps a database of lost members. People looking for their superannuation can search the database on the ATO website. Clients who have lost superannuation benefits can apply to the ATO to confirm the existence of such benefits and then apply to the appropriate superannuation fund or ERF for payment of the benefit. Superannuation funds investment choices Most superannuation funds offer a multitude of investment (asset allocation) choices. These include: • single-sector investment options, which may range from cash to international equities • diversified investment options, including conservative, balanced and growth options • investment options managed by a range of investment funds • a range of listed securities. Approved deposit funds Approved deposit funds (ADFs) are managed investments that can accept only ETPs. ADFs were originally established as tax-free investment vehicles with the main purpose of allowing people changing jobs to hold their superannuation payout until retirement. All earnings accumulate within the fund and are reinvested. Investment earnings are taxed at 15% within the fund. ADFs offer investors a range of investment choices, including cash, diversified funds and single-sector funds. Some banks offer ADFs, sometimes with nil entry and exit fees. © Kaplan Education 3.23 3.24 Specialist Knowledge: Superannuation (924) Deferred annuities A deferred annuity (DA) is a managed investment offered by a friendly society or life company that accepts ETP rollovers. Investors can roll over to an annuity to convert the investment into an income stream. After starting an annuity, a commuted lump sum payment received after age 60 would be tax-free. Deferred annuities are regulated primarily under the Life Insurance Act (Cth), but are also subject to the benefit protection standards prescribed in the SIS Regulations. Investments can be either capital guaranteed or market linked. Providers offer many asset allocations. Products include diversified funds and sector funds. 6.5 Effects of rolling over an employer ETP A rolled-over ETP generally retains the value of restricted and unrestricted non-preserved benefits as at the time of rollover. This may be different from the benefit’s preservation status within the fund prior to rollover if any preserved or restricted non-preserved benefits become unrestricted due to a condition of release. The main exception to this rule is for employer ETPs, which become preserved if rolled over, even though they could be taken out in cash when first payable. In any case, earnings on the rolled-over amounts are treated as preserved benefits. Example: Retention of restricted and unrestricted benefits Gary is retrenched from his job and receives an ETP from his employer of $8000. He is eligible to rollover his employer ETP because he qualifies under transitional provisions (see section 7.6). In addition, he has a $17,000 superannuation benefit in his employer’s superannuation fund, with $7000 of restricted non-preserved benefits and $10,000 of preserved benefits. Gary decides to roll over both his superannuation benefit and the employer ETP. His $25,000 benefit in the rollover fund is then: • $18,000 preserved benefits, from $10,000 preserved benefits rolled over from the employer fund and $8000 of benefits automatically preserved due to the rollover of his employer ETP • $7000 unrestricted non-preserved benefits, as Gary met a condition of release when he terminated employment. 6.6 Transitional rules for employer ETPs Transitional rules apply to employment termination payments that were specified in existing employment contracts at 9 May 2006 if they are paid before 1 July 2012. These payments are known as ‘transitional termination payments’ (TTPs) and are subject to concessional tax rules (see Table 2). They can be taken in cash or rolled over. 924.SM1.9 Unit 3: Tax If the taxable component is cashed out, it is included as assessable income and taxed as follows: • For a person who has reached preservation age (currently age 55) or who will reach preservation age in the income year in which they receive their employment termination payment: – maximum 15% on taxable payments up to $145,000 (for 2008/09) – maximum 30% on taxable payments between $145,000 and $1 million – at the top marginal rate plus Medicare levy for taxable payments over $1 million. • For a person who is under preservation age: – maximum 30% on taxable payments up to $1 million – top marginal rate plus Medicare levy for taxable payments over $1 million. The tax-free component of a lump sum payment is not subject to tax. Rolled-over amounts up to $1,000,000 will not count towards the $50,000 cap on concessional contributions. Rolled-over amounts above $1,000,000, however, do count towards the concessional contribution cap. No employment termination payments can be rolled over into a superannuation fund from 1 July 2012. This means that after that time all employment termination payments must be received in cash. Table 2 Summary of the tax treatment for transitional termination payments (TTP) Age TTP cashed out prior to 1 July 2012 Tax treatment Tax-free component Nil Taxable component: Under preservation age Preservation age and over TTP rolled into superannuation prior to 1 July 2012 First $1,000,000 @ 30% max > $1,000,000 45% + Medicare levy First $145,000 @ 15% max $145,000 to $1,000,000 @ 30% max > $1,000,000 @ 45% + Medicare levy Any First $1,000,000 @ 15% > $1,000,000 @ 45% + Medicare levy Payment of tax (PAYG and ATO assessment) A payer of a superannuation benefit must deduct tax at source from the payment and remit it to the ATO under the PAYG tax system. From 1 July 2007, PAYG tax at source must be calculated on any taxable component (taxed and untaxed elements): • using the rates quoted above, and • assuming, if the taxpayer is over age 55, that the low rate threshold is available. If, however, the recipient’s tax file number (TFN) is not quoted to the payer before the payment is made, PAYG tax is deducted at source at the highest marginal tax rate of 46.5%, including the Medicare levy. © Kaplan Education 3.25 3.26 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 Unit 3: Tax Suggested answers Apply your knowledge 1: Australian fund (a) Australian fund. (b) Australian fund. (c) Australian fund. (d) Australian fund. (e) Not an Australian fund. Apply your knowledge 2: Active members (a) Active member. (b) Not an active member. (c) Not an active member. Apply your knowledge 3: Non-resident makes a contribution The fund would cease to be an Australian superannuation fund and would automatically lose its complying status (subject to the automatic 2-year residency rule). The trustee of the non-complying fund would be liable to pay tax of 45% on $450,000 (i.e. $500,000 less $50,000), being the net asset value of the fund at the beginning of the year. Further, any investment income earned by the fund in Australia during the 2007/08 income year would attract tax at 45%. Apply your knowledge 4: Interest and franked dividends $ Interest Dividends: Franked Franking credit gross-up 5,000 $7,000 $7,000 × 30/70 = 3,000 Total assessable income Allowable deduction: administration expenses Total allowable deductions Taxable income Tax payable on taxable income of $13,000 at 15% 10,000 15,000 $2,000 (2,000) 13,000 1,950 Less franking credit offset (3,000) Tax refund due 1,050 Note: The franking credit offset is fully available even if the fund is in the pension phase and is therefore not subject to taxation on investment income. © Kaplan Education 3.27 3.28 Specialist Knowledge: Superannuation (924) Apply your knowledge 5: CGT calculation If the asset is sold for $130,000, no assessable capital gain would arise — neither would there be a capital loss for tax purposes. If the asset is sold for $96,000, a deductible capital loss of $4000 would arise. Apply your knowledge 6: Comparing CGT methods If, in the above example, the sale proceeds were $205,000, the assessable capital gain would be calculated as follows: Indexed cost base method $ Discount method $ Sale proceeds 205,000 205,000 Less indexed cost base (134,100) Cost base Assessable capital gain Nominal capital gain (100,000) 70,900 105,000 Less one-third discount 35,000 Assessable capital gain $70,000 In this case, the assessable capital gain would be calculated using the one-third discount method, and the assessable amount would be $70,000. 924.SM1.9 Unit 3: Tax Review your progress 1 The following contributions to a superannuation fund are taxable: • Employer contributions, whether or not concessional (tax deductible). • Contributions made by persons other than: – the member – the federal government under its co-contribution scheme – parents, relatives or friends for a person below 18 years of age, whether or not these are tax deductible – eligible spouse contributions. • Concessional contributions made by a member (e.g. a self-employed or other eligible person). • The untaxed element of the post-June 1983 component of a lump sum payment rolled over into the fund. • Contributions made by a person under s 65 of the SIS Act. • Amounts transferred from the Superannuation Holding Accounts Reserve. • Amounts transferred from a foreign superannuation fund and treated as a taxable contribution pursuant to an election made by the member. Review your progress 2 In general, expenses incurred in the carrying on of a fund’s activities are deductible. Examples are actuarial costs, accountancy costs, audit fees, trustee fees, benefit payment costs and member service costs. Expenses are also deductible under specific sections. For example, tax agents’ fees and APRA lodgement fees are deductible under s 25-5 of ITAA 97. Expenses incurred in connection with the acquisition of investments in life insurance policies and pooled superannuation trust units are not deductible. Expenses incurred in deriving exempt income are also not deductible. © Kaplan Education 3.29 3.30 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 4 Superannuation benefits Overview 4.1 Unit learning outcomes ....................................................................4.1 Further resources ............................................................................4.2 1 1.1 1.2 1.3 1.4 When can superannuation benefits be paid? 4.3 The concept of ‘preserving’ benefits.........................................4.3 Funds accumulated prior to 1 July 1999 ...................................4.3 Funds preserved from July 1999 ..............................................4.5 No compulsory cashing ...........................................................4.5 2 2.1 2.2 Preservation rules 4.6 Conditions of release for preserved benefits .............................4.6 Transition to retirement...........................................................4.9 3 3.1 3.2 3.3 3.4 Taxation of superannuation components 4.10 The tax-free component.........................................................4.10 The taxable component .........................................................4.11 Superannuation benefits paid to non-residents........................4.14 Disability superannuation benefits .........................................4.15 4 Tax on superannuation death benefits 5 5.1 5.2 Reasonable benefit limits 4.18 RBL requirements prior to 1 July 2007 ...................................4.18 Advisers and RBLs................................................................4.20 Suggested answers 4.16 4.21 Unit 4: Superannuation benefits Overview From 1 July 2007 superannuation benefits, whether lump sum or pension, became tax-free for those over age 60, provided those benefits have been subject to tax in the fund. This unit concentrates on options available for withdrawing benefits from a superannuation fund. It details the taxation on the various options and illustrates strategies to maximise the tax-effectiveness. The thresholds used in this unit are current for the 2008/09 financial year. This unit specifically addresses the following subject learning outcomes: • Critique available superannuation structures and contribution strategies for different client situations. • Evaluate the taxation implications of superannuation strategies for contribution, withdrawal and insurance at the fund level. Unit learning outcomes On completing this unit, you should be able to: • outline the circumstances when superannuation must be kept in superannuation (preserved) • outline the circumstances when superannuation can be withdrawn • describe the two components of superannuation benefits (i.e. tax-free and taxable) which apply from 1 July 2007 • calculate the tax payable on the taxable component of superannuation if withdrawn as a lump sum • outline the ongoing effect of reasonable benefit limit rules that were applicable before 1 July 2007. © Kaplan Education 4.1 4.2 Specialist Knowledge: Superannuation (924) Further resources • APRA, ‘Early release of superannuation benefits’ [online]. Available from: <http://www.apra.gov.au> by entering ‘early release superannuation’ in the search box [cited 18 June 2008]. • ATO 2007, ‘Departing Australia superannuation payment summary instructions’ [online] 13 December. Available from: <http://www.ato.gov.au> by entering ‘departing Australia superannuation payment summary’ in the search box [cited 18 June 2008]. • ATO 2007, ‘Paying a disability lump sum benefit’ [online] 31 August. Available from: <http://www.ato.gov.au> by entering ‘disability superannuation benefit lump sum’ in the search box [cited 18 June 2008]. • ATO 2007, ‘Paying a disability income stream benefit’ [online] 31 August. Available from: <http://www.ato.gov.au> by entering ‘disability superannuation benefit income stream’ in the search box [cited 18 June 2008]. • ATO 2007, ‘Paying a lump sum death benefit’ [online] 30 August. Available from: <http://www.ato.gov.au> by entering ‘superannuation lump sum death benefit’ in the search box [cited 18 June 2008]. • ATO 2007, ‘Paying an income stream death benefit’ [online] 30 August. Available from: <http://www.ato.gov.au> by entering ‘superannuation income stream death benefit’ in the search box [cited 18 June 2008]. • ATO 2007, ‘Reasonable benefit limits — practical tips for tax practitioners’ [online] 13 September. Available from: <http://www.ato.gov.au> by entering ‘RBL practical tips’ in the search box [cited 18 June 2008]. • Taylor, S, Juchau, R, Houterman, B & McDonald, T 2007, ‘Chapter 6: Superannuation and retirement’, Financial planning in Australia, 2nd edn, LexisNexis Butterworths, Australia, pp. 569–572. 924.SM1.9 Unit 4: Superannuation benefits 1 When can superannuation benefits be paid? Advising clients on when and how they can access their superannuation is an important role for the financial adviser. 1.1 The concept of ‘preserving’ benefits The government provides tax concessions to encourage saving into superannuation. In return for tax concessions, the government restricts a fund member’s ability to withdraw superannuation before retirement. Additionally, a fund may include restrictions on withdrawing benefits in its trust deed. Superannuation benefits accrued since 1 July 1999 are generally preserved until retirement, that is, they cannot be withdrawn. However, some benefits accrued before 1 July 1999 may be accessed before retirement because of the grandfathering of old rules. There are three categories of superannuation benefits, as defined by the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SIS Regulations): • preserved • restricted non-preserved • unrestricted non-preserved. Restricted and unrestricted non-preserved benefits were determined according to accumulated benefits held at 30 June 1999. 1.2 Funds accumulated prior to 1 July 1999 Before 1 July 1999, the distinction between preserved and non-preserved benefits depended on the source of the contribution to the fund. The dollar amounts for unrestricted or restricted non-preserved benefits were fixed (frozen) at 30 June 1999. No indexation applies to these non-preserved benefits and they will not increase as all future contributions and investment earnings are preserved. The fund trustee advises each member how much of their benefit is preserved, restricted non-preserved and unrestricted non-preserved. This information should be included in a member’s annual statement as well as: • the prepayment statement provided by a superannuation fund advising that a benefit is payable • the rollover statement if any of the benefit has been rolled over • the group certificate if any of the benefit has been taken in cash. © Kaplan Education 4.3 4.4 Specialist Knowledge: Superannuation (924) Preserved benefits Preserved benefits must generally be kept in the superannuation system until a condition of release is met (see section 2.1 below). If a member of an employer fund changes employers, they will usually be asked whether they wish to keep their preserved benefits in their original fund or roll them over to another fund. In some cases, they may be required to change funds. The receiving fund must continue to preserve the preserved portion of a rolled-over benefit. Restricted non-preserved benefits Restricted non-preserved benefits are generally benefits that are not preserved but that cannot be cashed until a condition of release is met. For example, some restricted non-preserved benefits accrued before 1 July 1999 in an employer-sponsored fund are restricted while the member is employed by that employer-sponsor. Upon terminating employment, the benefits become unrestricted and can be paid out. The conditions of release for restricted non-preserved benefits are less strict than for preserved benefits. Unrestricted non-preserved benefits Unrestricted non-preserved benefits have already met a condition of release and can be immediately paid to an individual without restrictions. Any part of a superannuation benefit that is unrestricted non-preserved can be: • withdrawn as a lump sum (i.e. cashed), possibly subject to lump sum tax • taken as an income stream • retained in the superannuation fund and left to grow indefinitely • accessed in some combination of the above measures. Example: Preservation Alicia, age 45, is about to leave her job at Alpha Ltd and start with Omega Ltd. Her latest statement from the Alpha Staff Superannuation Fund stated that her withdrawal benefit comprised: Unrestricted non-preserved $5,000 Restricted non-preserved $7,000 Preserved $28,000 Total $40,000 When Alicia ceases employment with Alpha Ltd, the restricted non-preserved benefit will become unrestricted non-preserved and her benefit would comprise: Unrestricted non-preserved Restricted non-preserved $12,000 – Preserved $28,000 Total $40,000 She could, if she wanted to, cash out some or all of the $12,000 unrestricted non-preserved amount and use this less tax to, say, reduce her mortgage or pay for a holiday. 924.SM1.9 Unit 4: Superannuation benefits 1.3 Funds preserved from July 1999 Preservation rules were tightened on 1 July 1999. From this date, preservation applies to: • all new contributions to superannuation, including non-concessional (after tax) contributions • all fund earnings, including earnings on existing restricted and unrestricted non-preserved benefits. Employer termination payments Prior to 1 July 2007, some payments made by an employer on cessation of employment were known as employer eligible termination payments (ETPs) and treated the same as a superannuation ETP. From 1 July 2004, any such payments rolled over into superannuation were preserved in the fund. Employer ETPs rolled over before 1 July 2004 continue to be unrestricted non-preserved benefits unless the superannuation fund trust deed imposed preservation restrictions. Note: A termination payment made by an employer from 1 July 2007 is called an employment termination payment (also abbreviated to ‘ETP’). These are no longer treated like a superannuation benefit and generally cannot be rolled over unless the transitional rules are satisfied. There are significant differences between the rules for an eligible termination payment made prior to 1 July 2007 and an employment termination payment made after 30 June 2007. 1.4 Remaining in the accumulation phase Members can remain in the accumulation phases indefinitely, including having some of their funds in a pension and some in accumulation. This provides flexibility to the member to decide when to withdraw superannuation benefits. Note: Prior to 10 May 2006 superannuation benefits had to be paid to members after age 65, either as an income stream or a cash lump sum, if a work test was not satisfied, or at age 75 regardless of work status. © Kaplan Education 4.5 4.6 Specialist Knowledge: Superannuation (924) 2 Preservation rules To ensure superannuation is used for the purpose of providing for retirement, benefits cannot be paid until certain conditions are met. The ‘conditions of release’ and ‘transition to retirement’ rules set out these conditions. 2.1 Conditions of release for preserved benefits Preserved benefits are accessible if the member: • reaches preservation age and receives the benefit as a non-commutable income stream, that is, starts a transition to retirement pension • retires after reaching the preservation age • terminates employment on or after the age of 60, irrespective of future work intentions • attains the age of 65, irrespective of future work intentions • ceases employment with a preserved benefit of $200 or less in an employer-sponsored fund • retires from the workforce due to permanent incapacity • receives a non-commutable income stream during a period of temporary incapacity • dies and the benefit is paid to a nominated beneficiary or the member’s estate • qualifies under financial hardship or compassionate grounds (limited amounts are released) • departs Australia permanently (in limited circumstances). Retirement and preservation age Preserved benefits must generally be retained in the superannuation system until retirement after the relevant preservation age. The definition of retirement varies depending on whether the member is aged over 60 or aged under 60 but over preservation age (currently 55). If a member has reached their preservation age (currently age 55) but not yet age 60, retirement occurs when: • an employment arrangement has terminated (at any age) • the trustee is satisfied that the member intends never again to be gainfully employed for 10 hours or more in any one week. If the member is aged 60 or over, retirement occurs as soon as an employment arrangement ceases. The member does not need to permanently retire. If the member satisfies these conditions, they can access all their superannuation benefits. 924.SM1.9 Unit 4: Superannuation benefits Date of birth and preservation age The preservation age of a fund member depends on their date of birth. For people born before July 1960, the preservation age is 55. For those born after this date, the preservation age is being phased up to age 60, as shown in Table 1. Table 1 Date of birth and preservation age Date of birth Preservation age Prior to 1 July 1960 55 1 July 1960 – 30 June 1961 56 1 July 1961 – 30 June 1962 57 1 July 1962 – 30 June 1963 58 1 July 1963 – 30 June 1964 59 After 30 June 1964 60 Permanent incapacity Preserved superannuation benefits can be accessed under permanent incapacity if the member is totally and permanently unable to ever again be employed in any occupation for which they are reasonably qualified based on their education, experience and training. This requires certification by two medical practitioners. Severe financial hardship Early release of a preserved benefit may be permitted if the member meets the rules for release under severe financial hardship or compassionate grounds. An early release of benefit under severe financial hardship is permitted only where the fund trustee agrees, the trust deed permits this, and the member satisfies one of two tests of release, depending on the member’s age. These tests are as follows: 1. If the person is aged less than 55 years and 39 weeks they must: • have received Commonwealth income support for a continuous period of 26 weeks • still receive income support • satisfy the trustee of the superannuation fund that they are unable to meet reasonable and immediate family living expenses. If this test is satisfied the trustee is limited to paying a single lump sum in a 12-month period. The minimum amount is $1000 or the account balance if less than $1000. The maximum is $10,000. 2. If the person is aged 55 years and 39 weeks or more, they must satisfy either the above test or the following: • have received Commonwealth income support for a continuous period of 39 weeks after turning 55 • not be gainfully employed on the date of application. If this second test is satisfied, the entire balance will become unrestricted non-preserved and can be accessed as cash or an income stream. It will remain subject to any payment restrictions imposed by the superannuation fund’s trust deed. © Kaplan Education 4.7 4.8 Specialist Knowledge: Superannuation (924) To access benefits under financial hardship, the member must provide the trustee with a letter from the Commonwealth department or agency that pays their income support, for example Centrelink or Veterans’ Affairs. The letter must verify the length of time the member has received the payments. Application for early release must be made to the trustee of the superannuation fund within 21 days from the date of the letter. People under age 55 years and 39 weeks must still be receiving income support at the date of the letter but, as the letter remains effective for 21 days, the person’s income support can cease during that time without disqualifying their application. Compassionate grounds from APRA Preserved benefits can also be released on compassionate grounds if APRA deems that the member’s situation fits defined criteria. This can occur if benefits are required to: • pay for medical treatment or medical transport for the person or a dependant • enable the person to make a payment on a loan to prevent: – foreclosure of a mortgage on the member’s principal place of residence, or – exercise by the mortgagee of an express or statutory power of sale over the member’s principal place of residence • modify the member’s principal place of residence or vehicle to accommodate special needs arising from severe disability of the person or a dependant • pay for expenses associated with a dependant’s: – palliative care, in the case of impending death – death – funeral – burial. Both the fund trustee and the provisions of the trust deed must permit the early release of benefits. APRA will specify the amount to be released. It will be limited to cover the approved expense. For example, if approved to prevent foreclosure on the home, the amount released is generally limited to an amount sufficient to cover three months of repayments. Permanent departure from Australia Since 1 July 1998, a person who permanently departs Australia can only access preserved and restricted non-preserved benefits at retirement on or after preservation age, or under another condition of release. Unrestricted non-preserved funds can be accessed at any time. From 1 July 2002, people holding a specified class of temporary residence visas can access their superannuation entitlements. See section 3.3 below for more details. 924.SM1.9 Unit 4: Superannuation benefits Apply your knowledge 1: Withdrawal of benefits Sally, age 40, has $55,000 in superannuation. Of this, $25,000 is restricted non-preserved benefits and $30,000 is preserved benefits. Employer contributions have been made into this fund during Sally’s employment at XYZ Company. Sally is now terminating gainful employment with XYZ Company. How much of Sally’s benefit can she withdraw? Example: Accessing unrestricted non-preserved benefits Ifham and Milena are each aged 60 and currently have $200,000 each in personal superannuation funds listed as preserved benefits. Ifham is still working, but Milena retired a few months ago. They have no funds outside of superannuation but need $40,000 to fund their daughter’s wedding. As Milena is aged 60 and retired, her superannuation funds are now unrestricted non-preserved and thus available for withdrawal. Milena should write to the trustee of the fund and inform them of her retirement. As retirement is a condition of release, the trustee can then allow Milena to make a lump sum withdrawal. Further resources APRA, ‘Early release of superannuation benefits’ [online]. Available from: <http://www.apra.gov.au> by entering ‘early release superannuation’ in the search box [cited 18 June 2008]. 2.2 Transition to retirement Since 1 July 2005, transition to retirement rules allow a limited condition of release for individuals to access superannuation as a non-commutable income stream once they reach preservation age. There is no requirement to retire from the workforce. This condition of release has allowed any non-commutable income stream to be purchased, including a: • non-commutable allocated pension • non-commutable account-based pension/annuity. Under these rules, access to capital is still restricted and lump sums cannot be withdrawn until the person meets another condition of release, such as permanent retirement or reaching age 65. For example, for a non-commutable account-based pension, the commutability restriction is lifted when the member retires. Subsequently, the income stream continues but as a standard account-based pension. Apply your knowledge 2: Preserved benefits Fred, age 61, terminated gainful employment at Sushi World on 20 May 2008. He now works at Sashimi World for more than 10 hours a week. Fred has $100,000 of preserved benefits in his superannuation fund. Can he access it? © Kaplan Education 4.9 4.10 3 Specialist Knowledge: Superannuation (924) Taxation of superannuation components Since 1 July 2007, all superannuation fund moneys have been classified simply as either tax-free or taxable components. 3.1 The tax-free component The tax-free component is tax-free when paid to a person of any age. It consists of: • any crystallised amount calculated at 30 June 2007, plus • non-concessional contributions made after 1 July 2007. Except for income streams which commenced prior to 1 July 2007, the crystallised amount was calculated at 30 June 2007 based on the rules that applied prior to 1 July 2007. The crystallised amount includes: • amounts representing the portion of a superannuation benefit that accrued before 1 July 1983 (pre-30 June 1983 component) • undeducted contributions (personal contributions made from after-tax income prior to 1 July 2007) • invalidity payments (post-30 June 1994 invalidity component) • capital gains from small business assets (CGT-exempt component). Of those with existing incomes streams at 1 July 2007, only pensioners who were age 60 or over had their tax-free component and the crystallised amount calculated at that date. For other pensioners, the tax-free component remains based on the deductible amount calculated under the old rules until a trigger event (see below) occurs. Generally this means that the pre-30 June 1983 component and any post-30 June 1994 invalidity components would not be included in the tax-free component until a trigger event occurs. Trigger events Trigger events include: • attaining age 60 • commutation of the income stream (in full or part, cash or rollover) • death. 924.SM1.9 Unit 4: Superannuation benefits 3.2 The taxable component The taxable component is calculated as the total superannuation benefit less the tax-free component. It includes concessional (deductible) contributions, such as employer or personal contributions on which a tax deduction has been claimed, and earnings. Most superannuation funds — including self-managed superannuation funds (SMSFs), retail superannuation funds, and industry and corporate superannuation funds — are taxed funds with taxable contributions and investment earnings being taxed at 15%. A few superannuation funds, mainly those in the public sector, have remained partly or fully untaxed funds. A taxable component of a superannuation benefit comprises: • a taxed element, which is the taxable component paid from a taxed superannuation fund or the taxed part of a superannuation fund that is partly untaxed • an untaxed element, which is the taxable component paid from the untaxed part of a fully or partly untaxed superannuation fund. When the taxable component is withdrawn as a lump sum, the rates of tax differ according to whether the benefit comprises a taxed or an untaxed element and based on the age of the person at the time of the withdrawal. The untaxed element rates are higher because these benefits have not been previously taxed. The rates of tax are also reduced or eliminated if the person defers withdrawal to age 60. The low-rate cap ($145,000 for 2008/09) is a lifetime limit, reduced by any payments which count towards the cap. It is applied first to taxed elements in the superannuation fund before it is applied to untaxed elements. Individuals who have utilised the post-30 June 1983 tax-free threshold ($135,590 for 2006/07) can only apply the difference between their 2006/07 balance and the low-cap rate to future withdrawals containing a taxable component. The taxation of the taxable component for lump sum withdrawals is shown in Table 2 below. Table 2 Tax on taxable components for lump sum withdrawals Taxpayer’s age Taxed element rates Untaxed element rates Under preservation age 20% Up to $1,045,000 — 30% > $1,045,000 — top marginal tax rate Preservation age to age 59 First $145,000 — exempt > $145,000 — 15% First $145,000 — 15% $145,000–$1,045,000 — 30% > $1,045,000 — top marginal tax rate Age 60 and over Exempt First $1,045,000 — 15% > $1,045,000 — top marginal tax rate Medicare levy also applies. There is a single low-cap threshold of $145,000 (2008/09) which may be used for the taxed element, the untaxed element, or across both. The cap may be used with withdrawals from different superannuation funds at different times. The low-cap threshold ($145,000) and the untaxed-cap threshold ($1,045,000) (2008/09) are indexed to average weekly ordinary time earnings (AWOTE) and will increase in amounts of $5000. © Kaplan Education 4.11 4.12 Specialist Knowledge: Superannuation (924) Example: Tax on lump sum benefits Michelle, age 58, receives two superannuation lump sum benefits from separate funds. The first superannuation lump sum is $150,000 ($40,000 tax-free component, $60,000 taxable component, taxed element, and $50,000 untaxed element). The second lump sum of $600,000 comprises $250,000 tax-free component and $350,000 taxable component (taxed element only). On the two lump sums, Michelle pays no tax on the $290,000 tax-free component and 30% tax (plus Medicare levy) on the $50,000 untaxed element. For the taxed element, she pays 15% (plus Medicare) on $265,000 — the amount by which $410,000 exceeds $145,000. The total tax on the lump sums is $60,300. Calculations are shown in Table 3. Table 3 Tax on Michelle’s lump sum benefits Lump sum Tax-free component Taxable component Taxed element Untaxed element $150,000 Tax rate $60,000 $50,000 $600,000 Total $40,000 $250,000 $350,000 Nil $750,000 $290,000 $410,000 $50,000 Nil Tax $145,000 tax-free ($410,000 – $145,000) × (15% + 1.5%) = $43,725 $50,000 × (30% + 1.5%) = $15,750 $43,725 $15,750 In this example the $145,000 tax-free threshold is first applied to the taxed element. Hence the rate for the untaxed element is the rate over $145,000, that is, 30%. This example has been adapted from Example 2.1 in Explanatory Memorandum to Tax Laws Amendment (Simplified Superannuation) Act 2007. Example: Recontribution strategy Emma, age 60, is a retired widow with two adult non-dependent children. She has a $150,000 taxable component, taxed element, in her superannuation fund. She has requested her children be nominated beneficiaries of the fund. To minimise tax payable on any superannuation payment made on Emma’s death, she could consider a recontribution strategy. To do this, she withdraws $150,000, which is possible because she has satisfied the retirement condition of release. The withdrawal is tax-free as she is age 60. She then makes a $150,000 non-concessional contribution back into superannuation. To make the contribution, Emma is not subject to an employment test as she is under age 65. Under this strategy, the $150,000 becomes a tax-free component which, if paid to Emma’s adult children on death, will be tax-free. If Emma had not recontributed this amount and died leaving a $150,000 benefit to the children, they would be taxed at 15%, equating to $22,500, plus the Medicare levy. 924.SM1.9 Unit 4: Superannuation benefits Part IVA anti-avoidance provisions Care is required with any recontribution strategy to ensure the transaction comes within the sole purpose test of providing benefits for retirement. If the ATO believes that the predominant purpose of the strategy is to reduce tax it can be challenged under the anti-avoidance provisions (Part IVA) of the ITAA (1936). Key concept: Importance of timing Timing is important as a person cannot withdraw their taxable component above $145,000 tax-free until age 60. The amount must be recontributed before age 65 unless the work test is satisfied. The amount recontributed is limited by the non-concessional contributions cap. For all members a proportional drawdown is required where there are taxable and tax-free components. However, to access the benefit, a person must have met a condition of release. A recontribution strategy effectively converts a taxable component into a tax-free component. This is particularly effective if paid to a non-dependant on death because it eliminates the tax on the recontributed funds. Also, for those commencing an income stream under age 60, the recontribution strategy maximises the tax-free amount of pension/annuity income. Note: Before undertaking the recontribution strategy for estate planning purposes, consideration must be given to whether the trustee will apply the anti-detriment rule. This rule allows a trustee to increase the death benefit with a refund of contributions tax. A tax-free component will not be increased by a refund of contributions tax. Apply your knowledge 3: Withdrawal of superannuation Clare turns age 65 on 1 August 2007. She has $50,000 in superannuation and is not currently working. Must she withdraw her superannuation benefits? Apply your knowledge 4: Lump sum benefits Trish, age 58, receives a lump sum from a personal superannuation fund of $300,000, of which $100,000 is the tax-free component and the remainder the taxable component, taxed element. What tax is payable on the lump sum? How much tax would be payable if the funds were being paid from an untaxed government superannuation fund? In both cases, if Trish had waited until she reached age 60 to make the withdrawal, what tax would she have paid? © Kaplan Education 4.13 4.14 Specialist Knowledge: Superannuation (924) No tax on lump sums for the terminally ill On 11 September 2007 the then Minister for Revenue and Assistant Treasurer, Peter Dutton, announced that people with a terminal illness under the age of 60 who access their superannuation would be exempt from tax on their lump sum benefit. A member is taken as being terminally ill if two medical practitioners, including at least one specialist, certify that they are suffering from an illness that in the normal course would result in death within 12 months. Amendments to legislation make the change effective from 1 July 2007. The amendment also creates a condition of release allowing trustees to pay the superannuation benefit when the member is terminally ill. 3.3 Superannuation benefits paid to non-residents Special care should be taken when advising non-residents working in Australia and Australian residents working abroad. From 1 July 2002, people who held certain temporary residence visas can access their superannuation entitlements as a cash benefit upon leaving Australia permanently. The visa must have expired or been cancelled. The benefit is called a ‘departing Australia superannuation payment’. From 1 July 2007, a departing Australia superannuation payment is not assessable and not exempt income. However, the person will be subject to final withholding tax at the rates shown in Table 4. Table 4 Post-1 July 2007 departing Australia superannuation tax Tax-free Nil Taxable (taxed) 30% Taxable (untaxed) 40% If a person does not hold a temporary visa, they cannot qualify for access under this condition and need to wait for a normal condition of release to access their superannuation. The same preservation and rates of tax will apply to each of the components of the superannuation interest as for a resident. One difference between residents and non-residents is that resident taxpayers are entitled to the tax-free threshold (currently $6000) on taxable income. Non-residents pay tax from the very first dollar of taxable income. However, non-residents are not subject to the Medicare levy on their superannuation payment. Further resources ATO 2007, ‘Departing Australia superannuation payment summary instructions’ [online] 13 December. Available from: <http://www.ato.gov.au> by entering ‘departing Australia superannuation payment summary’ in the search box [cited 18 June 2008]. 924.SM1.9 Unit 4: Superannuation benefits 3.4 Disability superannuation benefits From 1 July 2007, a disability superannuation benefit can be paid to a person who has suffered physical or mental ill health. Two qualified medical practitioners must certify that the person is incapable of being gainfully employed according to their education, experience or training. A 15% tax offset can be applied to a person who receives a disability superannuation benefit containing a taxed element as an income stream when they are under age 60. Once the person reaches age 60, payments from the income stream are received tax-free. Further resources ATO 2007, ‘Paying a disability lump sum benefit’ [online] 31 August. Available from: <http://www.ato.gov.au> by entering ‘disability superannuation benefit lump sum’ in the search box [cited 18 June 2008]. ATO 2007, ‘Paying a disability income stream benefit’ [online] 31 August. Available from: <http://www.ato.gov.au> by entering ‘disability superannuation benefit income stream’ in the search box [cited 18 June 2008]. © Kaplan Education 4.15 4.16 4 Specialist Knowledge: Superannuation (924) Tax on superannuation death benefits From 1 July 2007, the taxation of superannuation death benefits varies depending on whether the recipient is defined as a dependant in the Income Tax Assessment Act 1997 (Cth) (ITAA 97). It also varies depending on whether the benefit is paid as a lump sum or income stream. This section provides a brief summary. From 1 July 2007, a death benefit superannuation income stream cannot be paid to a non-dependant of the deceased. Death benefit income streams that started to be paid to non-dependants prior to 1 July 2007 will be taxed in the same way as for dependants. The tax on superannuation death benefits is outlined in Tables 5 and 6 below. Table 5 Tax on superannuation death benefits paid to dependants Age of deceased Superannuation death benefit Age of recipient Tax on taxable component* Any age Lump sum Any age Tax-free Aged 60 and over Income stream Any age Taxed element — tax-free Untaxed element — marginal tax rates with a 10% offset Below age 60 Income stream Aged 60 and above Taxed element — tax-free Untaxed element — marginal tax rates with a 10% offset Under age 60 Taxed element — marginal tax-rate with 15% tax offset Untaxed element — marginal tax-rate * Medicare levy also applies. Table 6 Tax on superannuation death benefits paid to non-death benefit dependants Age of deceased Age of recipient Tax on taxable component* Lump sum Any age Tax-free — nil Taxable component — 15% Untaxed element — 30% Income stream Any age Superannuation death benefit Any age Not applicable, however income streams commenced prior to 1 July 2007 will be taxed as if received by a dependant * Medicare levy also applies. 924.SM1.9 Unit 4: Superannuation benefits Example: Death benefits Fei-Lee, age 58, recently passed away after an unexpected illness. Her husband Donny, who is age 63 and retired, and their only son John, who is age 33, are listed as the two nominated beneficiaries. Fei-Lee had a total of $250,000 in her superannuation fund (all taxable components) with $150,000 going to Donny and the remaining $100,000 to John. In this situation, Donny would receive his lump sum tax-free as he is a dependant. As John is an adult child and a non-dependant, he would be taxed 15% (plus Medicare levy) on the taxable component. Apply your knowledge 5: Death benefits Dora, age 50, dies. A lump sum death benefit is paid to her husband Dex, also age 50. The death benefit contains a $300,000 tax-free component and a $500,000 taxable component. What tax is payable? Example: Tax-free death benefits John, age 75, is a widower with two adult sons. He has $600,000 taxable component in superannuation. He plans to split his estate amongst his two sons. Unfortunately, after several months of illness, a recent diagnosis has given John just two months to live. To reduce the tax on his superannuation when it goes to his beneficiaries, John withdraws all funds from his superannuation. As he is over age 60, the withdrawal is tax-free from a taxed fund. He can then either gift the money to his sons or allow his sons to receive the money through his will without paying any tax. Further resources ATO 2007, ‘Paying a lump sum death benefit’ [online] 30 August. Available from: <http://www.ato.gov.au> by entering ‘superannuation lump sum death benefit’ in the search box [cited 18 June 2008]. ATO 2007, ‘Paying an income stream death benefit’ [online] 30 August. Available from: <http://www.ato.gov.au> by entering ‘superannuation income stream death benefit’ in the search box [cited 18 June 2008]. Kaplan Education 4.17 4.18 5 Specialist Knowledge: Superannuation (924) Reasonable benefit limits Prior to 1 July 2007, the government had limits on the benefits received from superannuation at concessional tax rates. These limits were known as reasonable benefit limits (RBLs). An RBL was the maximum amount of concessionally taxed superannuation benefits that a person could receive over their lifetime. On 1 July 2007, RBLs were abolished. This section outlines the features of RBLs prior to 1 July 2007. It is important for the financial planner to understand RBLs as a client’s current pension may be designed according to those rules. The following discussion describes how: • amounts over RBLs were ‘excessive components’ • different RBLs existed for lump sums and pensions • RBLs were triggered by cashing out superannuation benefits • employer ETPs were subject to RBLs • superannuation death benefits and life insurance were subject to RBLs • transitional RBLs protected some clients against disadvantage • advisers devised strategies around RBLs for clients’ benefit • RBLs still affect the superannuation income streams of some clients. Further resources Taylor, S, Juchau, R, Houterman, B & McDonald, T 2007, ‘Chapter 6: Superannuation and retirement’, Financial planning in Australia, 2nd edn, LexisNexis Butterworths, Australia, pp. 569–572. ATO 2007, ‘Reasonable benefit limits — practical tips for tax practitioners’ [online] 13 September. Available from: <http://www.ato.gov.au> by entering ‘RBL practical tips’ in the search box [cited 18 June 2008]. 5.1 RBL requirements prior to 1 July 2007 Excessive component As noted above, a member was permitted to receive benefits up to a certain amount — the RBL — at a concessional rate. Any amount over the RBL was an ‘excessive component’. An excessive component received as a lump sum could be taxed at up to the highest marginal tax rate plus Medicare levy. If an excessive component was used to purchase an income stream, the client could not receive the 15% pension/annuity tax offset on the taxable portion of the pension payment. Cashing out superannuation benefits An RBL assessment was triggered upon cashing out superannuation benefits or commencing a superannuation income stream. 924.SM1.9 Unit 4: Superannuation benefits Different RBLs for lump sums and pensions There were two RBLs — lump sum RBL and pension RBL. For the 2006/07 financial year, the limits were: • $678,149 for the lump sum RBL • $1,356,291 for the pension RBL. These limits were indexed on 1 July each year to AWOTE. Higher ‘transitional’ RBLs were available at 1 July 1994 for those on high salaries or with high superannuation balances. The RBL that applied depended on the combination of lump sums and/or pensions received by the client. For the higher pension RBL to apply, a client had to commit at least 50% of RBL assessable benefits to a complying income stream. Prior to 1 July 2007 there were eight superannuation components. Not all superannuation components counted for RBL purposes. Employer ETPs subject to RBLs Post-1 July 2007, an employer ETP is an ‘employment termination payment’ and can only be received in cash unless the payment falls under the transitional rules. Prior to 1 July 2007, an employer ETP was an ‘employer eligible termination payment’ and could be rolled over into a superannuation fund. If received in cash, employer ETPs were assessed against a client’s RBL immediately. The RBL assessment was deferred if the employer ETP was rolled over. An additional complexity was determining the amount that was assessable for RBL purposes. Several factors affected this determination. The factors included whether payment was received in cash or as a rollover, and whether the employer was an ‘associate’. Death benefits and life insurance subject to RBLs Death benefits paid from superannuation were also assessed for RBL purposes. This limited the amount a beneficiary could receive with concessional taxation. If life insurance was held within a superannuation fund, the RBL would apply to the total of the superannuation death benefit and the life insurance payment. If the lump sum payment was paid from the accumulation phase of superannuation and above the deceased’s pension RBL, excess benefits tax was imposed on the ‘excessive component’ payment. For clients with large superannuation balances, this acted as a disincentive to holding life insurance within superannuation. Lump sum payments made from the commutation of an income stream upon a client’s death were measured against the rebatable proportion of the income stream to determine if there was an excessive component. The rebatable proportion refers to the amount determined to be within the client’s RBL when the income stream commenced. © Kaplan Education 4.19 4.20 5.2 Specialist Knowledge: Superannuation (924) Advisers and RBLs Because of the complicated tax regime, clients sought advice under the RBL provisions to maximise their superannuation benefits according to taxation and social security rules prior to 1 July 2007. Advisers provided the following services to clients: • assessing whether a client qualified for and could increase their concessionally taxed superannuation by applying for a transitional RBL • calculating which components of their ETPs (employer and superannuation) counted towards the RBL • calculating how much of the RBL was left over if some benefits had been taken in previous years • structuring the superannuation payment so that the pension RBL was utilised, for example by rolling over at least 50% of the money to a complying income stream • choosing a pension or annuity that was ‘complying’, that is, meeting the superannuation rules, to access the higher pension RBL if an appropriate amount was invested • assisting the client to maximise concessional tax treatment of income streams by not mixing excessive and non-excessive components • calculating the ‘excessive component’ of the client’s superannuation, which would be taxed at much higher rates • structuring the excess benefit to minimise tax, for example by taking the benefit as an income stream that would: – be taxed at the person’s marginal tax rate, which may have been lower than the excess RBL lump sum tax rate – spread the taxation of the excess benefit over a number of years, thus deferring the payment of tax • structuring superannuation and life insurance to minimise excessive death payments • developing strategies to allow for a combination of lump sum and pensions to be paid to beneficiaries to effectively manage an excess benefit upon the death of the client • commuting an ETP pension or annuity to a lump sum which could trigger RBL assessment. 924.SM1.9 Unit 4: Superannuation benefits Suggested answers Apply your knowledge 1: Withdrawal of benefits Sally can access her restricted non-preserved benefits of $25,000. The remaining benefits are preserved until a condition of release is satisfied. Apply your knowledge 2: Preserved benefits Fred has satisfied the retirement definition, being over age 60 and having ceased a gainful employment arrangement. (It does not matter that he subsequently was gainfully employed elsewhere.) Apply your knowledge 3: Withdrawal of superannuation No. Due to the abolition of the compulsory cashing restrictions, Clare is not required to withdraw her superannuation benefits. Apply your knowledge 4: Lump sum benefits From the personal superannuation fund, Trish pays no tax on the $100,000 tax-free component and $9075 on the taxable component — ($200,000 – $145,000) × 16.5% including Medicare levy. From an untaxed government superannuation fund: Trish pays no tax on the tax-free component. Tax on the taxable component is $145,000 × 16.5% + $55,000 × 31.5% = $23,925 + 17,325 = $41,250. If she had waited until she was 60, Trish would not pay any tax from her personal superannuation fund. The taxable component which comprises a taxed element is tax-free at age 60. Over age 60 from an untaxed fund (e.g. government super) — tax = 16.5% × $200,000 = $33,000. Apply your knowledge 5: Death benefit No tax is payable as the superannuation death benefit is paid as a lump sum to a death benefit dependant as defined in ITAA 97. © Kaplan Education 4.21 4.22 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 5 Income streams Overview 5.1 Unit learning outcomes ....................................................................5.1 Further resources ............................................................................5.1 1 1.1 1.2 1.3 1.4 Retirement income strategies 5.2 Providing financial advice on retirement income streams............5.2 Making a decision on superannuation benefits..........................5.3 Range of retirement income strategies .....................................5.8 Pre-retirement strategies .........................................................5.9 2 2.1 2.2 2.3 2.4 2.5 2.6 2.7 Account-based income streams 5.11 How allocated pensions and annuities work ............................5.11 Key features ........................................................................5.12 Advantages and disadvantages..............................................5.13 Conversion of an existing pension..........................................5.14 Commutations......................................................................5.14 Death benefits .....................................................................5.15 Transfers and fees ...............................................................5.16 3 3.1 3.2 3.3 3.4 Transition to retirement income streams 5.17 Background to transition to retirement measures ....................5.17 How transition to retirement works.........................................5.17 Limited condition of release ..................................................5.18 Determining preservation components....................................5.18 4 4.1 4.2 4.3 Other retirement income streams 5.20 Complying income streams....................................................5.20 Defined benefit pensions ......................................................5.21 Immediate annuities .............................................................5.22 5 5.1 Incorporating retirement income streams into the SOA 5.23 Income stream payments ......................................................5.24 6 6.1 6.2 6.3 6.6 Taxation of pensions and annuities 5.26 When is tax payable on retirement income streams? ...............5.26 Tax applicable on income streams .........................................5.27 Superannuation income streams commenced from 1 July 2007 .........................................................................5.28 Income streams commenced before 1 July 2007 ....................5.30 Triggering of a pre-1 July income stream .................................5.31 Superannuation annuity and pension tax offset (PTO) ..............5.31 7 7.1 7.2 Death and disability income streams 5.33 Death benefit income streams...............................................5.33 Permanent disability benefits.................................................5.36 6.4 6.5 Suggested answers Appendix 5.37 Unit 5: Income streams Overview This unit looks at the different product categories and product types offering retirement (and transition to retirement) income streams. It examines products in both the superannuation and non-superannuation environment, examining key features, strategies and taxation treatment. Death and disability income streams are also looked at briefly. This unit specifically addresses the following subject learning outcome: • Critique superannuation retirement income stream strategies according to their benefits, tax implications and social security treatment as they relate to different client situations. Unit learning outcomes On completing this unit, you should be able to: • distinguish between the various retirement income products available for investors • outline the key features of a range of retirement income streams and explain how they work (including annuities, allocated pensions, transition to retirement income streams, defined benefit pensions, and term allocated pensions) • apply the basic taxation assessment rules to retirement income streams • explain the different taxation calculations applying to superannuation income streams purchased before and after 1 July 2007 • calculate the taxation treatment and pension tax offset applicable to an income stream benefit • outline the strategies for using retirement income stream products. Further resources • ASIC 2007, ‘Retirement income’, 20 September [online]. Available from ASIC’s consumer website <http://www.fido.gov.au> under ‘About financial products’ [cited 24 June 2008]. © Kaplan Education 5.1 5.2 Specialist Knowledge: Superannuation (924) 1 Retirement income strategies Many clients will have been following the advice of a financial planner in the accumulation stage of their lives to achieve their desired lifestyle and income in retirement. The transition from the accumulation to the pension phase is an important time for putting in place new retirement income strategies to achieve the goals the client has been working for. 1.1 Providing financial advice on retirement income streams As a client moves from the accumulation to the retirement phase, a financial adviser can add value by advising on issues such as: • timing of the move to an income stream • appropriate asset allocation for the income stream (covered in Investment Products (FIN212)) • the balance between lump sum withdrawals and an income stream • leaving money in (or adding extra money to) superannuation • the balance between superannuation and non-superannuation investment • purchase of income streams outside superannuation • the percentage able to be withdrawn as an income stream • ongoing income projections and balances • whether insurances held within superannuation can or should continue • taxation treatment of income streams • the appropriate product provider for the income stream • social security treatment of income streams • what social security benefits may be available to supplement the income stream. Paperwork The financial adviser can also assist clients in completing the paperwork required, including application forms attached to a product disclosure statement and proof-of-age documentation (generally only required by a life company for lifetime annuities and some fixed-term annuities). Reflect on this: Advice on income streams How important do you think it is for a client to receive advice on entering retirement? If the client simply completes the administrative matters with their existing product provider, would they be significantly disadvantaged? Is financial advice more relevant and impact more on the client during the accumulation phase? Should advisers concentrate more on accumulation than pension products? 924.SM1.9 Unit 5: Income streams 1.2 Making a decision on superannuation benefits There are three broad options facing clients when they become eligible to access their superannuation benefits. They can: • leave all or part of their benefit in the same superannuation fund or roll it over into another fund (i.e. keep the benefit in the accumulation phase) • cash out all or part of their benefit and potentially invest the lump sum in non-superannuation investments • purchase a retirement income stream or transition to retirement income stream if not yet fully retired. Despite having the option to remain in accumulation, once a person has retired they will probably find it advantageous to purchase an income stream to reduce tax. While in the accumulation phase, the superannuation fund pays tax on earnings at 15% (with any long-term capital gains eligible for a one-third discount); once fund assets are used to provide pension benefits, the fund pays no tax on income or capital gains. Clients can choose to implement more than one of these options, i.e. they may withdraw a lump sum, convert most of their superannuation into an income stream, and keep some of their funds in accumulation. Meeting a condition of release Preserved and restricted non-preserved benefits must remain in the superannuation system until a condition of release is met, generally retirement on or after reaching preservation age (i.e. from age 55 depending on date of birth) or reaching age 65. Superannuation investors over the age of 65 have the choice of retaining their superannuation benefits in an accumulation fund indefinitely, using them to commence an income stream at any time of their choosing or making lump sum withdrawals from their accumulation account. While making lump sum withdrawals from an accumulation account could effectively provide the same income as an income stream, it would have the disadvantage that the funds are still being taxed at 15% in the accumulation phase. For some investors, terminating employment with an employer who contributed to the fund is a condition of release if they have any restricted non-preserved benefits. In addition, once an investor reaches their preservation age, they can commence a transition to retirement income stream, without having to satisfy any other condition of release (i.e. they do not have to be retired). Transition to retirement income streams are discussed in detail in section 3. © Kaplan Education 5.3 5.4 Specialist Knowledge: Superannuation (924) Unrestricted non-preserved benefits Unrestricted non-preserved superannuation benefits may be taken in cash at any time, subject to the payment of lump sum tax, or used to start an income stream. Reflect on this: Using non-preserved benefits With recent interest rate rises and pressures on the cost of living it has been reported that many households are now accessing their non-preserved benefits to help pay their mortgages. Is this a wise move? Would you recommend that strategy? Issues to consider At the time when retirees have to make decisions about utilising their superannuation benefits, the financial adviser can help them to select strategies that are most appropriate for their circumstances and goals, and the products that match. Considerations include: • the balance between funds left in accumulation, lump sum withdrawals and the funds available for an income stream • whether the client should withdraw some superannuation to invest in non-superannuation products • whether the client should contribute more to superannuation before commencing the income stream • whether a re-contribution strategy could be used before an income stream is commenced • whether the opportunity should be taken to more equalise superannuation benefits between partners before income streams are commenced • the timing of commencement of an income stream, which will necessarily depend on the client’s age, but may also depend on income and taxation outside superannuation • how many payments per year the client wishes to receive • the tax effectiveness of the income stream • whether the client wants certainty of income, or will trade off certainty for the potential of increased returns • whether the client wants total or partial residual capital at the end of the income stream • whether the client wants the income stream to be able to be commuted fully or partially back to a lump sum at a later date • the degree of flexibility the client wants in the income stream in terms of amount and frequency • whether the client wants the income stream to continue to a reversionary beneficiary after their death • the appropriate product provider whose product features match the client needs and goals. 924.SM1.9 Unit 5: Income streams Retirement income stream products Table 1 provides a broad overview of the income streams available from 1 July 2007. Table 1 Retirement income streams available from 1 July 2007 Income stream type Term Payment rules Commutable Residual capital value (RCV) Allocated/ account-based Until account exhausted Minimum annual payment Yes n.a. — investor retains an account balance Transition to retirement Until account exhausted Minimum annual payment. Maximum payment of 10% of account balance Yes — if unrestricted benefit or condition of release met n.a. — investor retains an account balance Lifetime (commutable, nil RCV) Life of beneficiary/ reversionary Minimum first year payment, then fixed percentage, CPI or AWOTE indexation Yes No Lifetime (non-commutable, nil RCV) Life of beneficiary/ reversionary Annual payment cannot fall, except with CPI indexation No No Fixed-term (commutable, nil RCV) Up to 100 less recipient’s age Minimum first year payment, then fixed percentage, CPI or AWOTE indexation Yes No Minimum annual payment every year Yes Yes — up to 100% Flexible — Not prescribed — fixed-term or lifetime could be any fixed (commutable, term or lifetime RCV income stream) Note: Some retirement income stream types discussed in this unit, such as complying income streams (including term allocated pensions (TAPs),) continue to be available after 1 July 2007 however they are not included here as their relevance is likely to diminish under current superannuation rules. ** RCV represents the amount of the initial purchase price returned to the investor at the end of the contract. Further resources ASIC 2007, ‘Retirement income’, 20 September [online]. Available from ASIC’s consumer website <http://www.fido.gov.au> under ‘About financial products’ [cited 24 June 2008]. Complying income streams (including TAPs) Complying income streams complied with the rules for reasonable benefits limits and had associated social security advantages. While it is not possible to start a new complying income stream, existing complying income streams can continue in their original form after 1 July 2007 under the grandfathered old payment standards. As a result, these income streams cannot be commuted to cash, other than as prescribed by the old rules. © Kaplan Education 5.5 5.6 Specialist Knowledge: Superannuation (924) In addition, a complying income stream (lifetime, fixed-term, or term allocated pension (TAP)) may be rolled over after the new rules commence to an income stream that: • meets one of the new requirements (for example those applying to account-based income streams), and • meets the requirements which applied prior to 1 July 2007 for complying fixed-term or term allocated pensions, or • meets the new standards for a non-commutable, nil RCV income stream. Therefore, a complying fixed term or term allocated pension can commence after 20 September 2007 from the commutation of another complying income stream provided that the new income stream also meets the new regulations. In the case of a new TAP, for example, this involves meeting the old TAP regulations and the new regulations. In practice, this means that the allowable term of the new TAP has to be chosen such that the total value of payments in each year is at least equal to the amounts determined using the percentage factors. Source of retirement income streams Figure 1 outlines the different products available as an annuity or a pension. Life companies and friendly societies pay annuities while superannuation funds pay pensions. Figure 1 Different retirement income stream products Life company/Friendly society Superannuation fund Annuity Superannuation pension Immediate Defined benefit Account-based Lifetime Fixed-term Flexible Super Account-based Allocated Term allocated Lifetime Fixed-term Flexible Allocated Transition to retirement Super Super Super Non-super Term allocated From Figure 1 it can be seen that the only type of retirement income stream that can be purchased with non-superannuation money is an immediate annuity. The most common types of new retirement income streams are the superannuation account-based pensions, i.e. allocated pensions and transition to retirement pensions. A defined benefit pension is most likely to be offered by a corporate or government superannuation fund. Self-managed superannuation funds (SMSFs) also previously offered defined benefit pensions, but from 1 January 2006 are no longer able to commence these. 924.SM1.9 Unit 5: Income streams Comparative features Some further differences between the retirement income categories are shown in Table 2. Table 2 Differences in retirement income stream products Allocated pension or annuity Immediate annuity Superannuation pension Term allocated pension or annuity Term/duration Payments made within pension valuation factors (PVFs) until account exhausted or funds commuted Fixed-term or guaranteed lifetime payments Can be paid for a fixed term or for life Fixed-term based on age and life expectancy of investor or reversionary at commencement Governing documents Trust deed and product disclosure statement Policy document and product disclosure statement Trust deed and product disclosure statement Trust deed or policy document, respectively, and product disclosure statement Residual capital payments No residual capital value (RCV) concept, account balance may be commuted* RCV elected by investor, from 0% to100% of original invested capital Generally, no RCV, some funds allow commutation of an adjusted purchase price No RCV * Except where limited by transition to retirement rules. Reflect on this: When do you discuss income streams? When would you, as a financial adviser, begin discussing income streams with your client? Would you discuss a transition to retirement income stream if the client had not sought advice on it? Would you discuss retirement income streams only when the client tells you they intend to retire? © Kaplan Education 5.7 5.8 Specialist Knowledge: Superannuation (924) 1.3 Range of retirement income strategies Table 3 below compares the features of different investment strategies for retirement income streams for both superannuation and non-superannuation moneys. It does not provide an exhaustive comparison as this will depend on individual circumstances. For example, if a guaranteed indexed income is your client’s major requirement, an annuity product might be suitable. On the other hand, if flexibility or access to capital growth is important to your client, an allocated pension or an investment portfolio might be attractive alternatives. A combination of different approaches is often the most effective strategy. Table 3 Comparison of different investment strategies Allocated pension or annuity Term immediate annuity or pension Term allocated pension or annuity Life annuity, nil RCV Cash lump sum and purchase an investment portfolio Can lump sum tax be deferred? Yes Yes Yes Yes No Are income payments guaranteed? No Yes No Yes No Is there a choice of investment portfolios? Yes No Yes No Yes Is all income tax-free once the investor reaches age 60? Yes Yes, if purchased with a superannuation benefit Yes Yes, if purchased with a superannuation benefit No Is there a tax offset on part of the income paid to an investor under age 60? Yes Yes, if purchased with a superannuation benefit Yes Yes, if purchased with a superannuation benefit No Is there a tax-free component of income for an investor under age 60? Yes Yes Yes Yes Yes for drawdown of capital Does the investor have access to their account balance at all times? Yes* No No No Yes Is income guaranteed for life? No No No Yes No Are income payments flexible? Yes No No (limited choice) No Yes * Except where commenced under the transition to retirement measures. 924.SM1.9 Unit 5: Income streams Advantages of investing outside superannuation The advantages of investing money outside the superannuation system are not as obvious as those for superannuation income streams, but do need to be considered: • Money can be more easily divided between husband and wife (or partners), allowing for income splitting. As superannuation pension income from a taxed fund is tax-free once a person is age 60, this is generally only a consideration for investors under age 60. • Franking credits are easily accessible to reduce tax liabilities, with any unused credits refundable to the individual, making share market investing a viable alternative. • Gearing may be used an may provide taxation advantages. • Other tax-advantages products outside of superannuation may be as suitable as superannuation. • Money outside superannuation is not subject to the legislative risk of changes to superannuation law. • Money outside superannuation may not be subject to tax disadvantages for death benefits for adult beneficiaries. • There may be fewer fees to pay. • The client may have more control of their investments. • The client maybe able to respond more quickly to changing circumstances. • Money outside superannuation may not be subject to tax disadvantages for death benefits for adult beneficiaries. A financial plan for retirement will usually contain a combination of retirement income streams and other investment strategies outside superannuation. Non-superannuation investment strategies are described in Investment Products (FIN212). 1.4 Pre-retirement strategies Topping-up strategies Non-concessional contribution strategy Clients who want to commence an income stream upon retirement might wish to top up their superannuation with additional non-concessional contributions before they retire. This can achieve two results: • It can increase the client’s overall superannuation benefit and therefore their potential retirement income. • It can increase the tax-free component of the client’s income stream, thereby reducing any tax payable on income prior to age 60. This strategy has raised some questions, with a Taxation Ruling IT 2393 (now withdrawn) suggesting that last-minute non-concessional (undeducted) contributions may not be taxed as ETPs when cashed out. However, a media release issued by the ATO in August 2004 stated the following: ‘Another superannuation strategy that also will not attract the general anti-avoidance provisions is where a person makes a large undeducted (non-concessional) contribution to their superannuation fund before they receive an ETP. The effect is to reduce the amount of tax payable on the ETP’, and now suggests that the ATO is comfortable with the taxation aspects of standard superannuation top-ups. Complex schemes may still come under ATO scrutiny. © Kaplan Education 5.9 5.10 Specialist Knowledge: Superannuation (924) Concessional contribution strategy Alternatively, a self-employed or unsupported person could top up their superannuation with concessional contributions for which they have claimed a tax deduction. Both concessional and non-concessional contributions are subject to caps. Recontribution strategy Another pre-retirement strategy is to make a cash withdrawal and recontribute the balance (after any tax) back into superannuation. Generally, the amount cashed out is limited to the amount that can be withdrawn with minimal lump sum tax and also by the amount that can then be recontributed under the relevant contribution cap. The aim of this strategy is to maximise the tax-free component in the income stream. Amounts recontributed will be fully preserved, and a condition of release may need to be met again. This strategy was also addressed in the August 2004 ATO media release mentioned above, with the ATO stating: Two recontribution strategies that will not attract the general antiavoidance provisions are: 1. A person withdraws a lump sum from their super fund and then recontributes the same or similar amount shortly after to the same fund for the purpose of commencing a superannuation pension. The effect of the strategy is to reduce the assessable portion (i.e. taxable component) of the annual pension over the person’s retirement years. 2. Simple variations to the first scenario such as where a person commences a pension in the year or years following that in which the lump sum was paid, or where the recontribution is made to a fund other than the one that paid the lump sum (for example, a spouse fund). Again, the effect is to reduce the assessable portion of the annual pension. Such a recontribution strategy undertaken before age 60 for the purpose of increasing retirement benefits through a more tax-effective income would be acceptable under these ATO guidelines. Where the strategy is undertaken after age 60 the only benefit is to increase death benefits, through an increase in the tax-free component, to non-dependants such as adult children. In a June 2007 industry liaison meeting, the ATO confirmed that it would be unlikely to apply Part IVA to recontribution arrangements given that the key policy thrust of the Simpler Super reforms is to increase concessions and provide more flexibility for people to manage their retirement. 924.SM1.9 Unit 5: Income streams 2 Account-based income streams 2.1 How allocated pensions and annuities work An allocated pension/annuity income stream is an account-based retirement income stream generally purchased with an unrestricted non-preserved superannuation benefit. Allocated pensions are regular income streams paid from a superannuation fund under a trust deed, while allocated annuities are paid by life companies or friendly societies. Investors in an allocated pension hold an individual account within the fund’s total pension asset pool, i.e. part of that pool is allocated to each investor. The account balance: • increases or decreases with earnings and market value movements • decreases due to pension payments, withdrawals and fees. Allocated pensions and annuities convert a lump sum to an income stream. Regular payments continue to be paid until the account runs out or is commuted. Payments comprise both the original capital invested and the investment earnings on that capital. The rate of income drawn each financial year is subject to a government-set minimum pension limit, based on age-based percentage factors. Once funds are exhausted, the account ceases. The investment performance for these account-based income streams is not guaranteed and depends on the underlying performance of the assets. Lump sums may be able to be commuted from the allocated income stream at any time. © Kaplan Education 5.11 5.12 2.2 Specialist Knowledge: Superannuation (924) Key features Allocated pensions/annuities have the following key features: • Income payments must be made each financial year. • Payments made each financial year must be at least equal to the amount set by the government’s minimum percentage factors for income streams commenced from 1 July 2007. • For allocated income streams continuing under the provisions applying prior to 1 July 2007, the maximum and minimum payments are obtained from a set of PVFs, which are set by the government. The different set of PVFs applying for income streams started before 1 January 2006 can be found in Appendix 1. • For an allocated pension or annuity commenced on or after 1 June in any financial year, there is no requirement to take a minimum level of payment in that first financial year. The first payment may be deferred until the next financial year, effectively giving the investor 13 months in which to take their first pension payment. • Lump sum amounts withdrawn that exceed the selected payment level in any financial year can be treated as either additional income or as a lump sum payment, at the discretion of the investor. The full commutation of a pension can only occur if a pro-rata minimum income payment has been paid. The same also applies for a partial commutation of a pension, except where the remaining balance after the commutation is at least equal to the remaining minimum income payments required for the year. • The account balance of an allocated pension can increase to an amount greater than the amount invested — it is entirely a function of investment performance and the pension payments (and commutations) made. • Income payments from allocated pensions/annuities are not guaranteed for any length of time. • Each July, the minimum payment is recalculated, based on the investor’s account balance at that time as well as the minimum percentage factor applicable to their age. • Investors can adjust their income at any time during a financial year, subject to any rules imposed by the fund manager, provided that the total level of payments taken in a financial year is greater than the minimum payment. • Most allocated pensions provide a selection of underlying investment options to provide flexibility of investment choice. Naturally, the risk profile of the client should be taken into account when determining the asset allocation of the invested funds. • An allocated income stream cannot be used as security for borrowing. 924.SM1.9 Unit 5: Income streams 2.3 Advantages and disadvantages Advantages There are significant advantages in investing superannuation benefits in pension or annuity products. These benefits are: • Franking credits derived from pension fund assets can be refunded, potentially increasing the fund’s returns. • Pension payments (paid from a taxed source) are tax-free once a person reaches age 60. • While pension payments to a person under age 60 are taxable, a portion of the payments may be tax-free, and a tax offset is usually available to reduce tax on the taxable component: a 15% offset from a taxed source or a 10% offset from an untaxed source (such as many public sector superannuation schemes). The 15% tax offset also applies if the income stream is paid due to death or disability. • Capital remains under the control of the investor and, other than for transition to retirement income streams, can be accessed at any time by lump sum withdrawals in addition to regular income payments (see also disadvantages below). • The investor has a choice of investment portfolios, and receives a benefit by way of any increased account balance for any capital growth that occurs. • Income can be varied subject to the minimum income payment based on the account balance as at 1 July each year. Disadvantages The disadvantages include: • Eventually capital may be exhausted, at which time pension payments will cease. • Investment returns on the capital depend on the investment option selected, market conditions and fund manager performance. This will have a major bearing on how long capital will last and the minimum amounts payable each year. • There is no facility to split income with a spouse. An allocated pension is commenced with a person’s superannuation benefits and the pension payments must be made only to that person. Strategies can be implemented prior to retirement to split superannuation benefits between members of a couple, providing an income stream for each person. This is generally only required for taxation purposes where the income stream is payable prior to age 60. • For social security clients, the whole balance of an allocated income stream (regardless of when commenced or if it is a transition to retirement income stream) is counted as an asset under the assets test. © Kaplan Education 5.13 5.14 2.4 Specialist Knowledge: Superannuation (924) Conversion of an existing pension From 1 July 2007, pension recipients are able to transfer an existing allocated pension to the new pension requirements, at the discretion of the income stream provider, without the need to commute their existing pension. This will save on the potential cost if an investor had to commute their existing pension to commence a new pension. An allocated income stream therefore may be converted to the new requirements by the application of the new percentage factors. This conversion can take place at any time from 1 July 2007 onwards, and will generally be done at the discretion of the income stream provider. It is not necessary to commute and restart the income stream for the percentage factors to take effect. However, for new taxation arrangements to take effect from 1 July 2007, an income stream may need to be commuted to ‘trigger’ the application of the new tax rules. Refer to section 8.5 for more details on triggering. Note: The new regulations allow a provider to continue an existing allocated income stream with the old factors, effectively grandfathering the old payment factors. However, as minimum income payments will generally be less under the new percentage factors, there seems little need for this. Where conversion to minimum percentage factors is not offered by a provider, allocated income streams commenced before 1 July 2007 may be rolled over to an income stream meeting the new requirements. 2.5 Commutations Retirement income streams can be commuted, that is converted from income payments to a lump sum, under certain circumstances. Because allocated income streams must generally be commenced with unrestricted non-preserved benefits (see below for an exception for transition to retirement income streams), they may be commuted at any time. However, prior to either a full or partial commutation, either a pro-rata minimum income payment must have already been paid during the financial year or the remaining account balance must be sufficient to ensure that at least the minimum annual payment could be paid. Commutations may also be made, regardless of the level of income payments made, to pay a: • death benefit • surcharge liability incurred before surcharges were abolished • family law payment splitting amount • cooling-off amount. Low rate cap on lump sum payments There is no maximum income payment for an allocated income stream (other than for a transition to retirement income stream or one commenced prior to 1 July 2007 and continuing under the old rules). Investors must specify whether any benefit payment in excess of a previously nominated income amount is to be paid as an income payment or as a lump sum commutation. Where the investor is over age 60, there will be no difference in the taxation of the amount because all benefits are paid tax-free from a taxed fund. However, an investor under age 60 may wish to withdraw a superannuation lump sum benefit to utilise their low rate cap. 924.SM1.9 Unit 5: Income streams Example: Income payment or lump sum? Goran is age 58 and is receiving minimum income payments (4% of his account balance) from his allocated pension. His pension has a tax-free component of 30% and a taxable component of 70% as he did not use a recontribution strategy prior to establishing the pension. He needs a one-off payment of $50,000, so must notify his pension provider whether this will be: • An increase in his current income payments, treated as an income payment for tax purposes. In this case, his $50,000 income payment will have a $15,000 tax-free component and a $35,000 taxable component. $35,000 will be added to his assessable income for the year and taxed at marginal rates, but will be reduced by a tax offset of $5250 (15% of $35,000). • A commutation of his pension, taxed as the payment of a superannuation lump sum. In this case, his $50,000 superannuation lump sum will also have a $15,000 tax-free component and a $35,000 taxable component. However, as he has not received any superannuation lump sums previously, the taxable component is within the low cap amount ($145,000 in 2008/09) and is therefore tax-free. 2.6 Death benefits An account-based income stream may be reverted on the death of the recipient only to a dependant of the recipient. Dependant for these purposes includes a spouse, child, financial dependant or interdependant. Child dependants However, if the dependant is a child of the deceased, an income stream may only be reverted if that child: • is under the age of 18 • is financially dependent and under the age of 25 (and paid only until the child reaches the age of 25), or • has a disability, the income stream may revert at any age and continue to be paid past the age of 25. ‘Disability’ means a disability of the kind described in subsection 8(1) of the Disability Services Act 1986, and is a disability that: – is attributable to an intellectual, psychiatric, sensory or physical impairment or a combination of such impairments – is permanent or likely to be permanent – results in: (i) a substantially reduced capacity of the person for communication, learning or mobility (ii) the need for ongoing support services. Once the child reaches the age of 25, any remaining account balance must be commuted and paid to them as a tax-free lump sum. © Kaplan Education 5.15 5.16 Specialist Knowledge: Superannuation (924) The child is not able to roll over the commuted lump sum — only the spouse of a deceased member is able to commute and roll over a reversionary income stream. Such a commutation by a spouse is treated as a superannuation member benefit in the spouse’s hands, meaning it may be rolled over to either another superannuation income stream or to an accumulation account. Reversion to an adult child (not financially dependent and not disabled) is not permitted after 20 September 2007, even if a binding nomination or trust deed provision to this effect was in place before this date. 2.7 Transfers and fees Transfers between allocated income stream providers Investors have the option to transfer or switch between allocated income stream providers. Normal fund manager and life company fees will apply. Each time a transfer occurs, the tax-free and taxable components calculated at the commencement of the income stream will be applied to the transferred superannuation lump sum and passed on to the new income stream. Provided no additional benefits are combined with the transferred amount, the tax-free and taxable components in the new income stream will be the same as in the existing income stream. For an income stream that commenced prior to 1 July 2007, a transfer will be a trigger event, resulting in the calculation of tax-free and taxable components. Fees and charges for allocated pensions Fees and charges applying to allocated pensions are, in most cases, transparent to the investor and must be clearly shown in the product disclosure statement. The type of charges that might apply are: • entry or exit fees • asset management fees or management expense ratio (MER) • trustee fees • custodian fees. 924.SM1.9 Unit 5: Income streams 3 Transition to retirement income streams 3.1 Background to transition to retirement measures With effect from 1 July 2005, clients can choose to commence a transition to retirement income stream with their superannuation benefits once they reach preservation age (currently from age 55) regardless of their work status. However, it is not mandatory for all funds to offer this facility. This option was designed to benefit clients who reduce their working hours or responsibilities and need to supplement their reduced employment income. However, it is also becoming an increasingly popular strategy for clients employed full-time to salary sacrifice and replace income with a transition to retirement income stream. This provides tax savings to boost retirement savings. The transition to retirement measures introduced the following: • the concept of a transition to retirement income stream (called ‘non-commutable income streams’ before 1 July 2007) • a new limited condition of release allowing a person who reaches their preservation age to access preserved and restricted non-preserved benefits as a non-commutable (i.e. transition to retirement) income stream (as described in section 3.3). 3.2 How transition to retirement works Transition to retirement income streams are a particular type of account-based income stream. They can be commenced with preserved and restricted non-preserved superannuation benefits (or unrestricted non-preserved benefits, if desired) at any time after the recipient reaches their preservation age. In addition to the payment requirements applying to account-based income streams outlined in section 2 above, transition to retirement income streams: • have a maximum annual income payment of no more than 10% of the account balance at the start of each financial year (or on commencement for the first year) • cannot be commuted to cash, except in the following circumstances: – where the income stream is purchased with unrestricted non-preserved benefits. For complying income streams, commutation is only allowed within the first six months. – when another condition of release with a ‘nil’ cashing restriction has been met, e.g. retirement after preservation age or reaching age 65 – to pay for a superannuation surcharge liability incurred before surcharges were abolished – to meet a family law payment split. © Kaplan Education 5.17 5.18 3.3 Specialist Knowledge: Superannuation (924) Limited condition of release In the context of the transition to retirement measures, attaining preservation age is a limited condition of release, allowing payment of benefits as a transition to retirement income stream only. There are no work or income tests or monetary limits applying to benefits that can be converted to a transition to retirement income stream. While there are restrictions on cash commutations, benefits in a transition to retirement income stream can be rolled over to another such income stream or back to the superannuation accumulation phase (with the exception of a non-commutable income stream). This may be considered, for example, if the person has taken a transition to retirement income stream while continuing to work part-time and they subsequently return to full-time work. 3.4 Determining preservation components When determining the preservation components of the rolled over amount, income payments and commutations from transition to retirement income streams will be taken to have been made in the following order: 1. from unrestricted non-preserved benefits 2. then restricted non-preserved benefits 3. then preserved benefits. Trustees can choose to either recalculate the preservation components of these income streams upon commutation (and thereby maintain necessary records) or fully preserve all benefits from commencement. 924.SM1.9 Unit 5: Income streams Example: Transition to retirement pension Sheila is age 58 and has agreed with her employer to reduce her hours of work from five days per week to three days per week. Her salary will reduce from $50,000 to $30,000 under the new arrangement. She has $200,000 in superannuation and decides to convert this to a transition to retirement pension. Sheila must draw an income payment between $8000 and $20,000 from her transition to retirement pension. She decides on an income payment of $10,000 each year to supplement her reduced employment income. The $200,000 comprises half preserved and half restricted non-preserved benefits. As she is under age 60, Sheila’s pension income is taxable, but she is eligible for the 15% pension tax offset (PTO) on the income she draws from her allocated pension. She is also eligible the mature age workers tax offset (MAWTO) and the low income tax offset (LITO). So she earns: Taxable salary $30,000 Taxable pension $10,000 Taxable income $40,000 Tax on income $6600 less LITO ($350) less MAWTO ($500) less PTO plus Medicare Net income ($1500) $600 $35,150 Two years later, at age 60, Sheila receives a job offer from a rival firm that is too good to pass up, but that will require her to work full-time. If she accepts the new position, she could continue her transition to retirement pension, using any excess income for further investment, whether in superannuation or in non-superannuation investments. If Sheila chooses to invest more in superannuation, she could do this through a salary sacrifice arrangement. Sheila’s pension remaining non-commutable until she permanently retires or reaches age 65. Alternatively, Sheila could roll her pension back to the accumulation phase, and leave her superannuation benefit to grow further until she can withdraw it or start an income stream once she meets another condition of release. The preservation components of the benefit rolled back to superannuation would reflect those initially used to start the income stream and the income payments she has received. If Sheila had received $30,000 in income payments, the preservation components rolled back to superannuation would be $70,000 restricted non-preserved ($100,000 initially, reduced by the $30,000 in payments, as restricted non-preserved benefits are reduced before preserved benefits) with the balance being preserved benefits. © Kaplan Education 5.19 5.20 Specialist Knowledge: Superannuation (924) 4 Other retirement income streams 4.1 Complying income streams Prior to 1 July 2007 Prior to 1 July 2007, the pension reasonable benefits limit (RBL) was used to determine if an excess benefit existed where purchased complying income streams had a capital value at least equal to the lesser of: • 50% of the pension RBL • 50% of qualifying RBL benefits. The complying pension or annuity had to meet minimum pension and annuity standards as set out in the Superannuation Industry (Supervision) (SIS) Regulations, with different requirements depending upon the type of income stream. Complying income streams used for these purposes were generally lifetime non-commutable income streams or fixed-term non-commutable income streams (where the fixed term was between the client’s life expectancy and the term until their 100th birthday), or term allocated pensions (TAPs). In each case, there is little flexibility in varying the level of income that could be received. After 1 July 2007 From 1 July 2007, all new retirement income streams are subject to the same taxation rules. It is important to note: • Complying income streams commenced before 20 September 2007 remain 50% asset-test exempt for social security purposes. The voluntary rollover of such an income stream after that date will mean a loss of the asset-test exemption. • Complying income streams can be rolled over after 20 September 2007 to either a lifetime non-commutable income stream or to a non-commutable fixed-term (life expectancy) income stream or a TAP, which must also meet the new pension requirements. • If the complying income stream is in an SMSF and the client wishes to continue an income stream in the SMSF, a TAP is the only available option, as SMSFs cannot commence new defined benefit pensions after 31 December 2005. • Complying income streams remain non-commutable after 1 July 2007, meaning that a client cannot cash out of the income stream or roll over to an allocated pension or to a superannuation accumulation account. • A non-commutable income stream may be commuted in cash only in very limited circumstances, including: – within the first six months of commencement – to pay a surcharge liability incurred before surcharges were abolished – on death – to roll over to another non-commutable income stream. 924.SM1.9 Unit 5: Income streams • Social security income and asset test exemption may be retained for rolling over into a complying income stream after 20 September 2007 where: – a payment split is made from a divorce property settlement – one member of an SMSF dies and the surviving member does not want to continue the SMSF – old age makes SMSF administration of the income streams difficult – a fund trustee significantly changes the product features of a term allocated pension. Term allocated pensions (TAPs) Term allocated pensions were designed as an account-based complying income stream, providing investors with taxation and social security benefits. TAPs are unlikely to be available to new investors, but for clients with TAPs commenced before 20 September 2007, 50% of the account balance of the TAP is exempt from the social security assets test, potentially providing additional age pension benefits. Note: If commenced before 1 July 2007, a TAP could have provided the investor with eligibility for the higher pension RBL. A complying income stream such as a TAP can be rolled over to another income stream that meets both the requirements prior to 1 July 2007 for such income streams (such as non-commutability, fixed terms based on age and life expectancy and consequent payment factors) and the new requirements for account-based income streams (minimum payments based on percentage factors). 4.2 Defined benefit pensions Defined benefit pensions are most commonly provided by a corporate or government superannuation fund. Defined benefit pensions may work in a manner similar to lifetime, term-certain or non-account-based annuities. The final benefit is generally based on a number of variables, including age, length of membership and salary. Generally, the benefit is a multiple of the person’s final salary at retirement. Defined benefit pensions can be purchased only with superannuation money, either amounts that have built up within the fund or have been rolled over to the fund. Pensions can only be held in one name (i.e. name of owner of the superannuation money) but a reversionary pensioner can usually be selected with the benefit that the income stream can continue to be paid to a beneficiary upon the owner’s death. SMSFs are not able to commence any new defined benefit pensions. © Kaplan Education 5.21 5.22 4.3 Specialist Knowledge: Superannuation (924) Immediate annuities An immediate annuity is an exchange of a lump sum in return for a guaranteed income stream being paid at predetermined intervals at a predetermined rate — either for a specific period of time (term-certain immediate annuity) or for life (lifetime immediate annuity). Only life insurance companies and friendly societies are permitted to provide immediate annuities. (A superannuation fund can offer a lifetime guaranteed pension, which is a comparable investment to a lifetime annuity.) Immediate annuities may be purchased with either superannuation or with non-superannuation (ordinary) money. Key features of immediate annuities While immediate annuities provide some structural flexibility, there are certain key points that must be observed to ensure they are classified as an immediate annuity: • payment must be made no less frequently than once a year • payment must be on a regular basis • the ‘term’ must be a clearly defined contingency, e.g. a set number of years or the life of the recipient • a final lump sum payment is allowed, but this may not be larger than the original investment amount • in general, the regular payments must be level equal payments, indexed under a clear predefined formula, or subject to minimum percentage payment factors (see Table 5). Immediate annuities purchased with superannuation money If a superannuation benefit is used to purchase an immediate annuity, for lump sum tax purposes it is deemed that the benefit has been rolled over and therefore no lump sum tax is payable on the amount used to purchase the annuity. This applies irrespective of the age of the purchaser. Investors are unable to split income with a spouse or partner for taxation purposes when using superannuation benefits to purchase an immediate annuity. This means the income stream must go to the individual rolling over the benefit (although it can be payable to a dependant upon death). Superannuation annuities can generally only be purchased with unrestricted non-preserved benefits, unless they are non-commutable under the transition to retirement rules (see section 3). Immediate annuities purchased with non-superannuation funds An immediate annuity is classified as an ordinary annuity where the funds used to purchase the annuity were sourced from private sources, that is any sources that have never been, or are no longer, superannuation benefits (these could include funds that were once superannuation benefits but on which lump sum tax had been paid). Immediate annuities purchased with non-superannuation funds can be used for income-splitting purposes, that is purchased in joint names. 924.SM1.9 Unit 5: Income streams Types of immediate annuities Immediate annuities are not used extensively in practice. While they provide certainty of income, this generally comes at the price of higher returns, and this combination does not appeal to most clients. Investors wishing to rollover their superannuation benefits to purchase an annuity have several alternatives from which to choose. An initial consideration may be whether to choose a fixed-term/term certain annuity or a lifetime annuity. Once this has been decided, the investor must decide between the different types and payment standards of each. Table 4 below shows the choices. Table 4 Types of immediate annuities Type of immediate annuity Sub-type Payment standard Lifetime • • • • • • • nil RCV commutable, nil RCV non-commutable, or flexible with or without RCV • • nil RCV commutable, flexible with or without RCV Term--certain (fixed-term) 5 single life joint life last-survivor reversionary Incorporating retirement income streams into the SOA Essentially, retirement income streams are used within a financial plan to provide regular income. Because the income payment is known at the outset of each year and paid at regular intervals, it can be budgeted against expenses for that year. Allocated or account-based income streams have the flexibility to allow extra income payments when needed in addition to regular living expenses. Term-certain and lifetime annuities, with their guaranteed payments, are useful in budgeting against regular living expenses. A financial plan should also have other investments, particularly growth assets, all of which will also generate further income. Growth investments are needed by many retirees to protect against the effects of inflation. Other factors affecting the income stream, such as social security entitlements, taxation effects (see section 6), and any investments outside superannuation, also need to be incorporated into the SOA. © Kaplan Education 5.23 5.24 5.1 Specialist Knowledge: Superannuation (924) Income stream payments Duration of payments With an allocated pension/annuity, the client always retains a visible account balance. Individuals are given flexibility regarding the type of assets they invest in, for example balanced funds, capital secure funds, share funds and cash funds. The earnings of the funds are credited to the account balance. As income payments are made, the account balance is reduced (units are sold). As earnings are made or lost, the account balance is adjusted accordingly. Owing to the flexibility in the level of income payments, the ability to commute and the effect of investment earnings, the duration of the allocated income stream will depend upon the amount of income payment and commutations taken and the type of assets the fund is invested in. Minimum payments from 1 July 2007 From 1 July 2007, the terms of an account-based income stream must ensure that an income payment of at least a certain amount is made at least annually. There is no maximum income payment that must be paid (unless it is a transition to retirement pension where the maximum annual income payment is capped at 10% of the account balance), however a fund may choose to impose a maximum payment under its own rules or it may permit any level of income payment in excess of the minimum to be drawn at the choice of the member. The minimum income amount (rounded to the nearest $10) is calculated as: Minimum income = Account balance × Percentage factor where: Account balance = initial purchase price + returns – fees – charges – taxes – payments determined on commencement of the income stream and at each 1 July thereafter Percentage factor = determined from the recipient’s age on commencement of the income stream and at each 1 July thereafter. Table 5 details the percentage factors applicable from 20 September 2007. Table 5 Minimum pension percentage factors from 20 September 2007 Age of recipient Minimum percentage factor Under age 65 4% 65 to 74 5% 75 to 79 6% 80 to 84 7% 85 to 89 9% 90 to 94 11% 95 and older 14% Where an income stream commences part-way through the financial year, the minimum income payment is a pro rata amount based on the days remaining in the year. Where an income stream is commenced after 1 June in a financial year, income payments can be deferred to the following financial year. 924.SM1.9 Unit 5: Income streams Example: Pro rata pension calculation Marie is 64 and commences her allocated pension on 3 March 2008. Her purchase price is $95,000 (net of charges). The minimum pro rata pension for the first year is: $95,000 × 4% × 120 ÷ 365 = $1249 Apply your knowledge 1: Minimum pension Sandeep commenced an allocated pension on 1 July 1995 at age 55, and on 1 July 2007 has an account balance of $223,000. The pension provider is going to apply minimum percentage factors to Sandeep’s pension. What is the minimum amount of income Sandeep may receive from his pension in 2007/08? A $11,260 B $14,970 C $11,150 D $8920 Reflect on this: More than the minimum With an account-based pension there is a minimum percentage factor, but no maximum. If a recently retired client said that they wanted to draw 15% for the first year’s pension, how would you react? What issues, if any, would you raise with them? If they have satisfied a condition of release and can get their superannuation and spend it, why shouldn’t they? Minimum and maximum payments prior to 1 July 2007 Allocated income streams commenced prior to 1 July 2007 can convert to the new provisions from 1 July 2007 without the need to commute the existing pension by the application of the new percentage factors. The regulations also allow allocated income streams commenced prior to 20 September 2007 to continue to be paid under provisions requiring income payments between minimum and maximum limits. Minimum and maximum pension valuation factors (PVFs) determine the minimum and maximum income payments each year using the formula: Maximum/minimum levels = AB PVF where: AB means the amount of the pension/annuity account balance: • on 1 July in the financial year in which the payments are made • if it is the year that payments commence, on the commencement day. PVF is the factor for the maximum or minimum (whichever is applicable) that represents the age of the beneficiary: • on July 1 in the financial year in which the payments are made • if it is the year that payments commence, on the commencement day. © Kaplan Education 5.25 5.26 Specialist Knowledge: Superannuation (924) If the allocated pension/annuity commences before 1 June, a pro rata minimum payment must be made for that financial year. This is based on the number of days from commencement until 30 June. For allocated pensions/annuities commenced in 1 June in any year, no minimum payment is required for that year. The amount determined by the formula is rounded to the closest number evenly divisible by 10. Example: Minimum allocated pensions As at 1 July 2007, Bruce (age 61) has an allocated pension valued at $167,000 (net of charges). The minimum pension Bruce has to take in that financial year is: $167 ,000 = 18.9 $8835.98 rounded to nearest $10 = $8840 The maximum pension Bruce can take in that financial year is: $167 ,000 = 10.7 6 $15,607.48 rounded to nearest $10 = $15,610 Taxation of pensions and annuities The taxation treatment of pensions is relatively similar to that of annuities and so they are treated together in this section, with any differences highlighted. 6.1 When is tax payable on retirement income streams? The issuer or provider of annuities or pensions (i.e. the life insurance company or fund manager) does not pay tax on the earnings generated within the pension or annuity fund. Income stream investors who are age 60 or over are not subject to tax on their pension or annuity income if it is paid from a taxed source. Such income is non-assessable and non-exempt income and is not required to be declared in the investor’s income tax return. As a consequence, it is not necessary for these investors to quote their TFN to the income stream provider. 924.SM1.9 Unit 5: Income streams Under 60 or untaxed source Other income stream investors (those under age 60 or whose income stream is paid from an untaxed source) should complete a tax file number (TFN) declaration form when the income stream is commenced. The completion of this form ensures that the correct tax is applied to income payments. The TFN declaration form applies to all pensions and annuities, including pensions paid by SMSFs. The TFN declaration form: • provides the individual’s tax file number or exemption reason (this is not compulsory, but if it is not given tax may be applied at the top marginal rate to assessable income) • claims the tax-free threshold/general exemption (tax is taken from the first dollar of income received in the same way as for employment income, if not claimed). An individual can only claim the tax-free threshold for one income source • claims the senior Australians tax offset (SATO) to reduce PAYG instalments • claims entitlements to the annuity and pension tax offset (PTO). Following correct completion of the TFN declaration form, the pension or annuity provider is able to withhold the correct amount of tax under the PAYG system. If the client is already claiming the tax-free threshold and SATO from another source, higher rates of PAYG tax will be deducted from the income stream. If this would result in tax being deducted in excess of the amount required, the client can submit a PAYG variation request to the ATO to have a lower rate applied to their income stream. Care should be taken, because if tax is underestimated, heavy tax penalties may apply. 6.2 Tax applicable on income streams Prior to 1 July 2007 Prior to 1 July 2007 the taxation of superannuation income streams and nonsuperannuation income streams was relatively similar, with income payments comprising a: • deductible amount — regarded as a return of capital and therefore not subject to tax • a taxable amount included in the assessable income of the pensioner or annuitant. 1 July 2007 onwards From 1 July 2007 the taxation of non-superannuation income streams remains unchanged, while superannuation income streams paid from a taxed fund to a person aged 60 or over are wholly tax-free. Those paid to a person under age 60 have a tax-free component and a taxable component, with a tax offset of up to 15% of the taxable component. © Kaplan Education 5.27 5.28 Specialist Knowledge: Superannuation (924) Table 6 below sets out the tax rules for superannuation income streams from 1 July 2007. Table 6 Taxable component of superannuation income stream payment Taxed element Untaxed element 60 and above Tax-free Marginal tax rates less a 10% tax offset Preservation age to 59 Marginal tax rates less up to a 15% tax offset Marginal tax rates (no tax offset) Below preservation age Marginal tax rates (no tax offset)* Marginal tax rates (no tax offset) * Death and disability superannuation income streams also receive a 15% tax offset. It is the responsibility of the income stream provider to deduct tax on a PAYG basis from each pension or annuity income payment and remit this to the ATO. 6.3 Superannuation income streams commenced from 1 July 2007 From 1 July 2007, all superannuation benefit payments, including income payments, must be proportioned into tax-free and taxable components that reflect the proportion these components make up of the total superannuation benefit. The percentage of each component is determined upon commencement of a superannuation income stream; with the tax-free and taxable components of all subsequent benefit payments — income and commutations — determined using these percentages. Note: Even though all benefit payments are tax-free when paid to those age 60 and over from a taxed fund, the tax-free and taxable components must still be calculated on commencement of the income stream. This is to ensure the correct taxation calculation for any superannuation death benefits. Example: Taxable components of an account-based pension Morgan is age 58 and on 1 July 2007 commenced an account-based pension with a value of $400,000. The pension includes a tax-free component of $250,000 and a taxable component of $150,000. Tax-free percentage of Morgan’s pension on commencement is: 62.5% ($250,000 ÷ $400,000 × 100). Taxable percentage of Morgan’s pension is: 37.5% (balance of pension or $150,000 ÷ $400,000 × 100). Morgan receives a pension payment of $5000 on 1 September 2007. The tax-free component of this payment is $3125 (i.e. 62.5% of $5000) and the taxable component is therefore $1875 (i.e. 37.5% × $5000). If the pension subsequently increased in value, for example to $500,000, due to earnings, and is then commuted and rolled over or paid out due to death, the tax-free amount is determined using the tax-free proportion at the time of commencement (i.e. of the $500,000 rolled over, 62.5% or $312,500 is the tax-free component). 924.SM1.9 Unit 5: Income streams Tax-free component The tax-free component has two parts — the crystallised segment and the contributions segment. The crystallised segment is the sum of the following components, assuming a lump sum equal to the value of the superannuation interest was paid on 30 June 2007: • undeducted contributions • pre-July 1983 contributions • post-June 1994 invalidity component • CGT-exempt amount • concessional contributions. The contributions segment is simply the sum of all non-concessional contributions (previously known as ‘undeducted contributions’) made from 1 July 2007. Taxable component The taxable component of a superannuation interest is the remaining balance and is essentially the sum of any post-June 1983 amounts just before 1 July 2007, any concessional contributions made from 1 July 2007 and all investment earnings. Example: Taxable and tax-free components Marjorie has a superannuation account worth $160,000 on 30 June 2007. On 1 July 2007, the tax-free component of her account is $60,000 and the taxable component is $100,000. Between 1 July 2007 and 30 June 2015, when she retires, Marjorie makes non-concessional contributions of $100,000 and concessional contributions of $150,000 into her account. When she retires on 30 June 2015, Marjorie’s account is worth $520,000. The tax-free component of her account is $160,000 ($60,000 initial tax-free component + $100,000 of additional non-concessional contributions) and the taxable component is $360,000 ($100,000 initial taxable component + $150,000 of additional concessional contributions + $110,000 of investment earnings). If Marjorie commences a pension on 1 July 2015, the components of her pension will be: • tax-free component = 30.8% ($160,000 ÷ $520,000) • taxable component = 69.2% ($360,000 ÷ $520,000) If she takes an annual pension payment of $35,000, $10,780 of this (30.8% × $35,000) will be tax-free and $24,220 (69.2% × $35,000) will be taxable. © Kaplan Education 5.29 5.30 6.4 Specialist Knowledge: Superannuation (924) Income streams commenced before 1 July 2007 Each income payment paid from a pension or annuity commenced before 1 July 2007 (and not subject to triggering, discussed at section 6.5 below, if it is a superannuation income stream) is made up of: • A deductible amount. This is the tax-free portion of each payment; it is not part of assessable income. The deductible amount is determined by the following formula: Deductible amount = UPP – RCV RN where: UPP = undeducted purchase price RCV = residual capital value RN = the relevant number. The UPP for allocated pensions, TAPs, defined benefit pensions or superannuation annuities is the sum of undeducted contributions, pots-June 1994 invalidity and CGT-exempt components. The relevant number is determined as follows: – for term-certain pensions/immediate annuities — the nominated term – for single-life pensions/immediate annuities — the life expectancy of the investor – for joint-life and reversionary immediate annuities — the longer life expectancy of the investors – for allocated pensions/annuities — the life expectancy of the investor (if an automatic reversionary beneficiary has been nominated, the relevant number will be the longer life expectancy of the pensioner and the reversionary beneficiary) – for term allocated pensions (TAPs) — the nominated term. • A taxable amount. This is the part of each payment included in the investor’s assessable income. It is the total income payment less the deductible amount. To ensure consistency with the post-1 July 2007 taxation regime, the deductible amount is converted into a tax-free amount. This is done by first calculating the proportion of the relevant income payment to all income payments from that superannuation income stream received for the year. For example, for a person receiving monthly income payments of $5000, this would be: $5000 ÷ $60,000 = 8.33% Then, the annual deductible amount is multiplied by the percentage calculated above to determine the tax-free component of the monthly pension payment. If the annual deductible amount is $18,000, this would mean a tax-free component of $1499 (8.33% × $18,000). The proportional deductible amount will continue to apply until a trigger event (see section 6.5) occurs. Note: Where the deductible amount exceeds the income payment, the unused deductible amount could be carried forward to reduce assessable income from the income stream in future financial years. This occurred most commonly in the first year of an income stream. 924.SM1.9 Unit 5: Income streams 6.5 Triggering of a pre-1 July income stream Investors with superannuation income streams commenced before 1 July 2007 will retain the deductible (i.e. concessional) amount of their superannuation income stream unless what is known as a trigger event occurs. Once a trigger event occurs, the tax-free and taxable components of the income stream are calculated. Trigger events are: • commutation of the income stream (in full or part, cash or rollover) • attaining age 60 • death. At the time of a trigger event, the tax-free component of a superannuation income stream is calculated as follows: • for post-1 July 1994 income streams — the sum of the unused undeducted purchase price (UUPP) plus the value of the pre-July 1983 component of the benefit • for a pre-1 July 1994 income stream — the UUPP of the income stream. The reason for the difference is that the UUPP for these income streams already includes an amount of pre-83 benefit. The taxable component is the difference between the total value of the income stream and the tax-free component. 6.6 Superannuation annuity and pension tax offset (PTO) Investors who use superannuation money to purchase an income stream may be eligible for a pension tax offset (PTO) equal to 15% of the taxable component of their income payment. This tax offset is available to: • investors who are preservation age or over but are under age 60 • investors of any age receiving a disability pension or annuity (i.e. paid due to their total and permanent disablement) • investors of any age receiving a death pension or annuity (i.e. paid due to the death of another person). Where an income recipient reaches preservation age part-way through a financial year, the tax offset will apply to income payments received after the relevant date. The 15% tax offset applies only to the taxable component of the income payment, that is the difference between the income payment and the tax-free component. The 15% pension tax offset can only reduce tax payable to nil. It can reduce tax on both pension and annuity income as well as income from other sources. Unlike refundable tax offsets, such as franking credits, this tax offset cannot be refunded in cash, nor can it be used to pay the Medicare levy. A 10% tax offset (essentially identical in all respects other than amount to the 15% tax offset) is available to clients who receive an income payment with a taxable component that includes an untaxed element. This is most likely to occur where the income stream is being paid from an untaxed or unfunded superannuation scheme, typically a government scheme. © Kaplan Education 5.31 5.32 Specialist Knowledge: Superannuation (924) Example: Calculation of tax-free component and tax offset Annuity commencement date 1 July 2008 Age 61 (male) Superannuation benefit $210,000 Tax-free component 4.76% ($10,000) Taxable component 95.24% ($200,000) Annual payment $15,000 Marginal tax rate 15% Step 1 — Calculate the tax-free component of the annuity payment Tax-free component = 4.76% × $15,000 = $714 Step 2 — Calculate taxable component of the annuity payment Taxable component = 95.24% × $15,000 = $14,286 Step 3 — Calculate the pension tax offset (PTO) 15% of $14,286 = $2142 Step 4 — Calculate the tax payable on the annuity payment Tax payable at 15% = ($14,286 – $6000) × 15% = $1243 Less 15% pension tax offset (PTO) = $2142 Net tax payable = $1243 – $2142 = nil Plus Medicare levy = 1.5% × $14,286 = $214.29 Total tax payable = $214.29 There is an excess tax offset of $899 (i.e. $2142 − $1243) available to reduce tax on income from other sources. This excess offset cannot reduce the Medicare levy and cannot give rise to a tax refund. Review your progress 1: Taxation of income streams Describe the different taxation treatment of income paid after 1 July 2007 from: 1. an ordinary (non-superannuation) annuity 2. a transition to retirement pension to a person aged 56 3. a fixed-term superannuation annuity to a person aged 63 4. an allocated pension commenced on 1 July 2005 to a person aged 57 5. an account-based pension from a taxed fund for a person over 60. 924.SM1.9 Unit 5: Income streams 7 Death and disability income streams In addition to commencing a superannuation income stream on retirement, a client may also commence an income stream as a result of: • their disability • the death of another person. 7.1 Death benefit income streams A person may commence a superannuation income stream due to the death of another person in two ways: • On the reversion or continuation of a superannuation income stream that had been payable to the deceased person. This may occur automatically as a result of a reversionary nomination, following the action of a binding beneficiary nomination or through trustee discretion. • As the payment of a death benefit from the deceased’s superannuation accumulation account. This may occur through either a binding beneficiary nomination or through trustee discretion. The components of a superannuation death benefit income stream are determined by the components of the underlying superannuation interest, in exactly the same way as for superannuation member benefits. Therefore, the death benefit income stream will comprise a taxable and tax-free component in the same proportion as existed in the underlying superannuation benefit. Tax treatment The tax-free component of the death benefit income stream is non-assessable and non-exempt income and is not taxable, regardless of whether it is paid to a dependant or a non-dependant. The tax treatment of the taxable component of an income stream death benefit depends on the ages of both the deceased person and the recipient. An income stream commenced prior to 1 July 2007 to a non-dependant will be taxed as if received by a dependant. The tax treatment of these income streams is set out in Table 7 below. Table 7 Taxation of superannuation income stream death benefits to dependants Age of deceased Recipient Taxation of taxable component Aged 60 and above Any age Taxed element — tax-free Untaxed element* — MTR less 10% tax offset Below age 60 Age 60 and above Taxed element — tax-free Untaxed element* — MTR less 10% tax offset Below age 60 Below age 60 Taxed element — MTR less 15% tax offset Untaxed element* — MTR * An untaxed element is generally payable in a death benefit income stream paid from an untaxed fund or unfunded scheme. © Kaplan Education 5.33 5.34 Specialist Knowledge: Superannuation (924) Example: Tax-free and taxable components of a death benefit income stream Hugh has an allocated pension that has a tax-free component of 85% and a taxable component of 15%. At the time of his death, his allocated pension account balance is $450,000. He has made a binding nomination to pay: • 50% of his account balance as a death benefit pension to his wife, Drew • 50% as a lump sum to his adult daughter, Sue. Drew’s benefit Drew will receive a death benefit pension of $225,000, with a: • tax-free component of $191,250 (85%) • taxable component of $33,750 (15%). If she draws a pension payment of $10,000, it will have a tax-free component of $8500 (85%) and a taxable component of $1500 (15%). If, 12 months after commencing the pension, Drew wants to commute part of the income stream as a lump sum of $30,000, $25,500 (85%) of this will be tax-free and $4500 (15%) will be taxable. Sue’s benefit Sue will receive a lump sum death benefit of $225,000 with a: • tax-free component of $191,250 • taxable component of $33,750. As Sue is not a tax dependant of Hugh’s, she will pay tax on the taxable component of the benefit at the non-dependant lump sum taxable component rate of 16.5%. The amount of tax payable is $5568.75 (16.5% of $33,750). Example: Deceased over age 60 Howard is age 62 and has $800,000 in superannuation at the time of his death. Equal benefits are to be paid as pensions to: • his mother, Martha age 85 (who is in an interdependent relationship with Howard) • his wife, Janet age 58. As Howard is over age 60, the age of his beneficiaries is irrelevant when determining the taxation of their death benefit pensions. Both Martha’s and Janet’s death benefit pensions will be tax-free. Example: Deceased under age Indira is age 58 when she dies, leaving death benefit pensions of $600,000 each to her: • current husband, Ajoy (age 73) • her former husband Sunil (age 36), who is her financial dependant. As Ajoy is over age 60, his death benefit pension is tax-free, even though Indira is under age 60. However, Sunil is under age 60 so his death benefit pension is taxable at marginal tax rates, with a 15% tax offset on the amount of the taxable component. When Sunil reaches age 60, his pension will become tax-free. 924.SM1.9 Unit 5: Income streams Commuting income stream death benefits Death benefit income streams can be commuted to a lump sum under certain circumstances. How this is done depends on whether it is commuted: • after the prescribed period, or • within the prescribed period. The prescribed period is the latest of: • six months after the date of death • three months after the grant of probate of the deceased’s will or letters of administration of the deceased’s estate – if the payment is delayed because of legal action about entitlements to the benefit, six months after the legal action ceases – if the payment is delayed because of reasonable delays in the process of identifying and contacting potential recipients, six months after that process is complete. Commutation after the prescribed period After the prescribed period, the commutation of a death benefit income stream will be in the form of a superannuation member benefit. It may only be rolled over (either to another income stream or to an accumulation account) by a spouse of the deceased person. Commutation within the prescribed period A commutation of an income stream death benefit within the prescribed period will be a superannuation death benefit and cannot be rolled over. The resulting payment will be taxed as a lump sum death benefit. Child beneficiaries An income stream death benefit paid to a child under the age of 25 must cease once the child reaches age 25 (unless the child has a disability). The child must then commute the income stream as a tax-free superannuation lump sum at this point. Prior to age 25, the child can commute the pension as a tax-free lump sum at any time, but cannot roll over the pension. © Kaplan Education 5.35 5.36 Specialist Knowledge: Superannuation (924) Child death benefit pensions From 1 July 2007, a person who is not a dependant of the deceased (under the SIS definition) will not be able to receive a superannuation income stream death benefit. Also, if the dependant is a child of the deceased member, the income stream may only be paid if, at the time of death, that child: • is under the age of 18 • is financially dependent and under the age of 25 (and paid only until the child reaches the age of 25), or • has a disability (as defined under section 8(1) of the Disability Services Act 1986), in which case the income stream may be paid at any age and continue to be paid past the age of 25. A child who receives an income stream death benefit that cannot be paid once they reach age 25 must commute any remaining income stream balance tax-free. The payment of an income stream death benefit to an adult child (not financially dependent and not disabled) is therefore not permitted after 1 July 2007, even if a binding nomination or trust deed provision to this effect was in place before this date. However, a death benefit pension may still be paid to a minor child. It is taxable at adult marginal tax rates, is eligible for the tax-free threshold ($6000 in 2008/09) and is eligible for a 15% pension tax offset. Therefore, the payment of death benefit pensions to minor children provides a relatively straightforward way in which to tax-effectively split income between surviving family members, without the need to establish testamentary or superannuation proceeds trusts. 7.2 Permanent disability benefits Permanent disability (or incapacity) is a condition of release for all superannuation benefits and benefits can be taken as a lump sum or as an income stream of any type. An income stream paid due to the disability of a person is known as a disability pension. In order to commence a disability pension, a person must have ceased to be gainfully employed and be suffering ill health (whether physical or mental), where the trustee is reasonably satisfied that the person is unlikely, because of the ill health, ever again to engage in gainful employment for which the person is reasonably qualified by education, training or experience. ‘Gainfully employed’ means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment. Where a person receives a disability superannuation income stream, they are entitled to a 15% tax offset on the taxable component of the income stream benefits. The pension will have a tax-free component and a taxable component in the same proportion as the underlying benefit. 924.SM1.9 Unit 5: Income streams Suggested answers Apply your knowledge 1: Minimum pension On 1 July 2007, Sandeep will be 67, with a minimum percentage factor of 5%. 5% of $223,000 = $11,150. Review your progress 1: Taxation of income streams 1. From an ordinary (non-superannuation) annuity: • Each payment consists of a taxable amount, and a deductible amount which is tax-free. • The deductible amount is calculated by dividing the purchase price by the relevant number (life expectancy or the number of years in a fixed term). • The taxable amount is included in the client’s income and taxed at marginal rates. 2. From a transition to retirement pension to a person age 56: • Each payment consists of a taxable component and a tax-free component. • The value of each component is based on the proportion of each component in the underlying pension account (determined at the commencement of the pension). • The taxable component is included in the client’s income and taxed at marginal rates. The client is also eligible for a tax offset equal to 15% of the value of the taxable component of the payment. • The tax-free component is neither assessable income nor exempt income of the investor and is not subject to tax. 3. From a fixed-term superannuation annuity to a person age 63: The whole payment is tax-free. 4. From an allocated pension commenced on 1 July 2005 to a person age 57: • The tax-free component of the pension is based on the deductible amount of the pension before 1 July 2007. The deductible amount is equal to the original undeducted purchase price divided by the life expectancy of the client at commencement. • The remainder of the payment is taxable and is included in the client’s income and taxed at marginal rates. The client is also eligible for a tax offset equal to 15% of the value of the taxable component of the payment. • The tax-free and taxable components of the pension payments will be recalculated once the pension experiences a trigger event such as commutation or when the client reaches age 60. 5. From an account-based pension from a taxed fund for a person over 60: The whole payment is tax-free. © Kaplan Education 5.37 5.38 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 5 Appendix 1 Allocated pension and annuity minimum and maximum factors — commenced before 1 January 2006 1 Unit 5: Appendix 1 Allocated pension and annuity minimum and maximum factors — commenced before 1 January 2006 The following PVFs are used to calculate the minimum and maximum income required to be withdrawn from an allocated pension or annuity that commenced before 1 January 2006 and not converted to minimum percentage factors on or after 1 July 2007. Age Minimum pension factor Maximum pension factor Age Minimum pension factor Maximum pension factor 55 19.8 9.6 78 10.0 2.2 56 19.4 9.5 79 9.5 1.4 57 19.0 9.4 80 9.1 1 58 18.6 9.3 81 8.7 1 59 18.2 9.1 82 8.3 1 60 17.8 9.0 83 7.9 1 61 17.4 8.9 84 7.5 1 62 17.0 8.7 85 7.1 1 63 16.6 8.5 86 6.8 1 64 16.2 8.3 87 6.4 1 65 15.7 8.1 88 6.1 1 66 15.3 7.9 89 5.8 1 67 14.9 7.6 90 5.5 1 68 14.4 7.3 91 5.3 1 69 14.0 7.0 92 5.0 1 70 13.5 6.6 93 4.8 1 71 13.1 6.2 94 4.6 1 72 12.6 5.8 95 4.4 1 73 12.2 5.4 96 4.2 1 74 11.7 4.8 97 4.0 1 75 11.3 4.3 98 3.8 1 76 10.8 3.7 99 3.7 1 77 10.4 3.0 100 3.5 1 Source: Superannuation Industry (Supervision) Regulations, Schedule 1A. 2 Allocated pension and annuity minimum and maximum factors — commenced on or after 1 January 2006 The following PVFs are used to calculate the minimum and maximum income required to be withdrawn from an allocated pension or annuity that commenced on or after 1 January 2006 and not converted to minimum percentage factors on or after 1 July 2007. Age Minimum pension factor Maximum pension factor Age Minimum pension factor Maximum pension factor 55 21.1 11.5 78 11.4 4.5 56 20.8 11.4 79 10.9 3.8 57 20.4 11.3 80 10.5 3.1 58 20.1 11.2 81 10.0 2.3 59 19.7 11.0 82 9.6 1.4 60 19.3 10.9 83 9.1 1 61 18.9 10.7 84 8.7 1 62 18.5 10.5 85 8.3 1 63 18.1 10.3 86 7.9 1 64 17.7 10.1 87 7.5 1 65 17.3 9.9 88 7.2 1 66 16.8 9.6 89 6.9 1 67 16.4 9.3 90 6.6 1 68 16.0 9.1 91 6.3 1 69 15.5 8.7 92 6.0 1 70 15.1 8.4 93 5.8 1 71 14.6 8.0 94 5.5 1 72 14.2 7.6 95 5.3 1 73 13.7 7.2 96 5.1 1 74 13.3 6.7 97 4.9 1 75 12.8 6.2 98 4.7 1 76 12.3 5.7 99 4.5 1 77 11.9 5.1 100 4.4 1 Source: Superannuation Industry (Supervision) Regulations, Schedule 1AAB. 3 Term allocated pensions pension factors The following pension factors are used to calculate the annual income required to be withdrawn from a term allocated pension. Term remaining Pension factor Term remaining Pension factor 45 22.50 22 15.17 44 22.28 21 14.70 43 22.06 20 14.21 42 21.83 19 13.71 41 21.60 18 13.19 40 21.36 17 12.65 39 21.10 16 12.09 38 20.84 15 11.52 37 20.57 14 10.92 36 20.29 13 10.30 35 20.00 12 9.66 34 19.70 11 9.00 33 19.39 10 8.32 32 19.07 9 7.61 31 18.74 8 6.87 30 18.39 7 6.11 29 18.04 6 5.33 28 17.67 5 4.52 27 17.29 4 3.67 26 16.89 3 2.80 25 16.48 2 1.90 24 16.06 1 1.00 23 15.62 0 1.00 Source: Superannuation Industry (Supervision) Regulations, Schedule 6. Notes 6 Social security Overview 6.1 Unit learning outcomes ....................................................................6.1 Further resources ............................................................................6.2 1 1.1 1.2 1.3 1.4 Introduction to social security 6.5 Types of payments .................................................................6.5 Changes to social security.......................................................6.5 Service delivery of social security .............................................6.6 Policy bases of social security .................................................6.7 2 2.1 2.2 2.3 2.4 2.5 Social security payments and concessions 6.8 Pensions ...............................................................................6.8 Allowances...........................................................................6.10 Baby bonus..........................................................................6.11 Concession cards .................................................................6.11 Indexation of payment rates ..................................................6.13 3 3.1 Calculating income support 6.14 Determining entitlement........................................................6.14 4 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 Understanding income and assets for social security 6.15 Definition of income..............................................................6.15 Definition of assets ..............................................................6.16 Income and assets assessment for couples ...........................6.16 Deemed investments ............................................................6.17 Assessing deemed income....................................................6.20 Superannuation and rollovers ................................................6.23 Income streams ...................................................................6.24 Assessment of income streams.............................................6.25 Splitting income streams after divorce....................................6.28 Other income and assets ......................................................6.28 Gifting and deprivation rules ..................................................6.37 5 5.1 5.2 5.3 5.4 5.5 Applying the income and assets tests 6.42 Effects of the assets test......................................................6.43 Strategies for reducing assessable assets .............................6.45 Effects of the income test .....................................................6.46 Strategies for reducing assessable income.............................6.54 Comparing the income test and assets test rates ...................6.56 6 6.1 6.2 6.3 6.4 6.5 6.6 Miscellaneous income support provisions 6.57 Waiting periods and reduction periods for allowances ..............6.57 Compensation payments.......................................................6.61 Hardship provisions ..............................................................6.62 Overpayments ......................................................................6.62 Anti-avoidance rules..............................................................6.63 Rights and appeals...............................................................6.63 7 7.1 7.2 7.3 7.4 7.5 7.6 Taxation considerations 6.64 Senior Australians tax offset..................................................6.64 Pensioner tax offset..............................................................6.66 Beneficiary tax offset ............................................................6.67 Transfer of unused tax offsets between partners .....................6.67 Medicare levy income threshold .............................................6.68 PAYG tax instalments............................................................6.69 8 8.1 8.2 8.3 Aged care provisions 6.69 Aged care residences............................................................6.70 Asset and income assessment for aged care ..........................6.73 Age pension for those in an aged care facility .........................6.74 9 9.1 9.2 9.3 9.4 9.5 Miscellaneous strategies 6.75 Superannuation exemption ....................................................6.75 Couples and asset ownership................................................6.76 Reassessing investment value...............................................6.76 Repaying debts ....................................................................6.77 Salary sacrifice.....................................................................6.77 Suggested answers 6.79 Unit 6: Social security Overview Social security entitlements can have a major influence on a client’s financial situation and should be carefully considered when preparing a financial plan. Most social security payments are means tested, with eligibility determined by an income test and an assets test. The test that produces the lower rate of payment is the one applied. Therefore, the effects of both tests must be understood — they should not be considered in isolation. Total income can be increased and the client’s overall financial situation improved by implementing social security-friendly strategies. The financial adviser can add value through strategies based on a detailed knowledge of what is assessed and how it is assessed. Specific tax rules also apply that can increase a social security recipient’s after-tax income. In formulating a long-term retirement and social security strategy, the tests, bonds and charges for potential entry into aged care should also be considered. This unit will provide students with a basic understanding of the different types of social security benefits available. It describes the assets and income tests, and details the effects they have on eligibility and payment. This unit specifically addresses the following subject learning outcome: • Evaluate strategies to maximise superannuation benefits and clients’ entitlements to social security benefits and access to aged care. Unit learning outcomes On completing this unit, you should be able to: • explain the income and assets tests that apply to pensions and allowances • assess simple client situations for pension and allowance eligibility • describe, and illustrate with examples, the application of the social security assessment of investments • assess how a client might be affected by waiting periods • explain and interpret the assessment of deemed income • outline the social security appeals process • outline the tax offsets available to clients • calculate an accommodation bond and an accommodation charge for a person entering an aged care facility • discuss the similarities and differences of income and assets test assessment for Centrelink’s pension entitlement and aged care fees. © Kaplan Education 6.1 6.2 Specialist Knowledge: Superannuation (924) Further resources • ATO, ‘Seniors and retirees essentials’ [online]. Available from: <http://www.ato.gov.au> by entering ‘seniors and retirees essentials’ in the search box [cited 1 October 2008]. • ATO 2008, ‘Medicare levy surcharge’ [online] 30 June. Available from: <http://www.ato.gov.au> by entering ‘medicare levy surcharge’ in the search box and selecting ‘Medicare levy surcharge’ from the results [cited 1 October 2008]. • Australian pension news, Centrelink, Canberra. Available from: <http://www.centrelink.gov.au> by entering ‘Australian pension news’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Disposing of assets’ [online] 17 April. Available from: <http://www.centrelink.gov.au> by entering ‘deprived assets’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Getting your Australian pension correct’ [online] 11 February. Available from: <http://www.centrelink.gov.au> by entering ‘royalties’ in the search box [cited 1 October 2008]. • Centrelink 2007, ‘Gifting factsheet’ [online] 8 August. Available from: <http://www.centrelink.gov.au> by entering ‘gifting’ in the search box [cited 24 September 2008]. • Centrelink 2007, ‘Liquid assets’ [online] 14 August. Available from: <http://www.centrelink.gov.au> by entering ‘liquid assets’ in the search box [cited 24 September 2008]. • Centrelink 2007, ‘Private trusts and private companies factsheet’ [online] 21 November. Available from: <http://www.centrelink.gov.au> by entering ‘private trusts private companies’ in the search box [cited 24 September 2008]. • Centrelink 2008, ‘Reviews and appeals factsheet’ [online] 21 August. Available from: <http://www.centrelink.gov.au> by entering ‘appeals factsheet’ in the search box [cited 24 September 2008]. • Centrelink 2007, ‘Rollover and superannuation investments factsheet’ [online] 14 August. Available from: <http://www.centrelink.gov.au> by entering ‘rollover superannuation’ in the search box [cited 1 October 2008]. • Centrelink 2007, ‘Who can get baby bonus?’ [online] 28 July. Available from: <http://www.centrelink.gov.au> by entering ‘baby bonus’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Compensation kit booklet’ [online] 10 September. Available from: <http://www.centrelink.gov.au> by entering ‘compensation kit’ in the search box [cited 24 September 2008]. • Centrelink 2008, ‘Deeming factsheet’ [online] 3 April. Available from: <http://www.centrelink.gov.au> by entering ‘deeming’ in the search box [cited 24 September 2008]. 924.SM1.9 Unit 6: Social security • Centrelink 2008, ‘Exempt assets’ [online] 27 June. Available from: <http://www.centrelink.gov.au> by entering ‘exempt assets’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Financial Information Service (FIS)’ [online] 8 May. Available from: <http://www.centrelink.gov.au> by entering ‘FIS’ in the search box and selecting ‘Financial Information Service (FIS)’ [cited 1 October 2008]. • Centrelink 2008, ‘Funeral expenses – preparations you can make factsheet’ [online] 1 July. Available from: <http://www.centrelink.gov.au> by entering ‘funeral bonds’ in the search box [cited 24 September 2008]. • Centrelink 2008, ‘Guide to Australian government payments’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘guide to Australian government payments’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘A guide to Centrelink concession cards booklet’ [online] 17 September. Available from: <http://www.centrelink.gov.au> by entering ‘concession cards guide’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Hardship information factsheet’ [online] 6 June. Available from: <http://www.centrelink.gov.au> by entering ‘hardship’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘How much disability support pension do I get?’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘How much disability support pension do I get’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Income test limits for pensions’ [online] 21 September. Available from: <http://www.centrelink.gov.au> by entering ‘income test limits for pensions’ in the search box and selecting ‘income test limits for pensions’ from the results [cited 1 October 2008]. • Centrelink 2008, ‘Newstart payment rates factsheet’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘newstart’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Parenting payment rates factsheet’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘parenting payment’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Pension bonus scheme brochure’ [online] 18 April. Available from: <http://www.centrelink.gov.au> by entering ‘pension bonus’ in the search box [cited 1 October 2008]. • Centrelink 2008, ‘Residential aged care fees’ [online] 8 April. Available from: <http://www.centrelink.gov.au> by entering ‘residential care’ in the search box and then selecting ‘residential aged care fees’ [cited 1 October 2008]. • Centrelink 2008, ‘Waiting periods’ [online] 1 July. Available from: <http://www.centrelink.gov.au> by entering ‘waiting periods’ in the search box [cited 1 October 2008]. • Department of Health and Ageing 2007, ‘Residential care manual’ [online] 6 December. Available from: <http://www.health.gov.au> by entering ‘residential care manual’ in the search box [cited 1 October 2008]. • Department of Veterans’ Affairs 2005, ‘DVA facts IS08 Veterans’ Affairs financial information service’ [online] 5 October. Available from: <http://www.dva.gov.au> by entering ‘VAFIS’ in the search box [cited 1 October 2008]. © Kaplan Education 6.3 6.4 Specialist Knowledge: Superannuation (924) • FaHCSIA 2007, ‘Questions and answers — social security income and assets tests: better super: changes to means test rules for income streams’ [online] 9 October, Department of Families, Housing, Community Services and Indigenous Affairs, Canberra. Available from: <http://www.facsia.gov.au> by selecting ‘Individuals’ and then ‘Seniors’. Locate and select ‘Seniors Information Publications’ down the page. Finally, select ‘Questions and Answers — Social security income and assets tests — Simplification of superannuation: Changes to means test rules for income streams’ [cited 1 October 2008]. • FaHCSIA 2008, Guide to social security law [online] version 1.141, 19 September, Department of Families, Housing, Community Services and Indigenous Affairs, Canberra. Available from: <http://www.facsia.gov.au> by entering ‘social security policy guides’ in the search box and then selecting ‘social security and family assistance legislation and policy guides’. Select ‘Guide to Social Security Law’ [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security 1 Introduction to social security Social security payments and benefits are intended to assist people in need. These needs may be long term or short term, and they include the need for a regular income in retirement, and for benefits during unemployment or sickness. 1.1 Types of payments Some examples of social security payments are pensions, allowances and benefits that are paid for: • retirement (e.g. age pension, age service pension) • disability/illness (e.g. disability support pension, disability service pension, sickness allowance) • unemployment (e.g. Newstart allowance, youth allowance) • family support (e.g. family payment, parenting payment) • student support (e.g. Austudy, youth allowance) • special support (e.g. drought relief payment). Social security also assists people receiving income support or on low incomes to meet everyday living expenses. These benefits include: • telephone allowance • pharmaceutical allowance • rental assistance. 1.2 Changes to social security Social security rules are often updated for a range of reasons, which include: • responding to social change (e.g. new family structures and workforce patterns) • keeping the system affordable • ensuring assistance is targeted to those genuinely in need • simplifying rules that have become complex • responding to current needs (e.g. drought assistance). Example: Drought relief Centrelink has recently changed rules to help farmers respond to the pressures facing rural and regional Australia. Initiatives include: • increasing the off-farm income exemption from $10,000 to $20,000 for client’s claiming exceptional circumstances relief payment or interim income support • offering an exit grant of up to $150,000 for farmers who have decided to leave the land, and an increase in the assets limit for accessing this grant to $575,000. © Kaplan Education 6.5 6.6 Specialist Knowledge: Superannuation (924) 1.3 Service delivery of social security A number of government departments and agencies are involved in social security and income support, including Centrelink, the Department of Veterans’ Affairs, the Department of Families, Housing, Community Services and Indigenous Affairs (FaHCSIA) and the Department of Health and Ageing. Centrelink Centrelink is a statutory government agency with responsibility for the general implementation of the social security system. It also provides a ‘one-stop shop’ for many payments and services spanning government departments. Centrelink is responsible for delivering services on behalf of the following Commonwealth Government departments: • Department of Families, Housing, Community Services and Indigenous Affairs (FaCHSIA) • Department of Education, Employment and Workplace Relations • Department of Health and Ageing. Further resources • Centrelink 2008, ‘Guide to Australian government payments’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘guide to Australian government payments’ in the search box [cited 1 October 2008]. The guide is issued quarterly even though some rates only change every six months or yearly. • Australian pension news, Centrelink, Canberra. Available from: <http://www.centrelink.gov.au> by entering ‘Australian pension news’ in the search box [cited 1 October 2008]. Financial information service The financial information service (FIS) is a Centrelink service that assists clients who wish to know how their assets and income will affect their social security entitlements. The FIS does not provide financial advice, but aims to complement private sector services by offering comprehensive information on how the means test applies to investment decisions. Information is available by telephone or in person at Centrelink offices. Clients with limited mobility can receive information in person at their homes. Further resources Centrelink 2008, ‘Financial Information Service (FIS)’ [online] 8 May. Available from: <http://www.centrelink.gov.au> by entering ‘FIS’ in the search box and selecting ‘Financial Information Service (FIS)’ [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security Department of Veterans’ Affairs The Department of Veterans’ Affairs pays disability and age service pensions to people who have rendered eligible war service or eligible defence service. They also pay pensions to war widows and dependants. This subject does not deal with Veterans’ Affairs payments in any detail. Veterans’ Affairs delivers its services through a nationwide network. The Department of Veterans’ Affairs also provides a service comparable to Centrelink’s financial information service (above) called the Veterans’ Affairs Financial Information Service (VAFIS). This is available for veterans and their families. Further resources Department of Veterans’ Affairs 2005, ‘DVA facts IS08 Veterans’ Affairs financial information service’ [online] 5 October. Available from: <http://www.dva.gov.au> by entering ‘VAFIS’ in the search box [cited 1 October 2008]. 1.4 Policy bases of social security Social security policy is underpinned by the Social Security Act 1991 (Cth). Two government departments play a significant role in policy development and administration relevant to the Act. Social Security Act 1991 The Social Security Act 1991 stipulates provisions on pensions, benefits and allowances. It also includes general provisions relating to payment eligibility and rates, international agreements and portability, and overpayments and debt recovery. FaHCSIA The Department of Families, Housing, Community Services and Indigenous Affairs (FaHCSIA) plays a major role in the development of policy related to social security. It is the Australian Government’s biggest source of advice on social policy and is responsible for administering social security legislation. Supplementing the Act, it sets some of the eligibility rules for pensions and allowances that are administered by Centrelink. © Kaplan Education 6.7 6.8 Specialist Knowledge: Superannuation (924) Department of Health and Ageing The Department of Health and Ageing works to achieve the Australian Government’s priorities through its policy, programs, research and regulation activities, and by leading and working with other government agencies, consumers and stakeholders. It provides essential information on health and ageing. Further resources • FaHCSIA 2007, ‘Questions and answers — social security income and assets tests: better super: changes to means test rules for income streams’ [online] 9 October, Department of Families, Housing, Community Services and Indigenous Affairs, Canberra. Available from: <http://www.facsia.gov.au> by selecting ‘Individuals’ and then ‘Seniors’. Locate and select ‘Seniors Information Publications’ down the page. Finally, select ‘Questions and Answers — Social security income and assets tests - Simplification of superannuation: Changes to means test rules for income streams’ [cited 1 October 2008]. • Department of Health and Ageing 2007, ‘Residential care manual’ [online] 6 December. Available from: <http://www.health.gov.au> by entering ‘residential care manual’ in the search box [cited 1 October 2008]. 2 Social security payments and concessions Many different types of payments and concessions are available to individuals depending on their needs and eligibility. Some of the more commonly used payments and concessions are outlined below. 2.1 Pensions Pensions are generally paid for long-term needs. Generally, only Australian residents who are living in Australia are eligible. Some payments may continue during absences from Australia. Details should be checked with Centrelink before clients leave the country. Common payments include: • age pensions • age service pensions • pension bonuses • disability support pensions. 924.SM1.9 Unit 6: Social security Age pension The age pension is payable to males age 65 or older. The eligible age for women is increasing from age 60 to 65 according to the scale shown in Table 1 below. Table 1 Age-pension age for women Date of birth Age pension eligibility age 1 Jul 1935 – 31 Dec 1936 60½ 1 Jan 1937 – 31 Jun 1938 61 1 Jul 1938 – 31 Dec 1939 61½ 1 Jan 1940 – 31 Jun 1941 62 1 Jul 1941 – 31 Dec 1942 62½ 1 Jan 1943 – 31 Jun 1944 63 1 Jul 1944 – 31 Dec 1945 63½ 1 Jan 1946 – 31 Jun 1947 64 1 Jul 1947 – 31 Dec 1948 64½ 1 Jan 1949 or later 65 Age service pension A service pension is a Veterans’ Affairs pension payable to eligible veterans, their partners, widows or widowers. For service pension purposes, a veteran is a person who has qualifying service, or who has served in operations against an enemy while in danger from hostile forces of the enemy. Veterans’ Affairs clients reach service-pension age five years earlier than social security agepension age. Therefore, males can apply for a service pension at age 60 and females at age 55. (The qualifying age for females is increasing to age 60, using the same timescale as Centrelink uses for the age pension — see Table 1.) Pension bonus The pension bonus is a one-off tax-free lump sum paid to people who defer claiming an age pension for up to five years. To be eligible, clients must: • register when they meet the requirements for the age pension • undertake paid work for at least 960 hours each year for a minimum of 12 months after registration • receive no income support (except carer payment) • meet gifting rules of not giving away more than $10,000 in a single financial year or $30,000 over five financial years. Clients claim the bonus when they eventually claim the age pension. The bonus is based on the pension rate at the time and how long the person deferred receiving it. In 2007, a single person who deferred the pension for five years would have received $32,853.50. © Kaplan Education 6.9 6.10 Specialist Knowledge: Superannuation (924) Further resources Centrelink 2008, ‘Pension bonus scheme brochure’ [online] 18 April. Available from: <http://www.centrelink.gov.au> by entering ‘pension bonus’ in the search box [cited 1 October 2008]. Disability support pension The disability support pension is a payment designed to assist people unable to work full time (defined as at least 15 hours per week) because of physical, intellectual or psychiatric impairment. It also covers people who are permanently blind. Some clients may find it easier to apply for the Newstart allowance as they will not need to have their disability assessed. Although Newstart participation agreements require recipients to undertake activities such as training or looking for work, these agreements can be modified in recognition of the person’s reduced capacity to work. Further resources Centrelink 2008, ‘How much disability support pension do I get?’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘How much disability support pension do I get’ in the search box [cited 1 October 2008]. 2.2 Allowances Allowances provide lower payment rates and generally have harsher income and assets test rules than pensions. Common payments include: • Newstart allowance (for the unemployed) • parenting payment. Newstart allowance The Newstart allowance assists people who are unemployed. To receive the allowance the recipient must satisfy an activity test to show that they are actively looking for work or participating in other activities designed to increase their chances of finding a job. Further resources Centrelink 2008, ‘Newstart payment rates factsheet’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘newstart’ in the search box [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security Parenting payment The parenting payment is designed to help people with children, particularly low-income families, by providing an independent income for the primary caregiver. Further resources Centrelink 2008, ‘Parenting payment rates factsheet’ [online] 16 September. Available from: <http://www.centrelink.gov.au> by entering ‘parenting payment’ in the search box [cited 1 October 2008]. 2.3 Baby bonus The baby bonus, previously known as the maternity payment, is a non-taxable payment to parents of babies born or adopted on or after 1 July 2004. Until 1 July 2008, the baby bonus was paid as a lump sum into a bank or credit union account. Until 1 July 2008, the payment was not subject to either an assets or income test. The 2008 budget announced several changes: • From 1 July 2008, the baby bonus will increase from $4258 to $5000. The payments will be indexed to the Consumer Price Index (CPI) on 1 July each year. • From 1 July 2009, there will be an income test for eligibility and the baby bonus will be limited to families with an adjusted taxable income of $75,000 or less in the six months after the birth of a baby. • From 1 January 2009, the baby bonus will be paid in 13 fortnightly instalments of around $385 instead of being paid as a lump sum. Further resources Centrelink 2007, ‘Who can get baby bonus?’ [online] 28 July. Available from: <http://www.centrelink.gov.au> by entering ‘baby bonus’ in the search box [cited 1 October 2008]. 2.4 Concession cards Concession cards reduce health care costs and are available to recipients of an allowance or a pension, low-income earners and some people of age-pension age who work or fund their own retirement. Concession cards are highly valued by many people. Obtaining one can be a prime motive for investment decisions. The value of a concession card varies according to usage and circumstances, but is generally estimated to be worth $1500–$2000 p.a. Table 2 below outlines who is eligible to receive the most common concession cards. © Kaplan Education 6.11 6.12 Specialist Knowledge: Superannuation (924) Table 2 Eligible recipients of concession cards Card Eligibility Pensioner concession card (PCC) Recipients of age pension, disability support pension, parenting payment (single) and carer payment Health care card (HCC) Recipients of allowances such as Newstart allowance, sickness allowance, partner allowance, special benefit, widow allowance, and youth allowance (job seeker), and low-income earners Commonwealth seniors health card Some self-funded retirees and some employed people of agepension age Benefits for card holders include: • concessions on prescription medicines • increased access to the Medicare safety net. The Commonwealth seniors card is available to some people of age-pension age who are not eligible for the pension. This can include self-funded retirees and people in employment. To get the card, they must meet an income test. The May 2008 budget proposed changes to eligibility rules for the Commonwealth seniors health card. Under these changes, the qualifying income test will include gross income from super income streams from a taxed source in addition to income that is salary sacrificed to super. State and territory concessions Centrelink’s guide to concession cards (see below) advises: Concession cards may also entitle cardholders, their partners and dependent children to other concessions from state and local government authorities and private businesses. Not all card types will attract the same type of concessions and the concession on offer to cardholders may also vary between different states and territories. Concessions potentially include benefits for: • council rates • electricity, gas, and water rates • telephone line rental • housing • training programs • road transport registration fees • driver licences • public transport fares. Further resources Centrelink 2008, ‘A guide to Centrelink concession cards booklet’ [online] 17 September. Available from: <http://www.centrelink.gov.au> by entering ‘concession cards guide’ in the search box [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security 2.5 Indexation of payment rates Payment rates and thresholds are indexed to CPI increases. Additionally, legislation ensures that the single rate of pension is maintained at 25% of male total average weekly earnings (MTAWE). This means that pensions might sometimes increase by more than CPI in line with wage movement. Key dates for regular increases to payment rates shown in Table 3 below. Table 3 Time of adjustment for payments and thresholds Payment or threshold Time of adjustment ABSTUDY 1 January Age pension 20 March and 20 September Asset test threshold 1 July Austudy payment 1 January Bereavement allowance 20 March and 20 September Carer allowance 1 January Carer payment 20 March and 20 September Child care benefit 1 July Deeming rates 20 March and 20 September Deeming thresholds 1 July Disability support pension 1 January (if under 21 and not a single parent) 20 March and 20 September (otherwise) Double orphan pension 1 January Family tax benefit Part A/threshold 1 July Family tax benefit Part B/threshold 1 July Funeral bonds 1 July Income test thresholds 1 July Maternity payment 20 March and 20 September Maternity immunisation allowance Not indexed until 60% of the maximum fortnightly rate of parenting payment (partnered) exceeds $208 Mature age allowance 20 March and 20 September Mature age partner allowance 20 March and 20 September Mobility allowance 1 January Newstart allowance 20 March and 20 September Parenting payment 20 March and 20 September Partner allowance 20 March and 20 September Pharmaceutical allowance 1 January Remote area allowance Adjusted by a change in the legislation Rent assistance 20 March and 20 September Sickness allowance 20 March and 20 September Telephone allowance 20 September Widow allowance 20 March and 20 September Widow B pension 20 March and 20 September Wife pension 20 March and 20 September Youth allowance 1 January (if there are dependent children) 20 March and 20 September (if there are no dependent children) © Kaplan Education 6.13 6.14 3 Specialist Knowledge: Superannuation (924) Calculating income support To receive a pension or allowance, a person must first satisfy the basic personal and residency eligibility criteria for that payment. Once basic eligibility has been established, the size of the payment can vary according to age, marital status, home ownership, and the number and age of dependent children. Most pensions and allowances are also subject to an income test and an assets test. Allowances may be subject to a waiting period before payments can commence. 3.1 Determining entitlement The following steps apply in assessing a client’s potential entitlement to income support once they have been deemed to be eligible. The actions in each step can vary depending on the payment and the client’s circumstances. Step 1 — determine the appropriate benefit Decide what payment the person might be eligible to apply for and determine if it is a: • pension • allowance • Veterans’ Affairs payment. Step 2 — determine the commencement date Pensions are generally payable from the date of claim, provided the client is eligible. Allowances, on the other hand, may have a waiting period before the client is entitled to any payment. Waiting periods can be lengthy, and financial plans need to ensure clients can support themselves throughout such periods. A period of time when the claimant is expected to support themselves, called an income maintenance period, applies to some allowances and the disability support pension. Step 3 — assess the rate payable The basic steps in calculating the rate of pension or allowance payable are as follows: 1. Determine the person’s total maximum payment rate by referring to the published rates. Include pharmaceutical allowance and rent assistance, if available to the client. 2. Determine the assessable assets and apply the assets test. 3. Determine the assessable income and apply the income test. 4. Compare the payment rates produced under the income test and the assets test. The lower of the two rates is the rate that applies. 924.SM1.9 Unit 6: Social security Step 4 — consider strategies to increase social security payments If step 3 shows that the client has little or no entitlement, consider financial strategies that may increase entitlement, such as: • reducing assessable assets • reducing assessable income. 4 Understanding income and assets for social security In the previous section, step 3 summarised the process for assessing a person’s pension or allowance rate using the income and assets tests. This section describes the rules for determining the client’s income and assets to be assessed by these tests. It is not within the scope of this subject to provide an exhaustive description of all rules and their exceptions. Specific cases should always be researched thoroughly, with reference to all material available from the government body concerned. The income and assets tests for Department of Veterans’ Affairs payments are generally similar to rules under the Social Security Act, but there are some differences. Veterans’ Affairs rules are administered under the Veterans’ Entitlements Act 1986 (Cth), and separate legislation needs to be passed to make changes to Veterans’ Affairs programs. Once the client’s income and assets have been determined, the tests proceed by applying these values to certain equations. That process is described in detail in section 5. 4.1 Definition of income When estimating entitlements, advisers need to understand what is included as ‘income’ in social security assessments. The definition of income in the Social Security Act differs from its definition in taxation or use in financial planning cash flows. For social security purposes, income from the following sources is assessed: • investments • business and employment • rent from investment properties • compensation payments • private trusts and private companies • overseas pensions • boarders and lodgers (unless near relatives) • regular gifts (except if paid by a member of the immediate family) • royalties • foreign sources • payments from sickness and accident policies. © Kaplan Education 6.15 6.16 Specialist Knowledge: Superannuation (924) Further resources Centrelink 2008, ‘Income test limits for pensions’ [online] 21Sepetmber. Available from: <http://www.centrelink.gov.au> by entering ‘income test limits for pensions’ in the search box and selecting ‘income test limits for pensions’ from the results [cited 1 October 2008]. Income from most investments is calculated under a system known as deeming. Deeming is described in section 4.4. Specific rules apply to other types of income, also outlined below. 4.2 Definition of assets An ‘asset’ is defined as any property or possession held in Australia or overseas that is owned partly or wholly by the assessable person. All assets are considered to be assessable unless they are specifically exempted under the Social Security Act or the Veterans’ Entitlement Act. If the person is a member of a couple, combined assets are assessed, even if only one partner is applying for social security benefits. Asset values The value of an asset is generally defined as the amount it would sell for on the open market less any encumbrances or debts. Some investments are assessed under special rules, which might result in an asset value different from the market value. People can fall into the trap of using insured values, which can be higher than market values, especially for personal effects, cars and contents. In most cases, Centrelink and Veterans’ Affairs use the same rules for assessing asset values. 4.3 Income and assets assessment for couples For couples, income can be assessed jointly or separately, depending on whether the couple is considered to be a ‘pensioner couple’ or a ‘non-pensioner couple’. Pensioner couples A pensioner couple is defined as a couple in which at least one partner receives a social security pension, service pension or rehabilitation allowance. A pensioner couple is assessed as a joint economic unit under both the income test and the assets test. This means that their total combined assets are assessed against the couple assets test thresholds. For the income test, total combined income is assessed and each person is assumed to earn 50% of the total. This amount is applied against each partner’s respective income test assessment. Within a pensioner couple, this method of determining income is also used for a partner’s allowance income test. 924.SM1.9 Unit 6: Social security This method of assessing pensioner couples ensures that if both partners are receiving a pension they will each receive the same payment rate. If one partner is receiving an allowance, they could receive different payment rates because of the differences in the maximum rates, income thresholds and reduction rates between pensions and allowances. Non-pensioner couples A person is defined as a member of a non-pensioner couple if neither partner receives a pension. Thus, both partners may receive allowances or one may receive an allowance while the other receives no payments. The two members of a non-pensioner couple are regarded as: • a joint economic unit under the assets test, with combined assets assessed against the couple assets test thresholds • separate economic units under the income test, with income assessed against the person who actually earned it or who owns the asset that the income relates to. Each person in a non-pensioner couple can be assessed as earning different amounts of income. Thus, if both partners apply for an allowance, they could receive different payment rates. However, income earned by one partner that exceeds the point where that partner’s payment would cut out can reduce the other partner’s entitlement. 4.4 Deemed investments Deeming is a system whereby a specified percentage of income is ascribed to certain investments, irrespective of the actual return received. Income that exceeds the deeming rates does not affect social security entitlements. Conversely, the deeming rate still applies even if the actual returns fail to reach it. Deeming applies to the income test assessment of people on or applying for: • any means tested Centrelink pension or allowance • any means tested Veterans’ Affairs payment • health care cards. Deeming does not apply to family tax benefits or the Commonwealth seniors health card, as assessments for these are based on taxable income. © Kaplan Education 6.17 6.18 Specialist Knowledge: Superannuation (924) Assets subject to deeming Most investments are included under the deeming rules. Centrelink refers to deemed investments as financial investments. Financial investments subject to deeming include the following: • Available money — money held by or on behalf of the person that is not deposit money or loan money owed to the person. This includes cash. • Deposit money — money deposited in an account with a financial institution, such as a bank, building society or credit union. This includes cheque accounts and home loan offset accounts. • Managed investment — money in public unit trusts, friendly society bonds and insurance bonds. • Listed security — securities listed on a stock exchange. This includes publicly listed shares, preference shares and convertible notes. Private company shares are not included. • Loan that has not been repaid in full — any money owing to the person as well as debentures, bonds and unsecured notes. • Unlisted public security — share in a public company, or another security, that is not listed on a stock exchange. • Gold, silver or platinum bullion — all bar, ingot and nugget holdings. • Superannuation and rollover funds — included only if the owner is over age-pension/service-pension age. • Short-term asset-tested income streams — includes income streams that are neither asset-test exempt nor longer than five years in term. Some gifts, known as ‘deprived assets’, may also be deemed. Further resources Centrelink 2008, ‘Deeming factsheet’ [online] 3 April. Available from: <http://www.centrelink.gov.au> by entering ‘deeming’ in the search box [cited 24 September 2008]. 924.SM1.9 Unit 6: Social security Asset values of financial investments The value of a financial investment is taken to be the gross market value. The value of encumbrances (e.g. mortgages) over financial assets is not deductible from the asset value for deeming purposes. The method of assessing value varies depending on the type of financial investment: • Cash and bank deposits — account balances are assessed at face value. • Fixed interest securities (including term deposits and government bonds) — the asset value is the amount paid; however, the customer can request that the market value be used if they can provide supporting documentation. • Bank bills and commercial bills — the asset value is taken to be the amount paid. This is because the investments are short term. • Debentures — the asset value of a debenture or unsecured note listed on the stock exchange is the market value. If the investment cannot be sold until maturity, the face value of the investment is assessed. • Managed investments and shares in public companies — the asset value is the latest buyback unit price or listed selling price. • Bullion — the asset value is the market value as determined by the client or independent dealer commissioned by Centrelink. • Loans and debts — the asset value is the total of any money owed to the client. This includes interest-free loans. Investment costs Deeming rules do not allow investment costs to be deducted from deemed income. However, some investment costs such as entry fees are deducted from the asset value. Example: Investment costs and asset value A pensioner invested $10,000 in a managed fund, $300 of which was an entry fee payment. The value of the financial investment is $9700, and this is the amount to which the deeming rules apply. © Kaplan Education 6.19 6.20 4.5 Specialist Knowledge: Superannuation (924) Assessing deemed income The value of all financial assets are added together to determine the level of income to be counted under the income test. Deemed income is then added to the person’s assessable income from all other sources. The total is used to determine the rate of pension or allowance payable under the appropriate income test. Deeming rates and thresholds Table 4 Deeming thresholds and rates (from 1 July 2008) Deeming thresholds Rate Single (receiving either a pension or an allowance) First $41,000 4.0% Balance thereafter 6.0% Couple (at least one person receiving a pension) First $68,200 4.0% Balance thereafter 6.0% Couple (non-pensioner) First $34,100 (each) 4.0% Balance thereafter 6.0% Source: <http://www.centrelink.gov.au>. Note: The deeming thresholds are rounded to the nearest multiple of $200. The deeming rates are reviewed twice a year, although they do not always change. Calculating deemed income for single persons or pensioner couples To calculate the income test assessment of financial assets for a single person or a pensioner couple, the following steps are applied: Step 1 Calculate the total value of financial investments. Step 2 Work out the deeming threshold (see Table 4). If the total value of financial assets exceeds the relevant deeming threshold, subtract the deeming threshold from the total value of those assets. (If the total does not exceed the threshold, go to step 4.) Step 3 Apply the higher deeming rate to the excess over the deeming threshold. Do this by multiplying the remainder from step 2 by the higher deeming rate (see Table 4). Step 4 Apply the lower deeming rate to the amount up to the threshold. Do this by multiplying the amount of financial assets up to the deeming threshold (i.e. the total financial assets less the remainder from step 2) by the lower deeming rate (see Table 4). Step 5 Calculate deemed income by adding together the amounts arrived at in steps 3 and 4. For couples, half of the total is ascribed to each member of the couple. 924.SM1.9 Unit 6: Social security Example: Deemed income for an age pensioner couple Freda and Ralph are an age pensioner couple and have the following assets: Home $500,000 (joint) Contents $10,000 (joint) Car $30,000 (Ralph) Cash $500 (Freda) Bank account $5,000 (joint) Debenture $20,000 (Ralph) Insurance bond $15,000 (Freda) Allocated pension Equity trust $245,000 (Ralph) $45,000 (Ralph) To calculate their deemed income: Step 1 Calculate the total value of financial assets. Financial assets total $85,500 (total of cash, bank account, debenture, insurance bond and equity trust). Note: Home, contents, car and allocated pension are not financial investments. Step 2 Subtract the deeming threshold from the total value of financial investments. $85,500 – $68,200 = $17,300 ($68,200 from Table 4 for a couple) Step 3 Calculate the deemed income on amounts in excess of the threshold. $17,300 × 6.0% = $1038 Step 4 Calculate deemed income on amounts up to the threshold using the lower deeming rate. $68,200 × 4% = $2728 Step 5 Total deemed income for the year: $1038 (from step 3) $2728 (from step 4) $3766 Deemed income assessed for each partner: $3766 ÷ 2 = $1883 p.a. © Kaplan Education 6.21 6.22 Specialist Knowledge: Superannuation (924) Apply your knowledge 1: Deemed income for an age pensioner couple Calculate the deemed income for Mark and Mandy who are an age pensioner couple and have the following assets: Home $410,000 (joint) Contents $12,000 (joint) Car $15,000 (Mark) Cash $1,500 (Mandy) Bank account $4,000 (Mark) Term deposit $6,000 (Mandy) Debenture $10,000 (Mark) Bank bills $12,000 (Mandy) Allocated pension Managed share fund $300,000 (Mark) $50,000 (Mandy) Calculating deemed income for non-pensioner couples The steps to calculate deemed income for non-pensioner couples are the same as for pensioner couples, but a separate deemed income amount is calculated for each person. Each partner will be assessed on the financial assets they own personally and not on those owned by the other partner. Joint assets are split equally. Example: Calculating deemed income for a non-pensioner couple James and Eleanor are a non-pensioner couple with the following assets: Cash $500 (Eleanor) Bank account $5,000 (joint) Debenture $20,000 (James) Insurance bond $15,000 (Eleanor) Equity trust $45,000 (James) Calculate James’s deemed income: Step 1 Total of James’s financial assets (joint bank account, debenture, equity trust): ($2500 + $20,000 + $45,000) Step 2 = $2004 = $1364 James’s deemed income (step 3 + step 4): ($2004 + $1364) 924.SM1.9 $33,400 Financial investments up to threshold × lower deeming rate: ($34,100 × 4%) Step 5 = Result from step 2 × higher deeming rate (Table 4): ($33,400 × 6%) Step 4 $67,500 Financial assets – deeming threshold (Table 4): ($67,500 – $34,100) Step 3 = = $3368 Unit 6: Social security Calculate Eleanor’s deemed income: Step 1 Total of Eleanor’s financial assets (cash, joint bank account, insurance bond): ($500 + $2500 + $15,000) Step 2 = $18,000 Financial assets – deeming threshold (Table 4) (Asset total is below threshold, therefore there is no excess.) Step 3 Result from step 2 × higher deeming rate (not applicable) Step 4 Financial assets up to lower threshold × lower deeming rate (Table 4): ($18,000 × 4%) Step 5 = $720 Eleanor’s deemed income (step 3 + step 4): ($0 + $720) = $720 The deemed income for each partner is then assessed against their individual income test. Apply your knowledge 2: Deemed income for a non-pensioner couple Calculate the deemed income for Jo and Roberta, a non-pensioner couple who have the following assets: Cash $1,500 (Roberta) Bank account $4,000 (joint) Debenture Insurance bond $12,000 (Roberta) Equity trust 4.6 $18,000 (Jo) $34,000 (Jo) Superannuation and rollovers The social security assessment of superannuation and rollovers has undergone several major changes over recent years. Summary of historical changes Before 20 September 1997, superannuation and rollovers were exempt for social security until age-pension age. Between 20 September 1997 and 30 June 2001, superannuation and rollover investments were exempt under the income and assets tests only if certain conditions were met. Otherwise, they were treated as financial investments. Between 1 July 2001 and 27 December 2002, funds were fully exempt only for clients between age 55 and age-pension age. The rules were often complex, with various exceptions applying. Contact Centrelink or refer to the online Guide to social security law (see below) if details of these historical assessments are required. © Kaplan Education 6.23 6.24 Specialist Knowledge: Superannuation (924) Current rules for superannuation and rollovers The current rules for superannuation and rollovers took effect from 28 December 2002. Superannuation funds held while under age-pension age Superannuation held by people under age-pension/service-pension age is usually exempt from both the income and assets tests. This exemption applies only to money held in the accumulation phase of superannuation, a deferred annuity or an approved deposit fund. No income assessment applies to withdrawals from superannuation funds. Amounts withdrawn are assessed according to how they have been used (e.g. spent or reinvested, because a reinvested amount will become a financial investment). Superannuation funds held after age-pension age Superannuation funds held after reaching age-pension age are financial investments, meaning they are subject to deeming and fully assessable under the assets test. Further resources • Centrelink 2007, ‘Rollover and superannuation investments factsheet’ [online] 14 August. Available from: <http://www.centrelink.gov.au> by entering ‘rollover superannuation’ in the search box [cited 1 October 2008]. • FaHCSIA 2008, Guide to social security law [online] version 1.141, 19 September, Department of Families, Housing, Community Services and Indigenous Affairs, Canberra. Available from: <http://www.facsia.gov.au> by entering ‘social security policy guides’ in the search box and then selecting ‘social security and family assistance legislation and policy guides’. Select ‘Guide to Social Security Law’ [cited 1 October 2008]. 4.7 Income streams The types of income streams available and their method of assessment have also undergone changes in recent years. Table 5 below shows how Centrelink categorises income streams according to when they were purchased. Table 5 Centrelink categories of income streams Type of income stream Characteristics Asset-test exempt — 100% exempt (if purchased before 20 September 2004) Lifetime guaranteed, or life-expectancy term certain that meet the specified criteria Asset-test exempt — 50% exempt (if purchased between 20 September 2004 and 20 September 2007) Lifetime guaranteed, or life-expectancy term certain that meet the specified criteria. Also includes market-linked income streams (term allocated pensions) Asset tested (long term) Not asset-test exempt. Term is > 5 years, or life expectancy ≤ 5 years and term equals life expectancy, e.g. allocated pensions Asset tested (short term) Not asset-test exempt. Term is 5 years or less 924.SM1.9 Unit 6: Social security 4.8 Assessment of income streams Asset-test exempt income streams Assets test assessment Pensions and annuities purchased on or after 20 September 2004 and before 20 September 2007 that meet the criteria of an asset-test exempt income stream receive a 50% exemption under the assets test. The remaining 50% is assessed as an asset using the same rules as for an asset-tested long-term income stream (see below). If the pension or annuity was purchased before 20 September 2004, it receives a 100% asset test exemption. Income test assessment The income test on asset-test exempt income streams assesses the gross income paid each year less the social security deductible amount (see below). If the income stream is paid from an accumulation scheme or purchased with superannuation or ordinary money, the deductible amount is calculated as: Deductible amount = Full purchase price Relevant number However, if the income stream is paid from a defined benefit scheme, the deductible amount is calculated as: Deductible amount = Member contributions Relevant number where: Deductible amount = the amount calculated at commencement (does not change unless a commutation is subsequently made) Member contributions = the amount of money a person has contributed to superannuation for which they have not received a tax deduction Relevant number the number of years in a fixed term income stream or, if there is no fixed term (i.e. lifetime guaranteed), the life expectancy of the person. If a reversionary option is chosen for a lifetime guaranteed income stream, ‘the life expectancy that will be used will be whichever is longer of the original beneficiary or reversionary. = Note: The deductible amount for defined benefit income streams commencing after 1 July 2007 will be expressed as the proportion of the total superannuation benefit that is taxfree. If the defined benefit income stream commenced before 1 July 2007, the calculation of the deductible amount is subject to transitional provisions. © Kaplan Education 6.25 6.26 Specialist Knowledge: Superannuation (924) Further resources FaHCSIA 2007, ‘Questions and answers — social security income and assets tests: better super: changes to means test rules for income streams’ [online] 9 October, Department of Families, Housing, Community Services and Indigenous Affairs, Canberra. Available from: <http://www.facsia.gov.au> by selecting ‘Individuals’ and then ‘Seniors’. Locate and select ‘Seniors Information Publications’ down the page. Finally, select ‘Questions and Answers — Social security income and assets tests — Simplification of superannuation: Changes to means test rules for income streams’ [cited 2 July 2008]. Asset-tested income stream (long term) Assets test assessment The asset value of asset-tested income streams is reassessed every six months if income is paid at least twice a year, or every 12 months if only one income payment is made in that year. There are three methods for calculating the asset value: 1. If the income stream has an account balance, as is the case for allocated pensions and annuities, the asset value is taken to be the account balance at the beginning of each sixmonth or 12-month period. 2. If the income stream does not have an account balance, as is the case for immediate annuities and/or super pensions, the asset value is calculated at the beginning of each relevant period as: Asset value = Purchase price – Purchase price – RCV × Term elapsed Relevant number where: Term elapsed = the number of years the income stream has been running for, rounded down to the nearest half-year. (If only annual payments are made it is rounded down to the nearest whole year.) RCV = residual capital value. 3. If the pension is not purchased but is instead paid as a benefit from the fund, as is the case with a pension from a defined benefit fund, the asset value is calculated based on the following formula: Asset value = Annual payment × Pension valuation factor (PVF) 924.SM1.9 Unit 6: Social security Income test assessment The income test assesses the gross income paid each year less a deductible amount. The formula to calculate the deductible amount differs from that applied in taxation legislation and varies according to whether the income stream is paid from an accumulation scheme or a defined benefit scheme. 1. If the income stream is paid from an accumulation scheme or purchased with superannuation or ordinary money, the deductible amount is calculated as: Deductible amount = Purchase price – RCV Relevant number 2. If the income stream is paid from a defined benefit superannuation scheme, the deductible amount is calculated as: Member contributions − RCV Relevant number Deductible amount = If a commutation is made after the income stream commences, the deductible amount is recalculated. The original relevant number continues to be used but the purchase price is reduced by the amount commuted. This will reduce the deductible amount. Example: Income test assessment Karl is age 65 and purchases an account-based pension for $220,000. His life expectancy is 17.70 years. Karl elects to receive $15,000 income in the first year. His income is assessed under the income test as follows: Deductible amount = ($220,000 – 0)/17.70 = $12,430 Assessable income = $15,000 – $12,430 = $2570 Therefore only $2570 is assessed as income for social security purposes. Six months later, Karl elects to withdraw a $20,000 lump sum from the allocated pension. His income test assessment is recalculated: Deductible amount = ($220,000 – $20,000)/17.70 = $11,300 Assessable income = $15,000 – $11,300 = $3700 The lump sum withdrawal is not assessable, but it reduces his deductible amount. Therefore, his income assessment increases to $3700. Asset-tested income stream (short term) Assets test assessment The same rules apply as for asset-tested income streams (long term). Income test assessment Income from income streams is assessed under deeming rules, as the asset is included in the definition of financial investments. © Kaplan Education 6.27 6.28 4.9 Specialist Knowledge: Superannuation (924) Splitting income streams after divorce Income streams purchased by superannuation moneys are split between the divorced spouses in the proportions dictated by the superannuation agreement or court order. This applies to the income stream payments, the asset value and the deduction amount applying to the continuing income stream payments. Currently, FaHCSIA carries out all assessments of split income streams. Advice should be sought from Centrelink for clients in this position. 4.10 Other income and assets There are many different assessment rules for the many different types of income and assets. This unit cannot cover every type. Rather, it details the more common forms of assets and income. Some significant items that have not yet been covered are addressed below. Exempt assets Some assets are specifically exempt from assessment under the Social Security Act and the Veterans’ Entitlements Act. The most important exempt asset is the ‘principal home’. The principal home includes the house or unit that is the person’s main residence and up to two hectares of surrounding land. From 1 July 2007, where the clients have had at least a 20-year connection with the property and it is used for private purposes, there is a full exemption for the full value of land on the same title as the home. The ‘principal home’ also includes permanent fixtures such as carpets, dishwashers, garages and swimming pools. The principal residence could be, for example, a house, flat, caravan or boat. If the person owns two homes and spends time in each, the principal home will be the home in which the person spends the most time. Other exempt assets include: • a life interest not created by the person or person’s partner • contingent, remainder or reversionary interest • interest in an estate until it is received or able to be received • medal or decoration for valour • funeral bond up to $10,250 or pre-paid funeral expenses (including the cost of a cemetery plot) • aids for disabled persons • certain insurance and compensation payments • native title rights and interests • assets-test exempt income streams. Rules relating to exempt assets can be complex. Details should be sought directly from Centrelink or Veterans’ Affairs. Their websites have further information. 924.SM1.9 Unit 6: Social security Further resources Centrelink 2008, ‘Exempt assets’ [online] 27 June. Available from: <http://www.centrelink.gov.au> by entering ‘exempt assets’ in the search box [cited 1 October 2008]. Personal effects and home contents Personal effects and household contents are assessed at market value (sometimes referred to as ‘garage sale’ value), not at insured value. A notional value of $10,000 is generally accepted by Centrelink; however, a customer can nominate a lower or higher amount as appropriate. No income is assessed under the income test for personal effects and home contents. Motor vehicles, caravans and boats Motor vehicles, caravans and boats (including motor cycles and trailers) are assessable at market value. A caravan or boat is not assessable if it is used as the principal home. No income from these sources is assessed under the income test. Employment income Employment income is any income from work as an employee in an employer/employee relationship. It includes but is not limited to: • salary • wages • commissions • employment-related fringe benefits • bonus payments. Real estate The asset value of real estate other than the principal home is assessed at net market value. Encumbrances on the property may be deductible from the asset value to determine net market value. Centrelink normally accepts the customer’s valuation of the real estate market value, but it might choose to obtain a valuation from the Australian Valuation Office. Income received from investment property is also assessed. Centrelink assesses current net income based on the client’s latest tax return. It follows most of the taxation rules for income assessment. However, some items that are deductible for tax are not deductible for social security. These include: • capital depreciation and development costs • offsetting of losses between rental properties • borrowing costs (although interest is deductible). If a property is negatively geared, a ‘negative’ income cannot be used to offset other income. Instead, a net income of zero results for this asset. © Kaplan Education 6.29 6.30 Specialist Knowledge: Superannuation (924) If a tax return is not available, the rental income can be reduced by a maximum of one-third to cover expenses, and a deduction is allowed for interest costs. Business interests The total net market value of business assets (including a farm) is assessed under the assets test. If the client is a joint or partial owner of the business, only their share is assessable. Private trusts and companies From 1 January 2002, assets in private trusts and companies are assessed as though they were held in the deemed owner’s name directly. The legislation aims to identify the owner of the underlying trust or company assets. This is achieved by applying a control test and a source test. Control test Under the control test, a social security recipient is deemed to have control of a private trust or company if they are a trustee, appointer or director. They may also be deemed to have control if a relative or associated person or entity has control, or if control is held by someone whom they influence. The ‘controller’ is assessed as owning all of the assets held by the trust or company under the assets test, unless circumstances justify a smaller proportion being assessed as owned by that person. The legislation is very broad and allows Centrelink wide discretion to assess the particular circumstances of each case. Loans owed by the trust or company are only deductible from the asset values if the loans are documented and on commercial terms. Under the income test, all of the actual income of the trust or company is assessed to the controller. Distributions made to other beneficiaries or shareholders after 1 July 2000 come under gifting and deprivation rules. Source test Gifts made to a trust or company after 7.30 p.m. on 9 May 2000 (the date of the Budget announcement) are assessed under the source test from 1 January 2002. They are not assessed under the normal gifting–deprivation rules. If a person makes a gift to a trust or company, this amount will be assessed as being still owned by that person. The trust or company income that relates to this portion of assets will also be assessed against that person’s income test assessment. In situations where the source test and control test could both apply, resulting in double counting of the assets, Centrelink’s discretion will determine how to allocate ownership of the assets and income. 924.SM1.9 Unit 6: Social security Options for private trusts or companies Options to consider for clients with interests in private trusts or companies are: • retain the company or trust with no changes to the structure and rearrange investments within the trust or distribution patterns to generate sufficient income • wind up the company or trust if this structure is no longer required, and invest funds elsewhere to replace income • relinquish control or gift assets. If clients wind up a company or trust, they might receive capital distributions that can be used to generate income. Distributions of capital made to the attributable stakeholder, that is, the person deemed to own the assets, are not assessable under the income test. If the capital distribution is retained and invested elsewhere, it will increase assessable assets and income. After 1 April 2002, trust or company assets that a client gifts or otherwise relinquishes control of will be subject to gifting rules. An assessment of deprivation may apply. Example: Controllers of a trust Phil and Jocelyn are age pensioners. They have a family trust with total assets of $250,000. It generates income of $10,000 p.a. Their two children are beneficiaries of the trust. Phil and Jocelyn are joint trustees and beneficiaries. Phil and Jocelyn are deemed to be controllers of the trust. The $250,000 assets are included in their assets test assessment, and the $10,000 income is included in their income test assessment. This will reduce their age-pension entitlement and, depending on other income and assets, might make them ineligible for payments. Any distributions made to their children will be assessed under gifting rules. If Phil and Jocelyn remained beneficiaries, but were replaced as trustees by their children, they could still be assessed as controlling the trust because they have not genuinely relinquished control, but merely passed it to ‘associates’. Their children are classified as ‘associates’ and control is not relinquished under the ‘associate rule’. Loans to private companies or trusts Loans made by a person to a company or trust are assessable assets and attract deeming. This could lead to double counting, as the amount lent could also be captured in the assets of the company or trust. The value of assets held in the company or trust will be assessed at the net market value. Loans can only be deducted from the value if the existence of the loan is fully documented and there is an intention for it to be repaid. The loan may then be offset against the assets that the funds were used to purchase. It is important for clients to properly document loans made to a private company or trust and to intend to repay them. © Kaplan Education 6.31 6.32 Specialist Knowledge: Superannuation (924) Testamentary trusts A testamentary trust is generally a private discretionary trust and is assessed under the private trust rules. Testamentary trusts established as a result of a person’s death before 1 April 2001 (date of death) are assessed using the control test from 1 January 2002. The trust is assessed to the surviving spouse from 1 January 2002 if: • the surviving spouse directly controls the trust (even if not a beneficiary) • an associate controls the trust and the surviving spouse is a potential beneficiary. Example: Assessment of testamentary trusts In July 2002, Brad died and his will established a testamentary trust. The beneficiaries of the trust are his three children from his first marriage. As his first wife had died, he appointed his second wife as trustee. The wife is not a beneficiary and has no entitlement to the income or assets of the trust. However, the assets and income of the trust will be assessed to her as she is the surviving spouse and directly controls the trust. This example illustrates that clients should assess their estate planning needs carefully. This could require changes to existing wills so they do not produce negative outcomes for the surviving spouse. Clients should consider bequeathing assets directly to beneficiaries rather than establishing a testamentary trust, although such trusts provide tax advantages if there are children under age 18. If a testamentary trust is appropriate, the trustee should not be the surviving spouse if social security entitlement is a consideration. Assets held solely in the deceased’s name can be left directly to beneficiaries without triggering deprivation for the surviving spouse. This also applies to assets held as tenants in common. It does not apply to assets held as joint tenants, as these pass automatically to the surviving owner. Example: Bequeathing assets to the grandchildren John is married to Jill. He has a $200,000 portfolio of shares he wishes to bequeath to his grandchildren. If he leaves the shares in his will to Jill she will be assessed with the assets. If she then gifts the shares to the grandchildren she will be assessed with a ‘deprived asset’ of $190,000 as only $10,000 can be gifted each year. If however the shares are bequeathed in the will directly to the grandchildren then Jill will not be assessed with these assets. 924.SM1.9 Unit 6: Social security Special disability trusts From 20 September 2006, the Family, Community Services and Indigenous Affairs and Other Legislation (2006 Budget and Other Measures) Act 2006 (Cth) allows parents and immediate family members to establish a special disability trust for the current and future accommodation and care of a severely disabled person. From September 2006, all trust income and trust assets up to an initial value of $500,000 did not affect the disabled person’s social security payments or Veterans’ Affairs payments. The maximum value is indexed annually and, from September 2007, is $516,500. Further resources Centrelink 2007, ‘Private trusts and private companies factsheet’ [online] 21 November. Available from: <http://www.centrelink.gov.au> by entering ‘private trusts private companies’ in the search box [cited 24 September 2008]. Conventional life insurance policies The surrender value of a conventional life insurance policy is assessed as an asset to the policy owner. Conventional life insurance policies include whole-of-life insurance policies and endowment insurance policies. Conventional life insurance policies are currently exempt under the income test only while they are held. When the policy matures or is surrendered, the entire growth on the policy since commencement is held as income for the following 12 months. The growth is taken to be the balance of the policy (before any loans are repaid) less any premiums or contributions made to the policy. Friendly society bonds — exceptions Most friendly society bonds are classified as financial investments, however some exceptions are assessed as conventional life insurance assets to the policy owner. The exceptions are those with a substantial insurance risk component, that is, those that provide life insurance cover. Details can be obtained from Centrelink. On withdrawal or maturity, the growth from such policies is assessed as income for the following 12 months. Funeral bonds Funerals can be costly. Many elderly people like to set aside funds to cover the cost of their funeral. Funeral bonds invest the money to counter the effects of inflation. Funeral bonds are exempt under the income and assets tests, provided: • the amount deposited does not exceed $10,250 (from 1 July 2008, indexed in line with CPI pension increases every 1 July) • the bond does not relate to a funeral for which funeral expenses have been prepaid or to which another exempt funeral bond applies. In addition to reducing a client’s assessable assets and income, investing in funeral bonds can also be tax-effective, depending on the client’s situation. Exempt funeral bonds cannot be realised, and the return is not payable, until the death of the owner. © Kaplan Education 6.33 6.34 Specialist Knowledge: Superannuation (924) If the amount deposited exceeds the limit, the funeral bond will not be exempt and the entire bond will be assessable as an asset. The entire bond will also be assessable as a financial investment and subject to deeming rules under the income test. However, exempt funeral bonds that rise over the limit because of growth will continue to remain exempt from the income and assets test. Funeral bonds are divided into two types. A type A funeral bond is one that is pre-determined to mature on the death of: • the investor, or • the investor’s partner. A type B funeral bond is made by a couple, or a member of a couple, and is predetermined to mature on the death of: • whichever member of the couple dies first, or • whichever member of the couple dies last. A single person can only obtain an exemption on a type A funeral bond, with a purchase value no higher than $10,250. A couple can purchase one type B funeral bond of up to $10,250, or each partner can purchase a type A funeral bond worth up to $10,250. (A funeral bond is also known as an estate bond.) Features of funeral bonds and funds In recommending a funeral bond or fund an adviser should consider the following: • The bonds may be capital guaranteed, but they only generate low investment returns. • Some of the bonds assign ownership to a funeral director, who receives the unused funds after the funeral. • Payment can sometimes be made in instalments over time rather than as a lump sum. • Many of the bonds have a cooling-off period (30 days) in which the client can reconsider. • If clients have not already contributed the maximum, they may be able to add funds at a later date. • Commissions associated with funeral bonds need to be disclosed. Prepaid funeral and cemetery expenses A person can claim an exemption for funeral expenses paid in advance, if paid with a contracted payment to a funeral director. A person can also claim as an exemption the cost of a cemetery plot bought prior to death. There is no limit on the amount that can be exempt under this provision. However, a person cannot claim an exemption for prepaid funeral expenses if an exemption has already been claimed for a funeral bond that relates to the same funeral. 924.SM1.9 Unit 6: Social security Further resources Centrelink 2008, ‘Funeral expenses - preparations you can make factsheet’ [online] 1 July. Available from: <http://www.centrelink.gov.au> by entering ‘funeral bonds’ in the search box [cited 24 September 2008]. Royalties and other lump sums Income is generally assessed over the period in which it is earned or accrued. Lump sum payments that do not relate to payment for work over a specific period are apportioned over the following 12-month period. For example, a royalty payment of $10,000 will be assessed as $384.62 ($10,000 ÷ 26 fortnights) of income received each fortnightly period for the following 12 months. Further resources Centrelink 2008, ‘Getting your Australian pension correct’ [online] 11 February. Available from: <http://www.centrelink.gov.au> by entering ‘royalties’ in the search box [cited 1 October 2008]. Interest in an estate A person’s share in a deceased estate is disregarded until it is received or able to be received. If the estate is not distributed within 12 months, Centrelink may review the circumstances to determine whether private trust rules apply. Investments specifically exempted from deeming The minister responsible for social security has the power under the Social Security Act to grant exemptions from deeming to specific financial investments or specific classes of financial investments. If an exemption is granted, the investment is assessed at the actual rate of return received. Church development funds Churches and charitable organisations (e.g. some nursing homes) can apply for an exemption from deeming for deposits and loans made by social security and Veterans’ Affairs recipients. The funds must be used for capital expenditure on churches, schools, hospitals, nursing homes and welfare services. Income on these amounts is assessed at the actual rate earned. Proceeds from the sale of a home Proceeds from the sale of the principal home residence are exempt under the assets test for 12 months if the person intends to use the funds to purchase another home within the 12 months. During this period, the proceeds are considered to be financial investments under the income test and are subject to deeming. © Kaplan Education 6.35 6.36 Specialist Knowledge: Superannuation (924) Granny flat right Granny flat rights are usually informal family arrangements that provide accommodation for an elderly family member. A granny flat right usually occurs when a person secures a right to accommodation for life in another person’s private home by: • transferring the title of a principal home to a near relative • providing the purchase price for the property that will be registered in a near relative’s name • providing funds for the construction of a granny flat on a near relative’s property. A right to live in the accommodation for life is generally considered to be adequate consideration for the disposal of assets, so deprivation usually does not apply. However, in some cases, a reasonableness test can apply to determine if gifting rules are used. Whether the person is considered to be a homeowner or a non-homeowner for asset test assessments depends on the value of the amount effectively paid for the granny flat right. If the payment or property transferred is greater than the difference between the homeowner and non-homeowner thresholds, the person is a homeowner and the amount is an exempt asset. If the amount paid is equal to or less than the threshold difference, the person is a non-homeowner and the amount paid is an assessable asset. Hostel accommodation bonds From 1 July 2005, the value of an accommodation bond paid to a hostel is an exempt asset. Accommodation bonds are not assessed under the income test. Life interest A life interest arises when the customer acquires a right to the use of an asset and/or income produced by the asset for life or until surrendered. The value of a life interest is exempt if it is created by someone other than the client or their partner (or deceased partner). Life interests created on the death of a partner before 19 May 1994 are also exempt assets. Life interests created by the person or their spouse are assessable on an actuarial valuation unless exempt as the principal residence. Reversionary, remainder and contingent interest Reversionary, remainder and contingent interests refer to the titleholder not gaining the benefit of their interest until the rights of another person expire. These assets are exempt unless the interest was created by the person or their partner. For example, an 83year-old man dies and leaves a life interest in the house to his 82-year-old wife, with a remainder interest to his 62-year-old son, who will inherit the house when his mother dies. The house is not counted as an asset for the son. Medal or decoration for valour Medals and decorations are exempt unless they are held as an investment or hobby. 924.SM1.9 Unit 6: Social security Loans Loans as borrower If a person obtains a secured loan, the value of the outstanding loan can only be deducted from the value of the asset used as security. Therefore, if the person’s own home is used as security for the loan, no deduction is allowable against assessable assets as the home is an exempt asset. If an assessable asset is used as collateral security or for the benefit of a third party, the debt cannot be deducted from the value of an asset. If the mortgage is unregistered to reduce the asset value, sufficient evidence will need to be provided to satisfy Centrelink that a court would accept that a legal mortgage exists. Unsecured loans are only deductible from the value of an asset if the person can provide evidence that the loan was obtained specifically for the purchase of that asset. Loans as lender If a loan has not been repaid and is not legally recoverable either because the relevant state statute of limitations period has expired or because the debtor is unable to repay the debt, the debt is deemed to have no value and is disregarded under the assets test. However, if the lender failed to take legal action to recover the debt within the statute of limitations, deprivation provisions may be applied to assess the outstanding amount as an asset for the following five years. 4.11 Gifting and deprivation rules From 1 July 2002 ‘deprivation’ occurs when a person makes one or more gifts of income or assets over a threshold level without receiving adequate financial consideration in return. Financial consideration is regarded as adequate when the amount received is equivalent to the market value of the asset, that is, the point at which a willing purchaser and a willing, but not anxious, vendor would reach agreement. Deprivation and gifting rules apply to all means tested pensions, allowances and benefits paid under both the Social Security Act and the Veterans’ Entitlements Act. Gifting an asset A person (or a couple combined) may give away income or assets up to limits specified in the legislation without adverse effects on their social security entitlements. Above the specified levels, gifts will be regarded as deprived assets, assessable in the assets and income tests. Effective from 1 July 2002, two gifting limits apply concurrently — the $10,000 rule and the $30,000 rule. $10,000 rule If a single person or a couple gifts over $10,000 in a financial year, the excess is a deprived asset. © Kaplan Education 6.37 6.38 Specialist Knowledge: Superannuation (924) $30,000 rule If a single person or a couple gifts over $30,000 across a five-year rolling period, the excess is a deprived asset. The rolling period is defined as the financial year in which the gift is made plus the four previous financial years. The legislation avoids double counting deprived amounts. This means that amounts already considered to be deprived assets are not included in the five-year rolling total. Assessment of deprived assets Deprived assets are assessable under both the assets and income tests for five actual years from the date of the excess gift. This rule also applies to assets gifted in the five years before becoming a recipient of relevant social security or Veterans’ Affairs payments. Example 1: Deprived asset for five years A married couple gifted $30,000 to their children on 10 January 2008. No other assets were gifted in this financial year. They have never gifted any other money. Amount gifted: $30,000 Less allowable limit: $10,000 Deprived asset: $20,000 Therefore, $20,000 of the gift is counted as a deprived asset under the assets test until the fifth anniversary of the gift, that is, until 10 January 2013. Example 2: Deprived asset for five years A married couple gifted $530,000 to their children on 10 January 2005. They have never gifted any other money. They then applied for the pension on 10 January 2008. Amount gifted: Less allowable limit: Deprived asset: $530,000 $10,000 $520,000 Therefore, $520,000 of the gift is counted as a deprived asset under the assets test until the fifth anniversary of the gift, that is, until 10 January 2010. After this time none of the gift will count as an asset. Further resources Centrelink 2008, ‘Disposing of assets’ [online] 17 April. Available from: <http://www.centrelink.gov.au> by entering ‘deprived assets’ in the search box [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security Gifts made before 1 July 2002 Gifts made prior to 1 July 2002 are assessed under the previous rules, which stipulated a maximum of $10,000 per pension year before deprivation applies. A pension year was a 12-month period commencing on the payday on which the pension, allowance or benefit first became payable. If members of a couple did not begin receiving the Centrelink benefit on the same day, the pension year commences on either: • the date they became members of a couple • the date the first person started receiving payments. Special gifting rules In certain circumstances, gifts may be given special consideration and deprivation might not be applied. These circumstances include: • transfer of a farm in payment for past contributions from a close relative • transfer of assets for services rendered by a close relative (e.g. unpaid care) • transfer of the title of a home in exchange for a life interest (e.g. granny flat rights). Clients in these situations should discuss their circumstances with Centrelink. Repayment of a gift Once a gift has been assessed by Centrelink there is no provision in the Act to disregard the deprivation amount if the assets are returned. Therefore, the return of a gift could lead to double counting. If clients wish to give away $20,000 in a short period of time, they can gift $10,000 either side of 1 July, so that each gift falls into a separate financial year. This assumes that no other gifts have been made in the first financial year and that none will be made in the second. The client must be within the $30,000 five-year limit. Similarly, it is possible to gift $30,000 in just over two financial years without an adverse effect on entitlements by ensuring that gifts in any financial year do not total more than $10,000. Care should be taken not to exceed the total of $30,000 over five years. Example: Double counting of a deprived asset Julie is receiving the age pension. She gifts $50,000 to her daughter and notifies Centrelink. Julie is advised that she has a deprived asset of $40,000 (i.e. $50,000 – $10,000) because she gifted over the $10,000 limit. After Julie explains the situation, her daughter repays the $40,000 thinking this will reverse the deprived asset. However, as no such legal provision exists, the social security value of Julie’s assets will now include the $40,000 cash returned from her daughter and the $40,000 deprived asset. Unfortunately for Julie, this double counting will artificially increase the value placed on her assets by the assets test. © Kaplan Education 6.39 6.40 Specialist Knowledge: Superannuation (924) Gifting strategy If a client wishes to gift more than $10,000 in a financial year, they might benefit from a loan–gift strategy. This will reduce the amount assessed under both the assets and income tests over three years. The best results are achieved from this strategy by: • gifting the first $10,000 in any financial year • providing the balance as a loan (with or without interest) that is reduced by further gifts of up to $10,000 each financial year subject to the $30,000 limit. Example: Interest-free loan strategy Harriett has not previously made any gifts but wants to gift $30,000 to her daughter. If Harriett gifts the entire amount at once, she will be assessed to have a deprived asset of $20,000 for five years. A better strategy may be for Harriett to gift $10,000 and provide the remaining $20,000 as an interest-free loan to her daughter. This allows Harriett’s daughter to receive the full amount of $30,000 immediately. The $20,000 is still assessed in the current financial year, so no advantage is gained to begin with. In the next financial year, Harriett can choose to gift $10,000 of the outstanding loan and advise Centrelink of this action. There is no deprived asset, and the assessable loan (and amount included in income and assets tests) reduces to $10,000. In the third financial year, Harriett advises Centrelink that the remaining $10,000 has been gifted. There is still no deprived asset and the amount included in income and assets tests has been reduced to nil. Further resources Centrelink 2007, ‘Gifting factsheet’ [online] 8 August. Available from: <http://www.centrelink.gov.au> by entering ‘gifting’ in the search box [cited 24 September 2008]. Reflect on this: Too much to consider? So far there has been a lot of information presented about social security. As a financial adviser, do you think that much of this work should be left to Centrelink? Why do financial advisers need to be aware of the ways to deem income, test assets etc.? 924.SM1.9 Unit 6: Social security Apply your knowledge 3: Determining assessable assets Jalpa and Nidal have the following assets Home $700,000 Car $20,000 Contents $10,000 Allocated pension (Jalpa) $250,000 Rental property $400,000 Loan (secured against rental property) $250,000 Cash at bank $20,000 Funeral bond $5,000 In addition, three years ago they gave their son $50,000 to assist with a home deposit. What are their assessable assets? © Kaplan Education 6.41 6.42 5 Specialist Knowledge: Superannuation (924) Applying the income and assets tests Most social security payments are subject to means testing through an income test and an assets test. The payment type governs the different rules that apply in each case. This unit deals only with the income and assets tests that apply for the age pension and Newstart allowance. The previous sections have shown how to work out the value of the client’s assets and income for social security means testing. This section moves on to calculating the social security rates payable. Only a few payments are not means tested, including: • blind pensions • war widow pensions • Veterans’ Affairs total and permanent invalidity (TPI) pensions. The maximum rates for the age pension and Newstart allowance are outlined in Table 6 and Table 7 below. Table 6 Social security age pension rates 20 September 2008 to 31 December 2008 Single $562.10 p.f. Couple $469.50 (each) p.f. Source: <http://www.centrelink.gov.au>. Note: Most pensioners also receive a pharmaceutical allowance of $5.80 for a single person or couple (combined), or $2.90 (each) for a couple where only one partner is a pensioner. The pharmaceutical allowance is payable to most pension recipients. Refer to the Guide to social security law available at <www.facsia.gov.au> for exclusions. Table 7 Maximum Newstart allowance 20 September 2008 to 31 December 2008 Single, no children $449.30 p.f. Couple, no children — each partner 21 or over $405.40 (each) p.f. Source: <http://www.centrelink.gov.au>. Note: Most allowances also receive a pharmaceutical allowance of $5.80. 924.SM1.9 Unit 6: Social security 5.1 Effects of the assets test Under the assets test, people can lose access to income support if they have assets worth over a certain level. The assets test differs between pensions and allowances, with the allowance assets test being significantly stricter. If a person’s assessable assets are over the specified level (the ‘lower threshold’), their payment is reduced (for pensions) or cancelled (for allowances). If a person is a member of a couple, the total assets of both partners are assessed, even if only one partner is applying for social security income support. Each person is assessed under either the pension assets test or the allowance assets test, as appropriate. The assets test thresholds vary depending on marital status and whether the person is a homeowner. The value of a person’s home is an exempt asset, so non-homeowner thresholds are higher to provide some equity. The total assessed value of assets is rounded down to the nearest $250 for a single person or $500 for a couple. This rounded amount is applied against the assets test thresholds. The lower thresholds (minimum payment) are indexed each year on 1 July and the upper thresholds (no payment) also increase in line with any pension rate increases. Table 8 below shows the social security asset test thresholds for pensioners. Table 8 Social security assets test thresholds from 20 September 2008 to 31 December 2008 Maximum payment if assets are equal to or less than No payment if assets are equal to or more than Single, homeowner $171,750 $550,500 Single, non-homeowner $296,250 $675,000 Couple, homeowner $243,500 $873,500 Couple, non-homeowner $368,000 $998,500 Source: <http://www.centrelink.gov.au>. Note: If a pensioner is renting privately and entitled to receive rent assistance, a higher upper threshold will apply. A higher upper threshold also applies for pensioner couples who are separated by illness. Allowance assets test The allowance assets test has a single cut-off point. If assessable assets exceed the lower threshold limit, no allowance is payable. If assessable assets are equal to or less than the lower threshold, the rate of payment is calculated under the income test. Example: Newstart allowance • Elroy is a single homeowner applying for a Newstart allowance. He has assessable assets of $149,000. This is below the applicable lower threshold. His allowance payable is determined under the income test. • Judy is a single non-homeowner applying for a Newstart allowance. She has assessable assets of $290,000. This is above the applicable lower threshold. As her assessable assets exceed the lower threshold limit, no allowance is payable. © Kaplan Education 6.43 6.44 Specialist Knowledge: Superannuation (924) Pension assets test The pension assets test is more generous than the allowance assets test as the single cut-off point under the allowance test serves as the pensioner’s lower threshold. Under the pension assets test, assessable assets up to the lower threshold are disregarded, that is, they do not reduce the maximum age pension payable under the assets test. From 20 September 2007, the pension reduction rate is $1.50 per fortnight (single person or couple combined) for every $1000 of assessable assets over the lower threshold limit. The steps in applying the pension assets test are as follows: Step 1 Determine the maximum pension payable, including the pharmaceutical allowance unless specifically exempted (see Table 6). Step 2 Determine the rounded assessable asset amount. Step 3 Determine the value of excess assets by finding the applicable assets test’s lower threshold (see Table 8) and working out the following formula: Assessable assets – Lower threshold = Excess assets If the result is zero or negative, there is no reduction in the pension under the assets test. Step 4 Determine the assets test reduction amount — multiply excess assets by the reduction factor ($1.50/$1000 excess assets). Excess assets = Reduction amount 1000 × $1.50 Step 5 Determine the pension rate under the assets test. Maximum rate from step 1 – Reduction amount from step 4 = Payment amount Alternatively, the age pension payable under the assets test can be formulated as: Age pension p.f. (single person) = (Max rate + PA) – 0.0015(Assets – Lower threshold) Age pension p.f. (each member of a couple) ⎡ ( Assets − Lower threshold ) ⎤ = (Max rate + 0.5 × PA) – ⎢0.0015 ⎥ 2 ⎢ ⎥ ⎣ ⎦ where: Max rate = the maximum rate of age pension payable PA Assets 924.SM1.9 = the pharmaceutical allowance = the assessable assets of a single person or the combined assets of a couple. Unit 6: Social security Example: Age pension assets test Paul and Kate are homeowners applying for an age pension with assessable assets of $300,100 on 1 December 2008. Their pension entitlement under the assets test is as follows: Step 1 Determine the maximum pension payable (see Table 6). $939.00 + $5.80 = $944.80 p.f. combined Step 2 Determine the rounded assessable asset amount. $300,000 Step 3 Determine excess assets (see Table 8). $300,000 – $243,500 = $56,500 Step 4 Determine the assets test reduction. $56,500 × Step 5 $1.50 = $84.75 p.f. 1000 Determine the pension rate under the assets test. $944.80 – $84.75 = $860.05 p.f. combined Alternatively, the assets test formula can be applied: ⎡ ($300,000 − $243, 500) ⎤ ⎢ ⎣ 2 Age pension p.f. = ($469.50 + 0.5 × $5.80 ) − ⎢0.0015 Each ⎥ ⎥ ⎦ = $472.40 – $42.38 = $430.02 p.f. Combined 5.2 = $430.02 × 2 = $860.04 p.f. Strategies for reducing assessable assets Financial advisers have a role in helping clients maximise their benefits through financial strategies tailored to be effective within the rules. For this reason, advisers should pay close attention to applicable income or asset thresholds, as exceeding these may reduce clients’ social security or stop their payments altogether. From 20 September 2007, pensioner couples receive an extra $390 p.a. for every $10,000 by which they reduce their assessable assets. This equates to a return of 3.9% p.a. However, capital must be given up in exchange for this income return. Reducing assessable assets might provide a much greater return for a person applying for an allowance, especially if they move from just over the lower threshold to just under it. This is because of the sudden elimination of benefits caused by tipping over the lower assets threshold when applying. © Kaplan Education 6.45 6.46 Specialist Knowledge: Superannuation (924) The impact of the assets test on social security entitlements can be reduced by: • investing in asset-test exempt assets such as: – exempt funeral bonds – superannuation (if under age-pension/service-pension age) (see section 10.1) • valuing investments correctly, that is, using market value, not insured value • spending on home renovations • personal expenditure, such as holidays • gifting assets within specified limits. Strategies that reduce assessable assets may also reduce assessable income. Apply your knowledge 4: Reducing assessable assets Peter is age 58 and has $400,000 in super. His wife, Michelle, age 64, could possibly receive some age pension but needs to reduce her assessable assets. She also has $400,000 in superannuation. As she is of age-pension age, her super counts towards the assets test. What simple strategy could you suggest to improve Michelle’s chances of receiving some age pension? 5.3 Effects of the income test The income test ensures that only people below certain thresholds of income can access pensions and allowances. The pension income test is more generous than the allowance income test as it has higher thresholds and slower tapering rates. Pension income test The pension income test gradually reduces the pension rate payable once a person’s assessed income exceeds an income threshold. Entitlement to the pension ceases when the rate payable reaches zero. Income test thresholds are shown in Table 9 below. Table 9 Social security age pension income test thresholds from 20 September 2008 to 31 December 2008 Lower threshold p.f. Cut-out threshold p.f. Single $138 $1,557.75 Couple (combined) $240 $2,602.00 Source: <http://www.centrelink.gov.au>. If the assessed income exceeds the lower income threshold, the maximum rate of pension for a single person is reduced by 40 cents for every dollar of income in excess. The pension entitlement for each member of a couple is reduced by 20 cents for each dollar of combined excess income. 924.SM1.9 Unit 6: Social security The pensioner income test assesses both singles and couples using the same process. The steps are as follows: Step 1 Calculate the maximum rate payable — include the pharmaceutical allowance unless specifically precluded. Step 2 Calculate the total assessable income from all sources. Step 3 Calculate the excess income over the lower income threshold by finding the applicable income threshold (see Table 9). Assessable income – Income threshold = Excess income If the result is zero or negative, there is no reduction in the pension under the assets test. Step 4 Calculate the reduction in the pension rate by multiplying excess income from step 3 by the reduction factor. Excess income × 0.4 (singles) or 0.2 (couples) = Pension reduction amount Step 5 Calculate the pension rate payable by subtracting the reduction amount of step 4 from the maximum rate payable in step 1. Maximum pension from step 1 – Reduction amount from step 4 = Rate payable For couples, each partner receives half the pension amount calculated in step 5. The effects of the pension income test can be calculated by the following formula: Age pension p.f.(single person) = (Max rate + PA) – 0.4 (Income – Lower threshold) Age pension p.f. (each member of a couple) ⎡ ( Income − Lower threshold ) ⎤ = (Max rate + 0.5 × PA) – ⎢0.4 ⎥ 2 ⎢ ⎥ ⎣ ⎦ where: Max rate = the maximum rate of age pension payable PA = the pharmaceutical allowance Income = the assessed income of a single person or the combined income of a couple. © Kaplan Education 6.47 6.48 Specialist Knowledge: Superannuation (924) Example: Income test for single age pensioner Frank is a single age pensioner. He has assessable income of $500.00 p.f. His age pension entitlement is calculated as follows: Step 1 Calculate the maximum rate payable (include pharmaceutical allowance). Maximum rate (from Table 6): $562.10 + $5.80 = $567.90 p.f. Step 2 Calculate the total assessable income from all sources. Total assessable income = $500.00 p.f. Step 3 Calculate the excess income over the income threshold (see Table 9). $500.00 – $138.00 = $362.00 Step 4 Calculate the reduction in the pension rate. $362.00 × 0.4 = $144.80 Step 5 Calculate the pension rate payable. $567.90 – $144.80 = $423.10 p.f. Alternatively, the income test formula can be applied: Age pension p.f. = ($562.10 + $5.80) – 0.4($500 – $138) = $567.90 – 0.4($362) = $567.90 – $144.80 = $423.10. Allowance income test The allowance income test is a stepped test that reduces the client’s allowance at growing rates as higher income levels are reached. Everyone who receives an allowance can earn up to $62.00 p.f. without their payment being affected. This applies both to singles and to each member of a couple. If the assessed income exceeds the $62.00 p.f. threshold, the allowance is reduced by 50 cents for each extra dollar of income up to $250.00 p.f. If the assessed income exceeds $250.00 p.f. the payment is further reduced by 60 cents for each extra dollar over $250 p.f. If the client is a member of a non-pensioner couple and the other partner has income exceeding the cut-off point at which no allowance is payable, the amount over this cut-off point reduces the client’s allowance by 60 cents for every excess dollar. This is often referred to as the spillover effect. Spillover reductions are applied before the client’s allowance is reduced by their own income. If the client’s partner is a pensioner, the client is not subject to a spillover effect. (In such a situation, the partner’s income would already have been factored into the test, as pensioner couples are assessed as a joint economic unit.) 924.SM1.9 Unit 6: Social security Reduction rates under the allowance income test are shown in Table 10 below. Table 10 Reduction rates under allowance income test 20 September 2008 to 31 December 2008 Income Reduction rate First $62.00 p.f. Payment not reduced $62.00 – $250.00 p.f. Payment reduced by 50c per $1 in this range Over $250.00 p.f. Payment further reduced by 60c per $1 over $250.00 Partner income over $731.33 p.f. Payment reduced by 60c per $1 of partner’s income over $731.33 A separate calculation is done for each partner of a couple. The steps are as follows: Step 1 Calculate the maximum rate payable (not including the pharmaceutical allowance)(see Table 7 for Newstart allowance). Step 2 Calculate the total assessable income from all sources. If the person has a partner, calculate the partner’s total assessable income from all sources. Step 3 Calculate the partner reduction amount. If the person has a partner who is not a pensioner, does the partner’s income exceed the partner income threshold? If yes: (Partner’s total assessable income – Partner income threshold) × 0.6 = Partner reduction amount If the person does not have a partner or the income is under the partner income threshold, go to step 4. Step 4 Calculate the first personal reduction amount. This reduction applies to income between $62.00 and $250.00 p.f. If total assessable income does not exceed $250.00 p.f.: (Total assessable income – $62.00) × 0.5 = First reduction amount Then go to step 6. If total assessable income exceeds $250.00 p.f.: ($250.00 – $62.00) × 0.5 = First personal income reduction amount = $94.00 Step 5 Calculate the second personal reduction amount. This applies to income over $250.00 p.f. (Total assessable income – $250) × 0.6 = Second personal reduction amount Step 6 Calculate the total reduction in the allowance rate. Partner reduction (step 3) + First personal reduction (step 4) + Second personal reduction (step 5) = Total reduction Step 7 Calculate the allowance rate payable. Maximum rate from step 1 – Total reduction from step 6 = Allowance rate payable. © Kaplan Education 6.49 6.50 Specialist Knowledge: Superannuation (924) Example: Single Newstart recipient Mark is age 40. He is a single Newstart recipient with $500.00 p.f. assessable income. His Newstart allowance is calculated as follows: Step 1 Calculate the maximum rate payable (see Table 7). $449.30 p.f. Step 2 Calculate the total assessable income from all sources. $500.00 p.f. Step 3 Calculate the partner reduction amount. Not applicable in this case. Step 4 Calculate the first personal reduction amount (see Table 10). ($250.00 – $62.00) × 0.5 Step 5 = First personal income reduction amount = $94.00 Calculate the second personal reduction amount (see Table 10). ($500.00 – $250.00) × 0.6 = $150.00 Step 6 Calculate total reduction in allowance rate. $94.00 + $150.00 Step 7 = $244.00 Calculate the allowance rate payable. $$449.30 – $244.00 = $193.10 p.f. Applying income tests for couples Care must be taken when applying the income test to couples. The test varies depending on whether the couple is a pensioner or non-pensioner couple. Additionally, different income tests may apply, depending on the type of payment claimed by each partner. For example, a person receiving an allowance will be considered part of a pensioner couple if their partner receives a pension. This means that the allowance income test will assess the person’s income as a part of a joint economic unit with their partner, that is, as 50% of the couple’s combined income (see section 4.3). The following examples illustrate the various combinations of rate assessments. The examples show the effect that different combinations of income ownership and payment types have on a couple’s combined social security income. 924.SM1.9 Unit 6: Social security Example 1: Both partners are pensioners Tom and Judy are age pensioners with a joint assessable income of $800 p.f. As a pensioner couple, their assessment is based on combined income. As they are both pensioners, they are both assessed under the same pension income test. Their pension entitlement is calculated under the income test as follows: Step 1 Maximum rate payable (including pharmaceutical allowance) = $944.80 p.f. combined. (See Table 6 — 2 × $469.50 plus $5.80 pharmaceutical allowance.) Step 2 Total assessable income from all sources = $800.00 p.f. combined. Step 3 Excess income over the income threshold (see Table 9) = $800 – $240.00 = $560. Step 4 Reduction in pension rate = $560 × 0.4 = $224.00. Step 5 Pension rate payable = $944.80 – $224.00 = $720.80 p.f. combined. Tom and Judy would each receive: $720.80/2 = $360.40 p.f. Alternatively, the income test formula can be applied: Age pension p.f. = ($469.50 + 0.5 × $5.80 ) − 0.4 ($800 − $240) 2 = $472.40 – $112.00 = $360.40 p.f. each or $720.80 p.f. combined Example 2: One partner is a pensioner, the other an allowee Steve receives an age pension and Janet receives Newstart allowance. They have $800 p.f. combined assessable income. They are a pensioner couple because Steve receives a pension. Their rate of payment is therefore based on combined income. Half of the combined income is assessed for Janet’s Newstart allowance (see section 4.3). • Steve’s income test calculation is based on the pension income test. • Janet’s income test calculation is based on the allowance income test. A separate calculation is made for each payment. Steve’s age pension calculation: Step 1 Maximum rate payable (including pharmaceutical allowance) = $472.40 p.f. (pensioner couple rate — see Table 6). Step 2 Total assessable income from all sources = $800.00 p.f. Step 3 Excess income over the income threshold = $800.00 – $240.00 = $560.00 (see Table 9). Step 4 Reduction in pension = $560.00 × 0.4 = $224.00. Step 5 Pension rate payable = $472.40 – $224.00 = $248.00 p.f. combined. © Kaplan Education 6.51 6.52 Specialist Knowledge: Superannuation (924) Janet’s Newstart allowance calculation: Step 1 Maximum rate payable (see Table 7 single rate) = $405.40 p.f. Step 2 Total assessable income from all sources = $800/2 = $400.00 p.f. Step 3 Partner reduction amount is not applicable as Steve is a pensioner. Step 4 First reduction amount = ($250.00 – $62.00) × 0.5 = $94.00 (see Table 10). Step 5 Second reduction amount = (Assessable income – $250) × 0.6 = ($400.00 – $250.00) × 0.6 = $90.00 (see Table 10). Step 6 Total reduction in allowance rate = $94.00 + $90.00 = $184.00. Step 7 Allowance rate payable = $405.40 – $184.00 = $221.40 p.f. Example 3: Only one partner receiving an allowance Harry is receiving a Newstart allowance. His wife Sarah earns $800.00 p.f. from part-time work. All their investments are in Harry’s name and his income is assessed at $160.00 p.f. They are a non-pensioner couple because neither Harry nor Sarah receives a pension. The rate of payment is therefore based on individually assessed income. Harry’s allowance income test calculation: Step 1 Maximum rate payable (see Table 7) = $405.40 p.f. Step 2 Total assessable income from all sources: Harry’s income = $160.00 p.f. Sarah’s income = $800.00 p.f. Step 3 Partner reduction amount = ($800.00 – $731.33) × 0.6 = $41.20 p.f. (see Table 10). Step 4 First personal reduction amount = ($160.00 – $62.00) × 0.5 = $49.00 p.f. (see Table 10). Step 5 Second personal reduction amount is not applicable as Harry earns less than $250.00. Step 6 Total reduction in allowance rate = $41.20 + $49.00 = $90.20 Step 7 Allowance rate payable = $405.40 – $90.20 = $315.20 p.f. 924.SM1.9 Unit 6: Social security Example 4: Both partners receiving an allowance Colin and Mary are each receiving Newstart allowance. Colin has assessable income of $500.00 p.f. and Mary has assessable income of $300.00 p.f. They are a non-pensioner couple because neither Colin nor Mary receives a pension. The rate of payment is therefore based on individually assessed income. Both income test calculations are based on the allowance income test. A separate calculation is done for each partner. Colin’s allowance income test calculation: Step 1 Maximum rate payable (see Table 7) = $405.40 p.f. Step 2 Total assessable income from all sources: Colin’s assessable income = $500.00 p.f. Mary’s assessable income = $300.00 p.f. Step 3 Partner reduction amount is not applicable as Mary’s income is under the partner income threshold. Step 4 First personal reduction amount = ($250.00 – $62.00) × 0.5 = $94.00 p.f. (see Table 10). Step 5 Second personal reduction amount = ($500.00 – $250.00) × 0.6 = $150.00 p.f. (see Table 10). Step 6 Total reduction in allowance rate = $94.00 + $150.00 = $244.00 p.f. Step 7 Allowance rate payable = $405.40 – $244.00 = $161.40 p.f. Mary’s allowance income test calculation: Step 1 Maximum rate payable (see Table 7) = $405.40 p.f. Step 2 Total assessable income from all sources: Mary’s assessable income = $300.00 p.f. Colin’s assessable income = $500.00 p.f. Step 3 Partner reduction is not applicable as Colin’s income is under the partner income threshold. Step 4 First personal reduction amount = ($250.00 – $62.00) × 0.5 = $94.00 p.f. (see Table 10). Step 5 Second personal reduction amount = ($300.00 – $250) × 0.6 = $30.00 p.f. (see Table 10). Step 6 Total reduction in allowance rate = $94.00 + $30.00 = $124.00 p.f. Step 7 Allowance rate payable = $405.40 – $124.00 = $281.40 p.f. © Kaplan Education 6.53 6.54 5.4 Specialist Knowledge: Superannuation (924) Strategies for reducing assessable income The impact of the income test on social security entitlements can be reduced by: • investing in assets that are not income test assessed such as: – antiques – collectibles – exempt funeral bonds – superannuation and rollovers (if under age-pension/service-pension age) • investing in assets that have a favourable income test assessment: – rental properties – financial investments that produce returns above the deeming rates. Using deeming Deeming rules mean that all financial investments will have the same impact on the income test, regardless of the actual income earned. Earning income above the deeming rates will increase overall wealth without reducing social security benefits. The following guidelines generally help maximise social security entitlements: • Use financial investments that provide income greater than the applicable deeming threshold. • Consider investments that are not affected by deeming and that produce assessable income less than the deeming rates, such as property. • Make capital drawdowns (if needed) from assets assessed under deeming that yield less than the upper deeming threshold. • Tax-paid investments (e.g. friendly society and insurance bonds) may be an unwise investment for maximising social security. 924.SM1.9 Unit 6: Social security Example: Deemed versus actual income A single pensioner has the following investments and investment income at the end of April 2008: Investments Cash $ Return Actual income ($) 3,000 (no earnings) 0 Term deposit 50,000 @ 6% p.a. 3,000 Term deposit 20,000 @ 5.5% p.a. 1,100 Unit trust 30,000 @ 9% p.a. 2,700 Total 103,000 6,800 The deemed income would be calculated as follows (using rates to December 2008, see Table 4): $ Deeming rate Deemed income ($) First $41,000 41,000 @ 4% p.a. 1,640 Above $41,000 62,000 @ 6% p.a. 3,720 Total 103,000 5,360 Therefore, these investments have a deemed income that is $1440 less than the actual income (i.e. $6800 – $5360). Advisers should note the following points about the example: • The deemed income will be counted for income test purposes and the actual income will be disregarded. Therefore, the actual income earned in excess of deemed income is particularly attractive, as it does not count for income test assessment and does not have any effect on pension entitlement. However, the actual income is still relevant for tax. • Pensioners and allowees will be better off to the extent to which they can achieve better than the deemed rate without exposing themselves to unacceptable investment volatility, insufficient access to invested funds or a high risk of losing investment capital. Shares that pay franked dividends can be advantageous for social security recipients for two reasons: • shares should outperform the deeming rates over the longer term • unused franking credits that are refunded do not count as assessable income. © Kaplan Education 6.55 6.56 Specialist Knowledge: Superannuation (924) Example: Deemed versus actual income A single pensioner has $50,000 in shares. The shares pay a 3% dividend, which is fully franked. The capital value is also growing at 4% p.a. Centrelink will deem the shares to earn: Deeming rate Deemed income ($) First $41,000 @ 4% p.a. 1,640 Remaining $9,000 @ 6% p.a. 540 Total 2,180 The actual returns from the shares are: Earnings rate Dividend Actual return ($) @ 3.0% p.a. 1,500 Franking credit Capital gain 643 @ 4.0% p.a. Total return 2,000 4,143 The shares have effectively returned a total of $4143 p.a. through dividends, refunded franking credits and capital growth, although Centrelink deems them to have earned only $2180 for the income test. 5.5 Comparing the income test and assets test rates The final step in applying the income and asset tests is to compare the rate calculated under each test. The lower amount determines the person’s entitlement. Apply your knowledge 5: Eligibility for the pension Jeff and Gayle are each age 65. They own their house valued at $500,000, a car worth $20,000, and home contents worth $10,000. Jeff has an account-based pension with a value of $400,000. He originally invested $350,000 when he was 63. He currently draws a pension of $30,000 p.a. Gayle has a super fund worth $50,000. She is not drawing any pension. They have joint bank account with a balance of $35,000. Calculate how much age pension they are entitled to. 924.SM1.9 Unit 6: Social security 6 Miscellaneous income support provisions There is a range of miscellaneous provisions for income support. The claimant may be required to support themselves for a period of time under what is known as a liquid assets waiting period or an income maintenance period. Similarly, a person who receives a compensation payment may have to wait to receive income support and may then receive reduced income support. Conversely, a claimant may be able to receive more benefits by having assets disregarded under hardship provisions. Income support may also be adjusted because of overpaid benefits. Finally, while there are no specific anti-avoidance provisions, Centrelink and the Department of Families, Housing, Community Services and Indigenous Affairs (FaHCSIA) have a significant discretion in assessing client circumstances. 6.1 Waiting periods and reduction periods for allowances Allowances are paid to people when they are unable to provide for themselves because of an unforeseen event, such as unemployment, illness or the death of a partner. People applying for allowances are expected to use some of their own liquid resources to support themselves before receiving income support. Although clients are subject to a waiting period before they receive any allowance payment, it is best for them to apply as soon as they know they will be needing support. Clients may also be subject to a period of reduced payment. Some waiting periods and payment reduction periods must take place one after another, while others can occur simultaneously. Generally, waiting periods and reduction periods do not apply to pensions. If a waiting period applies, no allowance is payable for the appropriate number of weeks. Different waiting periods may apply, depending on whether a claimant: • holds liquid assets (see below) • has a compensation preclusion period (this might affect pensions) • is a newly arrived resident. Unlike waiting periods, payment reduction periods do not necessarily result in nil payment. The amount of reduction will vary depending on circumstances. Payment reduction periods may be applied to allowances because of: • activity test breaches • income maintenance periods (IMPs) (see below). If a payment reduction period is applied, the maximum payment rate will be reduced for the appropriate number of weeks. Ordinary waiting period — one week The ordinary waiting period of one week applies to all claimants. It may be waived only in limited circumstances. © Kaplan Education 6.57 6.58 Specialist Knowledge: Superannuation (924) Liquid assets waiting period — up to 13 weeks Newstart allowance and sickness allowance applicants may face a liquid assets waiting period (LAWP) of between one and thirteen weeks. The LAWP applies if the total value of the applicant’s liquid assets exceeds: • $3000 (for a single with no dependent children), or • $6000 when combined with the client’s partner’s liquid assets (for a member of a couple and/or a person with dependent children). The LAWP commences after the normal one-week waiting period. Centrelink defines liquid assets as cash and readily realisable assets that can be accessed within 28 days, even if accessing the funds induces a penalty. The category includes employer payments that are payable on termination of employment, but does not include: • superannuation and rollover funds • termination payments that have been rolled over or that are going to be rolled over directly from the person’s employer. The applicant’s liquid assets are assessed according to their value on the day the applicant became unemployed or unable to work because of sickness or accident. However, the waiting period commences from the date employment terminates. The liquid assets waiting period (LAWP) is calculated as: LAWP = Liquid assets − a n where: a = $5000 for a member of a couple or a person with one or more dependent children, or $2500 for a single person n = $1000 for a member of a couple or a person with one or more dependent children, or $500 for a single person Example: Liquid assets test A couple has liquid assets of $10,000. Their liquid assets waiting period is worked out as follows: LAWP = $10,000 – $5000 = 5 weeks $1000 This couple is not eligible to receive allowance payments for six weeks (i.e. five-week LAWP plus one-week ordinary waiting period). 924.SM1.9 Unit 6: Social security Strategies for reducing the liquid asset waiting period The LAWP can be reduced by converting liquid assets to non-liquid assets. Examples of such a conversion include: • contributing to superannuation before employment terminates (preservation issues should be considered) • paying off debts not related to property. A successful conversion must occur in time for the relevant liquid assets test (see above). If the waiting period has already been calculated it will be recalculated based on the new level of liquid assets. A conversion strategy will confer no advantage if the allowance is reduced to nil by an income maintenance period (see below) lasting as long or longer than the LAWP. Further resources Centrelink 2007, ‘Liquid assets’ [online] 14 August. Available from: <http://www.centrelink.gov.au> by entering ‘liquid assets’ in the search box [cited 24 September 2008]. Income maintenance period The income maintenance period (IMP) is a time when a client receives reduced social security payments because of leave or redundancy entitlements from an employer. Depending on how much they receive, payments may be reduced to nil. Under the IMP provisions, the claimant can not receive a payment from the date they received any leave or redundancy entitlements up to the end of the period covered by those entitlements. During this time, IMP leave income is added to other income assessable under the income test. This means that if the person’s previous position saw them earning above the income test cut-off, their allowance payment will be reduced to nil throughout the income maintenance period. Any portion of the redundancy payment that is rolled over to a superannuation or rollover fund by the employer is exempt from the income maintenance period. The IMP can be concurrent with waiting periods. Payments subject to the IMP The income maintenance period applies to people applying for or receiving Newstart allowance, youth allowance, partner allowance, mature age allowance, widow allowance, Austudy, parenting payment, sickness allowance and the disability support pension, except for clients who are permanently blind. © Kaplan Education 6.59 6.60 Specialist Knowledge: Superannuation (924) Pensioner’s income test not affected by partner’s IMP leave income If a client subject to the IMP has a partner who is a pensioner, the client’s leave income will not affect the income test of their pensioner partner. Normally, the income of a pensioner couple is combined and Centrelink assesses each partner as receiving half. IMP leave income is an exception. Half of the leave payments are assessed to the client receiving the leave and included in their income test assessment. The other half are allocated to their partner, but ignored in their partner’s pensioner income test assessment. Example: Waiting period Rod is a single person earning $1200 p.w. He is made redundant and receives $30,000 for 19 weeks unused leave. His other liquid assets total $50,000. He applies for a Newstart allowance, and his waiting and reduction period is calculated as follows. Ordinary waiting period = 1 week = LAWP Total waiting period $80,000 − $2500 $500 155 (limited to 13 weeks) = 14 weeks (i.e. 13 + 1). = The IMP, however, will run for 19 weeks (i.e. the period that leave is paid for). For each week Rod is assessed to earn $1579 income (plus other income from investments etc.). This exceeds the income test cut-off threshold of $800.50 p.f. for a single person. Therefore Newstart payments are reduced to nil for 19 weeks. The combined waiting period and the IMP can take place concurrently. This means that the waiting period will be completed within the 19-week IMP. If Rod was married, the situation would be as follows: Ordinary waiting period = 1 week LAWP = $80,000 − $5000 $1000 = 75 (limited to 13 weeks) = 14 weeks (i.e. 13 + 1) Total waiting period Income during the 19-week IMP is assessed as $790 per week each. This is over the Newstart income test cut-off threshold for a married person, so Rod will be ineligible to receive payments for 19 weeks. If his wife applies for an allowance, she will also be ineligible for 19 weeks. However, if she applies for a pension, her share of the income from the IMP is not assessable. She will not have to serve a waiting period and may be eligible immediately, depending on other income and assets. Further resources Centrelink 2008, ‘Waiting periods’ [online] 1 July. Available from: <http://www.centrelink.gov.au> by entering ‘waiting periods’ in the search box [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security 6.2 Compensation payments The income test rules for dealing with compensation payments are very complex. Advisers should obtain specific details from Centrelink before advising clients on such matters. The Australian Government encourages Australians to access money from other sources before relying on Centrelink payments. Thus, a person receiving a lump sum payment might not be able to receive social security income support for many years. Careful financial advice is required to ensure they are able to support themselves during this period. Ongoing periodical compensation payments usually reduce social security payments dollar for dollar. An exception to this applies for people already receiving social security income support when the accident or injury occurred. Compensation payments are then assessed under standard income test rules. If a client receives a lump sum compensation payment for economic loss (i.e. lost earnings or lost potential to earn), they may not have access to social security income support for some time. In addition, the client may have to pay back income support they received while waiting for the claim to be finalised. This may be deducted from their compensation payment. If a client converts part or all of their compensation settlement into assets, for example by purchasing or paying off a house or car, they may be expected to sell the asset so they can support themselves before having access to social security. The period for which the person is precluded from receiving social security benefits is calculated by: No. of weeks in preclusion period = ( Lump sum × 50%) Income cutoff limit* * The income cutoff limit at 1 July 2008 is $759.75. It is based on the income a single person can receive per week before the pension entitlement ceases under the income test. It applies for both single people and married people. Further resources Centrelink 2008, ‘Compensation kit booklet’ [online] 10 September. Available from: <http://www.centrelink.gov.au> by entering ‘compensation kit’ in the search box [cited 24 September 2008]. © Kaplan Education 6.61 6.62 6.3 Specialist Knowledge: Superannuation (924) Hardship provisions Pensioners (or people applying for a pension) who own substantial assets that produce little or no income may apply to Centrelink to have the value of the assets disregarded under hardship provisions. To be eligible, the clients cannot be reasonably expected to sell the assets or use them as security for a loan. The hardship provisions may be applied to some allowees, but unless there is a legal restriction on the sale of the assets, they are expected to place the assets on the market at a realistic price before they can apply for consideration under hardship provisions. Special provisions apply for farmers and primary producers. A pensioner or allowee is considered to be in financial hardship if their total income is less than the maximum rate of pension and their readily available assets are below the following limits: • single $14,216.80 • couple combined $23,753.60. Note: Rates are current at March 2008 and indexed each year in line with pension indexation in March and September. Source: <http://www.centrelink.gov.au>. Further resources Centrelink 2008, ‘Hardship information factsheet’ [online] 6 June. Available from: <http://www.centrelink.gov.au> by entering ‘hardship’ in the search box [cited 1 October 2008]. 6.4 Overpayments Centrelink considers overpayments to clients as recoverable debts, regardless of whether the overpayment occurred because of incorrect information from the client or error by Centrelink. Pensioners must advise Centrelink of any changes to their income or assets within 14 days, while allowees must advise Centrelink of changes within seven days. If the client notifies Centrelink within this time, their pension or allowance will be adjusted from the date of notification, not the date of increase. Overpayments must be repaid either as a lump sum or through regular deductions from future payments, depending on client circumstances. 924.SM1.9 Unit 6: Social security 6.5 Anti-avoidance rules Social security legislation does not have general provisions for disallowing schemes designed to increase social security entitlements. It has nothing analogous to the anti-avoidance measures in the Income Tax Assessment Act, for example. However, many sections of social security legislation give Centrelink and the Department of Families, Housing, Community Services and Indigenous Affairs (FaHCSIA) significant discretion in assessing clients according to their individual circumstances. This extensive discretion can make it difficult to predict how Centrelink will respond to some scenarios. A valuable tool is the Guide to Social Security Law available from the FaHCSIA website <www.facsia.gov.au>. Much of the social security legislation is very general in its wordings and this guide indicates the department’s current interpretation. However, care should be taken as the guide is subject to regular changes that can alter the way a situation is assessed. These changes do not have to be passed through parliament and are not well publicised, creating problems for the unwary financial adviser. Further resources FaHCSIA 2008, Guide to social security law [online] version 1.138, 1 July, Department of Families, Housing, Community Services and Indigenous Affairs, Canberra. Available from: <http://www.facsia.gov.au> by entering ‘social security policy guides’ in the search box and then selecting ‘social security and family assistance legislation and policy guides’. Select ‘Guide to Social Security Law’ [cited 2 July 2008]. 6.6 Rights and appeals If a person disagrees with an assessment made by Centrelink, they can request the decision be reconsidered. Clients must follow certain steps to have a decision reconsidered. If the client is unhappy with the result of one step, they can lodge a further appeal at the next step. Steps cannot be skipped. Step 1 Discuss the matter with the original reviewing officer. Step 2 If still unhappy, request a review within three months with the Review Officer at the Centrelink area office. Step 3 Apply to the Social Security Appeals Tribunal (SSAT) for a review. This is an independent statutory authority. There is no charge to lodge an appeal. Step 4 Apply to the Administrative Appeals Tribunal (AAT). This is a more formal body than the SSAT that resolves disputes between people and government authorities. There is no charge to lodge an appeal. Decisions are binding and can only be appealed to the Federal Court on a matter of law. Further resources Centrelink 2008, ‘Reviews and appeals factsheet’ [online] 21 August. Available from: <http://www.centrelink.gov.au> by entering ‘appeals factsheet’ in the search box [cited 24 September 2008]. © Kaplan Education 6.63 6.64 7 Specialist Knowledge: Superannuation (924) Taxation considerations Most pensions, allowances and benefits are taxable. The main exceptions are: • disability support pension (DSP) (if recipient is under age-pension age) • wife pension (for wives of DSP recipients if both partners are under age-pension age) • carer payment (if carer and caree are both under age-pension age) • family tax benefits • add-on benefits such as the pharmaceutical allowance and rent assistance. Pay as you go (PAYG) tax can be deducted from pension and allowance payments if requested. People who receive taxable payments will receive a PAYG payment summary at the end of the financial year. Tax offsets may apply to people who receive taxable social security payments. These offsets generally ensure that people who receive the maximum rates of social security pensions and allowances do not pay any tax on their benefits. The values of the various offsets vary each year and details are usually released in April or May in the relevant financial year. Social security income assessment rules vary significantly from rules for taxable income, and a person may receive a full-rate pension but have taxable income over the social security threshold for the year. The ATO TaxPack provides details about when a pensioner is required to submit a tax return. 7.1 Senior Australians tax offset The senior Australians tax offset applies to all eligible people regardless of whether they are pensioners. Recipients must satisfy four tests: an age test, a residency test, a prison test and an income test. Age test A person will meet the age test if they are of age-pension/service-pension age. Residency test To meet the residency test, a person must either have received an Australian Government pension or similar payment during the financial year, or have qualifying Australian residency sufficient to receive an age pension (generally 10 years residency). Further resources FaHCSIA 2008, Guide to social security law [online] version 1.138, 1 July, Department of Families, Housing, Community Services and Indigenous Affairs, Canberra. Available from: <http://www.facsia.gov.au> by entering ‘social security policy guides’ in the search box and then selecting ‘social security and family assistance legislation and policy guides’. Select ‘Guide to Social Security Law’ [cited 2 July 2008]. 924.SM1.9 Unit 6: Social security Prison test The person cannot have been in prison for the whole of the financial year. Income test The income thresholds and cut-off limits for the 2007/08 financial year are shown in Table 11. Table 11 Senior Australians tax offset income thresholds and cut-off limits 2007/08 Category Income threshold Cut-off income threshold Maximum tax offset available Single persons $25,867 $43,707 $2,230 Persons married or partnered for the whole of the financial year $21,680 $34,496 $1,602 Note: Higher rates apply for couples living apart due to illness. Proposed new marginal tax rate thresholds for the 2008/09 financial year applicable from 1 July 2008 mean these thresholds will increase to $28,867 for singles and $24,680 each for couples. If the person’s taxable income is below the income threshold, the maximum tax offset is available. For every dollar of income above the income threshold the rebate is reduced by 12.5 cents. The rebate is nil at the cut-off income threshold. The tax offset allows a person to earn up to the maximum income threshold and effectively pay no tax. This is because the maximum tax offset neutralises any tax at that level. Example: Senior Australians tax offset Frank is a single person of age-pension age. He meets the residency and prison tests. His taxable income for the 2007/08 financial year was $30,000. Frank’s senior Australians tax offset for 2007/08 is calculated as follows: (Taxable income – Income threshold) × Reduction rate ($30,000 – $25,867) × 0.125 = $516.63 = Maximum offset – Offset reduction = $2230 – $516.63 = Offset entitlement = = Offset reduction $1713.37 Further resources ATO, ‘Seniors and retirees essentials’ [online]. Available from: <http://www.ato.gov.au> by entering ‘seniors and retirees essentials’ in the search box [cited 1 October 2008]. This page contains multiple links to information on tax for retirees, the senior Australian tax offset and the pensioner tax offset. © Kaplan Education 6.65 6.66 7.2 Specialist Knowledge: Superannuation (924) Pensioner tax offset The pensioner tax offset is available for people on pensions and some allowances who are not eligible for the senior Australians tax offset. The pensioner tax offset enables a pensioner to receive the maximum rate of pension plus private taxable income up to the annual amount of the social security income-test-lower threshold without paying any tax. People receiving the following payments may qualify for the pensioner tax offset: • age pension • bereavement allowance • carer payment • disability support pension (if under age-pension age) • parenting payment (single) • widow B pension • age service pension • income support supplement • invalidity service pension • partner service pension • wife pension. Table 12 Pensioner tax offset rates for 2008/09 Category Income threshold Cut-off income threshold Maximum tax offset available Single persons $20,194 $37,226 $2,129 Persons married or partnered for the whole of the financial year $16,734 $29,614 $1,610 Note: Higher rates apply for couples living apart due to illness. Source: <www.ato.gov.au>. The offset is reduced by 12.5 cents for every dollar of income above the income threshold. Example: Pensioner tax offset Mary is a single carer payment recipient. For the 2008/09 financial year she had a taxable income of $22,000. Her pensioner tax offset is calculated as follows: ($22,000 – $20,194) × 0.125 $226 (round up to nearest dollar) = Maximum offset – Offset reduction = $2129 – $226 = 924.SM1.9 (Taxable income – Income threshold) × Reduction = Offset entitlement = = Offset reduction $1903 Unit 6: Social security 7.3 Beneficiary tax offset The beneficiary tax offset is available to taxpayers who receive certain Centrelink benefits and Commonwealth education allowances, including: • Newstart allowance • parenting payment (partnered) • partner allowance • sickness allowance • special benefit • widow allowance • youth allowance. The beneficiary tax offset is set as the amount required to offset the tax liability on the rebatable allowance paid during the year, regardless of any other income received. This means that the eligible allowee will pay no tax for the year if they have no assessable income other than the allowance. The following formula is used: Offset = (Actual amount of rebatable allowance received – Tax-free threshold) × Lowest marginal tax rate Example: Beneficiary tax offset Glen earned a total taxable income of $8000 for the financial year. This included $6800 from Newstart payments. Glen is entitled to a beneficiary tax offset of: Rebate = ($6800 – $6000) × 15% = $120 ($6000 = the 2008/09 tax-free threshold) 7.4 Transfer of unused tax offsets between partners An unused senior Australians tax offset or pensioner tax offset can be transferred to a partner, but only if both partners are eligible to either of the offsets. An unused tax offset occurs if the person’s tax liability for the year is less than their eligibility offset. The portion of the tax offset that is not used is called the excess or the unused tax offset. © Kaplan Education 6.67 6.68 7.5 Specialist Knowledge: Superannuation (924) Medicare levy income threshold Thresholds for the Medicare levy depend on age and income. Table 13 shows the income thresholds for standard individuals and for people who are eligible for the senior Australians tax offset or the pensioner tax offset. Table 13 Medicare levy income thresholds for 2007/08 Threshold type No levy payable if income up to: Full levy payable if income over: * $19,694 $21,637 ** $25,455 $24,867 $29,255 Standard — individuals $16,740 Persons eligible for the pensioner tax offset (under pension age) Persons eligible for the senior Australians tax offset These rates are valid for the 2007/08 financial year and have increased in line with the changes to the tax rates and thresholds. * The 2008 budget proposed that the low-income threshold be increased to $17,309 for individuals with effect from 1 July 2007. ** The 2008 budget proposed that the Medicare levy threshold for pensioners below age-pension age be increased to $22,922, with effect from 1 July 2007. Note that the Tax Laws Amendment (Personal Income Tax Reduction) Bill 2008 (Cth) also proposes to increase the Medicare thresholds to ensure that senior Australians do not pay the Medicare levy when they do not have an income tax liability. For taxable incomes between the lower and upper thresholds, the Medicare levy is 10% of the amount exceeding the lower threshold. Once taxable income reaches the upper threshold, the Medicare levy is payable at the normal rate of 1.5% of total taxable income. Medicare surcharge A Medicare surcharge of 1% applies to people without qualifying private health insurance. The surcharge applies to singles with taxable income over $50,000 and to couples with a combined taxable income over $100,000 (if they have no dependent children). The May 2008 budget announced these thresholds would change to $100,000 and $150,000, respectively. The proposed changes were opposed by the Opposition in the Senate and on 16 October 2008 a Bill was passed setting the thresholds at $70,000 for singles and $140,000 for couples. The amount couples can earn before paying the surcharge rises with each dependent child. Further resources ATO 2008, ‘Medicare levy surcharge’ [online] 30 June. Available from: <http://www.ato.gov.au> by entering ‘medicare levy surcharge’ in the search box and selecting ‘Medicare levy surcharge’ from the results [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security 7.6 PAYG tax instalments PAYG tax instalments are not payable if the person: • is eligible to claim all or part of either the pensioner tax offset or the senior Australians tax offset, or • is receiving a pension and has taxable income below certain thresholds. Net capital gains or bonuses from insurance or friendly society bonds are not included in taxable income for this assessment. The income thresholds are indexed each year and details are available from the ATO. People who receive beneficiary tax offsets are not exempt from PAYG tax instalments. 8 Aged care provisions In Australia, there are a variety of aged care facilities providing different levels of care. Services are available in private homes, retirement villages, hostels and nursing homes. Determining which type of accommodation is most suitable and accessible is often a complex and emotional process. An aged care assessment team (ACAT) of health professionals help by assessing the level of care most appropriate for the person. A referral from ACAT is necessary before a person can: • be accepted into an aged care facility • receive government-subsidised services in their own home. Advisers should consider the financial consequences of moving a client into an aged care facility. Of particular importance is the effect a person’s assessable assets have upon the accommodation bond or charge for aged care facilities. Also, pensioners and nonpensioners are charged at different rates. From 20 September 2007, the treatment of income streams under the assets test for aged care is aligned with Centrelink’s pension assessment. These unit notes provide an overview of hostels and nursing home facilities that are funded by the federal government only. Non-government funded services have different fees and charges. Further resources Department of Health and Ageing 2007, ‘Residential care manual’ [online] 6 December. Available from: <http://www.health.gov.au> by entering ‘residential care manual’ in the search box [cited 2 July 2008]. The manual may also be available from a Centrelink office or an aged care facility. © Kaplan Education 6.69 6.70 8.1 Specialist Knowledge: Superannuation (924) Aged care residences Hostels Hostels provide personal care accommodation with some low level nursing care. They are generally a unit in a bed-sit arrangement with a shared dining room and recreational facilities. Hostel accommodation bond An accommodation bond is usually charged on entering a hostel. This bond is set according to the person’s assets at the time of purchase and fixed for the duration of the person’s stay. The cost of the bond is generally negotiable, and the government sets no absolute upper limit. However, the government does regulate costs relative to the individual means of the residents. When determining the accommodation bond payable, the person must not be left with assets below a certain minimum level at the time of entry, which is currently $34,500. This means that a person with less than the minimum permissible assets will not pay an accommodation bond when entering a hostel. However, places may be limited and the person may not have immediate access to the hostel of their choice. Assets are assessed in manner similar to the age pension assets test, although there are some key differences (see section 8.2). The accommodation bond is like an interest-free loan to the hostel provider with a refund payable to the person (or their estate) when they leave (or die). The hostel can deduct a retention amount from this bond each year for the first five years. The hostel may also retain any interest they derive from accommodation bonds. The maximum retention rate is shown in Table 14. Table 14 Maximum retention rate from 1 July 2008 Accommodation bond paid Maximum per month <$18,120 $151 $18,120–$35,040 >$35,040 Maximum retention rate p.a. $1812 p.a. for five years 10% of bond paid p.a. for five years $292 $3504 p.a. for five years Source: <http://www.health.gov.au>. The accommodation bond can be paid in the following ways: • Lump sum payment — an upfront payment in which the hostel provider keeps all interest earned on the amount. • Periodic payment — an agreed amount payable that includes an interest component for interest forgone as a result of not having the bond paid upfront. The Department of Health and Ageing sets a maximum interest rate, which is 10.5% at 20 September 2007. See <www.health.gov.au>. • Combination payment — a combination of a lump sum upfront payment and periodic payments. 924.SM1.9 Unit 6: Social security Hostel daily care fees Hostel providers also charge a daily care fee comprising a basic rate and an income-tested fee. The amount payable varies depending whether the person receives the age pension. The basic daily fee is set by the hostel up to the maximum rates listed in Table 15. In practice, most hostels charge the maximum rate. The income-tested fee applies to part-pensioners and non-pensioners only. The fee is calculated as 25 cents for every dollar of assessable income above the lower threshold used in the Centrelink income test for the age pension (see Table 9). The fees are capped at maximum levels shown in Table 15. In calculating the income-tested fee, Centrelink applies the same income test and definition of income as it does for the age pension. Table 15 Maximum daily care fees from 20 September 2008 Fee Receiving any pensioners income maximum Non-pensioners maximum Basic rate $32.95 $32.95 Income-tested fee $25.35 $58.15 Source: <http://www.health.gov.au>. Nursing homes Nursing homes provide high level care throughout the day and night. Accommodation is usually in a shared room in a bed with some private furnishings. Nursing homes generally provide meals, toiletries, mobility aids and most medical supplies. Nursing home accommodation bond Some nursing homes charge an accommodation bond. This is most common in nursing homes that provide superior accommodation. Nursing home accommodation bonds are calculated in the same way bonds are calculated for hostels. Nursing home accommodation charge or bond Nursing homes usually charge an accommodation charge. The accommodation charge is negotiated between the nursing home provider and the person. The agreement specifies the amount charged, and the frequency and method of payment. The charge: • generally cannot be paid more than one month in advance • is calculated on a daily basis • is payable for a maximum of five years if the resident entered a nursing home before 1 July 2004, otherwise no maximum period applies. The accommodation charge varies depending on: • when the person entered care • whether the person is fully supported • whether the person is in receipt of a means-tested Australian pension • the assets of the person. The minimum asset value is indexed in March and September. © Kaplan Education 6.71 6.72 Specialist Knowledge: Superannuation (924) For those with assets below the minimum asset value, no daily charge is payable. Similar to hostels, limited places are available for people entering a nursing home that are not required to pay the accommodation charge. Table 16 below shows the complex range of charges dependent on the client circumstances. Table 16 Maximum accommodation charges from 20 September 2008 to 19 March 2009 Residents who first entered residential aged care from 20/9/2008 For fully supported residents N/A non-supported residents, if their assets at entry are at least $91,410.40 — who are not in receipt of a means-tested Australian pension $26.88 – who are in receipt of a means-tested Australian pension $21.39 supported residents, if their assets at entry are equal to or less than $91,410.40 calculated amount Pre 20 March 2008 residents who enter a home For concessional residents and charge exempt residents N/A Residents who first entered residential aged care from 1/7/2004: – assisted residents, if their assets at entry are at least $55,448 $10.93 – assisted residents, if their assets at entry are less than $55,448 calculated amount – other residents, if assets at entry are at least $70,358 $19.10 – other residents, if assets at entry are less than $70,358 Calculated amount Residents who first entered residential aged care before 1/7/2004 assisted residents, if their assets at entry are at least $50,739 $8.35 assisted residents, if their assets at entry are less than $50,739 calculated amount other residents, if assets at entry are at least $65,887 $16.20 other residents, if assets at entry are less than $65,887 calculated amount Source: <http://www.health.gov.au>. Nursing home daily care fees Daily care fees are also payable by nursing home residents and are calculated in the same manner as described for hostels. However, some additional services will attract an extra cost. These costs can be significant. 924.SM1.9 Unit 6: Social security 8.2 Asset and income assessment for aged care As discussed above, a person’s assets and income will affect the cost of residence in hostels and nursing homes. Further information about the income and assets assessment is detailed below. Differences between Centrelink and aged care assets tests The aged care assets test is similar to Centrelink’s pension assets test with two differences. These relate to the assessment of the family home and gifted assets. Family home Unlike the Centrelink assets test, the family home may be included in the aged care assets assessment. Generally, if a person moves to an aged care facility and the home is kept and untenanted, clients will have a two-year grace period before their home is assessed as an asset. After two years, the net market value of the home is assessable. Exemptions to this rule are as follows: • If the home is rented and the client is paying an accommodation bond with periodic payments, the rental income from the client’s home is disregarded. This exemption also applies to clients paying an accommodation charge. • The home is considered an exempt asset if it is occupied by: – a spouse or dependent child – a carer who is eligible for income support and has lived there for two years, or – a close relative who is eligible for an income support payment and has lived in the home for the last five years. Gifted assets A person entering an aged care facility on or after 1 January 2007 has assets gifted after 9 May 2006 included in their aged care assets test. For those who entered an aged care facility before 1 January 2007, gifted assets are not included in the assets test. Income streams From 20 September 2007, the aged care assets test is the same as the Centrelink pension entitlement assets test in the assessment of pensions and annuities. This means that: • complying income streams purchased prior to 20 September 2007 will retain their aged care assets test exemption • income streams purchased after 20 September 2007 will be fully assessable. © Kaplan Education 6.73 6.74 Specialist Knowledge: Superannuation (924) Couples When one member of a couple is entering an aged care facility, half the combined assets are assessed. Daily care fees When calculating daily care fees, income is assessed according to Centrelink’s pension income test. 8.3 Age pension for those in an aged care facility When a person moves to an aged care facility, several factors can affect their age pension entitlement. As stated in section 4.10, accommodation bonds are not counted under the pension assets or income tests. For clients who are sensitive to asset tests, paying the accommodation bond upfront may result in a higher age pension payment. Moving to an aged care home can affect the person’s homeowner status. Centrelink has precise rules for determining whether a person is considered a homeowner. The rules are more generous for nursing home residents than they are for hostel residents. The person’s change in homeowner status may affect decisions to lease out or sell the home. If one member of a couple moves into an aged care facility, they will usually be entitled to a higher maximum rate of pension. This is because Centrelink views the couple as being ‘separated due to ill health’. When considering strategies to maximise a person’s age pension, it is also important to consider how these issues might affect the cost of entering and residing in an aged care facility. Review your progress 1 1. A single pensioner gifted $25,000 on 1 January 2008. The pensioner had made no previous gifts. How will Centrelink treat the gift for pension assessment? 2. Andrew receives a Newstart allowance; his wife Maria is an age pensioner. Are they a pensioner couple or non-pensioner couple for assessment purposes? Which means test does this affect? 3. Fred is a resident of Waves Nursing Home, which charges the maximum basic rate of the daily care fee. He is a pensioner. What daily care fee will he pay? Further resources Centrelink 2008, ‘Residential aged care fees’ [online] 8 April. Available from: <http://www.centrelink.gov.au> by entering ‘residential care’ in the search box and then selecting ‘residential aged care fees’ [cited 1 October 2008]. 924.SM1.9 Unit 6: Social security 9 Miscellaneous strategies 9.1 Superannuation exemption As discussed in section 4.6, superannuation in the accumulation phase is exempt from the income and assets tests if the client is below age-pension/service-pension age. Advisers can take advantage of this exemption through the following strategies: • retaining money in the accumulation phase of superannuation or rollover fund until age-pension/service-pension age • contributing non-super money into superannuation (preservation issues need to be considered as well as the concessional and non-concessional limits on amounts that can be contributed) • transferring investments from a client over age-pension/service-pension age to the superannuation of a partner still under age-pension age. Countervailing considerations The strategies above should be considered carefully as the additional social security benefits they bring about may be outweighed by other consequences. For example, transferring assets into superannuation might involve losing access to funds for a limited period or for life. For example, preserved funds are inaccessible until a condition of release is satisfied, and lifetime-guaranteed superannuation pensions are inaccessible beyond normal pension rates for life. Clients also need to consider the 15% tax on super fund earnings in the accumulation phase. The additional Centrelink benefits brought about by a transfer strategy need to be compared to the potential tax savings of converting the super to a pension, especially for clients over age 60. In deciding which partner should hold superannuation investments, advisers need to consider a range of factors, including: • the type of income support received and its specific rules; for example exceeding the lower assets test limit is less disadvantageous for a couple receiving pensions than it is for a couple receiving allowances • the client’s desire or need to own and control their own investments. In addition, cashing in super benefits and transferring them to the other partner through a spouse contribution or a non-concessional contribution will have tax implications, which should be taken into account. © Kaplan Education 6.75 6.76 9.2 Specialist Knowledge: Superannuation (924) Couples and asset ownership Unlike pensioner couples, non-pensioner couples have their income and assets assessed as individuals rather than as a combined entity. For non-pensioner couples, income is allocated to the person who owns the asset or derives the income. This makes asset ownership an important consideration in developing financial plans. Advisers should aim to divide assets between the partners in a way that minimises income test reductions to social security payments. The effective ownership split for investments is determined by two factors: • use of the lower deeming threshold • the reduction rate that would be applied to income earned by each person. Both partners apply for allowances If both partners of a non-pensioner couple apply for allowances, the ownership of financial assets should generally be split so that each person can use the full lower deeming threshold (see Table 4). However, this strategy may not always be effective. Advisers should consider whether the extra income would reduce one partner’s payment at a higher rate than the other. For example, each dollar of extra income may reduce one partner’s payment by 60 cents and the other’s by 50 cents. One partner applies for an allowance and the other does not Allowees can only earn $62 p.f. before their pay is reduced by 50 cents for each dollar of excess income. However, their partners can earn around $731 p.f. before the allowee’s entitlement is affected. Therefore, investment income should not be allocated to the allowee until their non-social security partner reaches the $731 limit. At least one partner applies for a pension Pensioner couples are assessed as joint economic units for both the income and assets tests, so for social security purposes ownership of investments is not an issue. 9.3 Reassessing investment value Each March and September, Centrelink automatically reassesses the asset values of investments that have regularly fluctuating market values, such as allocated pensions, shares and managed investments. However, investment values might vary significantly between these review dates. Social security recipients can request assessment reviews at any time if they feel their situation has changed. If market values have fallen since the last automatic assessment date, a reassessment might increase their social security entitlements. This is because a reduced asset value would flow on to reduce deeming assessment, which could mean reducing the impact of the income and assets tests. Remember that if a reassessment is requested, all investments will be reassessed. Some investments might have increased in value, causing social security entitlements to decrease, so care should be taken. 924.SM1.9 Unit 6: Social security 9.4 Repaying debts Personal debts and unsecured debts are generally not deductible from the value of assessable assets. This can unnecessarily increase the value of assets the person is assessed to own. If the person receives income support calculated under the assets test, their entitlement will be reduced by having personal and unsecured debts. If social security recipients have unsecured debts or personal debts they should either: • repay them • arrange for a registered mortgage over an assessable asset to cover the debt. 9.5 Salary sacrifice If a person is under age-pension age, employment income is assessed as the salary received plus any reportable fringe benefits. In May 2008, salary sacrifice amounts to superannuation are not fringe benefits and are not assessable income. Therefore, assessable income can be reduced by salary sacrifice to superannuation. However, there are now limits on this strategy. In the May 2008 budget, the Commonwealth Government announced its intention to expand the definition of income to include certain salary sacrifice contributions to income from 1 July 2009. If a person is age-pension age or over, any superannuation contributions made by the employer above the superannuation guarantee (SG) will be assessable as income. Since 1 April 2007, fringe benefits paid by the employer over the value of $2000 are reported for tax purposes on an employee’s payment summary. However, social security income tests extend beyond this to include the total value of all fringe benefits. In the May 2008 budget, the Commonwealth Government announced its intention to tighten rules for fringe benefits tax concessions for work-related items. Review your progress 2 1. If a person gives up control of $250,000 worth of assets in a private trust, have they improved their access to social security in the short term? 2. What is the potential social security advantage of paying off a personal debt? © Kaplan Education 6.77 6.78 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 Unit 6: Social security Suggested answers Apply your knowledge 1: Deemed income for an age pensioner couple Financial assets total = $1500 + $4000 + $6000 + $10,000 + $12,000 + $50,000 = $83,500 Note: Home, contents, car and allocated pension are not financial investments. First $68,200 at 4% = $2728 Balance of $15,300 at 6% = $ 918 $2728 + $918 = $3646 Apply your knowledge 2: Deemed income for a non-pensioner couple Calculate the deemed income for Jo and Roberta, a non-pensioner couple who have the following assets: Financial assets total for Roberta = $1500 + $2000 + $12,000 = $15,500 $15,500 at 4% = $620 Financial assets total for Jo = $2000 + $18,000 + $34,000 = $54,000 $54,000 at 4% = $2160 Apply your knowledge 3: Determining assessable assets Car $20,000 Contents $10,000 Allocated pension $250,000 Rental property (net) $150,000 ($400,000 – $250,000 loan secured against this property) Cash at bank $20,000 Deprived asset $40,000 ($50,000 – $10,000 allowed as a gift) Total $490,000 © Kaplan Education 6.79 6.80 Specialist Knowledge: Superannuation (924) Apply your knowledge 4: Reducing assessable assets Michelle could cash out some superannuation. They could then reinvest the money into Peter’s name as it will be exempt from the assets test until he reaches age-pension age (age 65). Apply your knowledge 5: Eligibility for the pension Assets test Total assets = $20,000 + $10,000 + $400,000 + $50,000 + $35,000 = $515,000 car + contents + pension + pension + bank The minimum threshold for married homeowners is $243,500, so they are over the threshold by $271,500. The combined reduction in pension is $1.50 p.f. × 271.5 = $407.25, so the pension reduction for each partner is $203.63. Therefore, the pension for each partner is $469.50 – $203.63 = $265.87 p.f. plus pharmaceutical allowance. Income test Deemed assets = Gayle’s $50,000 super + $35,000 cash in bank = $85,000 $66,200 @ 4% p.a. = $2728 p.a. $18,800 @ 6% p.a. = $1128 p.a. Assessable income from account-based pension = $30,000 less deductible amount. Deductible amount from Jeff’s pension = $350,000 ÷ 19.24 = $18,191 p.a. (life expectancy for male age 63 = 19.24 years) Assessable income for Jeff’s pension Total assessable income = = = $30,000 – $18,191 = $11,809 p.a. $2728 deemed + $1128 deemed + $11,809 pension $15,665 p.a. or $602.50 p.f. Excess over minimum threshold = $602.50 – $240 = $362.50 Combined reduction in pension = $362.50 × 0.4 = $145.00 So, pension reduction each = $72.50 ($145.00 ÷ 2) So, calculated pension each = $469.50 – $72.50 = $397.00 p.f. plus pharmaceutical allowance. Result Asset test = $265.87 p.f. each. Income test = $397.00 p.f. each. They will receive the lowest amount, that is, the asset test amount of $265.87 p.f. each plus pharmaceutical allowance. 924.SM1.9 Unit 6: Social security Review your progress 1 1. After subtracting the allowable gifting limit of $10,000, the asset deprivation will be $15,000. This will be included in full (i.e. $15,000) under the assets test for five years from the date of the gift (i.e. until 1 January 2013). The deprived asset is assessed as part of the pensioner’s financial assets. Income is assessed on the $15,000 under the deeming rules. 2. Maria receives a pension, therefore Andrew and Maria are a pensioner couple. This means that their income is assessed jointly for the income test, regardless of ownership of the source of the income. 3. Fred will pay $32.95 as the basic rate (the maximum). Review your progress 2 1. Probably not, because the value of the trust assets will be subject to gifting rules and an assessment of deprivation may apply. 2. Personal debts are not deductible from the value of assessable assets, so paying off a personal debt will reduce assessable assets by the amount paid. © Kaplan Education 6.81 6.82 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 7 Death benefits Overview 7.1 Unit learning outcomes ....................................................................7.1 Further resources ............................................................................7.2 1 Payment of superannuation death benefits 2 2.1 2.2 2.3 2.4 Determining the recipient of death benefits 7.4 Dependants under the SIS Act .................................................7.4 Benefits paid to an estate .......................................................7.5 Binding nominations and reversionary options...........................7.6 Role of the Superannuation Complaints Tribunal .......................7.6 3 3.1 3.2 3.3 3.4 3.5 3.6 Death benefits from income streams 7.7 Automatic reversionary beneficiary ...........................................7.7 Nominated binding beneficiary .................................................7.7 Split of tax-free and taxable components ..................................7.8 Minimum income payment.......................................................7.8 Taxation of income stream converted to a lump sum .................7.8 Non-binding nomination or no nomination .................................7.8 4 4.1 4.2 4.3 4.4 Taxation of death benefits 7.9 Benefits paid as a lump sum ...................................................7.9 Death benefits paid as an income stream...............................7.11 Child allocated pensions .......................................................7.12 Strategies to minimise tax from superannuation death benefits ...............................................................................7.13 Suggested answers 7.3 7.17 Unit 7: Death benefits Overview On death, superannuation is an asset that can be distributed to dependants or the estate by either: • the determination of the trustees under a discretionary nomination • the binding nomination of the member. It is important for the financial adviser to understand the issues that may arise regarding the distribution of these funds including: • whether binding nominations are valid according to superannuation regulations • whether the superannuation fund or the estate pays any relevant tax • whether the moneys will be taxed because of the beneficiaries’ status • whether insurance such as a lump sum paid on death is included in the final benefit payment. This unit works through a case study to outline how death benefits from superannuation are determined, distributed and taxed, and looks at strategies that can be employed to reduce tax. The unit specifically addresses the following subject learning outcome: • Evaluate strategies for superannuation death benefits. Unit learning outcomes On completing this unit, you should be able to: • establish how death benefits will be paid out in specific situations • explain the taxation implications of superannuation death benefits • discuss the issues relating to superannuation death benefit nominations • discuss the strategies relating to superannuation death benefits. © Kaplan Education 7.1 7.2 Specialist Knowledge: Superannuation (924) Further resources • AMP 2007, ‘Flexible lifetime® — super: super for life: product disclosure statement — part 1’ [online], issue 5, 1 July. Available from: <http://www.amp.com.au> by selecting ‘Superannuation’, then ‘Products’, then ‘Flexible Lifetime® — Super’ and then ‘Download brochure’ [cited 27 May 2008]. • APRA 2006, ‘Superannuation circular no. 1.C.2: payments standards for regulated superannuation funds’ [online], September. Available from: <http://www.apra.gov.au> by entering ‘superannuation circular’ in the search box [cited 27 May 2008]. • ATO 2007, ‘Chapter 4: Taxation of superannuation death benefits to nondependants of defence personnel and police killed in the line of duty’ [online], Explanatory memorandum. Available from: <http://law.ato.gov.au> by clicking on ‘Browse database’ on the left-hand menu. Select ‘Extrinsic Materials’ then ‘Explanatory Memorandum and SRS’ then ‘2007’ then ‘Tax Laws Amendment (2007 Measures No. 3) Act 2007’ and then ‘Explanatory Memorandum — REPS’ [cited 27 May 2008]. • Kelly, P 2007, ‘Superannuation death benefits — paid to a non-dependant’ [online], Timely Tips 10 October, Bundall, Queensland: Professional Investment Services Group of Australia. Available from: <http://www.profinvest.com.au> by selecting ‘Newsletters’, then ‘Timely Tips’. Select ‘2007 Archives’, then ‘TimelyTips 2007 10 October — Superannuation death benefits.doc’ [cited 27 May 2008]. 924.SM1.9 Unit 7: Death benefits 1 Payment of superannuation death benefits The payment of superannuation death benefits is a complex process. This unit uses a case study for a detailed examination of the intricate considerations involved. Case study: Anna’s superannuation Anna dies in a car accident at age 50. She is in a de facto relationship with John, age 40, at the time of her death. She has three children from her marriage to Peter: Sam (age 30), a self-employed plumber; Alexander (27), a serving army officer based in Afghanistan and Kate (25), a banker. John also has two children from his marriage: Mark (15) and Jack (13). John and Anna also have one child, Emily (10), who has Down syndrome. Anna’s family relationships are set out in Figure 1 below. Anna had made out a will 20 years earlier, before her divorce, leaving all her assets to her ex husband, Peter. However, in New South Wales, wills are nullified by divorce. Figure 1 Family relationships for Anna, deceased Peter (51, ex-husband) Anna (50, deceased) John (40, de facto) Sam (30, ex-nuptial) Mark (15) Alexander (27) Kate (25) Emily (10) Jack (13) The case study will be used to answer the following questions throughout this unit: • Who in Anna’s family should get the superannuation benefit? (section 2) • What happens if the benefit is paid into the estate? (section 2) • What is a binding nomination? (section 2) • What role does the Superannuation Complaints Tribunal play? (section 2) • Does superannuation form part of Anna’s estate? (section 3) • What are the tax implications for Anna’s family? (section 4). Unfortunately, superannuation death benefits are not always straightforward, especially in situations similar to the case study where there are children from an earlier marriage. Unless Anna had a valid and current binding death benefit nomination, the trustee will decide who receives the death benefit. © Kaplan Education 7.3 7.4 Specialist Knowledge: Superannuation (924) 2 Determining the recipient of death benefits The payment of superannuation death benefits is covered by Part 6 of the Superannuation Industry Supervision (SIS) Regulations and APRA circular no. 1.C.2. When a fund member dies, the superannuation trustee must pay the designated money to dependants or to the legal personal representative, that is, the estate. In general terms, superannuation does not form part of the deceased’s estate. It is up to the superannuation trustee — or the member, if there is a valid binding nomination — to determine who should receive the benefit. However, in many cases the trustee may pay the benefit to the estate and it is then distributed according to the will. It is also possible for the member to instruct payment to be made to the estate through a binding nomination. Therefore, it is always important for clients to have instructions in their will on dealing with superannuation in case it is paid into the estate. The trustee may only pay the benefit to a non-dependant if, after reasonable efforts, they are unable to find a dependant or legal personal representative. For example, if a young man age 24 dies with no spouse, no children and no will, the trustee can pay the benefit to a non-dependant such as his parents or siblings. Further resources APRA 2006, ‘Superannuation circular no. 1.C.2: payments standards for regulated superannuation funds’ [online], September. Available from: <http://www.apra.gov.au> by entering ‘superannuation circular’ in the search box [cited 27 May 2008]. This APRA circular gives details of all the conditions of release from regulated superannuation funds and includes details of to whom death benefits can be paid in paragraphs 11–19. 2.1 Dependants under the SIS Act A dependant is defined in the SIS Act as: • the member’s spouse (legal or de facto) • children of any age (includes an adopted child, a stepchild or an ex-nuptial child) • a person who is financially dependent upon the member at the time of death, irrespective of family relationship • a person who was in an interdependency relationship with the member. For the purposes of the definition above, a spouse does not include a same-sex partner or an ex-spouse. A same-sex partner is included as a dependant under the interdependency relationship category. An ex-spouse is only a dependant if they can prove financial dependence. Changes proposed in the May 2008 budget, if they become law, will allow a same-sex partner to receive benefits as a spouse rather than as a person in an interdependency relationship. According to the Parliamentary Senate web site: ‘On 18 June 2008, the Senate referred the Same-Sex Relationship (Equal Treatment in Commonwealth Laws-Superannuation) Bill 2008 to the Legal and Constitutional Affairs Committee for inquiry and report by 14 October 2008 or after the consideration of any related bill or bills that may be introduced to give effect to the recommendations of HREOC’s report Same Sex: Same Entitlements, whichever is the sooner.’ 924.SM1.9 Unit 7: Death benefits Interdependency relationship According to s 10A of the SIS Act two people have an interdependency relationship if: • they have a close personal relationship • they live together • one or each of them provides the other with financial support • one or each of them provides the other with domestic support and personal care. Special rules also exist for those with a close personal relationship but who live apart due to injury or illness. Apply your knowledge 1: Anna’s dependants Identify dependants under the SIS Act in the case study on Anna’s superannuation in section 1. Further resources AMP 2007, ‘Flexible lifetime® — super: super for life: product disclosure statement — part 1, [online], issue 5, 1 July. Available from: <http://www.amp.com.au> by selecting ‘Superannuation’, then ‘Products’, then ‘Flexible Lifetime® — Super’ and then ‘Download brochure’ [cited 27 May 2008]. The ‘Nominating your beneficiaries’ section of the AMP PDS (p. 48) provides the company’s definitions of ‘dependants’ and ‘interdependency relationships’. Major superannuation providers — such as AMP — may have definitions that are more restrictive than imposed by the SIS regulations. 2.2 Benefits paid to an estate If the payment is to the estate, it is normally paid to the executor or administrator. This depends upon whether probate or letters of administration have been granted. Probate is granted when there is a valid will. An application is made to court and an executor is appointed by the courts. This person is then responsible for looking after the estate. Letters of administration are granted when the deceased dies intestate, that is, without a valid will. Similar to probate, a judge appoints an administrator after an application is made to court. The administrator’s role is like that of an executor. Apply your knowledge 2: Probate or letters of administration? Would probate or letters of administration be applied for in the case of Anna’s estate? © Kaplan Education 7.5 7.6 Specialist Knowledge: Superannuation (924) 2.3 Binding nominations and reversionary options Binding nominations bind the superannuation trustee to pay the death benefit to the person the member nominated, provided the nomination is valid. According to the SIS Act: • the nominated beneficiary must be either a dependant or the estate • the nomination must be clear • the nomination must be witnessed by two persons over the age of 18, not themselves nominated as beneficiaries. Example: Binding nominations If Anna chose a binding nomination, she could have bound the trustee to pay the benefit in accordance with her wishes. If, for example, she had chosen to have the money paid to John, the trustee would simply have made the benefit payment to John, provided he was still her spouse when she died. Spouses are considered dependants under the SIS Act. The trustee must disclose the nominated beneficiary on the annual statement, and state that it may be amended, reconfirmed or revoked. Most nominations cease to have effect after three years unless updated. This must also be reported in the annual statement. (A few funds may offer non-lapsing binding nominations, which remain current indefinitely.) Apply your knowledge 3: Anna’s binding nomination If Anna had nominated Peter under a binding nomination, would the trustee have had to pay the benefit to Peter? Why/why not? 2.4 Role of the Superannuation Complaints Tribunal Where a payment has been made to an SIS dependant under trustee discretion, dependants who are dissatisfied with the decision can lodge a complaint with the Superannuation Complaints Tribunal (SCT) (but not for a self-managed superannuation fund). 924.SM1.9 Unit 7: Death benefits 3 Death benefits from income streams Often, superannuation benefits are being paid to members as an income stream prior to their death. There are three options for what will happen to the income from a pension or annuity on the death of the original pensioner/annuitant. The pensioner/annuitant can: • nominate an automatic reversionary pensioner/annuitant (must be nominated at commencement of the income stream) • nominate a binding beneficiary • make a non-binding nomination or no nomination. The options, discussed below, will differ depending on the product. In the case study, Anna was 50 when she died and thus her superannuation would have been in the accumulation phase, that is, prior to receiving payment. As such, this section is not relevant to the case study, but the comparison highlights the difference between income streams and the accumulation stage. 3.1 Automatic reversionary beneficiary Nominating an automatic reversionary beneficiary is effectively a binding nomination for a pension or annuity that has already commenced. A member can only nominate a death benefits dependant, as defined by taxation law. The income stream product might restrict who can be nominated even further (e.g. only the spouse). Where an automatic reversionary beneficiary is nominated, payments made from a pension/annuity will continue to that beneficiary. If the benefit cannot be paid to the reversionary beneficiary (e.g. if they are deceased or they are not a dependant at the time of death), a lump sum death benefit will generally be paid to the estate or to another beneficiary as determined by the trustee. 3.2 Nominated binding beneficiary A binding nomination, in both accumulation or pension phase, compels the trustee to pay the nominee(s) provided the nomination is valid at the time of death. If it is not valid, trustee discretion applies as explained below. If a death benefits dependant has been nominated, the trustee may agree to continue income payments to the nominated beneficiary instead of paying a lump sum, subject to any product restrictions. ATO draft determination SMSFD 2008/D1 Self Managed Superannuation Funds advises that specific super law requirements regarding binding death benefit nominations do not apply to SMSFs: ‘The governing rules of an SMSF can allow members to make binding death benefit nominations that are binding on the trustee, even if the nominations do not meet specific super laws.’ © Kaplan Education 7.7 7.8 Specialist Knowledge: Superannuation (924) 3.3 Split of tax-free and taxable components If the original pension commenced before 1 July 2007 and the member was under age 60 at the time of death, the split between tax-free and taxable components is calculated at the point of death. This split then applies to all future income payments and lump sums paid to the beneficiary. If the pension commenced on or after 1 July 2007, the split that applied to the member (i.e. the split that was calculated at commencement) continues to apply to future income payments and lump sums paid to the beneficiary. 3.4 Minimum income payment The minimum income payment that applied for the member will continue for the rest of the financial year. It is recalculated on 1 July based on the beneficiary’s age. 3.5 Taxation of income stream converted to a lump sum If the nominated beneficiary commutes the income stream to a lump sum it is considered a death benefit lump sum and is taxed according to the death benefit tax status of the recipient of the lump sum. 3.6 Non-binding nomination or no nomination Where a beneficiary is nominated but it is not a reversionary or binding nomination, the trustee has discretion to determine whether the benefit will be paid to the nominated person or to another person or to the estate. The trustee also has sole discretion on whether to pay the death benefit as a lump sum or to continue the pension to a dependant. The issues that concern determining the component split are the same as for a binding nomination. Apply your knowledge 4: Anna’s superannuation death benefits Given that Anna’s superannuation was in the accumulation stage, what are the options available to the trustee for distributing the death benefits? 924.SM1.9 Unit 7: Death benefits 4 Taxation of death benefits Death benefits are potentially subject to taxation. How they are taxed and how much they are taxed depends on whether the beneficiary is a tax dependant or not, whether the superannuation moneys are taxable or tax-free, and whether the payment is as a lump sum or an income stream. Because of the varying treatments, there may be opportunities for financial advisers to provide advice to their clients. 4.1 Benefits paid as a lump sum The tax treatment of death benefit lump sums disadvantages non-dependants, such as adult children. Whereas dependants can receive a lump sum tax-free, non-dependants, such as adult children, will pay between 16.5% and 31.5% tax, as Table 1 shows. This is despite the fact that the beneficiary, if over age 60, could have withdrawn their benefits tax-free from a taxed fund. Table 1 Summary of tax treatment of lump sum death benefits Paid as Payment to Lump sum Death benefits dependant (tax law) Estate 1 Tax treatment Tax-free Taxed in accordance with the distribution of the estate (e.g. if to dependant then tax-free). ATO has some discretion. 2 Non-dependant No insurance in fund Tax-free component — nil tax Taxable component — 16.5% With insurance in fund Tax-free component — nil tax Taxable component (taxed element) — 16.5% Taxable component (untaxed element) — 31.5% 1 2 If payment is made to the estate, superannuation payment forms are provided to the executor/administrator but no lump sum tax is deducted. The executor/administrator must determine whether they are distributing the death benefit to a dependant or to a non-dependant and deduct the appropriate tax. There is an exception for service personnel — see below. Lump sums cannot be rolled over to superannuation or used to start another income stream. Definition of ‘dependant’ The definition of ‘a death benefits dependant’ under the Income Tax Assessment Act 1997 (Cth) (ITAA 97) is almost the same as the definition of ‘dependant’ under the SIS Act with two key differences: • ex-spouses are treated as dependants (contrary to the SIS definition) • a child must be under age 18 to be considered a dependant (compared to a child of any age under the SIS Act). In the case study, to be dependant under ITAA 97, the children over 18 would need to prove they are financially dependant on Anna. Evidence would normally be living under the same roof as Anna and receiving food and personal care from her. Other persons who are financially dependent on, or in an interdependency relationship with, the deceased will also be classified as financial dependants under ITAA 97. © Kaplan Education 7.9 7.10 Specialist Knowledge: Superannuation (924) Payments to dependants (accumulation phase) Assuming that the superannuation benefits are paid in the accumulation phase — meaning the deceased had not converted their lump sum into a pension — any payment to a death benefits dependant as defined by tax law is tax-free. Any person who was a tax dependant of Anna’s will receive superannuation death benefits tax-free for both the tax-free and taxable components. Payments to non-dependants Death benefit payments to non-dependants are taxed as follows: • tax-free component — nil • taxable component – taxed element — 16.5% – untaxed element — 31.5%. The split between the taxable and tax-free components is based on the percentage of each component in the total upon death. The untaxed element is usually an insurance payout from the fund. The untaxed element is basically the amount of the total benefit related to the period from the date of death up to the normal retirement age. With one exception (see below), tax must be deducted by the trustee from any taxable component unless paid to the estate. Exception for service personnel from 1 January 1999 There is an exception to the tax treatment of lump sums for non-dependants. From 1 July 2007, non-dependants of Australian Defence Force personnel, Australian Federal Police (including Australia Protective Service Officers), and state and territory police killed in the line of duty receive lump sum superannuation death benefits tax-free. The exception applies retrospectively, taking effect from 1 January 1999. Eligible non-dependants who received a lump sum superannuation death benefit payment between 1 January 1999 and 30 June 2007 will receive an ex gratia payment equal to the tax already paid on the superannuation death benefit from the Australian Taxation Office (ATO). Further resources ATO 2007, ‘Chapter 4: Taxation of superannuation death benefits to non-dependants of defence personnel and police killed in the line of duty’ [online], Explanatory memorandum. Available from: <http://law.ato.gov.au> by clicking on ‘Browse database’ on the left-hand menu. Select ‘Extrinsic Materials’ then ‘Explanatory Memorandum and SRS’ then ‘2007’ then ‘Tax Laws Amendment (2007 Measures No. 3) Act 2007’ and then ‘Explanatory Memorandum — REPS’. 924.SM1.9 Unit 7: Death benefits Apply your knowledge 5: Anna’s tax dependants What members of Anna’s family (see Figure 1 in section 1) would be considered tax ‘dependants’ under ITAA 97? Payments to the estate If the death benefit is paid to the estate, no tax is deducted by the superannuation fund. The executor/administrator of the estate must account for the tax correctly when distributing the estate’s assets, according to whether the payment is made to a death benefits dependant or not. If the death benefit is paid to the estate, the ATO assumes the estate beneficiaries will be paid in the same proportion as the total payment made out of the estate unless otherwise specified in the will. For example, if a death benefit of $100,000 is paid into an estate and the total assets ($500,000) are distributed 50% to adult children and 50% to the spouse, the ATO will tax with the assumption that $50,000 of the benefit is paid to adult children. This is because the benefit is taxed as the ATO considers appropriate, having regard to the extent to which dependants of the deceased taxpayer may reasonably be expected to benefit from the estate. As the ATO has some discretion, there is latitude to argue a different split. 4.2 Death benefits paid as an income stream Death benefits paid as an income stream (from a taxed fund) to a death benefits dependant are taxed according to the situation and the age of the member and/or beneficiary. As Table 2 below shows, these benefits are usually tax-free. The exception is when both the deceased and the beneficiary are under age 60. In this case, the taxable component will be taxed at the marginal tax rate but with up to a 15% offset. Table 2 Summary of tax payable on death benefits paid as an income stream Paid as Continuing pension Age of deceased member/beneficiary Tax payable Both over age 60 Tax-free Deceased member over age 60 Beneficiary under age 60 Tax-free Deceased member under age 60 Beneficiary over age 60 Tax-free Both under age 60 Tax-free component — tax-free Taxable component — taxable at MTR but with up to a 15% offset Prescribed period If a reversionary beneficiary commutes the pension to a lump sum, the taxation treatment will depend on whether the commutation is within or outside the prescribed period. The prescribed period is six months after the death or three months after probate. If the commutation is within the prescribed period, it is considered as a death benefit lump sum and no tax is payable. If the commutation is outside the prescribed period, it is taxed as a normal superannuation lump sum in the recipient’s hands. © Kaplan Education 7.11 7.12 4.3 Specialist Knowledge: Superannuation (924) Child allocated pensions A pension can be paid to a child under age 18 or a child age 18–25 who is financially dependant upon the member. However, the income stream must be commuted to a lump sum by the child’s 25th birthday. The lump sum is paid tax-free and cannot be rolled over. The income stream can only continue beyond the child’s 25th birthday if the child meets the disability definition in s 8(1) of the Disability Services Act 1986 (Cth). Tax advantages of child allocated pensions The benefit of a child allocated pension is to minimise tax on income from the death benefit. Paying the death benefit in full to the spouse would potentially push up their marginal tax rate. Directing funds into a child allocated pension, however, takes advantage of the child’s tax-free threshold and tax offsets, reducing the overall tax substantially. Taxing child allocated pensions A pension paid to a child under age 18 from a death benefit is taxed at normal adult marginal tax rates. Tax offsets, such as the 15% pension tax offset (PTO) and the low income tax offset (LITO), will also apply. This allows a child to receive taxable income of up to $38,000 p.a. (in 2007/08) with no tax applied, although the Medicare levy may still apply. Taxable income $38,000 Tax at MTR $6,000 Less: 15% PTO $5,700 Less: LITO Tax liability $430 nil ($6000 – [$5700 + $430]) Apply your knowledge 6: Tax on Anna’s death benefits Anna’s benefits are paid directly to the six children in six equal proportions. All the children are found to be dependants under to SIS Act, including Mark and Jack, who have proven financial dependency. How will the benefits be taxed? Assume that Sam, Alexander and Kate were not financially dependent upon Anna at the time of her death, and that no life insurance is involved. 924.SM1.9 Unit 7: Death benefits 4.4 Strategies to minimise tax from superannuation death benefits The taxation of superannuation death benefits for non-dependants creates an opportunity for estate planning to reduce taxation. There are four strategies to minimise tax from superannuation death benefits: • keep life insurance outside of superannuation • withdraw funds out of superannuation • nominate only dependants as superannuation beneficiaries • withdraw superannuation benefits and recontribute them. Life insurance outside superannuation Life insurance inside superannuation is taxed at 31.5% when it is paid as a death benefit to non-dependants such as adult children. Life insurance outside superannuation paid to adult children is tax-free. However, life insurance outside of superannuation has some increased costs because: • life insurance premiums within superannuation are tax deductible • life insurance within superannuation may be at a less expensive group rate. Withdrawing funds from superannuation If a superannuation beneficiary over 60 has adult children who will pay tax on a death benefit, the simplest way to avoid that tax is to withdraw funds from superannuation before death. A person over 60 can withdraw lump sums from a taxed fund without paying tax. The disadvantages here are that the beneficiary loses the tax-free status of: • earnings within the fund • income or lump sums from the fund. This strategy may be only viable when the superannuation beneficiary is terminally ill and knows that they will not be holding the moneys outside of superannuation long term. Nominating only dependants as superannuation beneficiaries Tax on superannuation death benefits can be minimised by nominating only tax dependants, such as a spouse or child under 18, as superannuation beneficiaries. In the benefactor’s will, they might choose to include an equalisation clause and indicate that non-superannuation benefits go disproportionately to adult children to balance the superannuation death benefits left disproportionately to a spouse and/or minor child. © Kaplan Education 7.13 7.14 Specialist Knowledge: Superannuation (924) Recontribution strategy If a lump sum death benefit is paid from the accumulation phase of superannuation, the split between tax-free and taxable benefits is determined based on the proportion that each component forms of the total superannuation interest held with the product provider. If the benefit is paid from an income stream, it is split according to the percentage that was calculated at the start of the pension, or at the trigger point if started before 1 July 2007. Therefore, strategies to increase the tax-free component can reduce the tax payable by a non-dependant on receipt of superannuation death benefits from an income stream. One such strategy is to cash out superannuation and recontribute before commencing an income stream. This is illustrated in the example below. Example: Recontribution before an income stream Alice is age 63 and has $450,000 in her superannuation fund. All the money in this fund is a taxable component. If Alice was to roll the money over to start an allocated pension, it will be 100% taxable. Alice can receive all income payments and lump sums tax-free. Upon her death any amount paid to a death benefits dependant is paid tax-free, but amounts paid to non-dependants (e.g. adult children) will be taxed at 16.5%. If Alice dies with $450,000 in an allocated pension, her adult children would pay tax of $74,250. Instead, Alice could cash out the full balance tax-free before starting the income stream. She then makes a recontribution back to superannuation as a non-concessional contribution (she is under age 65 and uses the three-year averaging to make a non-concessional contribution of $450,000 in the one year). This amount is then rolled over to an allocated pension, now an entirely tax-free component. Upon her death, there will be no tax payable by a non-dependant. Issues to consider with recontribution When recommending this strategy, consideration should be given to the: • tax payable on the cash-out (which may depend on age and whether the fund is taxed) • ability to make a contribution back to super • non-concessional limits on contribution • whether the death benefit could have been subject to an anti-detriment payment and refund of the contributions tax • preservation status of the contribution. Apply your knowledge 7: Advice before age 60 What would you recommend Anna have done with her superannuation and her will until she was 60? 924.SM1.9 Unit 7: Death benefits Further resources Kelly, P 2007, ‘Superannuation death benefits — paid to a non-dependant’ [online], Timely Tips 10 October, Bundall, Queensland: Professional Investment Services Group of Australia. Available from: <http://www.profinvest.com.au> by selecting ‘Newsletters’, then ‘Timely Tips’. Select ‘2007 Archives’, then ‘TimelyTips 2007 10 October — Superannuation death benefits.doc’. This article looks at superannuation death benefits post-1 July 2007. In an extended case study, it accesses the options for a surviving spouse passing superannuation to adult children in a tax-effective manner. Apply your knowledge 8: Advice after age 60 If Anna had died when she was 62 and she had already established an income stream for her superannuation, what could she have done to plan the distribution of her estate? Review your progress 1 1. How will the following superannuation benefits be taxed if the member dies? (a) An accumulation superannuation fund pays a lump sum to a death benefits dependant (under tax law). (b) Commutation of an income stream is paid to a non-dependant. (c) A reversionary beneficiary who was a spouse of the original member commutes the pension 12 months after the death. © Kaplan Education 7.15 7.16 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 Unit 7: Death benefits Suggested answers Apply your knowledge 1: Anna’s dependants Under the SIS Act definition of dependants: • John is a dependant, as he was Anna’s de facto partner. • Anna’s children — Sam, Alexander, Kate and Emily — will be dependants under the definition of a child. • However, as Anna and John were not married, Mark and Jack would not be stepchildren to Anna and are unlikely to have been formally adopted. Therefore, Mark and Jack may not be immediately classified as Anna’s children. They can only be dependants if they can prove financial dependency. • The ex-husband, Peter, would not be a dependant unless he can show that he was financially dependent upon the deceased. This is unlikely to be the case. Apply your knowledge 2: Probate or letters of administration? Anna died with a will. However, that will was made many years ago and, more importantly, it was made prior to her divorce from Peter. In New South Wales, divorce nullifies a will, so Anna died without a valid will. Therefore, she died intestate and letters of administration would have to be applied for. The estate would be divided according to statutory rules. Apply your knowledge 3: Anna’s binding nomination The trustee must act in accordance with the SIS Act requirements. Therefore, the benefit has to be paid to a dependant or the legal personal representative unless neither can be located. As Peter is not a dependant under the SIS Act requirements, the nomination would become invalid and the benefit would normally be paid in accordance with the trust deed. This might be at the trustee’s discretion. Apply your knowledge 4: Anna’s superannuation death benefits The trustee has the sole discretion on whether to pay the death benefit as a lump sum or to continue the pension to a dependant. The trustees have the option of paying the benefit to any of the adults or children, except for Peter, as he is not a dependant under the SIS Act. The trustee may decide instead to pay the benefit to the legal personal representative, that is, the estate. © Kaplan Education 7.17 7.18 Specialist Knowledge: Superannuation (924) Apply your knowledge 5: Anna’s tax dependants Under the ITAA 97 definition of dependants: • John is a dependant as a de facto partner. • Peter is a dependant as an ex-spouse. (However, Peter will not receive payment from the superannuation fund unless he can prove financial dependence.). • Emily, Mark and Jack are dependants as children under 18. • Sam, Alexander and Kate — as children over 18 — will not qualify as dependants unless they can prove financial dependency. For example, Kate might be considered a dependant if she was studying at university and living at home. Apply your knowledge 6: Tax on Anna’s death benefits Fifty per cent of the benefit will be paid to death benefit dependants (tax-free) and 50% to non-dependants. The non-dependants will pay tax at 16.5% on the taxable component (taxed element) and 31.5% on any taxable component (untaxed element). Apply your knowledge 7: Advice before age 60 Anna could have considered: • putting in a valid binding nomination to her superannuation fund to leave the superannuation moneys to her de facto husband and/or her dependant children • putting in a valid binding nomination to her superannuation fund to leave the superannuation moneys to her estate • having a valid will • having an equalisation clause in her will that compensates her adult children for not receiving the proceeds from her superannuation, which went to her de facto husband and her dependant children, thus minimising tax overall. Apply your knowledge 8: Advice after age 60 Anna could have considered: • nominating her de facto husband and/or her children as reversionary beneficiaries of her income stream • commuting the income stream by withdrawing and recontributing the superannuation moneys, and then recommencing an income stream. This will enable her to nominate adult children and minimise taxation • having a valid will • having an equalisation clause in her will that compensates her adult children for not receiving the proceeds from her superannuation, which went to her de facto husband and her dependant children, thus minimising tax overall. 924.SM1.9 Unit 7: Death benefits Review your progress 1 1. (a) The full amount is tax-free. (b) When paid to a non-dependant, the commutation value is taxed as a death benefit superannuation lump sum. There is no tax payable on the tax-free component, but the taxable component is taxed at 16.5%. (c) If a reversionary beneficiary commutes the pension after 12 months and this is outside the prescribed period (i.e. later than six months after the death or three months after probate), it is taxed as a normal superannuation lump sum in the recipient’s hands. If, however, it is still within the prescribed period, that is, within three months of probate, it is considered as a death benefit lump sum and no tax is payable. © Kaplan Education 7.19 7.20 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 8 Divorce, bankruptcy and complaints Overview 8.1 Unit learning outcomes ....................................................................8.1 Further resources ............................................................................8.2 1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 1.11 1.12 1.13 1.14 1.15 Superannuation, divorce and split benefits 8.3 Superannuation treated as property from 28 December 2002 ....8.3 What superannuation products can be split?.............................8.3 What superannuation products cannot be split? ........................8.4 Second and subsequent marriages ..........................................8.5 Splitting and flagging agreements ............................................8.5 Making and acting on valid agreements ....................................8.6 Operative time........................................................................8.7 Responding to eligible requests for information .........................8.7 Methods for splitting superannuation .......................................8.8 Preservation...........................................................................8.9 Tax........................................................................................8.9 Estate planning ....................................................................8.11 Steps to splitting on divorce ..................................................8.12 Impact on social security.......................................................8.15 Self-managed superannuation funds and marriage breakdown ..8.15 2 2.1 2.2 2.3 2.4 2.5 Bankruptcy protection 8.16 Bankruptcy protection prior to 2007 .......................................8.16 Bankruptcy protection from 2007...........................................8.16 Amounts recoverable by bankruptcy trustee ............................8.16 Determining the bankrupt’s main purpose ..............................8.17 Implications for superannuation fund trustee ..........................8.17 3 3.1 3.2 Superannuation Complaints Tribunal (SCT) 8.18 Operations of the SCT...........................................................8.18 Complaints resolution process...............................................8.20 Suggested answers 8.21 Unit 8: Divorce, bankruptcy and complaints Overview Superannuation is often the biggest asset for clients, possibly with the exception of the family home. However, a client’s superannuation balance is not protected from the impact of major life events such as divorce or bankruptcy. When a married couple’s marriage breaks down they can now include superannuation as a divisible asset. It can be split just like any other asset. This unit discussed the different legal methods for splitting benefits as well as the administration process. The unit also looks at the implications for superannuation benefits of bankruptcy. Protection may only be afforded if the member can show that contributions were genuine retirement savings and not made to hide assets from creditors. This unit also describes the role of the Superannuation Complaints Tribunal and the procedures a member should follow if they wish to make a complaint about their superannuation fund. This unit specifically addresses the following subject learning outcome: • Evaluate strategies for superannuation in respect of divorce and bankruptcy. Unit learning outcomes On completing this unit, you should be able to: • discuss the options for splitting superannuation in the case of marriage breakdown • identify which benefits can be split and those which cannot • outline the taxation implications and components of a split benefit • outline the steps involved to help a client effect a split • outline the circumstances whereby superannuation can be protected from bankruptcy • discuss the role of the Superannuation Complaints Tribunal and the steps required to lodge a complaint. © Kaplan Education 8.1 8.2 Specialist Knowledge: Superannuation (924) Further resources • Barr, S 2005, ‘Super and divorce’ [online] 17 November. Available from: <http://www.superreview.com.au> by entering ‘barr super and divorce’ in the search box, and selecting ‘Super and divorce’ from the ‘News’ results [cited 20 June 2008]. • Bourke, S 2002, ‘Super splitting on marriage breakdown’ [online] 1 December. Available from: <http://www.mensrights.com.au> by selecting ‘Family Law’ and then ‘News and Articles — Family Law.’ Scroll down the page to find a link to the article [cited 20 June 2008]. • Family Law Courts, ‘Superannuation’ [online]. Available from: <http://www.familylawcourts.gov.au> by selecting ‘Property and Money Matters’ and then ‘Superannuation’ [cited 20 June 2008]. • First State Super 2007, ‘Marriage and divorce’ [online] 30 June. Available from: <http://www.firststatesuper.com.au> by selecting ‘Life events & super’ and then ‘Marriage and divorce’ [cited 20 June 2008]. • First State Super 2007, ‘Superannuation and Family Law’ [online] 29 June. Available from: < http://www.firststatesuper.com.au> by selecting ‘Life events & super’, then ‘Marriage and divorce’, and then downloading the ‘Superannuation and Family Law’ fact sheet PDF [cited 20 June 2008]. • Insolvency and Trust Service Australia 2008, ‘Superannuation and bankruptcy’ [online] 19 May. Available from: <http://www.itsa.gov.au> by selecting ‘Law Reform’ then ‘Amendments’ [cited 20 June 2008]. • Nielson, L 2007, ‘Bankruptcy Legislation Amendment (Superannuation Contributions) Bill 2006’, Bills Digest [online] no. 91, 13 February, Parliamentary Library, Department of Parliamentary Services. Available from: <http://www.aph.gov.au> by selecting ‘Publications’ then ‘Library publications’, then ‘Bills digests’ and finally ‘2006–07’ [cited 20 June 2008]. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints 1 Superannuation, divorce and split benefits Until 28 December 2002 the Family Court had no jurisdiction over superannuation. Consequently, on divorce, superannuation assets tended to be left in the name of the member. In a traditional situation with a working husband and non-working spouse, this often meant the husband kept his superannuation and the wife kept the house and other assets. 1.1 Superannuation treated as property from 28 December 2002 Amendments to the Family Law Act 1975 (Cth) provide that from 28 December 2002 superannuation is treated as property in divorce property settlement. These changes allow superannuation to be split on marriage breakdown. Splitting rules apply to property settlements finalised from 28 December 2002, but they only apply to the breakdown of legal marriages. The Act will not apply if the couple has made a valid Binding Financial (Pre-nuptial) Agreement. Splitting rules do not apply to de facto or same sex couples. Rules relating to de facto spouses and same sex couples require state governments to pass legislation. The situation in each state should be checked in such cases. 1.2 What superannuation products can be split? The superannuation splitting rules apply to benefits that are held inside: • self-managed superannuation funds • corporate superannuation funds • industry superannuation funds • non-complying superannuation funds • public sector superannuation schemes, as well as regulated public offer superannuation funds • approved deposit funds (ADFs) • retirement savings accounts (RSAs) • accounts within the meaning of the Small Superannuation Accounts Act 1995 • income streams. The rules do not apply to overseas superannuation funds, over which the Family Law Act has no jurisdiction. © Kaplan Education 8.3 8.4 Specialist Knowledge: Superannuation (924) Commonwealth public sector schemes Under the Superannuation Legislation Amendment (Family Law and Other matters) Act 2004, from 19 May 2004 the Family Law Act will be applied to marriage breakdowns of members in: • the Defence Forces Retirement and Death Benefit Scheme • the Military Forces Scheme • the Commonwealth Superannuation Scheme • the Public Service Scheme • the Parliamentary Contribution Scheme. The above funds are now subject to the same splitting rules as other superannuation funds. 1.3 What superannuation products cannot be split? The following superannuation products cannot be split: • payments released to the member spouse under compassionate grounds • payments released to the member spouse under severe financial hardship • salary continuance payments to the member spouse • payments from a total and permanent disability (TPD) insurance policy to the member spouse • superannuation interests less than $5000 • death benefit payments to or for the benefit of a child under age 18 • life insurance office products, such as annuity and deferred annuity contracts • death benefit payments to or for the benefit of a child over age 18 for education purposes or to provide for the child’s physical or mental disability. Any of the above payments made by the trustee do not have to be split with the non-member spouse on divorce. Apply your knowledge 1: Splitting products Peter and Mary have been married for 20 years. Peter has worked for the police force for 18 of those years. Recently Peter was exposed to a series of traumatic incidents that led to a mental breakdown and diagnosis of post-traumatic stress disorder. While he received medical care, he was unable to return to work and was relieved of his duties and paid out a TPD. Peter had been contributing an additional 3% to his superannuation fund and last year made a lump sum payment of $40,000, which he received from a death benefit payment following the death of his mother. If Peter and Mary divorced, what part of the superannuation could be split and what is protected? 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints 1.4 Second and subsequent marriages For people who marry and divorce more than once, there may be more than one payment split on the same superannuation interest. The legislation prevents a non-member spouse from being disadvantaged by later spouses taking an interest in the same fund. 1.5 Splitting and flagging agreements Couples can enter into a superannuation agreement to split or flag the benefits (see below). This agreement can be made at any time, including before or during their marriage, but most commonly it is made on the breakdown of the marriage. If the couple is unable to come to a mutual agreement at the point of the marriage breakdown, they can seek a court order to either split or flag the benefits. Splitting agreement A splitting agreement specifies how to divide the account balance either at the operative time (see section 1.7 below) or at a point in the future. Flagging agreement A flagging agreement prevents the superannuation trustee from paying benefits out of the flagged superannuation account from the operative time until the flag has been lifted. The flag does not specify how superannuation benefits are to be apportioned; it simply places a hold on the member spouse’s account. A flagging agreement may be used if the value of the superannuation benefit cannot be determined until a future event occurs, for example, retirement. A flagging agreement can be made on an accumulation account but is more common on defined benefit accounts. A flag can only be lifted when a court orders the flag to be lifted, or when the member and the spouse provide the trustee with a ‘flag-lifting agreement’ specifying how the flagged benefit is to be dealt with. A flag-lifting agreement may specify how the superannuation benefit is to be split, or it may simply lift the flag over the member spouse’s superannuation without specifying a split. © Kaplan Education 8.5 8.6 Specialist Knowledge: Superannuation (924) 1.6 Making and acting on valid agreements To be valid and binding, a superannuation agreement must: • be signed by each spouse • state that each spouse received independent legal advice on the agreement • include certification by the independent legal advisers confirming the advice was given • not have been terminated or set aside by a court • be provided to each spouse (one receives the original and the other a copy). Calculation method for the split The splitting agreement or court order must identify the superannuation interest and the calculation method for the split. There are three methods that may be used: • base amount — to determine the total fixed dollar amount each person is to receive from the superannuation benefit • percentage — to determine the proportion of the total superannuation interest or each benefit payment that the non-member spouse is to receive • specific calculation — to calculate a base amount (splitting agreements only). This method may be used when the member’s superannuation is not subject to a clean break. Evidence of marriage breakdown The trustee can only act on an agreement (i.e. split or flag an interest) if provided with evidence of marriage breakdown. The evidence required differs depending on whether the individuals have formally divorced or just separated. If the couple has formally divorced, a decree absolute will suffice as evidence of marriage breakdown. For separated couples, a separation declaration is satisfactory. Low rate cap and length of separation Even after a valid agreement and suitable evidence of marriage breakdown, the trustee may not be able to split the superannuation straight away. Two more factors determine whether the trustee is able to split the benefit: • whether the superannuation benefit is above or below the low rate cap ($145,000 for 2008/09 and indexed annually) • how long the couple has been separated. Table 1 below outlines the varying requirements needed before the trustee can split the superannuation benefit. Table 1 Requirements before trustee splits superannuation benefits Separated less than 12 months Separated 12 months or more Superannuation value < $145,000* Declaration: Married but separated Declaration: Married but separated Superannuation value > $145,000* Cannot split superannuation until separated for more than 12 months Declaration: Married but separated for more than 12 months and living apart and will not cohabitate * Low rate cap for the 2008/09 financial year (indexed annually in $5000 increments). 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints 1.7 Operative time Superannuation agreements and court orders, both splitting and flagging, only take effect from the operative time. The operative time under a splitting agreement is four business days after the trustee is served with both the agreement and the necessary evidence of marriage breakdown. The operative time for a court order is the date specified in the court order. Until the operative time commences, the trustee can deal as normal with the member spouse’s superannuation interest. Any withdrawals requested by the member spouse and honoured by the trustee before the operative time has commenced do not breach an agreement or order. Within 28 days of the operative time for the split, the trustee must provide confirmation to both parties that the superannuation is subject to a split in the manner specified in the agreement. The trustee does this by sending each of them a payment split notice. The non-member spouse must respond to the trustee within 28 days of receiving this information. If they do not, the trustee may start a new account for them or transfer their benefit to an eligible rollover fund. It must inform them which option it will take. 1.8 Responding to eligible requests for information To ensure both members of a couple can accurately identify any superannuation for splitting, the trustee must provide information about a member’s benefit to a non-member spouse making an appropriate request. The non-member spouse must declare that they require the information to negotiate a superannuation agreement with their spouse or otherwise in connection with Part VIIIB of the Family Law Act. They must use a Form 6 declaration. Trustee may charge a fee for information The Family Law Act allows a trustee to charge a fee for providing information about a member’s benefit. Some funds charge no fee; others charge between $70 and $110. Trustee cannot inform member about non-member spouse request If a trustee receives a valid request for information on a member’s benefit from a non-member spouse, or anyone other than the member, the trustee must not: • inform the member that the request has been received • provide the member with contact details for the non-member spouse. © Kaplan Education 8.7 8.8 Specialist Knowledge: Superannuation (924) Statement information If a valid request for information is received the fund trustee must provide a statement outlining: • the value of the superannuation or pension benefit at certain specified dates • any withdrawals made between those dates • details it holds on payment flags or splits in effect over the superannuation account and the amounts to which they apply • any fees charged for payment splits and flags (some fund charge up to $600; the fee is often shared jointly between the partners) • the member’s eligible service period and date of commencing membership in the plan • preservation and ETP components of the interest • vesting terms and scales • details regarding reversionary beneficiary entitlements if the benefit is in the pension phase. 1.9 Methods for splitting superannuation Once the splitting agreement is ready to be put into effect, superannuation can be split by means of either an interest split or a payment split. Interest split An interest split is where benefits are taken out of the member spouse’s account and created as a separate interest for the non-member spouse at the operative time. The non-member spouse can transfer the benefits to an account in his or her own name within the same fund (subject to trust deed restrictions) or roll the benefits over to another fund. There are also provisions for the trustee to establish an account in the fund on behalf of the non-member spouse or to transfer the interest to an eligible rollover fund if insufficient instructions are received within the specified time. Once the split is complete, the non-member spouse has no rights over the member spouse’s remaining benefit. An interest split is becoming the most popular approach (where possible) as it reduces the administration burden and makes the cleanest and simplest separation for the couple. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints Payment split If the trustee is unable to apply an interest split, the split is effectively deferred until payments can be withdrawn from the fund. Until a benefit payment is made, all superannuation benefits are retained in the member spouse’s account. It is then the trustee’s responsibility to ensure that any future benefit payments, whether superannuation lump sums or pension payments, are split in accordance with the superannuation agreement or court order. For example, if the member spouse reaches preservation age, retires and then cashes out unrestricted non-preserved benefits, the trustee must split the payment as appropriate with the non-member spouse. 1.10 Preservation Both payment splits and interest splits are divided over the three preservation categories — preserved, restricted non-preserved and unrestricted non-preserved — in the same way as the original member spouse’s benefit. The non-member spouse must meet their own condition of release to access any preserved benefits transferred from the member spouse’s account. If the non-member spouse has met a relevant condition of release, or if the transferred benefits are unrestricted non-preserved, they can withdraw superannuation lump sums as required. 1.11 Tax Benefits split to the non-member spouse are not assessed as lump sum withdrawals and have no tax implications for the member spouse. Once the benefit has been split, the non-member spouse owns the superannuation interest. Any tax liability on subsequent withdrawals from the split superannuation is levied on the non-member spouse. Splitting superannuation components It is important to consider the following three points for split superannuation components: • From 1 July 2007, superannuation benefits are divided in two components — tax-free and taxable. The ratio of these two components in split benefits remains the same as the ratio held by the member spouse. • Each member of the couple is entitled to their own low rate cap ($145,000 for 2008/09) according to normal lump sum tax rules. • The start date for the split benefits to the non-member spouse is the date of the split. © Kaplan Education 8.9 8.10 Specialist Knowledge: Superannuation (924) Example: Splitting superannuation Tom and Nicole are separated. Tom has $500,000 in superannuation. Nicole has entered into a superannuation agreement with Tom to receive 50%. Table 2 Tom and Nicole’s benefits before the split Tom Nicole Total $500,000 $0 Tax-free component $360,000 $0 Taxable component $140,000 $0 Preserved $150,000 $0 Restricted non-preserved $150,000 $0 Unrestricted non-preserved $200,000 $0 Table 3 Tom and Nicole’s benefits after the split Tom Nicole Total $250,000 $250,000 Tax-free component $180,000 $180,000 Taxable component $70,000 $70,000 Preserved $75,000 $75,000 Restricted non-preserved $75,000 $75,000 $100,000 $100,000 Unrestricted non-preserved Note: Since it is a 50% split, all components and preservation are apportioned equally. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints 1.12 Estate planning Once a superannuation agreement or court order becomes operative, in most cases it will override any binding beneficiary nominations on a member spouse’s superannuation account. If a member dies while their superannuation interest is subject to a payment split, the outcome will depend on the status of the death beneficiary. Death benefit dependant takes precedence over superannuation split A death benefit paid to or for the benefit of a child under age 18 is not a splittable payment. The same applies to death benefit payments for the educational expenses or disabilities needs of a child age over 18. A binding nomination for such a child would take precedence over any superannuation agreements or court orders when the member spouse dies. Superannuation split takes precedence over non-dependant A death benefit for any non-dependant is a splittable payment, meaning that the splitting agreement or order takes precedence over the beneficiary nomination. Superannuation split after death of non-member spouse If the non-member spouse dies while the interest or payment split is operative, the split will continue to operate and the payment will be made to the non-member spouse’s legal personal representative (LPR). The LPR has all the rights the deceased spouse would have had on the payment split. Further resources Students are advised that some of these resources provide historical commentary on superannuation and divorce. Students should note the date of the articles and check against current legislation. • Family Law Courts, ‘Superannuation’ [online]. Available from: <http://www.familylawcourts.gov.au> by selecting ‘Property and Money Matters’ and then ‘Superannuation’ [cited 20 June 2008]. • Bourke, S 2002, ‘Super splitting on marriage breakdown’ [online] 1 December. Available from: <http://www.mensrights.com.au> by selecting ‘Family Law’ and then ‘News and Articles — Family Law.’ Scroll down the page to find a link to the article [cited 20 June 2008]. • First State Super 2007, ‘Marriage and divorce’ [online] 30 June. Available from: <http://www.firststatesuper.com.au> by selecting ‘Life events & super’ and then ‘Marriage and divorce’ [cited 20 June 2008]. • First State Super 2007, ‘Superannuation and Family Law’ [online] 29 June. Available from: < http://www.firststatesuper.com.au> by selecting ‘Life events & super’, then ‘Marriage and divorce’, and then downloading the ‘Superannuation and Family Law’ fact sheet PDF [cited 20 June 2008]. • Barr, S 2005, ‘Super and divorce’ [online] 17 November. Available from: <http://www.superreview.com.au> by entering ‘Barr super and divorce’ in the search box, and selecting ‘Super and divorce’ from the ‘News’ results [cited 20 June 2008]. © Kaplan Education 8.11 8.12 Specialist Knowledge: Superannuation (924) 1.13 Steps to splitting on divorce There are four steps to splitting superannuation benefits on divorce: Step 1 — Determine the value of the superannuation benefit to be split. Step 2 — Make a valid superannuation agreement or obtain a court order. Step 3 — Notify the trustees of the superannuation agreement. Step 4 — Notify the trustees how and where to split the benefits. The trustee then splits the benefit. These four steps are highlighted in the case study below. Case study: Jack and Joan Jack and Joan were married in January 1992 and have been separated for two years. Joan did not work during the marriage. She stayed at home to take care of the house and children. Jack has $300,000 in superannuation. Joan intends to enter into a superannuation agreement with Jack to receive some of his superannuation as part of their property settlement. Joan intends to make a clean break, and roll over her portion of the split benefits to another fund. Step 1 — Determine the value of superannuation benefit to be split This is an optional step in the splitting process. For Joan to enter into a superannuation agreement with Jack, she must have information on the value of his superannuation assets accumulated during their marriage. Joan can request details of the account balance at the date of separation from the trustee of Jack’s fund. Joan’s request must be accompanied by a Form 6 declaration. Once the trustee has received Joan’s Form 6 declaration, they can provide her with the following information: • the date Jack’s fund membership commenced • Jack’s current superannuation components: – tax-free component $150,000 – taxable component $150,000 • Jack’s current preservation components: – preserved $150,000 – restricted non-preserved $85,000 – unrestricted non-preserved $65,000 The trustee also advises that a fee of $100 is charged for splitting a superannuation interest or benefit payment. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints Step 2 — Make a valid superannuation agreement Joan calculates that she is entitled to $90,000 of Jack’s superannuation benefit. This is half of the superannuation accrued during their marriage. Jack agrees and they each obtain independent legal advice about the appropriateness of the split. Jack and Joan’s superannuation agreement specifies that $90,000 is to be split to Joan, with the remainder retained by Jack. Jack and Joan’s agreement only becomes valid once it is set down in writing and signed by both Jack and Joan. Both parties must state they received legal advice and include certification from each of their legal advisers. If they were not able to agree to the split, they would need to obtain a court order to split assets. Step 3 — Notify the trustee of the superannuation agreement For the superannuation agreement to be effective, a copy must be provided to the trustee of Jack’s superannuation fund. The trustee must also receive the necessary evidence of marriage breakdown. In this case Jack and Joan have separated but not yet divorced, so they must provide a separation declaration. The value of Jack’s superannuation is more than $145,000 (low tax cap for 2008/09). Therefore, the declaration must state that they are married but separated. It must state that they have been living separately and apart for 12 months continuously and that there is no reasonable likelihood of cohabitation resuming. If they had been separated for less than 12 months, the trustee would be unable to act on the agreement. If Joan waits until they divorce, a copy of the decree absolute is adequate evidence to prove marriage breakdown. The payment split becomes operative four business days after the agreement and the evidence of marriage breakdown is provided to the trustee. If Jack and Joan had not been able to agree, they could have sought a court order. The order would have become operative at the date specified. Step 4 — Notify the trustee how and where to split the benefit Within 28 days of the operative time for the split, the trustee provides confirmation to Jack and Joan that Jack’s superannuation is subject to a split by sending each of them a payment split notice. The trustee also sends Joan a statement with the information she needs to decide what to do with her split benefit. This includes the fund’s contact details, the amount she is entitled to receive, whether she can join Jack’s fund, and her options for either starting a new account or transferring to another fund. If she meets a relevant condition of release, she may also choose to receive the benefit as a lump sum. Joan responds to the trustee within 28 days of receiving this information stating where she wants her benefits paid. © Kaplan Education 8.13 8.14 Specialist Knowledge: Superannuation (924) Joan notifies the trustee in writing within the 28-day period that she wishes to have the benefit transferred to her superannuation fund and provides the relevant details. Her notice is dated and includes her name, date of birth and address. Trustee acts on payment split The trustee acts on Joan’s request and splits Jack’s superannuation interest. Joan’s share is transferred to the fund of her choice. The details of Jack and Joan’s benefits before and after the split are as follows: Table 4 Jack and Joan’s benefits before the split Jack Joan Total $300,000 Tax-free component $150,000 (50%) $0 Taxable component $150,000 (50%) $0 Preserved $150,000 $0 Restricted non-preserved $85,000 $0 Unrestricted non-preserved $65,000 $0 Table 5 $0 Jack and Joan’s benefits after the split Jack Joan Total $210,000 Tax-free component $105,000 (50%) $45,000 (50%) Taxable component $105,000 (50%) $45,000 (50%) Preserved $90,000 $105,000 ($150,000 × $210,000/$300,000) $45,000 ($150,000 × $90,000/$300,000) Restricted non-preserved $59,500 ($85,000 × $210,000/$300,000) $25,500 ($85,000 × $90,000/$300,000) Unrestricted non-preserved $45,500 ($65,000 × $210,000/$300,000) $19,500 ($65,000 × $90,000/$300,000) The trustee transfers Joan’s benefit within 28 days and notifies her once it has been done, satisfying its splitting obligations. This results in Joan having her own superannuation account. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints 1.14 Impact on social security Assets test Generally, superannuation is not regarded as an asset for social security purposes if the owner is under age-pension age. Thus, if superannuation is split in the accumulation phase, it will have no effect on the assets test of a member or non-member spouse under age-pension age. If either the member spouse or the non-member spouse is over age-pension age, their superannuation is regarded as an asset for their social security assessment. Splitting benefits in the accumulation phase will reduce the assessable value for the member spouse and increase the assessable assets for the non-member spouse. The same applies to benefits split in the income phase. Income test Superannuation is not considered a financial investment for people under age-pension age. Thus, for these people, a benefit split will not affect the income test or social security entitlements. For anyone over age-pension age, however, superannuation is deemed a financial investment. For these people, a benefit split will reduce the member spouse’s assessable income and increase the non-member spouse’s assessable income. This may affect social security entitlements. If the member spouse’s assessable income is reduced, the deductible amount will need to be recalculated. Apply your knowledge 2: Superannuation accumulation phase and divorce Both the member spouse and non-member spouse are in the accumulation phase and under pension age when a superannuation split is made because of divorce. What effect, if any, does this have on each person’s eligibility for social security under the assets test? 1.15 Self-managed superannuation funds and marriage breakdown A couple who divorce may no longer wish to remain members of the same self-managed superannuation fund. In these cases, one or both partners may wish to rollover their benefits to another superannuation fund. Under CGT rollover relief provisions, in specie transfers of assets to a new fund will not trigger a CGT event. Reflect on this: Financial adviser responsibilities Having read the content of section 1, how do you feel about advising people who are going through a possible divorce? As a financial planner what skills do you need to demonstrate in these situations? What responsibilities do you have to each person? © Kaplan Education 8.15 8.16 2 Specialist Knowledge: Superannuation (924) Bankruptcy protection Superannuation used to be a fully protected asset in bankruptcy. Its protection, however, has reduced following changes to bankruptcy law in 2007. Superannuation benefits may now be available for distribution in bankruptcy. 2.1 Bankruptcy protection prior to 2007 Prior to 2007, legislation protected superannuation assets from creditors in the event of bankruptcy. The benefits were protected up to the pension reasonable benefit limit (RBL) ($1,356,291 for 2006/07). Some clawback provisions applied in the previous five years, that is, it may have been possible for creditors to gain access to contributions made in the previous five years. The capital up to the RBL remained protected if the bankrupt met a condition of release and converted superannuation benefits into an income stream, such as an allocated pension. However, the bankruptcy trustee could claim the pension payments if, when added to other claimable income payments, they exceeded 3.5 times the maximum basic age pension payment rate. Historical note: It was common for trust deeds to contain a clause to forfeit a member’s benefits on becoming bankrupt. Legislation enacted from 1 July 2004 make these clauses void. 2.2 Bankruptcy protection from 2007 In 2007 legislation changed to allow the courts to look at each contribution and determine how much is protected. As the pension RBL no longer exists in legislation, there is no longer a set protection limit. If people want superannuation protection in bankruptcy, they need to establish a pattern of regular contributions. 2.3 Amounts recoverable by bankruptcy trustee Changes to legislation in 2007 allow a bankruptcy trustee to recover the value of contributions made to superannuation on or after 28 July 2006 if the contributions were made to defeat creditors. The contributions can be recovered if: • the amount contributed would have formed part of the creditor’s property if it was not contributed to superannuation • the main purpose of the contribution was to prevent the money from being available to creditors or to delay the process of distribution. Contributions made to superannuation by a third party for the benefit of the bankrupt are also at risk if they were made under a scheme to which the bankrupt was a party. This does not apply to benefits payable on the bankrupt’s death. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints Benefits rolled over to another fund can be traced through and recovered. The courts can place a freeze on superannuation accounts pending the outcome of any action. If a member wishes to access any benefits subject to a freeze, they need to obtain permission from the official receiver. 2.4 Determining the bankrupt’s main purpose In determining the bankrupt’s main purpose, a court can consider the historical pattern of contributions and assess whether any contributions were out of character. This may indicate an intention to defeat creditors. Example: Contribution potentially recoverable Connor has contributed $20,000 into superannuation each year for the last 10 years. In the 2006/07 financial year he experiences financial difficulty and his business steadily declines. He decides to make a contribution of $100,000 in the 2006/07 financial year. Shortly after, Connor declares bankruptcy. At this time his superannuation account balance is $380,000. The courts will assess whether the bankruptcy trustee can recover any of this amount. There is a chance that only the $100,000 contribution made just before bankruptcy will be recoverable as the other contributions (and their earnings) were part of a regular savings plan. 2.5 Implications for superannuation fund trustee Amounts recovered from a person’s superannuation by the courts and paid to the bankruptcy trustee cannot impose any loss on the superannuation fund trustee. Therefore, creditors can only recover the net amount — after any fees, charges and taxes have been deducted from the benefit. Apply your knowledge 3: Bankruptcy and superannuation Why will rolling over funds from one superannuation account to another not protect superannuation assets from a creditor in the event of bankruptcy? Review your progress 1 Why does a person with a pattern of regular contributions to superannuation have a better chance of having their superannuation benefits protected in bankruptcy? © Kaplan Education 8.17 8.18 Specialist Knowledge: Superannuation (924) Further resources Students are advised that some of these resources provide historical commentary on superannuation and bankruptcy. Students should note the date of the articles and check against current legislation. • Insolvency and Trust Service Australia 2008, ‘Superannuation and bankruptcy’ [online] 19 May. Available from: <http://www.itsa.gov.au> by selecting ‘Law Reform’ then ‘Amendments’ [cited 20 June 2008]. • Nielson, L 2007, ‘Bankruptcy Legislation Amendment (Superannuation Contributions) Bill 2006’, Bills Digest [online] no. 91, 13 February, Parliamentary Library, Department of Parliamentary Services. Available from: <http://www.aph.gov.au> by selecting ‘Publications’ then ‘Library publications’, then ‘Bills digests’ and finally ‘2006–07’ [cited 20 June 2008]. 3 Superannuation Complaints Tribunal (SCT) The Superannuation Complaints Tribunal (SCT) is a Commonwealth statutory authority established to enable members and beneficiaries to complain to a low-cost independent party on decisions and actions of superannuation fund trustees. 3.1 Operations of the SCT The SCT has the power to consider complaints about: • all superannuation funds (except self-managed funds) • superannuation income streams • retirement savings accounts (RSAs) • annuities and deferred annuities • approved deposit funds (ADFs). SMSFs not covered Members of self-managed superannuation funds (SMSFs) cannot complain to the SCT and need to take complaints to the court if they cannot come to a resolution. Cost of the SCT The member is not charged any fee to lodge a complaint with the SCT or for the conciliation and arbitration processes. The SCT is funded through an annual levy on superannuation funds. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints Jurisdiction of the SCT The SCT only has authority to deal with certain types of matters. It can deal with complaints about the decisions and conduct of trustees, life companies (for annuities) and retirement savings accounts. This jurisdiction includes complaints about people acting on behalf of the trustees and insurers in relation to insurance benefits provided under superannuation. In the December 2006 quarter, 45.8% of the complaints lodged (256 complaints) were outside the jurisdiction of the SCT. Many of these complaints could not be heard by the SCT because the member had not followed the complaints resolution process properly. The main reason for this was that the complainant had not yet complained to the trustee. Death benefits is the most common source of complaint Trustee decisions on who receives death benefits are the most frequent basis of complaint to SCT. In these cases, the SCT does not determine whether the trustee has made the right decision, but whether the trustee has been fair and reasonable in how it handled the payment of death benefits. Of the 1258 complaints within jurisdiction in the 2007: • 31.3% related to superannuation death benefits • 25.3% related to superannuation fund administration • 16.6% related to disability benefits • 14.8% related to payments • 12% related to disclosure/fees. Lengthy time for resolution While the SCT provides a free and independent service that enables members to avoid complaining through the courts, resolution may take a long time. In the December 2006 quarter, each complaint took an average of 254 days to settle by conciliation and 463 days to settle by arbitration. In the December 2007 quarter, 58.7% of the finalised cases affirmed the trustee’s decision. Therefore, almost half of the cases result in a different outcome to that decided by the trustee. Apply your knowledge 4: Complaints tribunal Research the following on the SCT’s website at <http://www.sct.gov.au>: (a) Can a complainant be legally represented? (b) Are there time limits for making a complaint? (c) Can a client complain about excess fees and charges? (d) Can a client comment on others’ submissions to the tribunal? (e) Can a complainant withdraw a complaint? (f) Can a complainant appeal a tribunal decision? © Kaplan Education 8.19 8.20 3.2 Specialist Knowledge: Superannuation (924) Complaints resolution process Before a complaint can be heard by the SCT, the member needs to follow the superannuation fund’s internal complaints resolution process. If no response is received or if the member is not satisfied with the response, only then can they lodge the complaint with the SCT. The steps for complaint resolution are outlined below: Step 1 — The member lodges a written complaint with the fund. The trustee has 90 days to reply. If a reply is not received within this time or if the member is not satisfied with the reply, the member can appeal to the SCT. Step 2 — The member will obtain a complaints form from the SCT. The form is available online at <http://www.sct.gov.au> or by phoning 1300 780 808. Post or fax the completed form to the SCT. A copy of the complaint letter sent to the fund and the fund’s response should be included. Step 3 — If the SCT agrees to handle the complaint, it will notify the member and the trustee of the time and date for a conciliation conference. Step 4 — The member can have a representative, such as a lawyer or a family member, join them in the conciliation process, but the member should request this in advance of the conference. Step 5 — At the conciliation conference, the conciliator will attempt to get the parties to agree. If successful, the settlement is recorded and signed by the parties involved. Step 6 — If the conciliation does not reach a resolution the matter goes to the SCT for review and arbitration. The member and trustee can lodge written submissions but generally they will not attend the review meeting. Step 7 — The SCT will make a decision and notify the parties involved. The decision is enforceable on the trustee by ASIC. Step 8 — The member and/or trustee can lodge an appeal with the Federal Court if they believe the SCT has made an error in law. This step will involve legal fees. 924.SM1.9 Unit 8: Divorce, bankruptcy and complaints Suggested answers Apply your knowledge 1: Splitting products The TPD payment would not be affected, but the other benefits (3% payments and $40,000 lump sum) would be open for splitting Apply your knowledge 2: Superannuation accumulation phase and divorce Neither the member spouse nor the non-member spouse is affected as superannuation is only an asset for social security if the owner is over age-pension age. Apply your knowledge 3: Bankruptcy and superannuation Superannuation benefits can be traced and recovered. Apply your knowledge 4: Complaints tribunal (a) Yes, but only with consent of the tribunal. (b) Yes. Time limits vary with the nature of the complaint. Two years is a typical time. (c) No. But they can complain about a lack of disclosure of fees. (d) Yes. (e) Yes. (f) Yes — to the Federal Court. Review your progress 1 Because the courts will investigate each contribution to determine whether its main purpose was to provide for retirement or to avoid creditors. Regular contributions are more likely to be regarded as a genuine and systematic retirement strategy than sudden and erratic contributions. © Kaplan Education 8.21 8.22 Specialist Knowledge: Superannuation (924) Notes 924.SM1.9 9 Self-managed superannuation funds . Overview 9.1 Unit learning outcomes ....................................................................9.1 Further resources ............................................................................9.1 1 1.1 1.2 1.3 Users of SMSFs 9.3 Who can establish an SMSF? ..................................................9.4 Why use an SMSF?.................................................................9.4 Comparing the benefits of SMSFs and public offer superannuation funds .............................................................9.7 2 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.15 Establishing and running an SMSF 9.10 Trusts and superannuation....................................................9.10 Key steps to establishing an SMSF ........................................9.10 Trustees ..............................................................................9.11 Trustee consent and disqualification ......................................9.13 Trustee declarations .............................................................9.14 Trust deed content ...............................................................9.14 Executing the trust deed .......................................................9.16 Electing to be regulated ........................................................9.17 Product disclosure statement requirements ............................9.17 Admitting members...............................................................9.18 Accepting contributions .........................................................9.20 Trust established upon gaining first property ...........................9.20 Administration......................................................................9.21 Trustees absent overseas .....................................................9.22 Penalties for failure to comply with trustee requirements .........9.23 3 3.1 3.2 3.3 3.4 Investment strategies and regulation 9.25 Sole purpose test .................................................................9.25 Regulatory requirements for investment..................................9.27 Investment strategy ..............................................................9.32 Financial adviser’s role .........................................................9.35 4 Superannuation interests 5 5.1 Accumulation and pension assets 9.40 Tax treatment of income from pension and accumulation assets.................................................................................9.40 6 6.1 6.2 6.3 6.4 6.5 6.6 Administration 9.41 Making investments..............................................................9.41 Cash flow management.........................................................9.42 Annual statutory requirements ...............................................9.42 Record keeping ....................................................................9.45 Payment of SMSF benefits ....................................................9.46 Monitoring Australian superannuation fund status ...................9.48 7 7.1 Winding up an SMSF 9.49 Procedures for winding up an SMSF .......................................9.49 Appendices 9.39 Unit 9: Self-managed superannuation funds Overview A self-managed superannuation fund (SMSF) contains fewer than five members and meets certain requirements defined in the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act). SMSFs have undergone rapid growth in recent years to become Australia’s second largest superannuation sector by assets. All superannuation funds, including SMSFs, must comply with rules governing: • trustee responsibilities and duties • investment standards • reporting requirements to regulators and members. Should all the conditions set out in the SIS Act be met, the Australian Taxation Office (ATO) will regulate the SMSF. If not, the Australian Prudential Regulation Authority (APRA) will regulate the fund. This unit outlines the circumstances in which clients of financial advisers might benefit from setting up an SMSF, the steps involved in establishing such a fund and the ongoing requirements and legal implications of an SMSF. The unit is not an SMSF administration manual. Rather it is designed to acquaint the financial adviser with general issues involved in establishing and managing SMSFs. This unit specifically addresses the following subject learning outcome: • Critique the structures and strategies of self-managed superannuation funds for different client situations. Unit learning outcomes On completing this unit, you should be able to: • identify circumstances in which it would be appropriate to establish an SMSF • describe the procedures for establishing, running and winding up an SMSF • explain the investment requirements for an SMSF • identify circumstances when a small fund would not qualify as an SMSF • demonstrate the tax treatment of SMSF pension and accumulation assets. Further resources • ABN AMRO, ‘Self managed super funds’ [online]. Available from: <http://www.abnamromorgans.com.au> by selecting ‘products & services’, then ’Financial Planning’ and then ‘SMSFs’ [cited 3 June 2008]. • Anderson, K 2007, ‘SMSFs and the acquisition of assets’, Money Management [online], 14 June. Available from: <http://www.moneymanagement.com.au> by entering ‘anderson smsfs acquisition assets’ in the search box [cited 3 June 2008]. • ASX, ‘Self-managed super funds’ [online]. Available from: <http://www.asx.com.au> by selecting ‘Self Managed Super Funds’ under ‘Resources & Education’ in the left sidebar [cited 4 June 2008]. © Kaplan Education 9.1 9.2 Specialist Knowledge: Superannuation (924) • ATO 2004, ‘DIY super — It’s your money ... but not yet!’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘your money but not yet’ in the search box, and then selecting ‘DIY super — It’s your money ... but not yet!’ from the results. Click the ‘DIY super — It’s your money ... but not yet!’ PDF download [cited 3 June 2008]. • ATO 2007, ‘Does SMSF suit me?’ [online]. Available from: <http://www.ato.gov.au> by entering ‘smsf suit’ in the search box [cited 3 June 2008]. • ATO 2007, ‘Role and responsibilities of trustees: operating a self managed superannuation fund (SMSF)’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘superannuation role trustees’ in the search box. Select ‘Self managed superannuation funds — role and responsibilities of trustees’, then select the ‘Role and responsibilities of trustees’ PDF download [cited 3 June 2008]. • ATO 2007, ‘Winding up a self managed superannuation fund’ [online]. Available from: <http://www.ato.gov.au> by entering ‘winding up super’ in the search box, and selecting ‘Winding up a self managed superannuation fund’ from the results [cited 3 June 2008]. • Bennetto, P 2005, ‘SMSFs: separation of advice’ [online] 18 August. Available from: <http://www.lonsdale.com.au> by entering ‘smsfs separation advice’ into the search box [cited 3 June 2008]. • Brett Davies Lawyers, ‘Self managed superannuation funds — are they for you?’ [online]. Available from: <http://www.taxlawyers.com.au> by selecting ‘SMSF’ [cited 3 June 2008]. • Ellis, P & Racky, L 2007. ‘The ATO’s latest thinking on the sole purpose test for SMSFs’ [online], Cleardocs. Available from: <http://www.cleardocs.com> by selecting ‘Resources’ then ‘ClearLaw legal bulletin’ and then ‘Superannuation’ [cited 3 June 2008]. • Ferizis, MN 2007, ‘Super strategy needs super caution’ [online], IFA, 27 August. Available from: <http://www.argylelawyers.com.au> by entering ‘super strategy caution’ in the search box, and then selecting ‘IFA_SMSFsupp_p26-32.indd’ from the results [cited 4 July 2008]. • IFSA 2006, ‘Self-managed super fund trends — February 2006’ [online]. Available from: <http://www.ifsa.com.au> by selecting ‘Information Area’ and then ‘Publications, surveys, statistics and reports’. Go to 2006 and select ‘Self-Managed Super Fund Trends — February 2006’ [cited 3 June 2008]. • SMSF Loans, ‘Case study’ [online]. Available from: <http://www.smsfloan.com.au> by selecting ‘Case Study’ [cited 3 June 2008]. • SuperGuardian 2005, ‘Winding up a self managed super fund’ [online], Your Guardian October, Adelaide: SuperGuardian. Available from: <http://www.superguardian.com.au> by selecting ‘online resources’ then ‘YourGuardian newsletter’ and then ‘October 2005’ [cited 4 June 2008]. • SuperRegistry 2007, ‘The SuperRegistry trust deed’ [online]. Available from: <http://www.superregistry.com.au> by placing the mouse over ‘About SuperRegistry’ and then clicking ‘The SuperRegistry Trust Deed’ [cited 3 June 2008]. 924.SM1.9 Unit 9: Self-managed superannuation funds 1 Users of SMSFs There has been phenomenal growth of SMSFs in recent years. ATO statistics show that there were more than 387,900 SMSFs with total assets of $287 billion as at 27 August 2008. This makes SMSFs the second-largest superannuation sector by assets now accounting for 25.95% of the total superannuation pool. Statistics on SMSF numbers are shown in Table 1 below. Table 1 SMSF statistics to June 2008 Jun–04 Jun–05 Jun–06 Jun–07 Jun–08 30,266 22,606 24,217 44,661 31,660 4,819 5,023 4,931 4,080 669 25,447 17,583 19,286 40,581 30,991 Total number of SMSFs 279,495 297,078 316,364 356,945 387,936 Total members of SMSFs 539,514 573,095 609,213 684,577 746,318 Establishments Wind ups Net establishments But who are the users of these increasingly popular funds? Who can legally establish them? And who are they appropriate for? This section provides answers to these questions. Further resources • IFSA 2006, ‘Self-managed super fund trends — February 2006’ [online]. Available from: <http://www.ifsa.com.au> by selecting ‘Information Area’ and then ‘Publications, surveys, statistics and reports’. Select 2006 and select ‘Self-Managed Super Fund Trends — February 2006’ [cited 3 June 2008]. • The IFSA report summarises 2006 data from the ATO and adds other information gathered from surveys. • Bennetto, P 2005, ‘SMSFs: separation of advice’ [online], 18 August. Available from: <http://www.lonsdale.com.au> by entering ‘smsfs separation advice’ into the search box [cited 3 June 2008]. Reflect on this: Financial advisers and SMSFs The IFSA report above shows that advice on SMSFs comes mostly from accountants, not financial advisers. Indeed, the Lonsdale article describes the limits within which accountants must act so that they do not step over the boundary of financial product advice as defined in the Corporations Act 2001 (Cth). Financial advisers are more involved in placing clients in retail funds. © Kaplan Education 9.3 9.4 Specialist Knowledge: Superannuation (924) 1.1 Who can establish an SMSF? An SMSF can only be established by fewer than five members, such as: • a single person • a husband and wife • family members • up to four individuals, provided that they are not employees of another member of the fund (other than where the employed member is a relative of the employer or another fund member). Directors of a business can be members of the same SMSF. Minors and fund membership It is possible for minors (those under 18 years of age) to become fund members. This might occur if a minor is earning income or is the recipient of a death benefit binding nomination. A minor, however, cannot become a trustee. Usually, a parent will act as a trustee on behalf of a child. 1.2 Why use an SMSF? A person or persons can establish an SMSF for the following reasons: • greater capacity for incorporating superannuation into a holistic financial plan • greater control over a wider range of investments • greater control over tax management • speedier response in administrative actions • more effective estate planning • reduced costs in investment and administration. Incorporating SMSFs into a holistic financial plan SMSFs can be incorporated into a client’s financial plan and may provide options that assist estate planning and long-term retirement planning needs. Control and range of investments One of the most important features of an SMSF is members’ ability to instruct the trustees on their investments. This allows members to take advantage of a greater range of investment options, perhaps focusing on their particular interests or expertise. In periods of economic downturn, SMSF numbers increase. This may be an attempt to flee from retail funds’ poor returns and a perception that they are not earning their high fees. 924.SM1.9 Unit 9: Self-managed superannuation funds In specie contributions Unlike most other superannuation funds, SMSFs can accept in specie contributions, that is, contributions of assets other than money. The most common types of in specie contributions are shares and commercial property. SMSFs can also invest in a home unit, private companies, private unit trusts, unlisted managed funds, bank bills, fixed deposits etc. In specie contributions have caused some trustees to breach the sole purpose test when they buy assets with superannuation moneys and then do not use them exclusively for the purpose of providing retirement benefits. There are alternative assets discussed below. Reflect on this: In specie contributions Why do you think in specie contributions are used for in an SMSF? What are their advantages and disadvantages? Are they too much of a temptation for naive trustees? 13 June 08 Media Release Warning on using in specie contributions to avoid caps In Taxpayer Alert 2008/12, the ATO warns of in specie transfers or other non-cash transactions that are effectively seeking to get around the limitations imposed by contribution caps. These non cash transactions are classed as contributions when they exhibit the following features: • The fund does not recognise and record the contribution at the true market value of the asset in its accounts. • A person (e.g. an employer of members of the fund) pays expenses on behalf of the fund and does not subsequently seek reimbursement from the fund. Alternatively, the fund pays the expense but seeks reimbursement from another person (e.g. an employer of members of the fund). • A person, usually a member of the fund or their associate, makes improvements to an asset of the fund to increase the asset's value without seeking reimbursement from the fund. For example, the fund owns real property and a member pays the cost of improvements to that property. • A person, usually a member of the fund or their associate, together with the trustee of the fund owns all of the units in a non-leveraged unit trust or shares in a company and further units or shares are issued or the rights attached to the units or shares are altered so that the value of the units or shares owned by the fund is increased. Similar warnings can be found in the ATO 13 June 08 Media Release ‘Contributions to superannuation funds under scrutiny’. © Kaplan Education 9.5 9.6 Specialist Knowledge: Superannuation (924) Protection of business asset in bankruptcy In bankruptcy, a member’s superannuation benefits may be protected from creditors if they form a regular pattern of contribution. As SMSFs can take in specie contributions, protected assets can include business premises (business real property). This is an attractive feature for some small business owners. In specie lump sum withdrawals In an SMSF, it is also possible to make in specie lump sum withdrawals in the pension phase, i.e. the commercial building that was contributed in the accumulation phase can be withdrawn in the pension phase. Alternative asset classes An SMSF can invest in alternative asset classes such as wine, art, jewellery and vintage cars. However, trustees must ensure that assets are acquired and maintained in accordance with the sole purpose test and SIS investment rules (see section 3.1). Trustees also have an obligation to ensure that the assets are properly stored in a secure location and insured. Tax management Certain tax benefits are available to an SMSF, for example: • tax on contributions can be reduced if the investment strategy includes a large proportion of share imputation credits • capital gains tax (CGT) can be avoided by adopting a buy and hold strategy on funds that ultimately pay a pension • overall fund taxation can be reduced by applying taxation credits of a pension member • tax deductions can be generated by the in specie contribution of business real property and other assets over time for SMSF members who are not receiving superannuation support from their employers. Estate planning The trust deed of an SMSF can be drafted with a specific outcome in mind. For example, it could stipulate that a death benefit be paid as a pension. Payment of death benefits are not necessarily limited in the same way as retail funds. For instance, in 2008 the Commissioner of Taxation ruled that binding death benefit nominations in an SMSF fund do not lapse after 3 years. Speedier administrative actions An SMSF offers the opportunity for much speedier responses in administrative actions. The SMSF trustees can meet and quickly decide to admit a member, sell or acquire an investment, change an investment strategy or start paying a pension. Such actions may take weeks or even months through a public offer fund. 924.SM1.9 Unit 9: Self-managed superannuation funds Reduced costs In certain circumstances it might be more cost effective to establish and manage an SMSF rather than maintain superannuation money in public offer funds. SMSFs have no entry or exit fees. Due to the flat costs associated with setting up and running an SMSF, administrations costs will decrease proportionally as assets increase, in contrast to retail funds. This is because retail funds generally set their fees on a percentage (not flat) basis. The break-even point, that is, when administrative costs are equal to or less than other comparable rates, will vary according to circumstances. A figure of $200,000 is often cited as the minimum amount SMSFs need in assets to become cost competitive with other superannuation fund options, taking into account average fees and charges. Sometimes $250,000 or $300,000 is cited as the minimum amount. Analysis of the ATO’s SMSF data shows that some SMSFs with small balances pay 10% of the fund in fees. The 2006 IFSA survey referred to in section 1 shows that a major reason for establishing SMSFs is not fees, but control. Further resources These resources describe the factors to be considered when assessing when an SMSF is suitable for a client. • ABN AMRO, ‘Self managed super funds’ [online]. Available from: <http://www.abnamromorgans.com.au> by selecting ‘products & services’, then ‘Financial Planning’ and then ‘SMSFs’ [cited 3 June 2008]. Also available from the same page ‘Guide for trustees’, ‘SMSF vs retail funds’ and ‘Is an SMSF right for me?’. • ATO 2007, ‘Does SMSF suit me?’ [online]. Available from: <http://www.ato.gov.au> by entering ‘smsf suit’ in the search box [cited 3 June 2008]. • Brett Davies Lawyers, ‘Self managed superannuation funds — are they for you?’ [online]. Available from: <http://www.taxlawyers.com.au> by selecting ‘SMSF’ [cited 3 June 2008]. 1.3 Comparing the benefits of SMSFs and public offer superannuation funds As noted in section 1.2, there are a number of differences between an SMSF and a retail superannuation fund. For example, they can differ significantly in running costs, as illustrated below. Example: Comparison of running costs Mr and Mrs Client have $300,000 accumulated in their superannuation, currently managed by three different public offer superannuation funds. They are considering establishing their own superannuation fund and wish to know what the ongoing costs would be compared with their current arrangements. Mr and Mrs Client have compared the cost of their current public offer funds with the estimated costs of two SMSFs, based on information provided by their financial adviser. Table 2 presents the comparison. © Kaplan Education 9.7 9.8 Specialist Knowledge: Superannuation (924) Table 2 Comparison of superannuation fund running costs Public offer fund SMSF A SMSF B $6,000 n.a. n.a. Cost of preparing accounts, tax return, ATO return and audit n.a. $2,000 $4,000 Investment manager fees ‘wholesale’ — 1% p.a. n.a. $3,000 $3,000 $6,000 $5,000 $7,000 Retail superannuation fund manager fees — 2% p.a. Total In the public offer fund, Mr and Mrs Client are paying 2% p.a. for full management and administration. This amounts to $6000. If they decide to establish their own fund, they will need to pay for: • preparing annual accounts • a tax return • an ATO return • an audit of the fund • brokerage and stamp duty • trustee liability insurance • legal costs for the establishment and maintenance of the trust deed • annual valuation of assets. SMSF provider A has estimated total costs of approximately $2000 each year. Provider B has estimated a yearly cost of $4000. Mr and Mrs Client will also have to decide how the fund assets are to be invested. This example assumes that Mr and Mrs Client will be able to access wholesale investment managers at a management fee of 1% p.a. Comparing total costs shows that Mr and Mrs Client will save money if they choose SMSF A. However, if they choose SMSF B, where the provider’s costs are higher, they will pay more. 924.SM1.9 Unit 9: Self-managed superannuation funds Key considerations in choosing a fund Table 2 illustrates the following points: • Investors should carefully compare the total costs of public offer funds and SMSFs. For public offer funds, total costs will include entry fees, account-keeping fees and fund manager fees, plus recoverable expenses. Public offer funds may also be paying commission on insurance taken out within the fund. • For master trusts, where members choose from a menu of externally managed funds, the external fund manager’s management expense ratio (MER) should be included in the total cost calculation. • Cost estimates should be obtained from providers of SMSF services. Any additional administration costs or charges should be included. • Investment costs under the SMSF alternative should be carefully estimated. Brokerage, stamp duty and the cost of investment advice will need to be taken into account. • SMSF establishment costs should also be taken into account, and these may be compared with any contribution or entry fee that might be charged in a public offer fund. • Professional support may be required to fulfil SMSF trustee duties, at an additional cost. The above points illustrate that the comparison is not straightforward. An adviser needs to take many factors into account when advising clients on the relative cost effectiveness of establishing an SMSF. However, cost might not be the most important consideration. The client may be more concerned about control over investments, tax management and estate planning. Disadvantages of SMSFs Being trustee of an SMSF involves taking on responsibility for ensuring that the fund is run according to a complex set of rules and regulations. Getting it wrong could not only result in the trustees and members being subject to substantial fines and tax penalties, it could also result in a criminal conviction. This risk, combined with the time, effort and expense required to establish and run a fund correctly, may outweigh the benefits for many clients. This is especially so when the client’s financial planning requirements are relatively straightforward and easily achieved with a large public offer superannuation fund. Reflect on this: Advising a client on SMSFs Clio, a client of yours, has a friend who has recently set up their own SMSF. The friend has invited Clio to join and Clio is quite enthusiastic about the idea. What issues would you recommend Clio consider before committing to her friend’s SMSF? Further resources SMSF Loans, ‘Case study’ [online]. Available from: <http://www.smsfloan.com.au> by selecting ‘Case Study’ [cited 3 June 2008]. © Kaplan Education 9.9 9.10 Specialist Knowledge: Superannuation (924) Reflect on this: An SMSF instead of a geared property? The SMSF Loans’ case study above suggests that, rather than gearing, a client would be better off using an SMSF to acquire a property and to salary sacrifice into the SMSF. Whether this actually is viable is quite a complex calculation: there are tax advantages in salary sacrifice, earnings on the superannuation fund, and potential savings in avoiding CGT by selling the property once the SMSF account is in the pension phase. But then there are the costs of setting up the SMSF, accountants, auditors and yearly returns. What do you think are the factors that have to be considered when deciding between an SMSF and gearing? Is it worthwhile to set up an SMSF just to acquire an investment property tax effectively? 2 Establishing and running an SMSF In establishing an SMSF there are a number of factors to consider. Choices need to be made about structure (corporate or individual trustee), regulating the fund and a range of administrative matters. This section discusses some of these factors. 2.1 Trusts and superannuation A trust is a special legal relationship that exists when one or more trustees hold assets (the trust property) in trust for one or more people (called beneficiaries) who are intended to benefit from the trust property. A trust is a suitable structure for superannuation funds because: • by paying contributions to the trustee, it is clear that the contributions are being made to a fund, rather than merely being set aside. This is necessary for claiming a tax deduction on the contributions • the trustee is only required to provide the benefits payable from the fund out of the assets of the trust, rather than being under a contractual liability to pay particular benefits • the trust structure is consistent with the requirements of the SIS Act (even though there is no SIS requirement for an SMSF to be established as a trust). After deciding on an SMSF, the investor can then establish the fund, starting with the trust. 2.2 Key steps to establishing an SMSF The four basic steps for establishing an SMSF are as follows: 1. Decide which type of trustee structure will be used (either corporate or individual). 2. Prepare the trust deed and have it executed by the trustee(s) and any other relevant parties. 3. Arrange for up to four eligible people to be admitted as members. 4. Accept contributions from the members. 924.SM1.9 Unit 9: Self-managed superannuation funds 2.3 Trustees For the fund to qualify as a regulated fund under the SIS Act, the trustee must be either: • individuals, or • a constitutional corporation. No payment trustees The trustee cannot be paid for acting as trustee, whether as an individual or as a director of a corporation. Individual trustees If the fund is to have individual trustees, the trust deed must clearly state that the fund is being established for the sole or primary purpose of providing age pensions. This brings the fund under the auspices of the federal government, which has constitutional power to legislate on pensions. If individuals are to be the trustees, the following requirements apply with few exceptions: • all members of the fund must act as trustees of the fund • all trustees must be members. Sole member SMSFs In SMSFs with only one member, the member must act as trustee, together with another individual who is not a member of the fund. The non-member trustee can be either a relative or someone who does not employ the member. Six months grace period An SMSF does not immediately lose compliance status upon failing to accord with the SIS rules. If an SMSF falls outside the rules, the trustees have a grace period of six months to restructure the fund to re-satisfy the definition of a complying fund. However, at the end of this six-month period or on the appointment of an independent trustee, whichever happens first, the fund will cease to be an SMSF. The exception is when the fund fails the residency tests (see below). In this situation, the ATO cannot allow any discretion or grace period under legislation. Special circumstances — Death and disability Special rules apply in the following circumstances for SMSFs with individuals as trustees: • If a member dies, the legal personal representative of the member can act as trustee until a death benefit is paid. • A legal personal representative can act as trustee on behalf of a person under a legal disability or over whom they have an enduring power of attorney. © Kaplan Education 9.11 9.12 Specialist Knowledge: Superannuation (924) Corporate trustee According to the SIS Act, corporate trustees must be constitutional corporations. To qualify, the company must be an Australian trading or financial corporation formed within the limits of the Commonwealth. This excludes foreign companies. Forming a company to be a corporate trustee Investors who want an SMSF with a corporate trustee will often need to incorporate a company for this specific purpose. If a company is formed, the investor will need to: • select an appropriate corporate structure • determine the company members/shareholders • appoint a company secretary, who must not be disqualified under SIS requirements, and a public officer. Reduced ASIC fees A company that operates solely as a superannuation fund trustee will generally qualify for reduced ASIC fees for filing annual returns. To qualify, the company’s memorandum of association must prohibit the company from distributing income or property among its members. All members must be directors All members of an SMSF must be directors of the corporate trustee and all directors must be members of the SMSF. The only possible exceptions are single member funds. For these, the member may act as director alone or have a second non-member director who is either a relative and not an employee of the other director. Corporate trustee versus individual trustee SMSFs Table 3 summarises the differences between corporate trustee and individual trustee SMSFs. In many circumstances, it may be better for a client to have a corporate trustee structure. Table 3 Comparison of corporate trustee and individual trustee SMSFs Issue Corporate Individual Succession Indefinite lifespan means greater estate planning flexibility Death of a member may mean a new trustee is required in six months or the fund becomes non-complying Establishment New director of corporate trustee required Re-registering of names on all jointly owned assets; tedious and labour intensive Sole member Only one trustee required Two trustees required Asset protection If trustee sued, company subject to limited liability If trustee sued, personal non-superannuation assets may become exposed Company expenses Expenses in company formation, audit, reporting, annual fees n.a. 924.SM1.9 Unit 9: Self-managed superannuation funds Reflect on this: Corporate versus individual trustees Are there other advantages and disadvantages that you can see in comparing corporate trustee and individual trustee SMSFs? Which is more tax effective? Further resources ATO 2007, ‘Role and responsibilities of trustees: operating a self managed superannuation fund (SMSF)’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘superannuation role trustees’ in the search box. Select ‘Self managed superannuation funds — Role and responsibilities of trustees’, then select the ‘Role and responsibilities of trustees’ PDF download [cited 3 June 2008]. 2.4 Trustee consent and disqualification The SIS Act requires that trustees: • consent in writing to act as a trustee • not be disqualified. A sample form of confirmation of trustee consent and eligibility is set out in Appendix 1. Definition of disqualification While obtaining consent from a potential trustee can be simple, ensuring that a trustee is not disqualified is a more complex process. Under the SIS Act, a person is disqualified if: • at any time, the person was convicted of an offence involving dishonest conduct, whether in Australia or elsewhere (even if the offence involving dishonest conduct was proved but no conviction was recorded), or if a civil penalty order was made in relation to the person under the SIS Act • the person is an ‘insolvent under administration’. In other words, the person must not be an undischarged bankrupt under the laws of any country, have any property subject to control under the Bankruptcy Act 1966 (Cth) (or any corresponding law), or have entered into a deed of arrangement or assignment or a composition under any of those laws during the preceding three years • the person has ever been disqualified by the regulator from being a trustee of an SMSF. This can occur where a trustee was involved with a fund that contravened the SIS Act on one or more occasions and the regulator was satisfied that the nature, seriousness or number of contraventions provided grounds for disqualifying the person. Waivers for disqualification APRA has the power under the SIS Act to waive disqualification if the person is disqualified because they committed an offence not involving ‘serious dishonest conduct’. An offence involving serious dishonest conduct is defined as one carrying a penalty of at least two years imprisonment or a fine of at least $13,200. Any application to APRA for a waiver of this kind must generally be made in writing and, for existing trustees, within 14 days of the person’s conviction. © Kaplan Education 9.13 9.14 Specialist Knowledge: Superannuation (924) Disqualified companies In the case of a corporate trustee, no responsible officers of the company can be disqualified persons. In addition, the company itself will be disqualified for having had any of the following: • a receiver or receiver and manager appointed for the company’s property • an official manager or provisional liquidator appointed • the start of winding-up. Penalties for breaching disqualification restrictions Allowing a disqualified person to act as the director of a corporate trustee or acting as a trustee if you are disqualified are very serious breaches of the SIS Act, with penalties of up to two years imprisonment. For this reason, declarations should be obtained from all proposed directors of the trustee company or all individual trustees, stating that the person is not disqualified under the SIS Act. 2.5 Trustee declarations Once the trustees (or directors of the corporate trustee) have been identified and have consented to act as trustees, they must declare they understand their obligations as trustees of an SMSF. This declaration must be made on an approved form within 21 days of their becoming a trustee of the fund. The declaration must be kept with the fund’s records for at least 10 years. Failure to make the declaration or keep it for the required time can incur fines of up to $5500. 2.6 Trust deed content A trust deed is an important legal document that sets out significant rights, duties and obligations of the various participants in the superannuation arrangements. It should, therefore, be prepared by a properly qualified and experienced solicitor. The provisions of the trust deed will state: • the correct name of the fund • the type of fund • details about the trustee(s), including a corporate trustee if applicable • details about how trustees are appointed and how they can be removed • a clear statement that the fund is established for the sole purpose of providing retirement benefits to its members • a statement that trustees cannot receive payment for their roles as trustees • details on how members’ benefits will be calculated and paid • details on what contributions will be accepted by the fund • the types of reserves allowed and how they can be used • provisions for winding up the fund if necessary • the fund’s rules of operation • the manner by which SIS Act and Regulations compliance will be achieved, including any recent legislative changes 924.SM1.9 Unit 9: Self-managed superannuation funds • the people who can become a fund member and how membership is established • the contributions that may be accepted by the fund • the manner by which earnings will be allocated to fund members • details on administrative issues such as record keeping, the conduct of meetings and recording of minutes • requirements relating to auditing, preparation of financial accounts, reports to members and compliance reporting. The trust deed should be developed specifically for the needs of individual clients, so the provisions will vary. The important consideration when developing the trust deed is to include everything that the trustees might want to do now or in the future within the limits of current applicable legislation. Further resources SuperRegistry 2007, ‘The SuperRegistry trust deed’ [online]. Available from: <http://www.superregistry.com.au> by placing the mouse over ‘About SuperRegistry’ and then clicking ‘The SuperRegistry Trust Deed’ [cited 3 June 2008]. This page contains a description of what could be in a trust deed and has a downloadable sample. Reserves Section 115 of the SIS Act allows the trustee of an SMSF to maintain reserves within the superannuation fund. Reserves are amounts set aside as unallocated moneys within the fund. The trust deed determines which types of reserves are allowed and how they can be used. If reserves are used, the trust deed must have the appropriate wording. Including SIS requirements in the trust deed An advantage of setting out the SIS requirements in the trust deed is that it will help make them clear to trustees. However, when the legislation is amended, there will be expense involved in updating the trust deed. When new or novel opportunities arise because of legislative change, there is typically considerable debate amongst experts whether the trust deed of a fund should explicitly reference (‘express provisions’) the powers it wishes to exercise. The notional alternative is for the trust deed to indirectly reference that it allows ‘whatever the SIS Act allows’. This reduces the likelihood and cost of ongoing Trust Deed upgrades. The Tax Office is tending to require or recommend the inclusion of express provisions. © Kaplan Education 9.15 9.16 Specialist Knowledge: Superannuation (924) No new defined benefit funds From 12 May 2004, a new SMSF must be an accumulation-type fund, and existing funds cannot convert accumulation members to defined benefit members. Similarly, an SMSF cannot offer a defined benefit pension starting after 1 January 2006. Funds that established defined benefit pensions prior to the cut-off can continue to pay them. Note: Previously, an SMSF could be established as an accumulation fund, a defined benefits fund, or a combination of the two. However, legislation was introduced with immediate effect on 12 May 2004 requiring new defined benefit funds to have at least 50 defined benefit members. 2.7 Executing the trust deed It is a good idea to prepare a number of copies of the trust deed for execution, so that if one is lost or destroyed other copies will be available. Signing the trust deed The trust deed should be executed by the trustee and, if the fund is to be an employer-sponsored fund, by the principal employer. Individuals acting as trustees should sign the deed in the presence of a witness, who also signs the deed to verify the signature. The same applies if the employer-sponsor is an individual or a partnership. Stamping the trust deed Once the trust deed has been signed by all parties, it might also need to be stamped, depending on the stamp duties legislation in the relevant state or territory. In some cases, this will involve lodging the trust deed with the Stamp Duties Office, but in some states the stamp duty can be paid by means of an adhesive stamp. Copies of the trust deed Once the trust deed has been executed, additional photocopies should be made to allow for inspection on request by fund members or the ATO. 924.SM1.9 Unit 9: Self-managed superannuation funds 2.8 Electing to be regulated To qualify as a regulated superannuation fund under the SIS Act, the fund’s trustee must give the ATO a written election stating that the SIS Act is to apply to the fund. The written election will be part of the fund’s ABN application form. The election is irrevocable and should be: • signed by each individual trustee, or • executed under common seal by a corporate trustee. Lodge the trust deed and election within 60 days The trust deed and election should be lodged within 60 days of the trust deed being executed and the fund being established to ensure that the SMSF will qualify as a regulated superannuation fund. Delays beyond this time might prevent the SMSF from qualifying for taxation concessions in its first year. 2.9 Product disclosure statement requirements Under the Corporations Act (Cth), anyone advising on or issuing an interest in a superannuation fund must provide a product disclosure statement (PDS) to members within six months of the member joining the fund. However, there is an exception from this requirement where an issuer or adviser believes on reasonable grounds that the member joining the fund has received, or has access to, all the information that the PDS would be required to contain. ASIC requires that any decision not to provide a PDS is made separately for each member of the fund and that the decision is ‘reasonable’. Trustees should use a trust deed that comes with a PDS or an SMSF administration service that provides offer documents containing all the information a PDS would otherwise be required to contain. Content of the PDS A PDS is generally required to include information on the costs, risks and benefits of the fund and outline any significant features of the fund. This could include the fund’s ability to provide a range of investment pools for the members or to pay a pension. © Kaplan Education 9.17 9.18 Specialist Knowledge: Superannuation (924) 2.10 Admitting members A person wishing to be admitted as a member of an SMSF must lodge an application form for membership, as well as an application to become a trustee of the fund or director of the corporate trustee (with accompanying declarations concerning consent and eligibility to act as trustee). Any supporting information, such as medical details required for insurance, should also be provided at this time. Nominating beneficiaries The application form should provide for the member to nominate one or more preferred beneficiaries in the event of the death of the member. Such nominations are not binding on the trustee but can be used as a guide as to who might receive such a benefit. Binding nominations If the trust deed provides for binding nominations, the member may stipulate the dependant(s) that the death benefits are to be paid to. Beneficiaries in trust deed Trust deeds for SMSFs may specify who will be the beneficiaries of the fund upon the death of a member. This is useful when the member wishes to have certainty as to who will receive their death benefit. Resolution to admit member Following receipt of the application for membership, the trustee should, at a trustees’ meeting (for individual trustees) or at a directors’ meeting (for corporate trustee), resolve to admit the applicant as a member and as a trustee of the fund. Benefit entitlements It will be necessary to prepare information about benefit entitlements which meets the requirements of the Corporations Act and Regulations (Cth). This information must be given to new members as soon as practicable after they join. Tax file number Within seven days of each new member joining the fund, the trustee must ask the member to provide their tax file number. The ATO provides a form to be used by trustees for this purpose. Penalties apply should the trustee fail to request the information within the specified time. While it is not compulsory for members to provide their TFN, if it is not provided, all employer contributions made to an account opened before 1 July 2007 will be taxed an extra 31.5% once those contributions exceed $1000 in an income year. This includes the first $1000 and is additional to the usual 15% contributions tax. If there is no TFN provided for super accounts opened after 1 July 2007, all employer contributions will be taxed an extra 31.5% regardless of the amounts contributed. 924.SM1.9 Unit 9: Self-managed superannuation funds Case study: Katz versus Grossman A dispute arose between a brother (Katz) and sister (Grossman) over who were trustees and members of their deceased parents’ superannuation fund, specifically their father’s (Ervin) $1 million death benefit. After his wife’s death, Ervin had appointed his daughter as sole replacement member/trustee relying on the powers of the Trustee Act 1958 (Vic). When Ervin died a month later, Mrs Grossman appointed her husband as the only other replacement member/trustee and together they exercised their discretion to ignore Ervin’s non-binding nomination directing an equal sharing of any death benefit between his two children. Mr Katz received nothing from the fund. The son applied to the court citing that Ervin’s SMSF trust deed gave the power for appointment of trustees to the executors and that the powers of the Trustee Act were misapplied. The court held that, although Mrs Grossman was not validly a member by virtue of the SMSF deed and although she had no express power to admit a member, she was nevertheless a valid trustee and therefore could appoint her husband. The latter determination hinged upon a complicated argument that the Trustee Act empowered a last surviving trustee to appoint another if there was no one else ‘able’ or ’willing’ to act. This was judged to have been validly applied first by Ervin and then by Mrs Grossman. The case study illustrates the following important points: • Disputes can occur and documentation will be subject to close scrutiny. • The express provisions of the trust deed were not solely applicable. • A binding death benefit nomination would have ensured Ervin’s wishes were carried out regardless of the trustee. At the direction of the court, extensive legal costs for both sides were met by the SMSF. © Kaplan Education 9.19 9.20 Specialist Knowledge: Superannuation (924) 2.11 Accepting contributions After the trust deed has been executed and members have been admitted to the SMSF, the next step is to accept contributions from members. Contributions are most conveniently made as direct payments to the fund’s bank account or cash management trust, keeping a ‘contribution advice and related minute’. The contribution advice and minute may be an annual advice notice, detailing regular contributions, such as salary sacrifice or superannuation guarantee payments. Alternatively, it may be completed at the time of contribution for one-off contributions taking advantage of taxation legislation. Allocating contributions to individual accounts Trustees of SMSFs must allocate all contributions to individual members’ accounts within 28 days of the end of the month in which the contribution was made. (Superannuation legislation effectively prevents contributions being allocated directly to reserves or remaining unallocated within the fund.) Assessing the acceptability of contributions Trustees assessing the acceptability of member contributions should ensure the following questions are asked and that the answer to each is ‘yes’: • Is the proposed contribution allowable under the trust deed? • Is the proposed contribution allowable under the SIS Act? • Is the proposed contribution allowable under income tax legislation? • Has the contribution been properly documented? 2.12 Trust established upon gaining first property The trust is not established until the first trust property is vested in the trustee. This will normally consist of the first member contribution. It may be an amount rolled over from another superannuation fund or approved deposit fund. However, before a member can request such a rollover, the SMSF will need an ABN. 924.SM1.9 Unit 9: Self-managed superannuation funds 2.13 Administration Once the fund has been established, the trustee needs to: • open a bank account and determine how it will be operated and who will be the signatories • establish membership and accounting records to enable the SMSF to be administered correctly and, in particular, the benefits to be calculated and paid in accordance with the trust deed • establish a minute book including: – a register of trustees (if individual) or a register of directors of the trustee (if corporate) – a file in which copies of all member reports can be kept • appoint external service providers • obtain quotes for and purchase insurance such as death, disability and income protection (if appropriate) • formalise an investment strategy in writing • invest contributions in accordance with the investment strategy • procure trustee liability insurance • register for GST and PAYG (if appropriate). Engaging external service providers The SMSF may require the following external providers: • accountant/auditor — to prepare the SMSF’s financial and regulatory audits and tax return • solicitor — to draft the trust deed and make any amendments required • actuary — to provide actuarial valuations for pre-existing defined benefit pensions • financial adviser — to provide investment advice and draft an investment strategy • SMSF administration company — to administer the fund. Written service agreements Written service agreements should be in place for all service providers engaged by the trustee, detailing: • the powers and duties of the service provider • the cost of the service or how the cost will be determined • the performance standards • the means by which the parties can modify the agreement and the extent of services provided • the starting date and duration of the agreement • the means by which trustees can access the SMSFs’ records • the circumstances in which the agreement can be terminated and the process for doing so. © Kaplan Education 9.21 9.22 Specialist Knowledge: Superannuation (924) 2.14 Trustees absent overseas Members and trustees of an SMSF must satisfy residency requirements to ensure the fund remains compliant. One stipulation is that the central management and control (CM&C) of the fund, effectively the decision-making activities of the trustees, cannot be exercised outside of Australia for more than two years at a time. Nor may absent members contribute to their SMSF unless there are other resident contributing members whose combined holdings are at least 50% of total fund assets. An example of non-compliance would be a fund whose only trustees were a husband and wife living outside Australia on an extended work assignment. In these circumstances, the ATO cannot exercise discretion and must apply a penalty 45% tax on fund assets excluding non-concessional contributions. Solutions to the residency requirements include: • converting the SMSF temporarily to a small APRA fund which would then result in the appointment of a third party Australian trustee company to manage the fund • appointing an Australian resident trustee under a power of attorney. Central management and control In Draft Taxation Ruling TR 2008/D5, the Tax Office has further clarified what is required to satisfy the central management and control test. Interestingly, for either individual or corporate trustees, the situation has become murkier: Establishing who is exercising the CM&C of a superannuation fund is a question of fact to be determined with reference to the circumstances of each case. Notionally, any trustee of the fund would seemingly be the person who should be considered to exercise ‘control’. However, the ATO only looks to a particular trustee if he/she ‘… performs the high level duties and activities of the fund … In the context of the operations of a superannuation fund, the strategic and high level decision making processes includes the performance of the following duties and activities: • formulating the investment strategy for the fund • reviewing and updating or varying the fund's investment strategy as well as monitoring and reviewing the performance of the fund's investments • if the fund has reserves — the formulation of a strategy for their prudential management • determining how the assets of the fund are to be used to fund member benefits. If the trustee(s) who remain(s) in Australia merely looks after lower level activities they will not be considered to be the controller at all. Examples of such lower level activities that would not evidence control include: • acceptance of contributions • actual investment of the fund's assets • fulfillment of administrative duties • preservation, payment and portability of benefits. 924.SM1.9 Unit 9: Self-managed superannuation funds 2.15 Penalties for failure to comply with trustee requirements Each member/trustee of an SMSF is responsible for any decision by the SMSF. The law deems every one actively involved in any breach. ATO compliance test To check the administration of an SMSF, the ATO applies a compliance test. An SMSF passes the compliance test if it did not contravene the SIS Act or Regulations during the year. If the compliance test is passed, the ATO provides the SMSF with a notice of compliance. If the trustee has contravened the legislation, the ATO can still issue a notice of compliance after considering: • the tax consequences of treating the fund as non-complying • the seriousness of the contravention • other relevant issues. ATO penalties for breaches The ATO has some discretion about the penalties for a breach. The ATO can choose to: • suspend or remove trustees and appoint an acting trustee • freeze assets of the fund • declare the fund to be non-complying and apply the relevant tax penalties • prosecute trustees under the civil penalty provisions of Part 21 of the SIS Act. The civil and criminal consequences of contravening civil penalty provisions are defined under s 193 of the SIS Act. Maximum penalties are fines of $220,000 for civil proceedings and five years imprisonment for criminal proceedings. A civil penalty order would also cause a person to become a disqualified person. This makes them ineligible to continue as a trustee of a superannuation fund. Strict liability for minor breaches Strict liability generally applies for minor breaches of the SIS Act and does not require proof of fault. Breaches may result in fines on trustees or in some cases on employers, investment managers and auditors, without investigation into the surrounding circumstances. In other words, knowledge of the breach does not need to be established before a penalty is imposed. © Kaplan Education 9.23 9.24 Specialist Knowledge: Superannuation (924) Fault liability for intentional or reckless breaches Fault liability provisions relate to breaches of the SIS Act where the trustee acted intentionally or recklessly. This is different from strict liability, when the regulator must prove these offences through the court system. Where both strict and fault liabilities apply to a breach, and the regulator is able to prove that the trustee acted intentionally or recklessly, harsher fault liability penalties can be applied. Table 4 details some of the penalties. Table 4 Sample of trustee requirements and related penalties Requirement Strict liability Fault liability Penalty Duty to keep minutes and records for 10 years Yes No 50 penalty units Duty to keep member reports for 10 years Yes No 50 penalty units Disqualified person acting as trustee No Yes Two years imprisonment Failure by trustee to prepare and retain proper accounts for five years Yes Yes Strict — 50 penalty units Fault — 100 penalty units Failure to arrange for proper audit of accounts Yes Yes Strict — 50 penalty units Fault — Two years imprisonment Failure to request TFN from member within prescribed time Yes Yes Strict — 50 penalty units Fault — 100 penalty units Each penalty unit has a cost of $110 per individual trustee. The courts can multiply the above penalty units for corporate trustees by up to five times. 924.SM1.9 Unit 9: Self-managed superannuation funds 3 Investment strategies and regulation In order to establish and maintain an SMSF, the fund must meet the sole purpose test, must not borrow funds and must not conduct a business. These and other factors must be considered when developing an investment strategy for the fund. Some of these features relevant to the strategy are outlined in this section. 3.1 Sole purpose test The sole purpose test requires the trustee of a regulated superannuation fund to ensure that the fund is maintained solely for either: • one or more core purposes • one or more of the core purposes and one or more ancillary purposes. Core purposes The core purposes are as follows: • providing benefits for each member on or after retirement or attaining age 65 • providing benefits in respect of each member on or after the member’s death if the death occurred before the member’s retirement or before the member attained age 65. The benefits must usually be provided to the member’s legal personal representatives and dependants. If a fund does not provide any of the benefits described above, it will fail the sole purpose test and the trustee will have breached the SIS Act. Ancillary purposes Ancillary purposes can be summarised as follows: • providing benefits for each member on or after the termination of the member’s employment with an employer who had contributed (or whose associates had contributed) to the fund for the member • providing benefits for each member on or after the member stopped working because of ill health (whether physical or mental) • providing benefits in respect of each member on or after the member’s death if the death occurred after the member retired or attained the age of 65. The benefits must usually be provided to the member’s legal personal representatives or dependants • providing other benefits approved by APRA in writing. Death benefits An important element of the sole purpose test is the requirement that death benefits generally be paid to a member’s legal personal representative or dependant. The only exception is if the member died without leaving any legal personal representative or any dependants. © Kaplan Education 9.25 9.26 Specialist Knowledge: Superannuation (924) Dependants (under the SIS Act) The dependant refers to the following under the SIS Act: • a spouse (includes a de facto spouse but does not include an ex-spouse or a same-sex spouse) • a child of the member of any age and regardless of financial dependency • a person with whom the member has an interdependency relationship. Interdependency relationship Two people have an interdependency relationship if: • they have a close personal relationship • they live together • one or each of them provides the other with financial support • one or each of them provides the other with domestic support and personal care. Special rules also exist for those with a close personal relationship but who live apart due to injury or illness. Same-sex partners can be considered to have an interdependency relationship. Contravention of sole purpose test Although the sole purpose test is primarily concerned with the type of benefits to be provided from the fund, it might also affect other aspects of the administration and, in particular, the type of investment the fund makes. Investments that are inconsistent with providing the prescribed type of benefits might breach the test. Maintaining the fund for additional purposes is likely to be a breach. Example: Contravention of sole purpose test In an Administrative Appeals Tribunal (AAT) case, a fund that invested in a chalet in Switzerland and in shares in a private company that were linked to membership of a golf club was held to have failed the sole purpose test. The AAT found these investments were made in order to confer immediate benefits on particular members of the SMSF, to the detriment of the fund’s ability to provide genuine superannuation benefits to members. SMSFs cannot conduct a business If an SMSF conducts a business, it could cause the fund to breach the sole purpose test. This is because the payment of business expenses, such as salary and wages to members, could be considered to be a present benefit rather than a retirement or death benefit. Penalties for failing sole purpose test A person who intentionally or recklessly breaches the sole purpose test is guilty of an offence punishable by up to five years imprisonment. Whether or not the contravention constitutes a criminal offence, a court can make a civil penalty order against a person who contravenes the test. It should be noted that any person involved in a contravention of the sole purpose test is taken to have personally contravened the test. 924.SM1.9 Unit 9: Self-managed superannuation funds Further resources • ATO 2004, ‘DIY super — It’s your money ... but not yet!’ [online] July. Available from: <http://www.ato.gov.au> by entering ‘your money but not yet’ in the search box, and then selecting ‘DIY super — It’s your money ... but not yet!’ from the results. Click the ‘DIY super — It’s your money ... but not yet!’ PDF download [cited 3 June 2008]. • Ellis, P & Racky, L 2007. ‘The ATO’s latest thinking on the sole purpose test for SMSFs’ [online], Cleardocs. Available from: <http://www.cleardocs.com> by selecting ‘Resources’ then ‘ClearLaw legal bulletin’ and then ‘Superannuation’ [cited 3 June 2008]. 3.2 Regulatory requirements for investment There are certain rules that all superannuation funds must follow to maintain compliance. These provisions apply equally to SMSFs: • All SMSFs must have an investment strategy and all investments must be in line with this strategy. • Investments must be at arm’s length. • An SMSF cannot lend, nor provide financial assistance, to members or relatives of members of the fund. • Generally an SMSF cannot acquire assets from related parties (with limited exceptions). • Generally, an SMSF cannot borrow. • All SMSFs must observe tests regarding in-house assets. • All SMSFs must comply with requirements regarding joint ownership of property. Requirements for investment strategy The SIS regime requires SMSFs to have a suitable investment strategy. An SMSF that does not comply with this requirement exposes trustees to potential legal action under s 53(3) of the SIS Act. The investment strategy must be in writing and must be carried out. The trustee of an SMSF should not enter into any investment that is not authorised by the written investment strategy. However, the investment strategy can be amended in a meeting of trustees at any time. Provided the investment strategy is appropriately amended prior to making an investment, these requirements will be satisfied. Investing must be at arm’s length Investments must be at arm’s length and must be done on a strictly commercial basis with no party owing or giving any concessions that would not be provided to any other person. For tax purposes, the Commissioner of Taxation can also amend the tax payable on a transaction if the parties are not dealing with each other at arm’s length. The Commissioner can substitute market value for the actual amount paid for an asset, and then tax that income as non-arm’s length income — which is taxed at 45%. © Kaplan Education 9.27 9.28 Specialist Knowledge: Superannuation (924) No loans or financial assistance to members or relatives An SMSF cannot lend money to a member even if it is at arm’s length. This prohibition extends to relatives of the member. No acquiring assets from a related party The trustee of an SMSF cannot acquire any assets from a related party, even at arm’s length. Exceptions are: • listed securities on the Australian Securities Exchange or any other recognised stock exchange • business real property, being real property used in the business of the owner of the property or used in anyone else’s business • in-house assets (see later in this section) provided they do not in total exceed 5% market value of the fund’s assets • exceptions to the in-house asset rules (see later in this section) • investments into related trusts and companies that: – do not borrow – do not run a business – conduct transactions at arm’s length – do not acquire or lease property from or to related parties (other than business real property). Residential real property is not exempted and therefore cannot be acquired from related parties. Nevertheless, exceptions to the general rule are effectively quite wide and allow a trustee of an SMSF to acquire many standard investments from related parties. Who is a related party? A related party is: • any member of the fund • an employer-sponsor of the fund • any associate of a member or an employer-sponsor of the fund. An associate of a member is: • any other member of the fund • a relative of the member • any trustee of the fund • any director of the trustee company • a partner in partnership with the member • any spouse or child of that partner • any entity controlled by the member. A relative of a member is: • a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of that individual or of their spouse • the spouse of that individual or of any other individual listed above. 924.SM1.9 Unit 9: Self-managed superannuation funds No borrowing An SMSF cannot borrow except to meet short-term liquidity requirements to pay benefits, in which case the superannuation fund can borrow up to 10% of its total assets. Such borrowings should only be short term. In-house assets test Generally, where a superannuation fund, including an SMSF, holds in-house assets, the total of all in-house assets cannot exceed 5% of the market value of all the assets of the fund. This also applies even if the in-house assets are purchased below the 5% mark but get pushed over because of market movement. An in-house asset is defined as: • a loan to, or an investment in, a related party of the SMSF • an investment in a related trust, or • an asset subject to a lease or lease arrangement between a related party and the trustee. Exceptions to the in-house assets test Exceptions to the in-house assets definition include: • life insurance policies • pooled superannuation trusts • business real property of an SMSF leased back to a related party • widely held trusts • residential property owned as tenants in common with a related party, provided the property is not leased to a related party • investments in related trusts or companies that do not have borrowings • any other asset specified by the regulator to be in a particular class of excepted asset • ‘limited recourse’ borrowings. A related trust is a trust controlled by a member, member’s associate or employersponsor of the SMSF. These are typically unit trusts set up so that all the units of the trust are held by the SMSF and/or members. As these trusts cannot be regulated by the SIS Act, new investments into these trusts are restricted to 5% of the SMSF’s assets, subject to transitional rules for trusts in place before 11 August 1999, discussed below. Limited recourse borrowings were allowed under the in-house assets test from September 2007 with an amendment to the SIS Act. A limited recourse loan can only claim the asset that is purchased from the borrowed funds as security. There are two main types of limited recourse borrowing affected by the legislative change: • instalment warrants • instalment warrant-type arrangements. © Kaplan Education 9.29 9.30 Specialist Knowledge: Superannuation (924) Further resources Anderson, K 2007, ‘SMSFs and the acquisition of assets’, Money Management [online] 14 June. Available from: <http://www.moneymanagement.com.au> by entering ‘anderson smsfs acquisition assets’ in the search box [cited 3 June 2008]. Instalment warrants Traditionally, instalment warrants are marketed investment products enabling the investor to acquire an asset, normally listed securities, by paying an initial instalment and borrowing money to fund the remaining amount required to acquire the asset. The borrowing is repaid by the investor making further instalment payments. The investor obtains an interest in the underlying asset that provides an entitlement to the income from the asset (e.g. dividends from shares). Instalment warrant-type arrangements A seemingly unintended consequence of this legislative clarification to the status of instalment warrants opened the door to arrangements that effectively mirrored a traditional instalment warrant structure. Figure 1 and the following steps describe how this happens. Figure 1 Instalment warrant-type arrangements Lender Trust SMSF Investment asset 1. The SMSF organises to borrow money from a lender. As the legislation does not stipulate who must act as the lender, the lender could be a lending institution, or an individual member or other related party. The fund pays interest to the borrower at commercial rates. 2. These borrowed moneys, as well as some of the cash holdings within the SMSF, are placed into a specifically created discretionary trust. This represents the initial ‘instalment payment’. The fund: • becomes the beneficial owner of any asset • receives a right (but not an obligation) to buy the asset from the trust at a later date. 3. This trust can then only purchase a new investment that it would normally be permitted to acquire had the fund acquired the asset directly, such as shares, managed funds, business property or residential property. The investments must be allowed under the SMSF’s documented investment strategy. 924.SM1.9 Unit 9: Self-managed superannuation funds 4. The SMSF will benefit from any income produced by the asset including rent and dividends. 5. Once the loan amount is repaid and the arrangement comes to an end, the ownership of the asset will pass from the trust into the SMSF but will not be regarded as having been purchased from a related party. The whole arrangement must be carefully documented. ATO warning on warrant-type arrangements Taxpayer Alert 2008/5 ‘Certain borrowings by self managed superannuation funds’ identifies a number of scenarios with which the ATO is concerned: • If the interest rate on the borrowing is zero or less than market value, it may be characterised as a contribution. • If the interest rate is in excess of commercial rates, it could be viewed as a breach of the sole purpose test and/or the fund giving financial assistance to a member or relative of the SMSF. • If interest on the borrowing is capitalised, it may result in the fund failing the borrowing exception requirement that the money borrowed is for, or has been applied for, the acquisition of an asset. • If a personal guarantee is provided by a third party, particularly by a member or related party, it may result in a financial obligation or debt being placed on the assets of the SMSF, which is not appropriate. Transitional provisions from 11 August 1999 The definition of in-house asset was substantially extended from 11 August 1999. Transitional provisions exempt certain investments in place before that date, provided the investments did not fall under the old definition of in-house asset to begin with. Exempted investments are: • contracts to acquire an asset entered into before 11 August 1999 • lease arrangements entered into before 11 August 1999. These leases can be extended indefinitely provided the asset leased is unchanged and the parties to the lease do not change • loans entered into before 11 August 1999 • issue of partly paid units in a related trust, or partly paid shares, provided the units or shares are paid up before 1 July 2009 • shares or units acquired by reinvesting distributions of trust income or dividends, provided they are acquired before 1 July 2009 • shares or units acquired before 1 July 2009 equal to the value of a loan outstanding at 11 August 1999 in the company or trust, provided an election was made before 23 December 2000. (Note: This option cannot be combined with the option to pay up partly paid units or shares and reinvest distributed income.) • any other investment prescribed by regulation. While the current definition of in-house asset limits the types of investment activities being undertaken by a superannuation fund, the transitional rules outlined above are extensive. SMSFs with these types of investments, if still in place and entered into before 11 August 1999, can continue. However, there will be some restrictions from June 2009. © Kaplan Education 9.31 9.32 Specialist Knowledge: Superannuation (924) June 2009 deadline After 30 June 2009, the SMSF will no longer be able to: • pay up any partly paid shares or units in the related trust • reinvest any dividends or trust distributions in the related trust • make any additional investments in the related trust. Any additional investment, reinvestments or loans will count towards the 5% in-house asset limit and this will apply even if there is an existing debt to which the funds are applied. The June 2009 deadline is an important planning issue for those subject to the transitional provisions. Note: ‘Uninterrupted’ lease arrangements entered into before 11 August 1999 will not need to be wound up. If the subject asset of the lease or lessee/lessor has changed since that date, or if it changes in the future, it will be considered an in-house asset after the June 2009 deadline. Audit of in-house assets If, at 30 June, the in-house assets (as defined above) exceed 5% of the SMSF’s assets, the trustee of the fund must put in writing a plan to dispose of the excess. The plan must be implemented by the end of the next financial year. 3.3 Investment strategy Although the legislation does not define what constitutes an investment strategy, it does specify that SMSF trustees must consider the following: • Risk — trustees must consider the overall risk of the total portfolio as well as the impact of making individual investments. • Expected return — trustees should consider the expected return of the portfolio and the impact of individual investments on that return. • Composition of investments — trustees should consider the SMSF as a whole, the extent to which the portfolio is diversified and how the individual investments contribute to overall diversification. • Liquidity requirements — investments should be able to meet liquidity requirements such as tax and benefit payment obligations. An example of an inappropriate strategy would be to invest the entire SMSF’s assets in investments that could not be easily redeemed for three years when a significant benefit payment will be required within one year. • Ability to meet liabilities — the fund must be able to meet current and future liabilities. • Management of reserves — if a superannuation fund has set aside a reserve, such as an investment fluctuation reserve, the trustees need an investment strategy for the reserve. In addition, trustees should consider the appropriateness of the chosen investments for meeting the investment objectives of the SMSF. This should be done regularly (at least every six months) and should be minuted. 924.SM1.9 Unit 9: Self-managed superannuation funds See Appendix 2 for section 52 of the SIS Act, dealing with certain covenants. Further resources The ASX resource looks at investment strategies for SMSFs. ASX, ‘Self-managed super funds’ [online]. Available from: <http://www.asx.com.au> by selecting ‘Self Managed Super Funds’ under ‘Education & Resources’ in the left sidebar [cited 4 June 2008]. Number of strategies A fund is not limited to one investment strategy and can have two or more investment strategies, depending on the different member risk profiles and investment time frames. Monitoring fund performance Trustees of SMSFs should ensure that they produce or receive regular reports showing the performance of the fund. These reports should address: • performances of relevant investment markets (benchmarks) • the level of volatility associated with the return (risk analysis) • performances of other similar investment managers (peer analysis) • inflation. Complying with taxpayer alerts Even if the investment strategy formally allows specific investments, the trustee must be aware of and comply with any specific restrictions occasionally imposed by the ATO. One example is the Taxpayer Alert 2008/4 ‘Self managed superannuation funds deriving income from certain uncommercial trusts’, released in March 2008, which places restrictions on distributions from ‘uncommercial’ trusts. This alert states that should the SMSF be a beneficiary of a family or other closely held trust directly or indirectly, then proceeds may be regarded as ‘special income’ and taxed at 45%. The alert details the signs of non-arm’s length dealings which it will penalise. Signs include: • the income received by the SMSF being disproportionate to its investment in the trust, that is, higher than ordinary commercial returns • flexibilities in the family trust deed that allow arbitrary alteration to normally fixed SMSF entitlements to the benefit of family members • issuing units or other interest to the SMSF for no consideration. © Kaplan Education 9.33 9.34 Specialist Knowledge: Superannuation (924) Special income Before 1 July 2007, the ATO routinely defined special income to include: • dividends paid by a private (i.e. non-listed) company • income from a transaction where parties are not dealing at arm’s length • income from a trust for which the beneficiary has no fixed entitlement • non-arm’s length income from a trust for which the beneficiary has a fixed entitlement. These details were outlined in ATO Tax Ruling 2006/7 ‘Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income’. From 1 July 2007, the Commissioner of Taxation no longer chose to assume that private company dividends were special income. Instead, fund trustees were allowed to self-assess whether a dividend was ‘arm’s length’. In doing so, trustees were to consider guidelines supplied by the ATO. Special income to an SMSF remains taxable at 45%. Joint ownership It is possible for an SMSF to own property jointly with another party, although the mechanism for achieving this needs to be carefully considered. Mechanisms for joint ownership are: • a non-geared unit trust • tenants in common. The two primary issues with being tenants in common are: • unless the property is business real property, the SMSF is unable to acquire the other party’s share of the property at a later stage • it may prove very difficult to sell the SMSF’s share of the property to an unrelated party if needed in the future. Joint venturing — property When it is deemed desirable to buy an expensive asset, such as property, an SMSF may choose to joint venture with other related parties including other SMSFs. This is especially so if any one of the joint venture partners has insufficient funds for outright purchase. The arrangements include: • purchase of business real property from a related party • arm’s-length purchase of any property from an unrelated third party. A favourite strategy has been to create a unit trust to hold the property to which each related party injects funds by purchasing units. A company could be used but the CGT implications on the sale of the property are typically less favourable. The unit trust itself may not borrow but each related partner may, with the exception of SMSF, by using assets other than the specific property as loan security. 924.SM1.9 Unit 9: Self-managed superannuation funds In addition, the trust itself may not acquire from nor lease assets other than business real property to related parties, nor may it conduct a business. All transactions must be at arm’s length. It is also possible to joint venture with multiple non-related parties using a unit trust, but this area is beyond the scope of this course. Joint venturing — agreements When entering a joint venture arrangement, the agreement should state that: • each party is a tenant-in-common • the intention is a joint venture not a ‘partnership’ • parties are not mutually liable for the debts of the joint venture arising from the activities of the other partner(s) • in the event of a forced sale of the asset, the SMSF has priority over any lenders engaged by the other joint venture parties. The use of a related trust (or company) to purchase property is a specific exemption under the in-house asset rules. The ATO clarified the issue in April 2008 in Interpretative Decision 2008/51 ‘Self managed superannuation fund: Division 13.3A of SIS Regulations — interest in another entity — units in a unit trust’ and Interpretive Decision 2008/52 ‘Self managed superannuation fund: Division 13.3A of SIS Regulations — interest in another entity — listed company shares’. These make it clear that the exemption is not applicable if the joint venture vehicle (unit trust or company) itself holds units or shares in another unit trust (or company). This holds even if the investment is itself one that an SMSF could legitimately hold directly. Joint venturing remains a useful strategy but has been recently augmented by new ‘limited recourse’ borrowing rules already described. 3.4 Financial adviser’s role The same principles used for preparing investment plans for individuals should apply to preparing investment strategies for SMSFs. In addition to complying with SIS Act, the adviser should take account of the following: • the trust deed • circumstances of the fund and its members, including risk profiles • the fund’s investment objectives • member choice • asset allocation ranges • a detailed investment plan, including minimum investment returns • selection of fund managers • the investment strategy for reserves. © Kaplan Education 9.35 9.36 Specialist Knowledge: Superannuation (924) Reviewing the trust deed The adviser should review the trust deed to determine if there are any investment restrictions. An adviser may be found negligent if they recommend actions that breach the rules in the trust deed. Matching investments to fund and member circumstances Advisers prepare investment objectives and a strategy for the trustee, who is acting for the benefit of members of the SMSF. Advisers must be careful to match investments to the particular needs of the members and their changing circumstances. If the fund provides death benefits for members, then investments should be sufficiently liquid to meet possible death benefit payments or an insurance policy should be in place to cover the death benefit. The trustees need to understand how the investment results will affect benefits to members. The trustees should review the membership profile to understand the distribution of ages of the members and their general level of balances. The investment decisions should not be based on ethnic, social or income characteristics, though these characteristics might influence the manner in which trustees communicate with members. In many circumstances, the trustees will find that members have a long-term investment horizon. However, as members near retirement, personal circumstances might mean that the long-term growth portfolio is too volatile. Investment choice If there are young members in the same fund as members close to retirement, the trustees might decide to offer members some amount of personal choice in determining their investment strategy. The most common method of providing investment choice is to offer two or three investment strategies. These choices usually include a long-term growth portfolio, at one end of the spectrum, and some form of protected portfolio (capital guaranteed, capital stable), at the other. Some SMSFs offer mix-and-match menu choices, offering specific choices of asset class and even investment managers. There are two important points to note for trustees considering member choice: • In most cases the trustee will still need to set the default strategy that determines how a member’s contribution will be invested if the member makes no choice. • The trustee must still supervise the investments, notwithstanding that the member has made the choice. 924.SM1.9 Unit 9: Self-managed superannuation funds The fund’s investment objectives The SIS Act requires the fund to have investment objectives. These could be: • a primary return goal • one or more conditions to be avoided. An SMSF, for example, might set one or both of the following objectives: • to maximise the long-term investment return of the fund subject to accepting no more than a one-in-four chance (25%) of a negative return in any one year • to have a reasonable chance (75%) in the long term of earning a real rate of return of 3% p.a. while minimising the risk of the investment portfolio. For an investment objective to be reasonable it must be: • achievable, based on known evidence • measurable (i.e. either the primary objective or the conditions must be able to be quantified). Asset allocation A central decision for trustees in setting an investment strategy is to allocate the fund’s investable assets among the asset classes. Asset allocations for superannuation funds tend to weight the growth assets (shares and property) more highly than income assets (bonds and cash). Typically the growth assets make up about 55–75% of the portfolio. Weightings in this range can be expected to produce real growth over the long term. To assist trustees in deciding asset allocation, the financial adviser could prepare a table recommending asset allocation ranges and a benchmark, as illustrated in Table 5 (this is displayed as an example only). Less detailed strategies are also acceptable. The ranges and benchmarks will vary with the risk profile of the members of the SMSF. Table 5 SMSF investment strategy — example of a benchmark allocation Allowable range (%) Benchmark allocation (%) Australian shares 25–55 38 International shares 10–30 19 5–25 11 15–40 23 Property Australian fixed interest International fixed interest 1–5 2 Cash 2–35 7 Total 100 © Kaplan Education 9.37 9.38 Specialist Knowledge: Superannuation (924) Detailed investment plan Note: The preparation of a detailed investment plan is not covered in this unit. The purpose of this section is to overview the restrictions and guidelines on investing SMSF assets. A list of recommended investments should be prepared for the trustees by the financial adviser in accordance with the superannuation SMSF’s stated investment objectives and strategy. The detailed investment plan and accompanying schedules should also address expected returns, risk and the liquidity of each investment. There are two critical issues for trustees in their selection of investment arrangements: • Trustees need to be confident that the investment pool has, and is likely to continue to have, investment strategies that match the fund’s objectives. • Trustees need to be confident that fund managers will operate the fund as agreed and in a professional manner. Selecting fund managers The selection of fund managers is a task that requires skill, judgment and experience. Good fund managers have defined and coherent investment processes. They follow a disciplined pattern. They employ teams of people with investment experience and make investment decisions consistent with their stated process. Trustees often seek consulting advice about setting objectives, allocating assets and selecting fund managers. The trustees can be reimbursed for the cost of such advice from the fund. Investment strategy for reserves If the superannuation plan holds reserves, such as an investment fluctuation reserve, there should also be an investment strategy prepared specifically for each reserve. Further resources Ferizis, MN 2007, ‘Super strategy needs super caution’ [online], IFA, 27 August. Available from: <http://www.argylelawyers.com.au> by entering ‘super strategy caution’ in the search box, and then selecting ‘IFA_SMSFsupp_p26-32.indd’ from the results [cited 4 July 2008]. This article discusses the role of financial advisers in helping SMSFs develop an investment strategy and the regulatory requirements that must be met. 924.SM1.9 Unit 9: Self-managed superannuation funds 4 Superannuation interests To determine the tax status of the funds in an SMSF, it is critical to first determine the relevant superannuation interests. Simply, each interest is compartmentalised. (A superannuation interest is rather unhelpfully defined by the ATO as ‘an interest in a superannuation fund’.) The Commissioner of Taxation considers this definition generally refers to a distinct claim of any kind against a fund. Practically, there are two main types of interest: • funds in accumulation attributable to a member • each distinct income stream attributable to a member. An amount that supports a superannuation income stream that is commenced from an SMSF is treated as a separate interest from immediately after the income stream commences (i.e. once its tax-free component and taxable component proportions have been determined). In the case of multiple income streams commenced from the same SMSF, each income stream commenced gives rise to a separate interest from the interest to which each other income stream gives rise. Except for that case, a member of an SMSF always has just one interest in the SMSF. Example: One accumulation account An existing SMSF has one account for a member which is in accumulation. Any withdrawal or contribution, if made from and to this member account, affects this one ‘interest’. Tax proportioning of components is calculated on this one account. Example: Two accumulation accounts The above fund commences a second accumulation account for the same member. This new contribution, together with any subsequent withdrawals or contributions made from either account, is regarded as one ‘interest’ and aggregated for tax proportioning of components. Example: One accumulation and one pension account An accumulation account becomes pension paying. Any subsequent contributions are made to a new accumulation account. The fund now has two separate ‘interests’, each potentially having their separate tax proportioning of components. © Kaplan Education 9.39 9.40 5 Specialist Knowledge: Superannuation (924) Accumulation and pension assets It is possible for the SMSF to have members in both the accumulation and pension phases. In fact, an individual member can have benefits in both phases. If the SMSF is paying any form of pension to its members, the assets generating income and growth for pension payments are referred to as pension assets. All other assets are referred to as accumulation assets. From 1 January 2006, an SMSF can only pay pensions as an account-based pension, allocated pension or term allocated pension (TAP). 5.1 Tax treatment of income from pension and accumulation assets It is important that trustees do not allow preserved or restricted benefits to be withdrawn as a lump sum or used to commence a pension unless the relevant member has satisfied a condition of release. Not only is this a serious breach of the SIS legislation, with significant trustee penalties applying, but any resulting lump sum will be taxed as income. One of the most important differences between pension and accumulation assets is the tax treatment of income and capital gains. The tax on income and capital gains on assets used to pay pensions is 0%, whereas income and capital gains on assets still in the accumulation phase are taxed at the normal superannuation fund rate of 15% and 10% (where eligible), respectively. The zero tax rate on pension asset income applies to all income, dividends, rent, interest and capital gains. Transfer of assets to pension phase without CGT A significant advantage of an SMSF is its ability to transfer assets from the accumulation phase to the pension phase without incurring any capital gains tax (CGT) liability. When the asset is eventually sold to fund pension payments, a zero tax rate will then apply to any realised gains. This applies even when the asset was acquired in the accumulation phase. CGT treatment of pension assets in the fund upon death Should an existing pension cease on the death of a recipient, the assets backing that pension return to the ‘accumulation phase’ of superannuation. Consequently, they will be subject to capital gains tax at SMSF rates if these assets are liquidated and paid as a death benefit. The cost base of the asset will be the value of the asset at the original date of purchase by, or contribution into, the fund. If it is foreseen that a pension may be discontinued at some future time, periodic sale and repurchase of favoured assets will refresh the cost base at no tax cost while the pension operates. This can potentially minimise the CGT at death. 924.SM1.9 Unit 9: Self-managed superannuation funds 6 Administration The administration of an SMSF is a crucial part of its success. Appropriate forms must be completed, and reports and statements prepared. There are also tasks relating to payments and tax. This section outlines several of the key administration processes needing to be covered for an SMSF. 6.1 Making investments After the investment strategy has been completed and submitted to the trustees for approval, specific investments have to be made. An investment consultant or financial adviser can provide trustees with assistance in selecting and placing the investments. Trustees, whether individual or corporate, are the legal owners of assets in SMSFs. The trustees or corporate trustee must be shown on all application forms and title documentation, rather than the SMSF. However, the documentation should clearly identify that the trustee is holding the investment on behalf of the SMSF. Application form Application forms for investments should be completed by the applicants and checked for accuracy before being lodged with the investment institution. There should be a follow-up procedure to ensure that applications have been received and that the following information has been recorded correctly by the investment institution: • the chosen investment • the amount invested • the number of units allocated and the allocation price • the registered name of the investor (the trustees or corporate trustee). If entering into contracts, the name of the individual trustees or corporate trustee should be used in the same manner as mentioned above. Investment reports After the investments have been placed, trustees should receive regular investment reports with appropriate comments on the status of the investment strategy. The reports should also detail how any changing requirements of the fund impact on the investment strategy. Superannuation fund bank account Payment for all investments should be from a bank account established specifically for the superannuation fund. This procedure helps to create an audit trail for all fund transactions. Details of each bank transaction should be recorded and retained for 10 years. © Kaplan Education 9.41 9.42 6.2 Specialist Knowledge: Superannuation (924) Cash flow management The bank account with accompanying description of each transaction is one of the source documents for the fund. During the year the SMSF will receive contributions and income from investments. The SMSF might also incur outgoings, such as tax payments, administration fees and benefit payments. The timing of such cash flows should be checked against the balance in the bank account to ensure there is no excess cash in the fund that should be placed into one of the investments. Before placing any investments, future cash flows should be determined to ensure that investment transactions are not incurred unnecessarily. 6.3 Annual statutory requirements Trustees must ensure that the following take place each year: • preparation of a set of accounts for the fund (this can be delegated to an accountant) • preparation of a tax return for the fund • preparation of an independent financial and regulatory audit on the fund • completion of member contribution statement(s) • lodgment of the annual return with the ATO. The return comprises the fund’s tax and regulatory returns plus the member contribution statement. Independent financial and regulatory audit Each year trustees must commission qualified independent audits of the fund. SMSF auditors do not have to be registered under the Corporations Act, but they must belong to a professional organisation listed in Table 6. Table 6 Auditor affiliations Professional organisation Manner of association Australian Society of Certified Practising Accountants Member The Institute of Chartered Accountants in Australia Member National Institute of Accountants Member Association of Taxation and Management Accountants Member or fellow National Tax and Accountants Association Ltd Fellow 924.SM1.9 Unit 9: Self-managed superannuation funds Audit requirements The auditor must check the preparation of the accounts and confirm that the SMSF has not breached certain sections of the SIS Act. These sections can change from year to year but generally require the auditor to check: • identification of the trustee(s) in the trust deed • consent and trustee eligibility declarations • compliance with the sole purpose test • compliance with the investment rules • keeping of certain records for certain periods • completion of the required annual returns • appointment of certain service providers in writing • compliance with the preservation rules. Auditor reporting breaches Auditors must report certain breaches to both the ATO and the trustees. Minor or immaterial breaches, however, only need to be reported to the trustees. In these cases, the auditor will need to document their reasons for not reporting the breach to the ATO. They must outline the action to be taken by the trustees to rectify the breach. Annual compliance return After conducting the audit, the auditor completes a compliance return. The compliance return must then be signed by the auditor and trustees or corporate trustee and lodged by the due date. Annual regulatory fee In 2007/08, a flat annual regulatory fee of $150 must be paid by the due date for annual report lodgement. A penalty of $110 applies for every 28 days or part thereof (up to a maximum of $550) that the annual return is lodged after its due date. Annual tax return From the 2007-08 income year, trustees will lodge the new Self managed superannuation fund annual return 2008 (NAT 71226). The new SMSF annual return replaces the old fund income tax and regulatory return and member contribution statements (MCS). This new annual return can be used only by SMSFs. Lodgement dates for SMSF returns prepared by a tax agent are: • new funds — 28 February of following year to income return • existing funds — 15 May of the following year to income return. © Kaplan Education 9.43 9.44 Specialist Knowledge: Superannuation (924) Valuing assets To complete their financial reports a fund must undertake to value its assets every year. In the Superannuation Circular 2003/1 ‘Self managed superannuation funds’, the ATO specified that it expects SMSFs to value their assets at market value for their financial statements. This allows trustees to: • ensure the fund is operating within its asset-weighting guidelines, as set out in the investment strategy • accurately measure the level of the fund’s in-house assets and ensure compliance with the 5% rule • obtain information on how the fund is performing • calculate member benefit entitlements. Member contribution statements An SMSF must also lodge a member contribution statement with its annual return to the ATO. This allows the ATO to track contributions for eligibility to the co-contribution as well as monitor contribution levels in relation to the concessional, non-concessional and CGT contribution caps. The member contribution statement must include all information that the trustees believe is reasonable for the member to understand their investment, including: • opening and closing balances of the member’s account at the end of the reporting period • the value of the member’s benefits at the end of the reporting period, including, as far as practicable, the various components of the benefit • details of any changes in the circumstances of the SMSF that affect the member’s benefits • the return achieved by the SMSF over the reporting period. Tax liabilities should be taken into account when reporting member benefits. 924.SM1.9 Unit 9: Self-managed superannuation funds 6.4 Record keeping SMSFs must follow common law principles on record keeping for trusts. Generally speaking, trustees or directors of a trustee company must be able to substantiate their decisions with appropriate documentation. Records that should be retained include: • minutes of all trustee meetings. Matters requiring minutes include, but are not limited to: – establishment of the fund – consent to act as trustee (or director of corporate trustee) – changes in trustee(s), together with consent(s) to act as trustee(s) from incoming trustee(s) – adoption of an investment strategy – choice of or change to investments – payment of benefits – acceptance of members into the fund – acceptance of annual accounts, tax return and ATO return – amendments to the trust deed • applications to become a member of the fund • trustee declarations from new members that they understand their obligations as a trustee of the fund • a nomination of beneficiary form for each member • an application to the ATO to become a regulated fund and acknowledgment by the ATO • an application for a tax file number and acknowledgment by the ATO • reports and/or statements given to members • accounting records • tax returns including information required to calculate tax on capital gains • information provided to members. This includes the PDS. Member records Generally, member records will include: • starting account balances of all members • contributions received for each member and whether they are concessional or non-concessional • government co-contribution • mandated and non-mandated employer contributions • child contributions • rollovers and transfers received for each member • investment earnings allocated to each member • expenses and tax debited to each member’s account • details of insurance premiums paid and insurance proceeds received, if any, for each member of the fund. © Kaplan Education 9.45 9.46 6.5 Specialist Knowledge: Superannuation (924) Payment of SMSF benefits SMSF benefits can be paid in the following ways, provided they are allowed for in the trust deed: • a single lump sum • an interim lump sum and a final lump sum • one or more pensions • two or more of the above methods. Paying a lump sum benefit Paying a lump sum benefit from an SMSF involves several steps: 1. The trustees should receive a written request from the member. 2. The trustees must confirm that the benefit can be paid, that is, that the amount is neither preserved nor restricted. 3. The trustees should resolve to pay the benefit if it is appropriate. 4. If the withdrawal is the total amount, the payment should include investment earnings to the date of withdrawal. A reasonable interim earning rate could also be used. 5. If the member is under 60, the trustees should prepare a PAYG payment summary with appropriate copies given to the member, sent to the ATO and retained by the SMSF. 6. Trustees should deduct tax to be withheld from the payment if the member is under age 60. This amount should be remitted to the ATO. Note: The final steps require a fund to be registered for PAYG. If only one benefit is likely to be paid, a fund can deregister after paying the benefit to avoid having to submit ongoing quarterly returns. 924.SM1.9 Unit 9: Self-managed superannuation funds Paying a pension Commencing to pay a superannuation pension from an SMSF involves the following steps: 1. The member provides a written request to the trustees to commence a pension. The request must specify the date and the benefit. 2. The trustee confirms that a condition of release has been met. 3. The trustee checks that the trust deed allows for payment of a pension. 4. The trustee completes a fund minute establishing the commencement of the pension. 5. The trustee determines the date of establishment and/or when commutation occurred. 6. The trustee establishes the asset value of the pension as at the start date. 7. The trustee establishes the components of the pension (taxable/tax-free). 8. If the member commencing the pension is under age 60, the trustee completes an application for PAYG withholding registration and obtain an actuarial certificate for the SMSF’s pension assets to confirm their tax-exempt status. (Note that this is not required for funds using the segregated assets method and paying only account-based pensions, allocated pensions or term allocated pensions.) 9. The trustee completes a tax file number notification form and lodges it with the ATO within 28 days of receiving it from the pension recipient. 10. The trustee advises the pension recipient of the pension income details and confirms the amount and frequency of payments. Calculate any tax to be withheld from each of the payments. 11. For transition to retirement pensions, the trustee advises recipients of the maximum and minimum payment ranges. Confirms the amount and frequency of payments. Calculates the tax to be withheld from each of the payments. 12. For market-linked pensions, the trustee confirms the term that the pension will be payable for and that no commutations are allowable (exceptions excluded). 13. The trustee arranges the periodical payment of net pension and remits tax where appropriate. Calculating the pension The calculation of the pension involves the following steps: 1. Determine the proportion of taxable and tax-free components calculated on commencement of the pension. 2. Determine any reversionary beneficiary who would receive benefits after the death of the member. (Note that pensions cannot revert to a non-SIS dependant or to a child of the member who is not under age 18 or, if financially dependent or disabled, under age 25. In the case of children under age 25, the pension must be commuted to a lump sum by the time they turn 25.) 3. Calculate the tax-free proportion of income payments. © Kaplan Education 9.47 9.48 Specialist Knowledge: Superannuation (924) Allocated pensions and term allocated pensions at the end of the financial year The procedures for allocated pensions and term allocated pensions are as follows: 1. Provide the statement to the client confirming the amount of the pension funded from the SMSF. 2. If the member is under age 60, prepare a PAYG payment summary for the payment of the pension to the member. 3. Complete any PAYG tax reconciliation requirements for members under age 60 and forward them to the ATO by the prescribed date. Existing pensions at the beginning of the financial year The procedures for existing pensions are as follows: 1. Establish the asset value of the pension at the beginning of the new period (1 July). 2. Advise the pension recipient of the new income level(s) based on the balance of pension assets at the beginning of the new period and the relevant payment or valuation factor. Confirm the amount and frequency of payments. For members under age 60 calculate the tax to be withheld from each payment. 3. Arrange for the periodic payment of the net pension, and pay tax when it falls due. 4. If there has been a change in circumstances, complete a tax file number notification form and lodge it with the ATO within 28 days of receiving it from the pension recipient. Reversion to public offer funds Once pension payments commence for an SMSF, keep in mind that $200,000 is generally considered a reasonable minimum level of assets required. This is because SMSFs can be relatively expensive to maintain (as discussed in section 1). If assets fall below this level, or below any other level that makes the SMSF viable, seriously consider saving costs by reverting to a public offer fund. 6.6 Monitoring Australian superannuation fund status To maintain compliance, SMSFs must always meet the SIS definition of an ‘Australian superannuation fund’, which is a fund that: • was established in Australia and holds assets in Australia • has its central management and control ordinarily located in Australia • does not have more than 50% of its assets attributed to a non-resident member that is actively making contributions. 924.SM1.9 Unit 9: Self-managed superannuation funds 7 Winding up an SMSF There may come a time when the trustees of an SMSF may wish to wind up the fund. This could occur for a number of reasons, such as: • the death of the primary member of the fund and the remaining members not wishing to accept responsibility for ongoing management of the fund • the realisation that a larger fund, such as a public offer, industry or corporate fund, can sometimes achieve better returns or cheaper fees • the realisation that with falling balances the SMSF is no longer cost-effective to maintain • reduced ability or willingness of trustee members to continue with the onerous duties and responsibilities of an SMSF as they get older. 7.1 Procedures for winding up an SMSF APRA guidelines specify the procedures for winding up an SMSF. Briefly, these guidelines require the trustees to: • record and document the decision to wind up the fund • formulate and record an action plan for the wind up • advise APRA that the fund intends to wind up • provide APRA with a time frame and action plan for winding up the fund • arrange for the valuation and realisation of fund assets in an orderly manner • record and distribute any fund reserves • pay outstanding liabilities • arrange for the production and audit of the SMSF’s final set of financial statements and provide for any final expenses, such as taxes and audit fees • calculate and have audited the final member account balances • arrange for the rollover of member balances to other regulated superannuation funds • complete the final wind-up tax return • lodge any outstanding income tax and regulatory returns and pay any outstanding taxes. The trustees should generally wait until the SMSF has no assets or liabilities before submitting the final wind-up tax return. If the fund is not wound up at the end of a normal financial year, an annual tax return will still be required to complete the final wind-up process. © Kaplan Education 9.49 9.50 Specialist Knowledge: Superannuation (924) Further resources • SuperGuardian 2005, ‘Winding up a self managed super fund’ [online], Your Guardian, October, Adelaide: SuperGuardian. Available from: <http://www.superguardian.com.au> by selecting ‘Online resources’ then ‘YourGuardian newsletter’ and then ‘October 2005’ [cited 4 June 2008]. • ATO 2007, ‘Winding up a self managed superannuation fund’ [online]. Available from: <http://www.ato.gov.au> by entering ‘winding up super’ in the search box. Reflect on this: Is winding up administration or advice? When a client decides to wind up their SMSF and move their moneys into a public offer pension, is the focus around the administration of the wind up or on advice? 924.SM1.9 9 Appendices 1 Confirmation of consent and eligibility form 2 Section 52 covenants 1 Unit 9: Appendix 1 Confirmation of consent and eligibility form CONFIRMATION OF CONSENT AND ELIGIBILITY To: The Trustees of the Superannuation Fund (‘Fund’) I confirm that I consent to act as trustee of the abovementioned fund and that I am eligible to act as a trustee of the Fund for the purposes of the Superannuation Industry (Supervision) Act 1993, and in particular, I confirm that: 1. I have never been convicted of an offence in respect of dishonest conduct against or arising out of a law of the Commonwealth, a State, a Territory or a foreign country and no order has ever been made in respect of me under section l9B of the Commonwealth Crimes Act 1914 or a corresponding law of a State, Territory or foreign country in relation to my having been charged with any such offence (being an order to the effect that the court, having decided that although such an offence was proved, it would not proceed to record a conviction). 2. No civil penalty order has ever been made in relation to me under the Superannuation Industry (Supervision) Act 1993. 3. I am not an undischarged bankrupt under the laws of any country and I have not, during the preceding 3 years, entered into a deed of arrangement or assignment or a composition under Part X of the Bankruptcy Act 1966 (or any corresponding law) and none of my property is subject to control under section 50 or 188 of the Bankruptcy Act 1966 (or any corresponding law). DATED: ...................................... ........................................................................ (Signature of Trustee) Notes 1 Unit 9: Appendix 2 Section 52 covenants One of the statutory duties imposed by SIS on both the trustees of superannuation funds and the directors of corporate trustees is to observe the covenants prescribed in s 52. In this way, SIS seeks to codify many of a trustee’s fiduciary duties by requiring them to be included as covenants in the trust deed of a regulated superannuation fund. These covenants will override any inconsistent provision in the trust deed and will not be able to be excluded. It is important to remember, however, that these covenants will not replace a trustee’s fiduciary duties, which will continue to operate subject to any specific provision in the trust deed. Section 52 of the SIS Act specifically provides, in regard to investment duties, that: ‘trustees are: (a) to act honestly in all matters concerning the entity (b) to exercise, in relation to all matters affecting the entity, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide (c) to ensure that the trustee’s duties and powers are performed and exercised in the best interests of the beneficiaries (d) to keep the money and other assets of the entity separate from any money and assets, respectively: (i) that are held by the trustee personally (ii) that are money or assets, as the case may be, of a standard employer-sponsor, or an associate of a standard employer-sponsor, of the entity (e) not to enter into any contract, or do anything else, that would prevent the trustee from, or hinder the trustee in, properly performing or exercising the trustee’s functions and powers (f) to formulate and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including, but not limited to, the following: (i) (ii) the composition of the entity’s investment as a whole including the extent to which the investments are diverse or involve the entity being exposed to risk from inadequate diversification (iii) the liquidity of the entity’s investments having regard to its expected cash flow requirements (iv) (g) the risk involved in making, holding and realising, and the likely return from, the entity’s investments having regard to its objectives and its expected cash flow requirements the ability of the entity to discharge its existing and prospective liabilities if there are any reserves of the entity - to formulate and to give effect to a strategy for their prudential management, consistent with the entity’s investment strategy and its capacity to discharge its liabilities (whether actual or contingent) as and when they fall due 2 (h) to allow a beneficiary access to any prescribed information or any prescribed documents. Note 1: Covenant referred to in paragraph (e) does not prevent the trustee from engaging or authorising persons to do acts or things on behalf of the trustee. Note 2: Covenant referred to in paragraph (f). An investment strategy is taken to be in accordance with paragraph (f) even if it provides for a specified beneficiary or a specified class of beneficiaries to give directions to the trustee, where: (a) the directions relate to the strategy to be followed by the trustee in relation to the investment of a particular asset or assets of the entity; and (b) the directions are given in circumstances covered by regulations made for the purposes of this paragraph.’ ...
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This note was uploaded on 10/10/2010 for the course ECON 7300 at University of Sydney.

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