Understanding Actuarial Certificates for a SMSF
When retirement phase pensions are being paid from a SMSF to its members an actuarial certificate is used to determine the amount of income from pension assets which is tax exempt based on the proportionate method (refer below).
An account based pension (ABP) qualifies as a retirement phase pension. Other pension accounts which also qualify are defined benefit pensions which include market linked pensions (also known as term allocated pensions) lifetime pensions and flexi pensions. Our discussions in this article focus on the most common pension being an ABP.
Numerous revisions have been made regarding the circumstances under which an actuarial certificate is required. This article discusses the current legislation effective from July 1, 2021.
It is important that a SMSF trustee understand what an actuarial certificate is and when a SMSF may need an actuarial certificate and when it doesn’t.
What is an Actuarial Certificate?
An actuarial certificate is a document prepared by an actuary who certifies the percentage of investment income earned by the SMSF which is exempt from tax when a SMSF provides a retirement phase income stream (pension) to a member. This is known as “Exempt Current Pension Income” (ECPI).
The tax exemption is based on the income earned in relation to the assets supporting the pension but on the other hand expenses supporting the pension are not tax deductible.
A transition to retirement phase income stream (TRIS) is a pension which can be taken by a member before retirement. After they turn 60 and before retirement or when they turn 60, and not retired, but have not reached 65. It is not a retirement phase pension. The SMSF does not obtain a tax exemption in relation to transition to retirement income.
The Australian Taxation Office (ATO) require an actuary certificate to be held as part of the fund’s records, but it is not required to be lodged with the ATO.
Why does my Superannuation Fund need an Actuarial Certificate?
The short answer is to obtain a tax exemption for the fund when the SMSF uses the proportionate (or otherwise known as the actuarial method) method (see below) to calculate the tax exemption.
As per the ATO website “Ordinary and statutory income a small super fund earns from assets held to support retirement-phase income streams is exempt from income tax. This income is called exempt current pension income (ECPI). ECPI is claimed in the SMSF annual return or the Fund income tax return.”
Let’s unpack what this means.
In relation to a small super fund the ATO is referring to SMSFs and small APRA funds (similar to a SMSF but have an external trustee and regulated by APRA).
The tax exemption for ECPI relates to ordinary income such as rent, interest, dividends and trust income and statutory income such as capital gains in relation to assets supporting an ABP or other retirement phase pensions.
Please refer to our article on segregated assets in our resources page for further details.
Proportionate Method vs. Segregated Method
There are two methods used to calculate ECPI being the segregated method or the proportionate method. It may be possible to use a mix of the two methods in the same year when the fund changes between accumulation and pension phases. An actuary certificate is only required when using the proportionate method.
Employer contributions and member taxable contributions are not exempt from tax regardless of the fund using the segregated or the proportionate method.
Proportionate Method
Generally, the proportionate method is used to determine the proportion of the fund’s total member balances that are in retirement phase pensions. Assets are pooled and not specifically set aside to support the pension. An actuary determines what the exempt proportion is which is then applied to the fund’s total assessable income for the appropriate period. A proportionate amount of the fund’s total income is tax free.
An actuarial certificate is required when the SMSF applies the proportionate method.
Segregated Method
The segregated method means that specific fund assets have been set aside to support a retirement phase pension. All income derived from segregated assets is ECPI and therefore tax free unless the fund has disregarded small fund assets (see below) or the fund is eligible to choose the proportionate method. Capital gains and losses are disregarded under the segregation method.
An actuarial certificate for your SMSF is not required in relation to income from segregated assets when using the segregation method. In some circumstances the SMSF trustee can choose (see below) to use the proportionate method regardless of it being eligible to claim ECPI on segregated assets.
When is an Actuarial Certificate required for your SMSF?
An annual actuarial certificate is provided:
- when using the proportionate method to claim a tax exemption – generally a fund which has both pension and accumulation accounts with no segregated assets
- when the fund is not in 100% pension mode AND the assets of the fund are disregarded small fund assets (see below)
- paying a defined benefit pension which include lifetime pensions and market linked pensions
Typically, the proportionate method would be used when one member is still working and receiving regular contributions and the 2nd member has retired and started an account-based pension. Another typical scenario when an actuarial certificate will be required is when the pension member has a total super balance which is over $1.6million (at the prior 30th June).
What are disregarded small fund assets?
A fund MUST use the proportionate method when the fund’s assets are deemed to be disregarded small fund assets when meeting the following criteria:
- any member of the SMSF had “total superannuation balances” of more than $1.6mil (this is not indexed)- this includes the balance in the SMSF plus any other superannuation funds where the member has a balance including pensions and accumulation accounts which is measured at the previous 30th June
- that same member was in receipt of a retirement phase pension from the SMSF OR any other superannuation fund which is measured at the previous 30th June -even if the member is not receiving a retirement phase pension from the SMSF but is receiving one from a different SMSF or a retail or industry superannuation fund
- the SMSF was not in 100% pension phase in the current financial year
The SMSF CANNOT use the segregated method if the assets are disregarded small fund assets unless the SMSF is in 100% pension mode for all of the financial year.
Example -Paul had $2.1million in his SMSF accumulation account at 30 June 2022. He had no other super monies. He commenced an account-based pension on 1 December 2021 with $1.7million. The fund was not in 100% pension mode in the 2022 financial year. No assets were specifically segregated to his pension account.
As the disregarded small fund assets are measured at the prior 30th June the fund does not have disregarded small fund assets in the 2022 financial year when the pension is first started. It is unlikely to use the segregated method in the 2023 financial year as Paul’s total super balance will probably be in excess of the $1.6milion threshold and will therefore meet the criteria for disregarded small fund assets.
In 2022 financial year the SMSF by default uses the segregation method to calculate the tax-free exemption for the period from 1 December 2021 to 30 June 2022. Paul can elect to use the proportionate method which would apply the actuaries ECPI to the income in relation to all of the 2022 financial year regardless of the pension not being started until 1 December 2021. This could be beneficial where the fund has made a large capital gain say in July 2021. It would be estimated the ECPI could be about 58% which may be more tax effective than the segregation method which only excludes income from 1 December 2021to 30 June 2022.
When isn’t an Actuarial Certificate required for your SMSF?
An actuarial certificate is not required when:
- there are no pensions being paid from your SMSF
- all of a fund’s assets are solely supporting retirement phase pensions at all times during a financial year
When a fund is in 100% pension phase at all times during a year the segregated method MUST be used. No tax is payable by the fund and possibly refunds may be obtained if the SMSF is receiving franked dividends as the franking credit is fully refundable.
Typically, a SMSF is in 100% pension mode when Mum and Dad are retired and both members are taking pensions, and no contributions are being received.
When can a SMSF Choose the Method of Calculating Exempt Current Pension Income (ECPI)?
SMSFs can choose the method of calculating the ECPI under certain circumstances which include:
- the fund cannot have disregarded small fund assets; and
- the fund cannot be in 100% pension mode for all of the financial year
The default position is that the segregation method must be applied to part of the year when the fund is in 100% pension mode with the proportionate method applied to those periods not in 100% pension mode. However, a SMSF can choose to apply the proportionate method to all of the income earned by a fund in a financial year.
Example – Bill’s SMSF is in 100% pension mode in July – September. During that time the fund sold a property and made a large capital gain of $140,000. Employer contributions of $10,000 were made in January. Rental income of $10,000 per month was received.
Bill was the sole member, and his total super balance was less than $1.6million at the prior 30th June.
The SMSF was not in 100% pension mode for all of the year and did not have disregarded small fund assets. Thus, the SMSF could choose to apply the proportionate method to the entire financial year or if no choice is made a combination of the segregation method and the proportionate method is applied to calculate the ECPI.
Bill decided the default position using the segregation method for the period July to December and the proportionate method for the period January to June provided the fund with the best tax advantage. Therefore, the capital gain of $140,000 and the rental income of $60,000 was disregarded and no tax applied to it. In the 2nd half of the year Bill applied the proportionate method and obtained an actuary certificate. The actuary certified that 90% of the fund’s rental income was exempt income being 90% x $60,000 =$54,000. The fund paid tax of $2,400 being (15% x $10,000) + (15%x10%x$60,000) = $2,400.
Bill could have chosen to apply the proportionate method to all of the fund’s investment income, but it would have resulted in more tax. The actuary indicated that the ECPI percentage to be applied to the entire year would have been 96%. Tax would have been $3,060 calculated as (15%x $10,000) +(15%x (($260,000- (96%x$260,000))) =$3,060.
An actuarial certificate would be required for Bill’s SMSF under either of the above scenarios as the fund has periods of time when the assets are not in full retirement phase.
Tips and Traps in relation to Actuarial Certificates when in Retirement Phase
It is worth noting that a SMSF does not automatically need to obtain an actuarial certificate simply because it is providing retirement phase pensions. SMSFs providing transition to retirement pensions should seek appropriate professional advice when the member is nearing their 65th birthday.
- TRIS automatically transfers to a retirement phase pension when a member turns 65 and generally an actuarial certificate is required and consideration of the member’s transfer balance cap (amount of super a member can have in pension mode) is crucial
- consider not claiming ECPI when the cost of obtaining an actuarial certificate to claim ECPI outweighs the benefit
- when a SMSF has a taxable loss the carried forward tax losses are reduced if the SMSF claims ECPI and we also note that there is no tax advantage in claiming ECPI when the fund has tax losses
- a SMSF which is permitted to apply the segregated method when part of an income year is supporting 100% retirement phase pensions can choose as an alternative to apply the proportionate method to all of the year without requiring a formal election but should retain records to show the choice made and the calculations
Key Takeaways
- there are two methods to calculate tax exempt income when a SMSF is paying a retirement phase pension being the segregation method and the proportionate method
- a SMSF is not required to obtain an actuarial certificate when there are no members of the fund being provided with retirement phase pensions
- a SMSF requires an actuarial certificate when applying the proportionate method
- an actuarial certificate must be prepared by a fully qualified actuary
- the ECPI percentage is calculated by the actuary
- the segregated method is used when a fund is providing 100% retirement phase pensions to members for all of a financial year
- the proportionate method is used when the fund has disregarded small fund assets
- a SMSF can choose to apply the proportionate method to all of the fund’s income when it does not have disregarded small fund assets and during the year it has periods of time when the assets are fully supporting retirement phase pensions and periods of time when the fund is also supporting accumulation or TRIS accounts
- consider if the SMSF should apply for an actuarial certificate when the fund has low taxable income or tax losses
Do you need help with understanding Actuarial Certificates?
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