By Graeme Colley
Executive Manager, SMSF Technical and Private Wealth
Anyone who receives a lump sum or pension from their superannuation fund may question why it includes a taxable and tax-free component, even where the whole amount may be considered tax exempt. This may occur when a lump sum or pension is paid to anyone who is at least 60 years old or in circumstances where a death benefit lump sum is paid to a superannuation dependant for tax purposes. So, what does it all mean?
How is a taxable and tax-free component assessed ?
Generally, a person has just one accumulation account in every self-managed superannuation fund of which they are a member. Their accumulation account is made up of any concessional contributions, non-concessional contributions, income and capital gains earned on the fund’s investments. These amounts are split into their taxable and tax-free components.
The tax-free component mainly consists of the non-concessional contributions made by the member to the fund. It can also include spouse contributions, child contributions co-contributions, and any payments made under the low-income superannuation tax offset (LISTO). All other amounts made to the fund, such as concessional contributions and income from the fund’s investments, form part of the taxable component.
The taxable component is calculated as a percentage of the person’s accumulation balance at the time a lump sum is paid from the fund, or just prior to the commencement of an income stream.
John who is 67 years old has an accumulation balance of $500,000, which includes a non-concessional contribution of $100,000. The remainder consists of concessional contributions plus income earned on the fund’s investments.
John meets a condition of release and decides to withdraw a lump sum of $50,000 from his accumulation account. The tax-free proportion of the amount he withdraws is equal to 20% of his accumulation account ($100,000 of $500,000) and the taxable proportion is equal to 80% of his accumulation account ($400,000 of $500,000). This means that $10,000 of the lump sum is a tax-free component and $40,000 is a taxable component. Given John is over 60 years old, the whole amount that he receives will be tax exempt.
Before a pension commences in the fund, the proportioning rule is applied to the person’s accumulation account in the same way as it applies to lump sums. However, the tax-free and taxable proportions remains with the pension until it ceases.
Maria retired at the age of 63 with an accumulation balance in her superannuation fund of $800,000 and wishes to commence a pension. The accumulation balance included non-concessional contributions plus co-contributions totalling $200,000, and the remainder consists of concessional contributions plus income earned on the fund’s investments. She has decided to use $500,000 of her accumulation balance to commence the pension.
The tax-free proportion of Maria’s accumulation balance will be 25% ($200,000 of $800,000) and the taxable proportion will be 75% ($600,000 of $800,000). When Maria receives a pension payment from the fund, it will include an amount consisting of 25% tax-free and 75% taxable proportion. If Maria decides to stop her pension and return it to her accumulation account, the amount credited to that account will be split into the same proportions (25% tax-free and 75% taxable). Given Maria is over 60 years old, the pension she receives will be tax exempt.
Then who is liable to pay tax on the taxable component?
So far, we have covered how to work out the taxable and tax-free components for lump sums and pensions which, when received, are tax exempt to the fund member. However, when does someone pay tax on superannuation benefits?
There are a number of circumstances in which tax is payable on lump sums and pensions payable from an SMSF. These include:
• lump sums withdrawn by the member prior to reaching 60 years of age;
• lump sum death benefits received by a non-dependant for taxation purposes;
• pensions received prior to a person reaching 60 years of age; and
• pensions received by a dependant for taxation purposes on the death of a member where they are both under 60 years of age.
A dependant, for taxation purposes, includes the spouse of a member, anyone dependent upon the member for support or anyone in an interdependency relationship with the member. The member’s children are treated as dependants for tax purposes if they are: under the age of 18, a disabled child of any age, or where the child received a benefit because the member died in the line of duty as a defence force or police force member. However, a tax dependant does not include an adult child of the member, unless they are disabled or the member died in the line of duty.
For any pension that is taxed, the taxable and tax-free components of the lump sums and pensions are determined exactly in the same way as calculated above. Tax is payable on the taxable component of the lump sum or pension. However, in the case of a lump sum received by anyone between their preservation age (currently age of 58) and 60 years of age, the first $225,000 of the taxable component paid at any time during that period is tax exempt.
If a death benefit pension is paid to a beneficiary prior to reaching 60 years of age and the deceased was also under 60 years of age at the date of death, any amount that is taxable will be taxed at personal rates less a 15% tax offset on the taxable amount. This treatment also applies to any pensions payable between preservation age and 60 years of age.
Benny who is 59 years of age has just retired and has withdrawn a lump sum of $900,000 from his SMSF. The tax-free component of the lump sum is $300,000, which means that the taxable component is $600,000. The first $225,000 of the taxable component will be tax exempt. Therefore, Benny is required to pay tax at the rate of 15%, plus Medicare, on $375,000 of the taxable component.
Michelle recently passed away and left her superannuation balance of $300,000 in a binding death benefit nomination to her daughter Simone, who is 45 years old. One third of Michelle’s super balance is a tax-free component and two thirds is a taxable component. As Simone is an adult child, the taxable component of the death benefit lump sum will be taxed at 15%, plus Medicare. If Michelle had directed the trustee of her fund to pay her death benefit to her estate and be paid to Michelle, a tax rate of 15% without the Medicare levy would have been payable.
Maurice is 48 years old and Marcia is 42 years old. Maurice dies in an industrial accident and Marcia decides to receive a pension from his superannuation fund, which has a balance of $1.5 million, including an insured benefit. The taxable component of Maurice’s benefit is equal to $1.2 million (80%) and the tax-free component is equal to $300,000 (20%). Given Maurice and Marcia were both under 60 years of age at the time of Maurice’s death, the taxable component of any pension payment received by Marcia will be taxed and receive a 15% tax offset. The pension payment is $2,000 per week, of which 80% will be taxed at personal rates less a tax offset equal to 15% of the taxable amount of the pension.
Anyone receiving a lump sum or an account-based pension from their SMSF, and who is at least 60 years of age, will receive the payment tax exempt and the taxable and tax-free components of the benefit will be irrelevant. However, there are a number of situations for anyone under 60 years old where the taxable components are important, especially in the case where death benefits are payable to an adult child who is a non-dependant for tax purposes.