Meg on SMSFs: Total Super Balance quirks unpacked

Jack,
"The mandatory minimum pension withdrawal from a super pension fund is the “flip-side” of a pension fund’s tax-exempt status." So, do you think that if (when) the govt. start taxing pensions that the minimum drawdown rates will be scrapped?

Taxing super pensions would also affect Industry Super funds and so would impact everyone, not just SMSFs. It would reduce the investment returns of industry funds and the fees they can charge. That seems unlikely with a Labor government, that enjoys the support of unions and their super funds.

Minimum pensions are a compulsory cashing out of super so I think it is more likely that the minimum pension drawdowns will increase to ensure that more of the super pension is consumed in your lifetime and not passed on to beneficiaries on your death. Imagine if the minimum drawdown was 10% per year after age 75. There wouldn't be much left as an inheritance at age 85.

Of course the money cashed out of super doesn't need to be spent but then it is no longer eligible for tax concessions. That's what this whole thing is about.

Having commenced my SMSF many years ago when the rules were very generous, it now has a TSB well over 3m, most in accumulation phase. Its investments include a number of core share holdings which, when sold, will incur significant CGT and thus reduce the TSB. I expect this applies to many
The question is then when to sell and realize this cost (and perhaps reinvest in ETFs)


The question then is when to sell and realise this

There are no significant CGT's in Superannuation.

The most you will ever pay is 15%

Usually 0% or 10%

Let's be clear, this is a "Wealth Tax" specifically targeted on SMSF's with large balances. It is designed to drive those balances out of the tax advantaged Super system and it will do just that.. We can all wax lyrical about the unfairness of taxing unrealised gains, the stupidity, the complexity and the unintended consequences but, I would suggest, if you are impacted, you plan as if it will happen. Chalmers does not care about you and does not believe he will lose a vote

It’s not a wealth tax. It’s a reduction of a concession because you have more money in superannuation than you need for a pension. You, like many people are using the superannuation purely as a tax-minimisation scheme.

I wish people were as concerned about the minimum withdrawal rules, which affects everyone, as they seem to be about the $3mil plan to tax unrealised capital gains, which affects a much smaller cohort. The minimum pension amount that must be taken next financial year is based on the value of the assets in pension phase at the end of the current financial year. To me, that's the same as having to pay a pension (yes, I know the difference is that this is not a tax) that will need to come from unrealised capital gains. The main point I want to make here is that if the value of the pension was determined at the end of June and markets tank, as they have and will, you still have to take the pension amount that is now being supported by a lower value pension account. I think that's a fundamental problem with the super system that needs to be fixed as it's a more corrosive aspect of the current system that affects everybody in pension phase.

Bryn you make a really interesting point here that I don't think has been talked about anywhere near enough. Over the last few years, we've had normal draw down rates halved to help people avoid realising assets during Covid. That ends from 1 July 2023. In addition, I think many people will be caught by the fact that they have ALSO had a significant birthday in that time - perhaps turning 85 (which is the time the normal draw down rate goes from 7% to 9%). Someone in this position will "feel like" their draw down rate has jumped enormously - they might not really have noticed the increase from 3.5% to 4.5% but they will definitely notice 3.5% to 9%.

As to whether the calculation of minimum pensions is fundamentally flawed (given that it doesn't allow for subsequent drops in market values after 30 June), I can see your concern but I don't have a better suggestion. I'm definitely not an investment adviser I do they often tell their clients to keep slightly higher cash balances than people with purely accumulation accounts because they want to be able to meet pension payments without being forced to sell assets at the wrong time. There are a couple of things people do to address your concern - not all may be suitable for you but I'll mention them just in case one is useful. Note that all of these are SMSF specific - they won't work in a public fund:
- some bring in younger members (eg adult children) who are still able to contribute (so that their contributions can be used to provide some of the cash flow needed for pensions and leave the assets untouched).
- those with accumulation accounts benefit from the fact that they get to use cash income from across the entire portfolio (including any accumulation balances) to fund pension payments - this is one reason to leave accumulation accounts in super rather than taking them out
- you could SELL some of your SMSF's assets to yourself for cash and use that cash to make pension payments. Note - this is different to making the payments themselves "in specie" by GIVING yourself those assets - you can't do that. But you can SELL assets to yourself and use the resulting cash to make payments. This means you have to take the assets out of super but if you think it's something that will go back up again, at least you're hanging on to the asset itself. (Note that sometimes if the asset is something like listed shares it's actually simpler to just sell them as usual in the super fund, pay yourself a pension, and then use that cash to buy the same thing in your own name.)

Of course eventually there's no way around it - pensions are specifically designed to make us draw down on our capital eventually. It's just that ideally you'd like to be able to control the timing.

The mandatory minimum pension withdrawal from a super pension fund is the “flip-side” of a pension fund’s tax-exempt status. You can’t have one without the the other. The minimum pension is something the auditor and ATO pay very close attention to, because failure to meet this requirement means the fund will lose it’s tax exempt status and will then be taxed as an accumulation fund. The date used is 30 June, because the tax return clearly sets out the fund balance and therefore the following year’s minimum pension can be precisely calculated.

You could choose to hold all your super in an accumulation fund, even in retirement. Unlike a pension fund, there is never a requirement to withdraw any money and so these funds can continue to grow until death which is a cash-out event. The downside is, of course, that the income in an accumulation fund is taxed at 15% and capital gains are taxed at 10%

I too have concerns with the minimum drawdown rates. I am very comfortable drawing down 'what I need for a comfortable life' as is currently the case with the halving of the drawdown rate due to economic conditions. (I draw about 2/3 of the usual minimum drawdown).
I dont want a heap of cash accumulating we need to spend, or reinvest, or something. It doesn't drive good decisions and creates extra work.
I'd even be comfortable to pay more tax on death, if that was the trade off.
I havent heard whats happening next financial year. Are the minimum drawdowns reverting back to the full amount?

Hi Trevor, I think it's likely the minimum drawdowns will return to 'normal' for FY24 as the Government does not want money accumulating in super pensions and expects people to withdraw it 'to live on'. But you don't need to spend it. It can become an investment outside super rather than inside.

How about, if a TSB of greater than $3m achieves an unrealised gain or profit ( ie, a theoretical profit that isn't actually received by the fund). In which case, it follows logically that it should only attract an unreaslised tax (ie a theoretical tax that isn't actually received by the ATO). Unrealised profits and gains are an imaginary accounting tool to estimate what might be realised if if an event occurs. Likewise any taxes attracted by an unrealised gain should also be an accounting tool only, to estimate what the ATO would receive if that event occurred. If I own a house that increases in value every year, I should not expect to have to pay an unrealised capital gains tax every year. It should only occur when an event occurs such as sale or transfer...logical. What next...what about the possessions, vintage cars, jewellery, great works of art. What, pay unrealised capital gains tax on everything every year? Morally one should never impose real taxes on unrealised events...that is just highway robbery. 

"...it follows logically that it should only attract an unrealised tax (ie a theoretical tax that isn't actually received by the ATO)."
I love your reasoning Mark. That is perfectly logical.

Tax Provision for Unit Pricing Policy:
https://www.aph.gov.au/-/media/02_Parliamentary_Business/24_Committees/243_Reps_Committees/Economics/46p/Banks_and_Financial_Institutions/2_Superannuation_-_First_Report/REST/REST74QW.pdf

Does not harm to estimate future tax liabilities.
Harms to pay tax on estimate future tax liabilities.

We need clarity! 1. Will existing pension phase funds be taxed if the total super balance is over $3 million? Outrageous! 2. How can unrealized gains be treated as income? Will this new definition apply to accounting outside of super? 

No one knows exactly what will be with the new legislation.

Unless you were living under a rock, you'd know the government were taking submissions from the public up until 17th April.

Most of us hoping taxing unrealised gains is removed, indexation of the $3M comes in and amendments to early access to Superannuation for those with amounts over $3M comes in.

Final legislation will hopefully have the Nitty gritty sorted out, personally I doubt it.

Absolutely. If they don't allow young people to pull their money out of super once they have more than $3 million than the policy is highly discriminatory based on age, because baby boomers can pull money out and put it into trusts and companies to get a lower tax rate but young people can't. Young people would be forced to pay the higher tax rates and be trapped in the super system for potentially decades with no way out until they turn 60.

The proposed tax is calculated from the values of the TSB at the start and end of the year. TSB includes money in the accumulation phase as well as any money in the pension phase. See page 8 of the consultation paper. It follows that the tax is based on both accumulation and pension accounts, regardless of how they might be segregated. If CPI inflation runs at around 7% for another 5 or 6 years, it will be possible for this tax to apply to accounts that are entirely in pension phase.

Couple of errors in your thinking JJ.
First, you can't assign certain assets to the pension phase and the rest of your super. The $1.9 mn in tax free is a share of all the assets in your total fund. So if you have $3.8 mn in total, then half the income you earn on that total is deemed to have been earned in the pension phase and won't be taxed, while the rest is taxed at 15%.
Second, the additional tax on, say, growth in your fund from $3.8 to $4.0 mn is only levied on the portion of earnings attributable to the fund over $3mn. In this case, the excess is 4 - 3 = 1, which is 25% of the total at year-end. So the taxable income is 25% of $200k (4.0 - 3.8) or $50k and it's this which is then taxed at an additional 15%. That doesn't create an effective taxation of any of the $1.9 mn in pension phase. It's a marginal tax on the marginal earnings, albeit defined differently to the 0% and 15% on earnings in the fund.
Your conclusion is therefore incorrect.

Yes, but no.

First off, of course you can segregate pension phase and accumulation. Simply transfer the TBC to a different super fund when you go into pension phase.

Secondly, since the additional tax is triggered by your TSB and then applies to a proportion of earnings, it's all a matter of perspective. One way to think of your TSB is in layers, with Pension at the bottom and Accumulation at the top. That way, it's earnings on the Accumulation piece that attract the additional tax. But you could just as easily think of the layers the other way around, in which case the additional tax applies to the Pension layer first. And, of course, you can also think of each $1 of earnings as being mixed between Pension and Accumulation in just the way that you explained the sharing in the first place!

Thanks Richard. Yes, if you use different funds you can segregate in that way. I was of course presuming (maybe not correctly) that the context was an SMSF. Of course once the ATO aggregates to get your total balance that segregation becomes irrelevant for the new tax. Does that mean that the earnings on the pension portion are being taxed? Only tobthe extent that your segregation strategy is an attempt to avoid tax in the first place! For anyone not trying that one on, yes you can still think.of the tax as being on some of the pension fund earnings if you are dead set on making that argument. But the reason the new tax is only based on the portion that's over $3mn is because it's not the earnings on the 1st $1.9mn that drive the tax. It's only because you are over $3mn that a tax becomes payable so clearly it's not a tax on the first $1.9 mn pool. I'd rather the tax didn't come in of course..But arguments against it that try to convolute it as a back-door tax on pension account earnings just don't stack up.

you are correct about the inability to segregate assets in the Pension vs. Accumulation phase.

However, the point JJ is trying to make is better illustrated by :
Assume you have only $1.9 m in Pension phase(none in Accumulation Phase) next FY. so all earnings are tax free subsequently. Suppose that you invest in Bitcoin now and it goes up to $10 M . You pension TSB is now in excess of $3 m and the unrealised gain is now taxable even though it all came from the tax free Pension phase initially.
Assume then that you paid the new tax of 15% on the amount above $3 m eg. 10 - 1.9 divided by 1.9 times 15% i.e. $639,000 tax bill due. You pay this but did not sell your Bitcoin. The next day the Bitcoin value drops to ZERO.
You have no recourse to recoup what you have paid. i.e. you are up s*** creek.

you are up s*** creek because you bought Bitcoin, a highly volatile asset, and took a heavily overweight exposure to it in your portfolio. NOT because of a new tax regime.

This example still doesn't make it a tax on the $1.9 mn, which was the point of the argument. It might make it a badly designed tax, but it's not a tax on tax-free earnings by the back door.

I am a keen reader of Firstlinks and thought I would send you a copy of a question I have sent to the ATO on the Consultation Paper. "I understand that, when in retirement, funds which have been contributed to a pension account up to the level of one's Personal Transfer Balance Cap generate tax-free income, and that this will continue regardless of whether the balance in the fund has grown to a higher level due to favourable investment performance. I am concerned at whether this will continue the new proposal. As an example, if one's overall superannuation funds were structured such that a high-earning investment were to be adopted for the tax-free part, with a lesser-performing but more secure investment for the remainder, it could well happen that the total earnings would cause a substantial increase in the Total Superannuation Balance beyond the new $3 million limit. This would mean a significant increase in tax payable, even though the bulk of the earnings were coming from the tax-free part. The funds which had orginated from beneath the Transfer Balance Cap, would now have become taxed! The promise of tax-free status for this quantum would have been destroyed. I hope this is not an unintended consequence of the proposed new rules. I would appreciate some feedback on the point which I raise."

As I see it, the tax-free status of a pension-paying fund which was properly created so as to not exceed the Transfer Balance Cap will be destroyed.

Hi JJ - in answer to your question, I really like Richard's explanation above about thinking of your super in layers. The key point is that tax within the FUND won't change and you'll continue to enjoy tax free investment income on whatever proportion of your fund is represented by your pension. But this new tax will be on you personally and will ignore differences between pensions & accumulation accounts and simply look at your super overall. In theory, as talkingcrap mentions, a fund that is 100% in pension phase but has experienced massive growth in assets could end up triggering this personal tax even though the fund itself isn't paying any tax (as it's all in pension phase, earnings remain 100% exempt from tax within the fund). And even worse (again, as mentioned above), the tax will be paid on growth even if this growth ends up not being realised because the assets go back down again. I (and others) have suggested that this outcome alone is enough to warrant losses giving rise to a tax REFUND (perhaps capped at the amount of this tax paid over your lifetime to date) not just a loss carried forward. Let's see if this tweak makes its way into the legislation.