Pensions, Superannuation

Revisit reserves before new tax starts

SMSF reserves legacy pensions superannuation earnings tax

Reserve and legacy pension allocations inside SMSFs should be revisited before the new earnings tax applies as they may be counted as earnings and not contributions.

SMSFs with large reserves or legacy pension balances may find allocations from them to members will be caught by the proposed tax on member  balances over $3 million and should consider reducing their size in the fund before 1 July 2025, according to an SMSF technical specialist.

Heffron SMSF technical and education services director Leigh Mansell said while reserves and legacy pensions are becoming a smaller part of the SMSF landscape, current strategies to allocate them to members may no longer be suitable under the Division 296 earnings tax.

“Some allocations from reserves will be considered a contribution and when you’re working out the adjusted current total super balance amount, they’ll be subtracted and not considered as earnings,” Mansell explained during a recent online technical update.

“Not every allocation from a reserve counts towards a concessional contributions cap, particularly where people have a reserve and they are trying to whittle it down in a way that doesn’t impose a tax cost on the member.

“The way they do this is to allocate just under 5 per cent to all of the account balances or to every member in the fund based on their account balances in the fund, and those allocations don’t count towards their concessional contribution cap so there is no tax to pay.

“Under this new tax regime, those reserve allocations won’t be carved out of earnings, they will be considered as earnings.”

She noted the same will apply to legacy defined benefit pensions and SMSF members should consider whether to wait for the long-proposed pension amnesty or use current methods to exit these pensions.

“At the moment, if you’ve got a lifetime pension, you could commute the pension and commence a market-linked pension with the commutation amount rolled forward, and you can do some restructuring to potentially get out of that market-linked pension too,” she added.

“Moving forward, anybody that decides in the future to get out of a lifetime pension and go to a market-linked pension, after this new law comes into play, those allocations from reserves aren’t assessed against the concessional contribution cap, they’re also going to fall into earnings for this new measure.

“We have been waiting for the pension amnesty, but still haven’t heard anything about it moving forward as yet.

“For clients with large complying lifetime pension balances thinking about going to a market-linked pension, it might be worth revisiting that before this new law comes in because they get hit with a bigger Division 296 tax bill if their earnings might include a fair chunk of that new market-linked pension balance.”

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