While the current rules for exempt current pension income (ECPI) and actuarial certificates have now been in place for nearly two years, the results are still sometimes surprising and often confusing. Our clients frequently question how we landed at the figures we provide in our certificates. Even where they have a good understanding of when the fund is allowed to (or must) claim its ECPI using the segregated method, it’s still sometimes tricky to understand how the actuarial percentage is derived for any unsegregated periods.
To briefly recap the rules on segregation – remember that:
- some funds cannot claim their ECPI using the segregated method at any time during the year even if they are 100 per cent in retirement pension phase for some or all of the year, while
- some funds must claim their ECPI using the segregated method at any time during the year when the fund is 100 per cent in retirement pension phase.
Any pension fund will be in one camp or the other for the entire year.
The fund falls into the first group (they can’t claim ECPI using the segregated method) if, at the previous 30 June (so 30 June 2017 for 2017/18 returns), the SMSF had any member who had:
- a total superannuation balance (across all funds) of more than $1.6 million, and
- a retirement-phase pension (of any size and in any fund).
If the fund answers yes to both these questions for any member, the fund is not allowed to claim ECPI using the segregated method (even if this particular member has no pensions in the SMSF). If the answer is no, the opposite applies – the fund can claim its ECPI using the segregated method and in fact must do so during any periods where the fund is 100 per cent in retirement pension phase.
Quite apart from the challenges of answering this threshold question, this new treatment presents some very interesting scenarios and new inconsistencies that make understanding the actuarial certificate much more challenging.
These are perhaps best explained using a case study.
Sally is the sole member of her SMSF and turned 65 in 2019. She has been receiving a pension since she retired in 2015. At 30 June 2017, her retirement-phase pension was valued at $1 million and she had no accumulation account. On 1 April 2018, she made a $300,000 non-concessional contribution, which remained in accumulation phase for the rest of the year.
She has no other superannuation.
Her SMSF falls into the can segregate category for 2017/18. At the key date (30 June 2017) the fund had no members with both:
- a retirement-phase pension (Sally did have one of these), and
- a total superannuation balance of more than $1.6 million (Sally didn’t have this).
Therefore, Sally’s SMSF can segregate and must claim its ECPI using the segregated method whenever it is 100 per cent in retirement pension phase.
In this case, the fund was in exactly this position for the first nine months of the year. For that period, therefore, the fund must calculate its ECPI using the segregated method – that is all investment income earned during that period is exempt from tax.
But what happens from 1 April onwards?
Income for that period is subject to the fund’s actuarial certificate.
For the last three months of the year, Sally’s fund had around $1.3 million – allowing for some earnings and the payment of her minimum pension, we have used the following figures in our calculations:
| 1 July 2017 | 1 April 2018 | 30 June 2018 | |
| Pension account | $1,000,000 | $1,030,000 | $1,000,000 |
| Accumulation account | $0 | $300,000 | $303,000 |
| Total | $1,000,000 | $1,330,000 | $1,303,000 |
There are two key figures shown on the actuarial certificate:
- average pension liabilities (the average value of the unsegregated pension account(s) over the whole year), and
- average superannuation liabilities (the average value of the fund over the whole year, ignoring any accounts backed by segregated assets).
These are then used to deduce the actuarial percentage.
Importantly, both the average pension and average fund figures are averages over the whole year, but we treat their values as $0 at any time when the fund is segregated – in this case, the first nine months of the year.
This means the average (unsegregated) pension account for Sally’s SMSF in 2017/18 is:
| $0 | x | 9/12 | + | ($1,030,000 + $1,000,000) x 1/2 | x | 3/12 |
| Avg value of the pension accounts for the first nine months, ignoring any that are segregated. In this case, all of the pension account is segregated so it is ignored entirely. | To reflect the fact this value only applied for part of the year. | Average value of the pension accounts in the last three months when the fund is no longer segregated. | To reflect the fact this value only applied for part of the year. |
This gives an average of $253,750. It looks odd. At all times during the year the pension account was around $1 million and so it would be reasonable to assume the average pension amount used in the actuarial calculations would be around this amount. It happens because the pension account is only ‘counted’ in the calculation for three months of the year.
The average fund balance is similarly unexpected – $329,125. Again, this is because the fund balance for the first nine months of the year is effectively treated as $0.
The resulting actuarial percentage is 77 per cent. This applies for the full year, but only to income that is not derived from segregated assets. Since all the assets are segregated for the first nine months of the year, it only applies to income received in April, May and June.
Sally’s fund would therefore report its ECPI as follows:
- all income received between 1 July 2017 and 31 March 2018 would be included in ECPI under the segregated method, and
- 77 per cent of income received in April, May and June would be included in ECPI under the actuarial certificate method.
What if Sally had a small accumulation account ($50,000) at 30 June 2017 that she cashed out in full on 30 September 2017?
The SMSF would still use the segregated method to determine ECPI for part of the year (1 October 2017 to 31 March 2018) when the fund was wholly supporting retirement-phase pensions.
But what about the first and last three months of the year when Sally had an accumulation account?
These again would be subject to the actuarial percentage. This time, the average pension and fund calculations above would include amounts for the first three months of the year as well as the last three months.
For example, the average pension accounts (excluding segregated accounts) would be the amount above ($253,750) plus:
($1,000,000 + $1,010,000) x 1/2 x 3/12 = $251,250
(assuming the pension account has grown slightly – from $1 million to $1.01 million in that time).
The total average pension accounts (excluding any segregated amounts) would therefore be $505,000 and the average fund balance (again excluding segregated amounts) would be $592,938.
Again, these amounts look odd because we know the fund had around $1 million in pension phase all year. But again, it’s because we effectively ignore half of the year.
The actuarial percentage in this example is 85 per cent.
We would apply that to all income earned during the year except for income on segregated assets (that is, we would exclude all income between 1 October 2017 and 31 March 2018).
Interestingly, even though nothing has changed for the period 1 March 2018 to 30 June 2018 (the amounts are exactly the same as in the first example), we would now apply a much bigger actuarial percentage to determine exempt income in that period. ECPI would be:
- 85 per cent of investment income received from 1 July 2017 to 30 September 2017 and 1 April 2018 to 30 June 2018, plus
- all income between 1 October 2017 and 31 March 2018.
Why does this change at the beginning of the year affect the actuarial percentage that is applied to income earned at the end of the year?
It’s because actuaries are required to provide a single percentage for the entire year. In this example, the fund had a very high proportion of pension liabilities (around 95 per cent) for the first part of the year and a much lower proportion (around 77 per cent) at the end of the year. The actuarial percentage for both periods combined is therefore somewhere in between.
While the calculations and figures are certainly far less intuitive than they used to be, it definitely pays to understand the mechanics here. If Sally’s SMSF somehow received a very large amount of taxable investment income in August 2017, she may be better off leaving her non-concessional contribution until much later in the financial year or even deferring it until 2018/19. That way her actuarial percentage would be closer to 95 per cent.
Meg Heffron is a director at Heffron SMSF Solutions.
