SMSFs and Intergenerational wealth transfer. October 2015

Transcription

1 SMSFs and Intergenerational wealth transfer October 2015

2 Updates We have recently updated our standard deed. Changes include some that provide greater certainty about the role of legal personal representatives. You should consider upgrading your SMSF deed to incorporate these changes. We will provide more details in the next few weeks We have recently integrated FIIG s service for researching and trading fixed income investments with our dashboard to make it easier to open a FIIG account and trade. This functionality is available from the My Investments page of your dashboard SuperIQ was recently named SMSF Administrator of the Year in the CoreData SMSF Awards. These awards are voted for by SMSF Trustees and Advisers and we would like to thank those people that voted for us

3 Agenda Will be looking at: Changes 1 July Re-contribution strategy Future Liability Benefit. Anti-Detriment Payment. Re-contribution strategy vs Anti-Detriment Payment.

4 Pre 1 July 2007 An income stream (such as an Allocated Pension) could be paid to an adult child. The definition of dependant was much broader. The money could be retained in the superannuation environment. The earnings would be exempt from tax. Provided greater flexibility with regard to inter-generational wealth transfer. It could also be paid out of the SMSF and (potentially) subject to lump sum tax.

5 Pre 1 July 2007 Example Pre Simpler Super rules Jenny, a widower, has a non-reversionary Allocated Pension in her SMSF worth $600,000. Jenny is the sole member of the SMSF. She has an independent adult, Simon. Jenny passes away on 1 January Simon can become a member of the SMSF after Jenny s death. He can take Jenny s benefit as a pension. The benefit does not need to be paid out to Simon as a lump sum.

6 Post 1 July 2007 The definition of dependant changed on 1 July Only a spouse, disabled child, person with an inter-dependant relationship, financial dependant or minor child can take a death benefit as a pension. An independent adult child or the Member s estate can receive a death benefit, but only as a lump sum. Since 1 July 2007 we have had a proxy for death duties. There was a belief that SMSFs could not longer provide intergenerational wealth transfers.

7 Post 1 July 2007 Tax on Death Benefits Lump sum tax is payable as follows if benefit goes to SIS dependant : Tax Free Nil Taxable 15%* *Plus Medicare Levy. The tax free component consists of non-concessional and undeducted contributions (also Pre 1 July 1983 component). The taxable component is the rest. The fund withholds the tax and pays the net benefit to the SIS dependant.

8 Re-contribution Strategy Re-contribution strategies increase the tax free component The tax free component of a superannuation benefit is received lump sum tax free by independent adult children. Therefore a re-contribution strategy that increases the tax-free component may be a worthwhile strategy. The benefit must physically leave the fund and then be re-contributed. Subject to non-concessional contribution cap limits.

9 Re-contribution Strategy Example Barry, 64, a retired widower, has $540,000 in his SMSF all a taxable component. Barry has an independent adult child, Alex. If Barry was to die, the lump sum tax payable by Alex would be 17% x $540,000 = $91,800. Barry could undertake a re-contribution strategy and withdraw the $540,000 tax free. He could then make a non-concessional contribution of $540,000.

10 Re-contribution Strategy Example This would convert $540,000 taxable into $540,000 tax free component. Whilst the monies would still have to be paid from the SMSF as a lump sum, the benefit would be received by Alex lump sum tax free. This would save $91,800 lump sum tax. However the money must leave the superannuation environment entirely. What happens to the SMSF? Is there a way the SMSF could still provide a benefit to the next generation?

11 Future Liability Deduction A tax deduction is created and can be used to offset assessable income in future years. Therefore concessional contributions do not incur 15% contributions tax. This means accumulators, such as adult children, can become members of the fund and have a contributions tax holiday. Funds with significant franking credits receive a refund from the ATO. The adult children can become members of the fund, and can use the carryforward deduction to build their retirement nest-egg. How does this strategy work?

12 Future Liability Deduction Section of the ITAA 1997 allows a fund to claim a deduction based on the fund s future liability to pay benefits. The deduction is available on the payment of a death benefit, terminal illness benefit, disability superannuation benefit or a temporary incapacity income stream payment. It brings forward the future years deductions on premiums that would have been paid providing insurance cover up to retirement age (65). Generally only available if the event occurs prior to age 65. The deduction is available as an alternative to claiming a deduction for insurance premiums.

13 Future Liability Deduction The ATO s view is to be eligible to claim the tax deduction, the fund must have a policy of insurance in place in respect of the member. The choice can be made after death. The Trustee can claim the future liability deduction even if it has claimed a deduction for insurance premiums in previous years. The choice must be made in the tax return for the financial year in which the death benefit is paid. Once the Trustee elects to claim a tax deduction for the future liability benefit, it cannot in future years claim insurance premiums for other members of the fund.

14 Future Liability Deduction How is it calculated? The formula for the future liability deduction is calculated as follows: Benefit Amount x Future Service Days/Total Service Days Where: Benefit Amount = Is the total benefit and can include the anti-detriment payment. Future Service Days = is the number of days from the date of termination to the members last retirement day (age 65). Total Service Days = is the sum of future service days plus the members eligible service period to the day of termination.

15 Future Liability Deduction Case Study Richard, 50, is married to Sandy and has been a member of his fund since 30 June The fund also owns a life insurance policy on Richard s life for $1 million with an annual premium of $2,000 paid a year in advance. His balance in the fund at the time of his death on 1 July 2014 is $500,000. Sandy is to receive a death benefit lump sum which will be paid in the 2014/15 financial year which is the year the fund will be entitled to claim the future liability tax deduction.

16 Future Liability Deduction Case Study (cont.) Benefit Amount = $1,500,000. Future Service Days = 5,480. Total Service Days = 13,881. The Future Liability Tax Deduction = $1,500,000 x (5,480/13,881) = $592,176 tax deduction. This can be used to offset the fund s assessable income.

17 Future Liability Deduction Case Study (cont.) Let s assume the fund has assessable income in 2014/15 as follows: Concessional contributions $25,000 Interest income $10,000 Rental income $22,000 Dividend income $10,500 Total $67,500 The carry-forward tax deduction of $592,176 offsets the assessable income of $67,500. The fund pays no tax for many years to come.

18 Future Liability Deduction The fund really needs to be in accumulation mode for the strategy to work. If the fund is in pension mode, the carry-forward loss is offset against Exempt Current Pension Income (ECPI). For example, if a fund earns $100,000 whilst in pension mode, it is exempt from tax. However, the $100,000 exempt earnings would be offset against any carryforward deduction created by the future liability deduction. It can also be used in conjunction with the anti-detriment payment.

19 Anti Detriment Payment Increased Amount of Super Lump Sum Death Benefit Another benefit through an SMSF (APRA funds also do this). Trustee is able to augment member benefits. Can increase the amount of a superannuation death benefit lump sum (an anti-detriment payment). The anti-detriment payment also creates a tax deduction within the fund. Again, provides intergenerational wealth transfer strategies. How does this strategy work?

20 Anti Detriment Payment Increased Amount of Super Lump Sum Death Benefit The purpose of this payment is to refund tax paid on concessional (deductible) contributions on death. It is therefore based on the member s taxable component in the SMSF. It increases the lump sum death benefit available to beneficiaries pensions are not eligible for this payment. To be eligible to claim the associated tax deduction, the SMSF must make the anti-detriment payment first. It must be funded from a source other than the deceased member s account.

21 Anti Detriment Payment How is it calculated? There are 3 methods of calculating the tax saving: The audit method (must have the actual records of actual contributions tax paid). The EM method (outlined in the Explanatory Memorandum to s ). The method in ATO ID 2010/5. The ATO ID 2010/5 method is the method we will use for the case study. It is the most commonly used method for the tax saving calculation.

22 Anti Detriment Payment How is it calculated? Using this formula, the anti-detriment payment is calculated as follows: (0.15 x P)/(R (0.15 x P)) x C Where: P = the number of days in component R that occur after 30 June R = the total number of days after 30 June 1983 in the eligible service period. C = the taxable component of the lumps sum.

23 Anti Detriment Payment How is it calculated? This formula determines the portion of the post-june 1983 eligible service date that occurs after 30 June It increases that portion of the taxable benefit by approximately %. The Trustee of the SMSF pays this amount plus the member s benefit then claims a tax deduction for making the payment. The tax deduction is calculated as follows: Tax Savings Amount 15% The deduction claimed must be grossed up by the superannuation tax rate (15%)

24 Anti Detriment Payment Case Study A 60-year old member s accumulated superannuation interest consists of $540,000, $240,000 taxable and $300,000 tax free. The member s service period start date is 1 February The member dies on 28 May The proceeds from the deceased member s account balance are paid as a lump sum death benefit. The fund has a life insurance policy of $200,000 on the deceased member.

25 Anti Detriment Payment Case Study (cont.) The formula is: ((0.15 x 9,463) / (11, x 9,463)) x $240,000 = $34, estimated anti-detriment payment. The Fund would also receive a tax deduction of $230, ($34,513.58/15%). Therefore the total payment from the fund will be $740,000 + $34, = $774,514. The tax deduction, like the future liability deduction, can be used as an intergenerational wealth transfer strategy.

26 Anti Detriment Payment Case Study (cont.) If the benefit is paid to a spouse, it can be paid as a tax free lump sum. $774,514 can be paid out as a lump sum. The deceased s children can come into the fund as new members to make use of the $230,000 tax deduction to offset contributions tax on salary sacrifice contributions. The spouse can re-contribute $720,000 to superannuation: $180,000 non-concessional before 30 June $540,000 non-concessional 1 July 2015 using the bring-forward provisions.

27 Anti Detriment Payment Anti-Detriment Payment The definition of a death benefits dependant for tax purposes differs from the definition of a dependant for anti-detriment purposes. A child does not need to be a minor, financial dependant or under a disability to receive an anti-detriment payment. Adult children are still not tax dependants so potentially pay lump sum tax on any death benefit received. This means an analysis of the specific client circumstance will need to be undertaken. Need to determine whether any tax savings obtained by undertaking the recontribution strategy outweighs any potential anti-detriment payments foregone.

28 Re-cont v anti-detriment Anti-Detriment Payment vs Re-Contribution Strategy Re-contribution strategy involves taking out the Unrestricted Non-Preserved portion of a benefit. If 60 or over and a condition of release has been satisfied, a member can withdraw their benefit from superannuation tax free. Under 60 there may be tax to pay. The strategy involves re-contributing the funds to superannuation as a nonconcessional contribution. This then becomes a tax free component inside superannuation. Can be received by non-dependants lump sum tax free.

29 Re-cont v anti-detriment Case Study Jason, 62, is retired and has $450,000 in his SMSF. It is all taxable and he has an eligible service period of 1 July As he has retired all his benefit is Unrestricted Non-Preserved. Jason is the only member of his fund. Has two independent adult children Paul and Sandra.

30 Re-cont v anti-detriment Case Study Jason has stated that on his death he would like his benefit paid to his adult children. If Jason undertakes a re-contribution strategy he would be able to save 17% lump sum tax on benefits paid to his non-dependants. This would save $76,500 in lump sum tax ($450,000 x 17%). However, consideration would need to be given to any CGT on the sale/transfer of assets to undertake the re-contribution strategy. Also transaction costs need to be taken into consideration (brokerage and buy/sell spreads).

31 Re-cont v anti-detriment Case Study As an alternative, Jason could look to pay an anti-detriment payment. Again using the formula prescribed in ATO ID 2010/5, the calculation for the anti-detriment payment is as follows: (0.15 x P) / (R 0.15 x P) x C Where R is the service period occurring after 30 June P is the number of days in R occurring after 30 June C is generally the taxable component of the superannuation interest, excluding any insured amount.

32 Re-cont v anti-detriment Case Study Therefore: (0.15 x 9,862) / (11, x 9,862) x $450,000 = $65,201 estimated anti-detriment payment. This would then create a deduction of $65,201/0.15 = $434,675. On Jason s death the anti-detriment deduction can be used to offset any CGT on the sale of the fund assets to pay a death benefit. Furthermore this large deduction can be used by new members coming into the fund (such as Sandra and Paul) to offset future contributions tax, tax on earnings and CGT.

33 Re-cont v anti-detriment Case Study Allocation from a reserve may be considered a concessional contribution (NTLG minutes June 2009 and s292-25(3) of the ITAA 1997). The $65,201 is in excess of Jason s concessional contributions cap of $35,000. It is the deceased s concessional contributions cap that is used. The anti-detriment payment will be taxed at 32%. Will then be considered a non-concessional contribution, counted against the deceased s cap.

34 Re-cont v anti-detriment Case Study Anti-Detriment Re-Contribution Account balance on death $450,000 $515,201 Tax-free component $0 $515,201 Taxable component $450,000 $0 Anti-detriment payment* $65,201 $0 Total death benefit $515,201 $515,201 Tax-free component $0 $515,201 Taxable component $515,201 $0 Tax on death benefit ($87,584) $0 Excess contributions tax** ($9,664) $0 Net benefit $417,953 $515,201 * Calculated using the formula in ATO ID 2010/5. ** Cap is $35,000 with excess taxed at 32%.

35 Re-cont v anti-detriment Case Study Jason s non-dependant children receive an extra $97,248 in benefits with a re-contribution strategy. This may be greater over time, for example if: Jason was to commence a pension after the re-contribution. Received positive earnings. Did not draw down excessively from the pension. Lived for his life expectancy. As the components would be crystallised at pension commencement the end benefit would still be 100% tax free and therefore not subject to lump sum tax.

36 Re-cont v anti-detriment Case Study If no re-contribution strategy is undertaken, then the fund would need to withhold lump sum tax of $87,584 ($515,201 x 17%). The net amount received by Jason s adult children would be $427,617. Using the anti-detriment payment Jason s adult children would receive $417,953 slightly less because of the excess concessional tax. Again the anti-detriment deduction of $434,675 can be used to offset any future tax within the fund. This can also have significant benefits for Sandra and Paul if they roll their benefits into the SMSF such offsetting contributions tax and fund earnings.

37 Re-cont v anti-detriment Case Study Anti-Detriment No Re-Contribution Account balance on death $450,000 $515,201 Tax-free component $0 $0 Taxable component $450,000 $515,201 Anti-detriment payment* $65,201 $0 Total death benefit $515,201 $515,201 Tax-free component $0 $0 Taxable component $515,201 $515,201 Tax on death benefit ($87,584) ($87,584) Excess contributions tax** ($9,664) $0 Net benefit $417,953 $427,617 * Calculated using the formula in ATO ID 2010/5. ** Cap is $35,000 with excess taxed at 32%.

38 Re-cont v anti-detriment Case Study However if the benefit was instead paid to a tax dependant, such as a spouse, the re-contribution strategy could actually have a detrimental effect. This is because the fund receives the tax deduction with the anti-detriment. Death benefits paid to a spouse are tax free regardless of the components. Using the re-contribution strategy the spouse would receive $515,201. Using the anti-detriment payment the spouse would receive $505,537. But must be paid out as a lump sum. Spouse may be able to re-contribute $505,537 as a non-concessional contribution.

39 Re-cont v anti-detriment Case Study Anti-Detriment Re-Contribution Account balance on death $450,000 $515,201 Tax-free component $0 $515,201 Taxable component $450,000 $0 Anti-detriment payment* $65,201 $0 Total death benefit $515,201 $515,201 Tax-free component $0 $515,201 Taxable component $515,201 $0 Tax on death benefit $0 $0 Excess contributions tax** ($9,664) $0 Net benefit $505,537 $515,201 * Calculated using the formula in ATO ID 2010/5. ** Cap is $35,000 with excess taxed at 32%.

40 Re-cont v anti-detriment Case Study But several factors need to be considered. Beware excess non-concessional contributions in the above example. Anti-detriment payment must be paid out first before the fund becomes entitled to the tax deduction. Because most probably funded from a reserve may mean some forward planning AND earnings on reserves are taxed at 15%. Allocation from a reserve may be a concessional contribution. If funded through allocation of earnings there will be less in the member account balance.

41 Call to action Seek advice! SuperIQ now offer an Estate Planning Review Service. Every client circumstance is different. Ensure the fund Trust Deed is up to date. Corporate vs individual Trustees. Enduring Powers of Attorney. Binding Death Benefit Nominations. Who will control the SMSF when you die?

42 Disclaimer This presentation was prepared by SuperIQ Pty Ltd (ABN ) ( SIQ ). Material contained in this presentation is a summary only and is based on information believed to be reliable and received from sources within the market. The information is believed to be accurate at the time of compilation and is provided by SIQ in good faith. However, the statements including assumptions and conclusions are not intended to be a comprehensive statement of relevant practice or law that isoften complex and can change. It is not the intention of SIQ that this presentation be used as the primary source of readers information but as an adjunct to their own resources and training. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. SuperIQ does not guarantee the performance of any fund or the return of an investor's capital. No representation is given, warranty made or responsibility taken as to the accuracy, timeliness or completeness of any information or recommendation contained in this publication and SIQ will not be liable to the reader in contract or tort (including for negligence) or otherwise for any loss or damage arising as a result of the reader relying on any such information or recommendation (except in so far as any statutory liability cannot be excluded). Individual circumstances, in particular relating to self managed superannuation funds, may vary greatly. This presentation has been prepared for general information purposes only and not having regard to any particular person s investment objectives, financial situation or needs. Accordingly, no recommendation (express or implied) or other information should be acted upon without obtaining specific advice from an authorised representative.

43 See your future clearly superiq.com.au superconcepts.com.au