Superannuation, volatility and rollovers

Anna Mirzoyan takes a look at the ways in which market volatility may affect superannuation rollovers.

In times of volatile markets, extra caution needs to be taken when rolling money from one superannuation fund to another – specifically in relation to the impact that action may have on the tax-free component amount and the non-preserved benefit amount.

Not considering how these amounts are impacted by volatile markets could permanently affect the amount of those components, which could impact the amount that can be withdrawn or the amount of tax payable on future withdrawals. 

Tax components within superannuation

From 1 July 2007 superannuation benefits are made up of tax-free and taxable components.

The tax-free component is the sum of the:

• Contributions segment – this consists of all non-concessional contributions made after 1 July 2007, and
• Crystallised segment – this is a fixed dollar amount calculated on 30 June 2007 consisting of the concessional component, post-June 1994 invalidity component, undeducted contributions, capital gains tax exempt component and pre-July 1983 component. 

The taxable component is the value of superannuation interest less the tax-free component.

From 1 July 2007 the proportioning rule is used to calculate the tax-free and taxable components of a superannuation benefit that is paid as a lump sum, which will be used to commence a superannuation income stream or rolled over to another superannuation fund.

Proportioning rule

A superannuation benefit in an accumulation phase is valued just before the benefit payment is made to obtain the proportions of the lump sum or rollover. This percentage of tax-free and taxable components is then applied to the superannuation benefit being paid or rolled over to another fund.

For example, if the balance of member’s superannuation interest was $100,000 ($40,000 tax-free and $60,000 taxable) and the amount was to be rolled over to another fund, the proportioning rule would apply. Therefore 40 per cent of the rollover benefit would be tax-free and 60 per cent would be taxable. 

The effect of volatility on super tax components

The effect of volatile and falling markets on superannuation tax components depends on whether the fund is in accumulation phase or pension phase.

In pension phase, the components are calculated at the commencement of the pension, therefore the percentage of the tax-free and taxable components in the pension phase will not be affected by negative markets.

However, as explained above, in the accumulation phase the components are not based on a fixed percentage, but rather calculated using the proportioning rule.

Therefore if the value of an accumulation account falls so that its value is less than the tax-free amount of the contributions segment, the tax-free component may be permanently reduced once the proportioning rule is triggered and the money is rolled to a new superannuation fund.

It is important to note that this reduction would not be permanent if the proportioning rule is not triggered.

There are a number of strategies to consider when the dollar amount of the tax-free component is temporarily reduced. These include:

• Waiting until the fund’s balance recovers before the money is rolled over to another superannuation fund
• Making an additional concessional contribution before the money is rolled over
• Rollover other superannuation benefits to the fund.

Let’s have a closer look at these scenarios based on the case study below.

Case study

John makes an initial non-concessional contribution of $150,000 to a new superannuation fund on July 1, 2011. Since that date the fund has had negative earnings of $30,000 and no other contributions.

If John rolls over his entire benefit of $120,000 into another superannuation fund, by applying the proportioning rule the tax-free component of the new fund would be $120,000. As such, if the new fund’s balance subsequently grows to $150,000, the tax components would be $120,000 tax-free and $30,000 taxable.

Strategy consideration 1 – retain the benefit until the balance recovers

If John retains his benefit in the current superannuation fund, the contributions segment of the tax-free component will remain at $150,000, although the account balance would only be $120,000.

If the balance of John’s fund grows to $150,000, the entire benefit of $150,000 would be tax-free, as any investment earnings will form part of the tax-free component until the account balance recovers to $150,000.

As such, by retaining the benefit in his current superannuation fund John is able to recover the tax-free amount of his superannuation interest.

Strategy consideration 2 - make a concessional contribution

If John makes an additional concessional contribution of $30,000 to superannuation, after deducting contributions tax of $4,500, the net amount added to his superannuation account would be $25,500.

The new balance in his superannuation fund would be $145,500 ($120,000 + $25,500), which is less than the amount of the tax-free contributions segment of $150,000.

Therefore, the new balance of $145,500 would be tax-free.

In effect, John’s concessional contribution has been reclassified from being taxable to tax-free. If the money was then rolled over to another superannuation fund, the amount of the tax-free component in the new fund would be $145,500.

Strategy consideration 3 – rollover another fund into the current fund

If John rolls over $100,000 of taxable benefits from another superannuation fund to his current fund, this would make the balance of John’s fund $220,000 ($120,000 + $100,000) and consist of $150,000 of tax-free and $70,000 of taxable components.

In effect, $30,000 of the taxable component has been converted into a tax-free component.

The effect of negative markets on non-preserved amount within superannuation

If the superannuation fund has negative earnings in a certain period, superannuation rules require that these losses are first offset against preserved benefits.

If the negative earnings exceed the member’s preserved benefits, the excess is then offset against restricted non-preserved benefits, then against unrestricted non-preserved benefits. Where this happens, the reduction is permanent.

The time at which the reduction is made will depend on the fund’s trust deed or when transactions occur.

For example, John’s superannuation benefit of $100,000 consists of an unrestricted non-preserved amount. Due to a fall in markets the benefit has fallen to $80,000 at the date the fund’s earnings are credited to his account. This means that John’s unrestricted non-preserved benefit has been permanently reduced from $100,000 to $80,000.

Summary

In times of volatile markets, extra caution needs to be taken when providing strategy advice to clients regarding their superannuation funds.

Importantly, where the impact on the tax-free and non-preserved components is not considered, this may affect the amount of tax that may be payable and the amount that could be accessed – and unfortunately be a lost planning opportunity.

Anna Mirzoyan is the technical services consultant at Fiducian Portfolio Services.