There are a great number of benefits to having a significant saving in Superannuation which will one day pay a pension to you in retirement. Once a pension is commenced, a fund that has all of its assets backing a pension is exempt from paying tax on its taxable income (except tax payable on concessional contributions) or taxable capital gains.
If 100% of the fund is in pension mode for the whole of the year, then your fund will enjoy a 100% tax exemption during that year. This can be extremely useful when combined with other tax advantaged income such as franked dividends. For example if we take a fund that receives $100,000 of income with $16,800 of franking credits attached, as well as receiving $49,000 of taxable contributions:
| Pension Phase | |
|---|---|
| Fully Franked Investment Income | 116800 |
| Concessional Contributions | 49000 |
| Total Taxable Income | 49000 |
| Tax Expense @ 15% | 7350 |
| Franking Credits | 16800 |
| Tax Payable (Refund) | -9450 |
As the income of the fund is not taxed, the franking credits are refundable and this offsets the tax payable on the contributions made to the fund. In the absence of the contributions, all the franking credits would come back to the fund once the tax return is lodged.
However, lets consider another example of a member who delays starting their pension until half way through the year. The SMSF has income of $100,000 with $16,800 of franking credits attached. As is common with investments, income was not received equally throughout the year with the fund actually receiving 65% of the years income in the first half of the year.
In this situation you have two options. You can draw a line in the sand with all income received while the fund was in accumulation mode being taxable, and the exemption applying only from the date the pension commenced. As you can see, the franking credits negate the tax payable during the accumulation phase for the year and the fund would receive a refund of $5,420.
Alternatively, you can get an Actuary to certify the tax exempt percentage of the fund for that financial year. If an actuarial certificate is obtained for the fund, it would show that the pension started exactly 50% into the year, and so the tax exempt percentage of the fund is 50%. Lets look at the resulting comparison of the tax exemption that your fund would enjoy.
| Income Exempt from Pension Commencement | Income Exempt as per Actuarial Percentage | |
|---|---|---|
| Total Investment Income | 100000 | 100000 |
| Franking Credits | 16800 | 16800 |
| Total Income | 116800 | 116800 |
| Taxable Income | 75920 | 58400 |
| Tax Expense | 11380 | 8760 |
| Tax Payable (Refund) | -5420 | -8040 |
As you can see, because not all the income was received evenly throughout the year, there is an advantage in using the Actuarial method. If on the other hand more income was received, or if a major asset was sold with significant capital gain in the later part of the year, then the result would have been reversed.
The good thing is that you don't have to decide which method you will use beforehand. You can choose the method that will give you the best result, once you know what the result will be. Where a fund has not been solely a pension fund during a financial year it is always worthwhile considering the strategies available. The benefits can be substantial.
