Have you ever taken note of the tax components within your SMSF? Behind the balance of your member account are two main components that make up your superannuation savings – these are the Taxable Component and the Exempt (or Tax Free) Component.
The Taxable bucket consists of contributions made to superannuation where a tax deduction has been claimed (i.e. SGC, salary sacrifice, personal deductible contributions) and the Exempt bucket is made up of after-tax contributions. Contributions where a tax deduction has been claimed are officially referred to as Concessional Contributions and after-tax contributions referred to as Non-Concessional Contributions.
Whilst your member balance is in accumulation phase (i.e. where you are not drawing an income) all positive and negative investment earnings will effectively be allocated to or from the Taxable Component. Then, once you eventually commence an income stream, the proportion of your components will freeze and the income stream will forever maintain the same proportion to each component.
For example, if you had an accumulation balance of $440,000 in year 1 made up of a $375,000 Exempt Component (85% of balance) and a $65,000 Taxable Component (15% of balance) and during that year earnings allocated to your balance amounted to $60,000, then your new account balance would be $500,000 and the $60,000 would be added to your Taxable Component – $125,000 (25% of balance). The Exempt Component would remain at $375,000 (75% of balance).
Let’s say at the beginning of year 2, you retire and decide to commence an income stream with your total balance. When you commence an income stream, the proportions of your income stream balance will remain as they were when it started (25%/75%) and all earnings will also be allocated proportionately. Furthermore, any withdrawals will need to be made proportionately. The effect of this is that your income stream account will always remain 25% Taxable/75% Exempt.
The significance of tax components is that it determines how tax will be paid on any withdrawals made from your account. For instance, if you are between the ages of 55 and 60 and in receipt of a superannuation income stream (using the same 25%/75% split above), 25% of the pension payment will be taxed at your marginal tax rate and 75% will not be assessed for tax at all. A 15% rebate will also be applied to reduce the tax on the Taxable portion. Under current legislation, all income received by those over age 60 is not assessed, so tax components are irrelevant in this instance – however legislation has been known to change.
The tax components are also important when you pass away. If you were to pass away, irrespective of age, and your member balance is paid as a lump sum to a ‘tax dependant’ (including spouse, child under 18, someone financially dependant – to name a few) your balance will be paid out completely tax free regardless of tax components. However, where your member balance is paid as a lump sum to a ‘non-tax dependant’, such as a child over 18, only the Exempt Component will be received by them tax free, with the remainder being taxed at 15%. So, based on our $500,000 account balance above, $18,750 in tax would be paid if you were to pass away and leave your balance to a ‘non-tax dependant’.
This highlights the benefits of having more of your account balance made up of the Exempt Component. If you are over 60 you may have the ability to withdraw some or all of your account balance without paying tax and then re-contribute it as a Non-Concessional contribution – thereby converting your total balance to Exempt component or at least watering down the Taxable Component.
However, if this strategy would cause you to breach contribution caps, or if you are between age 55 and 60 and would incur tax from employing such a strategy, then there may be another way to eliminate your taxable component, provided you have the ability to commence an income stream.
Let’s go back to year 1, where your account balance was $440,000 and instead of earning $60,000, lets say your balance declined by $65,000. Remember, we are in accumulation phase; so all earnings are effectively added to or subtracted from the taxable component. Based on our initial 85%/15% split – our new balance would be $375,000 and would be made up 100% of the Exempt component. Knowing that you have the ability to recoup these losses over the next few years, it may be an idea to commence an income stream now, which will forever be 100% Exempt as all earnings to the account are allocated proportionately. Sure, you now need to draw a minimum income stream, but being made up purely of the Exempt component would mean no income tax. If you don’t need the income, why not just contribute it back into super? Better yet, salary sacrifice the equivalent of this income stream from your wage.
Warrick Hanley
Chairman and Founder, SMSF Education
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The information above is general information only and is not intended to be taken as personal advice. It is important that you consider your personal circumstances and seek professional advice from your financial planner and accountant prior to implementing any such strategies, as incorrect implementation may lead to excess taxes, penalties or losses.
