Super – maximise tax free

On midnight 30 June 2007, the ‘crystallisation’ rules strike on your superannuation interests. Similar to musical chairs, if you have overlooked your prior planning, you may be on your own. We receive many queries on this topic and provide some answers below.

What are the crystallisation rules all about?

Broadly, the crystallisation rules ‘lock in’ the following components as tax free:

• undeducted contributions
• pre-July 83 component
• concessional component
• post-June 1994 invalidity component
• CGT exempt component

Under the new regime, money in super will generally be comprised of only two components: ‘tax free’ and ‘taxable’. When money is paid out of super, the tax free component will always be tax free. However, the taxable component might be subject to tax (eg, a super death benefit paid to an adult child).

How does crystallisation affect accumulation balances?

Calculate the total dollar value of the tax free components on midnight 30 June 2007 assuming that a lump sum payment is paid to the super fund member of all their superannuation interest.

That dollar figure is now ‘crystallised’ as the tax free component. The balance of the member’s superannuation interest is the taxable component.

Moving forward, any non-concessional (ie, undeducted) contributions will increase the tax free component. Generally, other contributions and any earnings in the fund will increase the taxable component.

What happens if I’m in pension mode?

If you are 60 and over, pretend that the pension is commuted and paid out as a lump sum on midnight 30 June 2007. The benefit is crystallised just like those in accumulation mode as discussed above.

If you are aged less than 60, crystallisation occurs only when a ‘triggering event’ occurs. These triggering events are:

• commuting an amount to a lump sum
• attaining age 60
• death

Upon a triggering event (ie, crystallisation) pretend that the pension is commuted and paid out as a lump sum. The benefit is then crystallised just like those in accudulation mode experience on 30 June 2007.

What If I’m under 60, should I crystallise earlier than 60?

It may be beneficial to trigger a crystallisation event as soon as possible (eg, 1 July 2007) but this is not always the case. The factors that should be considered include:

• whether the pension assets are likely to rise or fall in value
• the pre-July 1983 component (if any)
• any undeducted contributions

$1m contribution and succession planning

Many have now contributed the majority of their wealth into super as part of the $1m ‘window of opportunity’ before the 30 June 2007 deadline.

However, few have planned for how this will be taxed upon death. Careful and timely planning may minimise tax on super death benefits (even if paid to adult children or your estate). Such planning may also result in advantages during your lifetime!

Thus, it is vital to have a clear understanding of the new ‘proportioning rule’ and the new pensions. Key questions to ask are:

• Has my SMSF received any deducted contributions?
• Am I able to access a pension (eg, the new account-based pension or a transition to retirement income stream aka ‘TRIS’)?
• Do I want to provide for the option that super is paid to a non-dependant on death (eg, adult child or estate)?

Reserving and pensions

Regulations that issued in April 2007 shed new light on reserving especially reserves captured in defined benefit pensions (‘DBP’).

Reserving

The new regulations regarding reserving are broadly summarised as follows:

Reserves transferred to a member after 30 June 2007 are counted as concessional contributions unless:

• they are allocated evenly and do not exceed 5% of a member’s balance; or
• they satisfy the pension switch over test. This test will allow scope for transferring certain reserves from an existing pension to a new pension for the member.

Also, non-assessable contributions transferred from reserves after 12 April 2007 are counted as non-concessional contributions.

Be careful as any excess contributions could give rise to excess contributions tax if the relevant $50,000 pa or $100,000 pa cap is exceeded. If the concessional cap is exceeded, 31.5% tax applies. If the non-concessional cap is exceeded, then an extra 46.5% tax applies resulting in an overall 93% penalty!

Defined benefit pensions

Most advisers are aware that pensions can generally now only revert to a spouse or a child under 18 or a financially dependent child over 18 up to their 25th birthday.

Some DBPs were structured to revert to children. Accordingly, the taxable reserves supporting such pensions have increased (solvency reserves are not covered by the fund’s pension exemption).

Many are considering a switch from a DBP to a new pension, eg, do you switch say a non-commutable lifetime to a market linked pension (aka TAP) or a commutable lifetime (aka flexi-pension) to an account-based pension?

Those with allocated pensions may also wish to consider whether they switch to an account-based pension. In addition to the normal pension documents that must issue on commencing a new pension, the Corporations Act 2001 (Cth) requires a product disclosure statement to be issued.

Many are considering their options prior to 30 June and some flexibility may also exist afterwards.