SMSF’s – The Basics
posted on April 11th, 2011 by David
There are a number of reasons why an increasing number of investors have been turning to self managed superannuation funds (SMSF) as the investment vehicle of choice within Australia over the past few years. SMSF investments total about $390 billion, being almost one quarter of the total superannuation system investment pool. Traditionally employees and investors have preferred to hold their superannuation balances in retail superannuation funds that offer limited control over flexibility and investment choices, a reduced number of taxation planning opportunities and percentage based annual fees. However investors today are becoming increasingly sophisticated and financial advisors are much more active in directing their clients towards establishing an SMSF, utilising their investment flexibility and potential taxation benefits.
Superannuation is an attractive investment vehicle for investors due to its concessionally taxed environment. A differentiation must be made between assets held in accumulation and pension phase within the SMSF for taxation purposes. A fund member during accumulation phase will pay tax at a rate of 15% on all taxable income (10% where capital gains held for greater that 12 months), whilst in pension phase the member pays 0% tax. Now when you make the comparison to the other investment vehicle options being, companies where income is taxed at 30% or trusts where the income will ultimately be distributed out at the beneficiaries marginal tax rate, you can see the tax effectiveness of holding savings inside superannuation.
All members will remain in accumulation phase until such time as reaching preservation age, currently age 55, and a condition of release.
From age 55 the member has the option to then commence drawing a pension from their superannuation fund whether they continue to actively work via what is known as a “Transition to Retirement Pension“ or permanently retire from the workplace, through an “Account Based Pension”. Obviously significant benefits can then be achieved through transferring the member’s accumulation balance across to pension phase.
Whilst between 55 and 59 years of age a Transition to Retirement Pension may significantly benefit the net tax position of a member inside an SMSF, it is important to understand that in pension phase a pension amount needs to be drawn from the fund each year. The concessional or taxable component of the member account will form part of the member’s personal taxable income, however a 15% tax offset may be claimed. It is worth noting that inside a Transition to Retirement Pension a member has the option of drawing anywhere between 4 – 10% of the value of their member account at the commencement of the financial period.
Upon reaching age 60 most superannuation fund members will be advantaged by commencing a Pension. In addition to the tax free status of income on assets supporting the pension inside the superannuation fund, all pension amounts withdrawn by the member are now tax free. Keeping this in mind you can see the great benefits in holding investments within a super fund once reaching what we term a “condition of release”
From age 65, or after the member has permanently retired from the workforce, a Transition to Retirement pension will revert to an account based pension. The main difference between the two pension types is the removal of the 10% limit on pension drawdowns each year.
An SMSF provides members with a level of flexibility and control that far exceeds any of the other offerings.
Cost is a significant factor when considering retirement savings. Within a retail fund both a husband and wife’s account may pay fees of up to 3% (often hidden) resulting in a combined balance of $500,000 paying management expenses in the vicinity of $10,000 – $15,000 each year, however within an SMSF the same $500,000 balance may only attract annual fees of $2,500 for administration and $400 for audit, with the advantage of remaining relatively constant despite any overall growth in SMSF assets.
Investment assets accumulated within an SMSF carrying significant unrealised capital gains can be disposed of free of tax once the member reaches age 55 and commences a pension. Within retail funds it is very common for members to have all investments effectively sold off prior to entering pension phase and of course triggering “unnecessary” capital gains tax prior to commencing the pension. The timing and choice of SMSF investment disposals remains in the hands of its members and their advisers and is crucial in the overall minimisation of tax within the fund.
Income generated on SMSF investment assets is taxed at a flat rate of 15%. Unlike a retail fund where a net investment balance movement is periodically attributed to their members, SMSF investments are directly owned and all income and their various components are retained. All Imputation and franking credits associated with dividends and trust distributions generated by the fund are able to be used to offset any income or contributions tax during the year and excess credits may result in a fund tax refund at year end. Where members are in pension phase most advantage is achieved, as all income and capital gains are tax free and the fund is still able to claim back the full amount of any tax credits generated.
An advantage may be gained due to the difference in timing of tax payments by an SMSF. Any taxable contributions made to a retail fund are reduced by the 15% contributions tax on the date they are received by the fund, hence only 85% of the contribution actually makes the members account. Now compare this with an SMSF where the full 100% of the contribution is available for investment with any tax generally payable at a later date or as far as 10 months after the end of the financial year the contribution is made. By having a member in both accumulation and pension phase the fund may never have to remit any contributions tax to the government due to tax credits generated on income offsetting this amount and the annual net tax position of the fund being a refundable one.
David Petterson – Premier SMSF Solutions