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There are tax tweaks built in to the super system that canny retirees can work to their advantage.
While providing income for retirement is the obvious purpose of a pension paid from a self-managed superannuation fund (SMSF), a little strategic application when managing a super pension can also make use of certain wealth-building attributes that have evolved out of the changing superannuation landscape.
The first issue to consider when starting a pension with all or part of your super savings is that returns from your investments will move to a zero tax status in respect of income derived from assets supporting the pension.
The fund’s investment earnings such as interest, dividends or rental income (if it owns a direct property) are taxed at 15% in the accumulation phase, and any realised capital gains will most likely be taxed at 10% (under the super rules, capital gains on investments held for at least 12 months are entitled to a one-third discount, which reduces the effective tax to 10%).
But once in pension phase – as long as the investments backing the pension stream are clearly identified and segregated, or an appropriate actuarial certificate is obtained – the super rules allow these investments to be exempt from any tax. So there is neither 15% levied on investment returns, nor 10% on net capital gains.
For example, the pension-paying SMSF has share holdings that are fully entitled to dividend imputation credits (and this will be a common scenario). In these circumstances, franked income such as imputation credits and in some cases trust distributions, can be valuable for an SMSF because of the 30% tax credit attached to most franked dividends.
These tax credits are used in an investor’s hands, in this instance an SMSF, to reduce the amount of income tax payable, and if the credits exceed the investor’s tax bill the amount will be refunded by the Tax Office once the fund’s tax return is lodged. The extra benefit for an SMSF results from its low (15%) or zero tax rate (depending if it is in accumulation or pension phase). When a fund receives a fully franked dividend, the franking credit will not only offset tax payable on the dividend itself, it will either offset tax payable on the SMSF’s other income (including concessional contributions) or be refunded.
One thing to remember in this scenario however is that an SMSF investor will be required to have held the dividend-paying shares at risk for more than 45 days (or 90 days for preference shares) in order to be eligible to claim the credit. The fund’s investment strategy document should record that it will invest in franked dividend paying equities.
But the tactical thinking doesn’t stop here. Say the fund member was born before July 1960, and has therefore attained preservation age. Being able to start a pension from age 55, combined with the transition to retirement income stream rules, means the member can receive a transition to retirement pension (ask this office if you need more information on transition to retirement pensions). This will give the fund member a valuable tax advantage (as spelled out above) with the potential to tactically enhance their pre-retirement earnings through a more tax-efficient treatment of investment returns.
Extra earnings may be able to be put back into super by way of concessional contributions that could be especially valuable as an added boost for retirement savings — keeping in mind the relevant contribution caps.
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