SMSF members who are not yet fully retired may have both a pension and accumulation interest in the fund. They may still making contributions but having some of their balance in the tax-free retirement phase.
It is not uncommon to see members who have met a condition of release move accumulation balances into the retirement phase to maximise tax free earnings. Since the capital supporting an income stream cannot simply be added to, in order to move the accumulation balance into retirement phase the member might:
- commence a new income stream with their accumulation interest and so have multiple pension interests in the fund. or
- commute their existing income stream back to accumulation phase and re-commence a new income stream with the total balance, maintaining one pension interest in the fund.
Whenever an income stream is commuted to accumulation phase the amount commuted will be added to the member’s accumulation interest at that time. If an income stream is then recommenced there is a requirement to re-calculate the tax free and taxable components of the new pension interest.
Commuting an income stream
At any time, a member of an SMSF may roll back, or commute, their superannuation income stream to accumulation phase. This commutation may occur for many reasons. For example:
- Commute in full to ensure minimum pension standards are met e.g. if the minimum pension payment requirement for the income year is not going to be met based on the pension payments made to date, the income stream might be fully commuted part way through the year so that the pro-rata minimum pension payments will have been met.
- Due to liquidity issues, perhaps due to falling investment markets, income streams might be commuted in full to remove the requirement to make a pension payment in the following year. This would allow the fund to avoid selling assets to meet benefit payments at a time when they might realise large losses.
- In order to ‘reboot’ an income stream to shift monies currently sitting in accumulation phase into retirement phase.
Recommencing an income stream
Unlike the tax components of an income stream, which are set at commencement, the tax components in accumulation phase will change over time as earnings and contributions are received. For example, earnings and concessional contributions increase the taxable component of the interest, and non-concessional contributions increase the tax free component of the interest.
When a new income stream is commenced trustees need to ensure they correctly calculate the tax-free and taxable components of the new superannuation interest based on the tax components of the accumulation interest at the time the income stream is commenced. This re-calculation of the tax components is also required if a member commutes an income stream in full in order to reboot their pension with existing accumulation balances on the same day.
The requirement to calculate the tax components whenever a new income stream is commenced is confirmed in Subsection 307-125(3)(a) of the ITAA 1997, which states,
(3) For the purposes of subsection (2), determine the * value of the * superannuation interest, and the amount of each of those components of the interest, at whichever of the following times is applicable:
(a) if the * superannuation benefit is a * superannuation income stream benefit--when the relevant * superannuation income stream commenced
Bob, a member of an SMSF, commenced an account-based pension on 1 July 2018 with the full balance of his accumulation account of $100,000. The tax-free component (TFC) of Bob’s new income stream was calculated to be 50% and the taxable component (TC) of the income stream was 50%.
At 30 June Bob’s account-based pension balance was $85,000, reflecting payments to Bob of $4,000 and negative investment returns of $11,000 allocated to his pension interest during the 2018-19 year.
In the 2018-19 income year Bob received $25,000 in concessional contributions, $50,000 in non-concessional contributions and a negative investment return of $2,000 was allocated to his accumulation interest for the year. His accumulation balance at 30 June was $73,000 with a tax-free component of $50,000 (68% TFC and 32% TC).
On 30 June 2019 Bob decided to fully commute his account-based pension to accumulation phase. As per paragraph 307-125(3)(c) of the ITAA 1997, the TFC of Bob’s commuted pension account was $42,500 and the taxable component was $42,500.
Bob decided to commence a new account-based pension on 1 July 2019 with his total accumulation interest of $185,000, comprising the $85,000 lump sum resulting from the full commutation of his original income stream and $73,000 accumulation balance.
At the time just before the new income stream was commenced, the TFC of Bob’s accumulation interest was 59% and the TC of the interest was 41%:
TFC = (42,500 + 50,000) / 158,000 = 59%
TC = 1 – 0.59 = 41%
Hence the TFC of Bob’s new account-based pension is 59% and the TC component is 41%.
It is important to include the relevant tax components in the pension documentation of any new pension interest. If the tax components of an income stream are calculated incorrectly at commencement it could cause subsequent pension payments, lump sums or death benefit payments to be taxed incorrectly.
Further, where tax components are not recorded, in can be very difficult to work out the appropriate tax component at commencement of the income stream in arrears, especially if insufficient information about accumulation interests such as income and expense allocations, and contributions, has been retained.