(03) 9020 2905PORTFOLIO POINT: Considering how to protect recent gains? Some trustees might benefit from a shift to a super pension.
Stock markets seem to be getting choppy, following a largely stellar run since the middle of last year.
After months of gradual rises, the last few weeks has seen daily movements turn jittery again. A big rise last Friday, a bigger fall of 2%-plus on Monday. And those moves aren’t alone – it’s been constant in the last month.
Some big gains have already been made, for those who stayed invested throughout, or who had the guts to invest mid last year. Some SMSF trustees’ minds will be turning to how to protect those gains. Or at least minimise the amount of tax paid on them.
One way to avoid capital gains tax, of course, is to never sell. However, sometimes that is a risk that isn’t worth taking.
Another is to turn on a pension in your super fund – even for those who don’t think they necessarily want to draw an income. This can be a handy way to allow capital gains to be crystallised without having to hand over too much (potentially not hand over anything) to the tax man.
Of course, not everyone can do that. Being able to turn on a pension is a birthright – you need to be at least 55 years of age (but see below).
For others who are only a few years of that mark, this is certainly something to start planning for, or keeping in mind as you plan that run to a pension.
Accumulation fund versus pension fund
There are two “states” a super fund can be in. They are either in accumulation mode or pension mode. An individual SMSF can be both accumulation and pension, depending on the life stage and financial ambitions of the members.
And in fact, it can have multiple accumulation/pension accounts running for every member, if it makes sense for each member’s situation.
Anyone born on or before 30 June 1960 has a preservation age of 55. (The preservation age rises on a sliding scale for those born after that date, so that those born on 1 July 1964 or later have a preservation age of 60.)
It is possible to turn on a pension at age 55, while you’re still working. This is generally called a “transition to retirement (TTR)” pension (see 8/12/2010 for a broader article on this). A TTR pension is one where you are drawing from a pension fund, generally while you are still working and contributing to an accumulation fund.
There are potentially several major benefits to starting a TTR pension and combining it with a salary sacrifice strategy, even if some of the benefits have been watered down in recent years by the Rudd and Gillard governments.
Pension funds are tax free
One of the primary benefits of turning on a pension fund is that it becomes tax-free. Any income (interest, coupons, rent, dividends, distributions, etc) a pension fund earns is tax free and any capital gains can be crystallised tax free. (It’s also true that capital losses in pension phase are of little benefit.)
(Further if the income comes with franking credits, those franking credits will come back to the pension fund.)
More accurately, it is those assets that are backing the pension that benefit from the tax-free status.
What is the difference? The most obvious example would be that a SMSF might have two members and only one of which has hit their preservation age, allowing the SMSF to start a pension.
Let’s say the older pension fund member (58) is male and has a balance of $600,000 and the younger female member (53) has a balance of $400,000.
The SMSF could potentially start a pension for the older member. It is possible (but be careful and read the warning below) that the assets with significant capital gains attached to them could be transferred to the husband’s pension account.
If the assets were subsequently sold by the pension fund, then no CGT would be payable.
The opposite strategy – one which is based on minimising income tax on assets – can also make sense. Sometimes it might make more sense to transfer assets into the pension fund that are spinning off high levels of income.
Warning: The ATO will be watching
Be aware that it will look suspicious – as in send off the stench of tax evasion – if the capital-gains intensive SMSF assets are suddenly segregated one day and sold the following day. Or in any short time frame.
And even worse, if the pension is turned on, assets sold, then the fund switched back to accumulation again, particularly if in quick succession.
The ATO has previously warned on this issue. It would see that sort of situation as tax evasion and is not afraid to investigate and penalise trustees.
So, like debt recycling – where ungeared assets are sold and used to pay down non-deductible debt, while fresh assets are purchased with borrowed money – it becomes a matter of timing and degrees.
Some planning and professional advice should be sought by anyone considering doing this. It is a legal strategy, but one that if executed incorrectly, can lead to unnecessary attention from the ATO.
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The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.
Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au