Understanding Actuarial Certificates for an SMSF

Overview

Where an SMSF pays a retirement phase income stream to one or more members, an actuarial certificate may be required to determine the proportion of the fund’s income that is exempt from income tax. This exemption is calculated under the proportionate (actuarial) method and is referred to as Exempt Current Pension Income (ECPI).

An account-based pension (ABP) is the most common form of retirement phase income stream. Other retirement phase income streams include defined benefit pensions such as market-linked (term allocated) pensions, lifetime pensions and flexi pensions. While multiple pension types may exist, this paper focuses primarily on ABPs due to their prevalence.

Legislative changes over recent years have materially altered when actuarial certificates are required. This paper reflects the law as it applies from 1 July 2021 onwards.

We outline:

• what an actuarial certificate is,

• when it is required,

• how ECPI is calculated under different methods, and

• practical examples illustrating common scenarios.

What Is an Actuarial Certificate?

An actuarial certificate is a formal certification prepared by a qualified actuary that determines the percentage of an SMSF’s assessable income that is exempt from tax where the fund provides a retirement phase income stream and applies the proportionate method.

This certified percentage represents the portion of the fund’s income that qualifies as ECPI.

Key points:

• ECPI applies to ordinary income (e.g. rent, interest, dividends, trust distributions) and statutory income (e.g. capital gains).

• While income supporting retirement phase pensions may be exempt, expenses attributable to pension liabilities are not deductible.

• An actuarial certificate must be retained with the fund’s records, but is not lodged with the ATO.

Transition to Retirement Income Streams (TRIS)

A transition to retirement income stream is not a retirement phase pension unless a condition of release with nil cashing restrictions is met (for example, attaining age 65).

Accordingly:

• Income supporting a non-retirement phase TRIS does not qualify for ECPI.

• No tax exemption applies to income attributable to assets supporting a TRIS in the non-retirement phase.

Why an Actuarial Certificate Is Required

An actuarial certificate is required where the SMSF applies the proportionate (actuarial) method to calculate ECPI.

As outlined by the ATO, income earned by a small superannuation fund from assets supporting retirement phase income streams may be exempt from income tax and is reported as ECPI in the SMSF annual return.

For this purpose, a “small superannuation fund” includes:

• SMSFs, and

• small APRA funds.

The exemption applies to:

• ordinary income, and

• statutory income, to the extent those amounts relate to assets supporting retirement phase pensions.

Methods of Calculating ECPI

There are two methods for calculating ECPI:

1. the segregated method, and

2. the proportionate method.

A fund may apply a combination of both methods in the same income year, depending on the fund’s circumstances. An actuarial certificate is only required where the proportionate method is applied.

Employer contributions and taxable member contributions are never exempt, regardless of which method is used.

Proportionate Method

Under the proportionate method:

• Fund assets are pooled, rather than specifically allocated to pension or accumulation interests.

• An actuary determines the average proportion of the fund’s liabilities that relate to retirement phase income streams for the relevant period.

• This percentage is then applied to the fund’s total assessable income to determine the exempt portion.

Where the proportionate method is used, an actuarial certificate is mandatory.

Segregated Method

Under the segregated method:

• Specific assets are set aside exclusively to support retirement phase pensions.

• All income derived from those segregated pension assets is treated as ECPI.

• Capital gains and losses on segregated pension assets are disregarded.

An actuarial certificate is not required where the segregated method applies, unless the fund has disregarded small fund assets or elects to use the proportionate method instead.

When an Actuarial Certificate Is Required

An actuarial certificate is required where the SMSF:

• applies the proportionate method to claim ECPI,

• has disregarded small fund assets and is not in 100% pension phase for the entire year, or

• pays a defined benefit pension (including lifetime or market-linked pensions).

Common scenarios include:

• one member in accumulation receiving contributions while another receives an ABP, or

• a member with a total superannuation balance exceeding $1.6 million at the prior 30 June.

Disregarded Small Fund Assets

An SMSF is deemed to have disregarded small fund assets where all of the following conditions are met:

• a member has a total superannuation balance exceeding $1.6 million at the prior 30 June (including all superannuation interests across all funds),

• that member is receiving a retirement phase income stream from any superannuation fund at that same date, and

• the SMSF is not in 100% pension phase for the relevant income year.

Where these conditions apply:

• the SMSF must use the proportionate method, and

• the segregated method is unavailable unless the fund is in 100% pension phase for the entire year.

Example – Disregarded Small Fund Assets

Paul held $2.1 million in his SMSF accumulation account at 30 June 2022 and had no other superannuation interests. He commenced an account-based pension with $1.7 million on 1 December 2021. The fund was not in 100% pension phase during the 2022 income year and did not segregate any assets.

As disregarded small fund assets are tested at the prior 30 June, the fund did not have disregarded small fund assets in the 2022 year. Accordingly, the fund defaulted to the segregated method from 1 December 2021 to 30 June 2022.

Paul could elect to apply the proportionate method to the entire year, which may be advantageous where, for example, a significant capital gain occurred earlier in the year (such as July 2021). In this case, an ECPI percentage of approximately 58% applied across the full year may yield a better outcome than segregating income only from December onwards.

From the 2023 year onward, Paul’s total super balance would likely exceed $1.6 million at 30 June 2022, resulting in the fund having disregarded small fund assets and requiring the proportionate method.

When an Actuarial Certificate Is Not Required

An actuarial certificate is not required where:

• the SMSF pays no retirement phase pensions, or

• all fund assets support retirement phase pensions for the entire financial year.

Where a fund is in 100% pension phase for the full year:

• the segregated method must be used,

• no income tax is payable, and

• franking credits may generate refundable tax offsets.

Choosing the Method of ECPI Calculation

An SMSF may choose to apply the proportionate method to all income for a year where:

• the fund does not have disregarded small fund assets, and

• the fund is not in 100% pension phase for the entire year.

Absent an election, the default treatment applies:

• segregated method during periods of 100% pension phase, and

• proportionate method during other periods.

Example – Choice of Method

Bill’s SMSF was in 100% pension phase from July to September. During that period, the fund sold a property, realising a capital gain of $140,000. Employer contributions of $10,000 were received in January. Rental income of $10,000 per month was earned throughout the year.

Bill’s total super balance at the prior 30 June was less than $1.6 million.

As the fund was not in 100% pension phase for the entire year and did not have disregarded small fund assets, it could choose its method.

Under the default approach:

• the capital gain and $60,000 of rental income earned during the segregated period were fully exempt, and

• an actuarial certificate applied to the remaining income, with 90% of the second-half rental income ($54,000) exempt.

Total tax payable was $2,400.

Applying the proportionate method to the entire year would have resulted in an ECPI percentage of 96%, but a higher tax liability of $3,060.

An actuarial certificate was required under both scenarios.

Practical Considerations and Common Traps

Key issues to consider include:

• A fund does not require an actuarial certificate merely because it pays pensions.

• TRIS automatically converts to a retirement phase pension at age 65, often triggering ECPI considerations and transfer balance cap implications.

• Claiming ECPI may be uneconomic where taxable income is low or where tax losses exist, as losses are reduced when ECPI is claimed.

• Where permitted, applying the proportionate method to the entire year does not require a formal election, but documentation supporting the choice should be retained.

Key Takeaways

• ECPI is calculated using either the segregated or proportionate method.

• An actuarial certificate is required only when the proportionate method is used.

• Funds in 100% pension phase for the entire year must use the segregated method.

• Disregarded small fund assets mandate use of the proportionate method.

• The ECPI percentage must be certified by a qualified actuary.

• The cost-benefit of claiming ECPI should be assessed, particularly where taxable income or losses are minimal.