With just two months to go before the superannuation reforms take effect, retired Australians who will need to transfer super savings from a pension to an accumulation account – which must occur by June 30 – should have a strategy in place if they intend to claim capital gains tax relief on investments that will become partly taxable as a result of the changes to the super rules.
CGT relief is a concession that allows profitable investments in super pensions, which are currently totally tax-free, to have their cost bases reset to a higher value – say, as of June 30 – so that when they are eventually sold any gains will not be taxed as severely.
Retirees who will be affected by the rule change are those who have, or are deemed to have, a pension interest in a total super balance that exceeds $1.6 million, as well as anyone with profitable investments in transition to retirement income streams (TRISs). From July the earnings generated by TRISs will no longer be tax free.
CGT relief could be worth many tens of thousands of dollars to retirees or TRIS holders. It's also an entitlement that many might overlook because of the complexity of implementing the strategy. But failing to capitalise on the concession could lead to regret down the track.
If you haven't already done so, says self-managed super strategist Darren Kingdon of Kingdon Financial Group, now is the time to create an action plan to gain access to CGT relief. Don't be lulled into thinking you can leave it until after June 30.
An action plan should involve being aware of the capital gains that exist for each investment you own in a super pension and where the new rules will oblige you to transfer assets to an accumulation account. Once in accumulation, assets will be either fully or partly taxed, albeit concessionally.
The plan should also involve having an estimate of the additional tax that will need to paid because pension assets will no longer be tax free and the impact this will have on a retiree's overall income. Earnings on assets rolled to an accumulation account will be taxed at 15 per cent and capital gains at either 10 per cent or 15 per cent,depending on how long they are held for.
An action plan will require being aware of the procedures that need to be followed in order to implement CGT relief, a task not helped by the fact that important documents, such as an approved form on which the assets in question must be recorded, are not yet available.
An action plan will boil down to tagging which assets are to be reset. Investments should be assessed on an asset-by-asset basis, says Kingdon, or in the case of shares, on a parcel-by-parcel basis. That's what the new regime will require.
For more complex assets, such as investment property and interests in investments owned through trusts, up-to-date valuations will be needed.
To illustrate how CGT relief might work, a 65 years-plus retired reader asks about his $4 million SMSF pension portfolio that is broadly made up of two $2 million commercial property units that are wholly dedicated to paying a pension. The properties each cost about $1 million.
Even though the reader will only be allowed to have $1.6 million of investments in a pension account from July 1, he expects both properties will remain in super because stamp duty will prohibit him from moving them elsewhere, even if he wanted to.
The reader asks if he will be able to commute property A to an accumulation account after having its tax base reset to $2 million under the CGT relief rules shortly before midnight on June 30.
And, in the case of property B, can he designate 80 per cent of its value, or $1.6 million, as being in the pension phase and 20 per cent, valued at $400,000, as being in accumulation phase and reset the cost base to $2 million as at June 30? And how would this property be taxed if, in two years' time, it was sold for $3.5 million?
Unfortunately, says Kingdon, it is not possible under Tax Office guidelines for an SMSF to partially segregate a single asset in the manner described for property B. Tax accountant Gordon Cooper of Cooper and Co says this is because you can't split the ownership of a single asset within the same legal entity.
In order to trigger an entitlement to CGT relief for both assets, a "cessation event" must occur between November 9, 2016 and June 30, 2017.
In order to claim CGT relief and reset the value of each property from $1 million to $2 million, the reader will need to commute the total excess of $2.4 million back to an accumulation account on or before June 30 and use what is known as the proportionate method to calculate tax for the remainder of the 2016-17 financial year, and in future years.
This approach locks in the CGT relief to $2 million. If property B is later sold for $3.5 million, the notional $1.5 million gross capital gain is reduced to $1 million under the one-third CGT discount available to SMSF assets owned for more than one year, or one year beyond the CGT reset date.
But that's not the only calculation that must be performed.
Under the current rules, 100 per cent of the $4 million pension is exempt from tax. Under the new rules, because only $1.6 million of $4 million is in tax-free pension phase – or 40 per cent – and 60 per cent will be in a taxable accumulation account, this proportion will apply to any future CGT liability.
It means 60 per cent of the $1 million gross gain, or $600,000, will be added to the fund's taxable income. It will be taxed at 15 per cent, resulting in a $90,000 tax bill. Without the CGT relief, the notional gains will be $2.5 million, discounted to $1.675 million. With 60 per cent or just over $1 million taxable, the tax liability will be around $151,000.
03 May 2017