Taking a self managed fund into retirement

The focus by senior executives on investment options has tended to centre on greater control over their superannuation affairs, long term retirement wealth creation and effective tax and estate planning.

Despite their desire for choice, executives are still challenged to find efficient wealth accumulation structures where they can exercise control in their investment decisions.

Self managed superannuation funds (SMSFs) have been among the most effective tools for executives and family members to jointly accumulate wealth, save tax and remain in control of their investment decisions.

Catering for up to four related investors, SMSFs require assets of about $100,000 to $150,000 to justify audit and lodgment fees.

Wealth accumulation within a SMSF is taxed at a maximum of 15 per cent throughout the saving phase and is then available for income (and withdrawal) in retirement using a tax-exempt pension strategy. A key benefit to SMSFs is also the seamless movement of accumulated savings to fund a pension without realising many years of accrued capital gains.

Combined, these features are very attractive to executives given the increasing trend towards longer saving phases. Capital growth of assets each year in the accumulation phase incurs a maximum tax rate of 15 per cent, and only when assets are realised, which compares more than favourably with the high personal marginal tax rates of most executives.

For example, assume an asset with a value of $100,000 is invested in the superannuation environment and grows at 5 per cent for 20 years, with an inflation rate of 2 per cent. By retaining this asset in the move to the pension environment the investor will be $17,500 better off compared to selling in the superannuation environment, paying capital gains tax and reinvesting on the change to a pension strategy.

Additionally, franking credits from Australian share investments can significantly reduce income tax, the impact of potential realised capital gains and contributions tax within the fund.

Allocated pensions have been considered one of the most tax effective retirement products available in the marketplace. They provide investment control and access to capital.

The allocated pension, however, is not always the best solution for clients because the full purchase price is counted for Centrelink Assets Test purposes, and is subject to the lump sum Reasonable Benefits Limit (RBL).

The fixed term pension is attractive to investors marginally in excess of their RBL because drawings, rather than purchase price, determine the RBL value.

In some circumstances, the RBL value of the retirement benefit can be lowered below the RBL, which entitles investors to additional benefits such as a full 15 per cent income tax rebate, retention of capital and tax-free payment to dependents upon death.

For example, Mr Smith is aged 58 with $600,000 in superannuation. Given a Lump Sum RBL of $485,692 he has an excess benefit of $114,308. If a fixed term pension is used then the following formula applies:

RBL Value = (1st years drawings x PVF) - UPP + RCV

= ($32,280 x 11.21) - $0 - $0

= $395,000

Assumptions: Three per cent indexation of income; term is the life expectancy of the investor; drawing rate from standard actuarial tables, PVF is Pension Valuation Factor from Taxation Determination TD 97/20, UPP is Undeducted Purchase Price, RCV is Residual Capital Value.

This value is well within the lump sum RBL, solving the excess benefits problem.

Complying pensions reflect the Government's positive view on income stream products and provide a structured income stream in exchange for locking away capital.

The pensions can shelter investments from the assets test and importantly allow assessment under the much higher pension RBL. This has significant advantages for income tax and estate planning because the 15 per cent income tax rebate can apply to a much higher benefit. Higher amounts can also be paid tax free to dependents upon death. Complying pensions eligible for the pension RBL and asset test exemption can be either a fixed term pension (for clients over age pension age) or a life time pension.

Increasingly, clients' income streams will comprise a combination of the allocated pension, fixed term pension and complying pension.

Proposed rule changes governing the membership of SMSFs are likely to be introduced in April next year which will require all members of the fund to be trustees or directors of the trustee company.

This will ensure all members of the fund are equally responsible for investment decisions. This move highlights the Government's view that where executives want the significant benefits of a SMSF arrangement, they and their member partners must take responsibility for the outcomes.