Holding more control over your investments and taxation is arguably the main drawcard for having a self-managed super fund over traditional superannuation funds.
However, that control still needs to be exercised within the parameters of the rules and regulations that apply.
Understanding the tax basics that apply to SMSFs not only keeps you out of hot water with the Australian Taxation Office (ATO), but also allows you to lay a foundation on which to continually build your SMSF tax and investment knowledge.
Tax rates are applied in a couple of ways within an SMSF.
The current rate of tax that you pay on earnings within a superannuation fund is 15%. This tax rate applies to superannuation funds across the board, whether they are self-managed, corporate, industry or retail funds.
The 15% earnings tax doesn't just apply to interest or dividends, but also to the fund's other assessable income. This can include:
Employer and personal deductible contributions
Net capital gains
Remember that you take off your capital losses, and if you've owned the assets for a year or more, a one-third capital gains tax (CGT) discount applies.
If the income that's produced in a super fund is by assets that wholly support an income stream (such as an allocated pension), then there is no tax payable.
As we've touched on, the earnings tax within a superannuation fund that's in the accumulation phase is 15%.
For members who have reached their preservation age and have shifted into the pension phase, there are even further tax concessions.
For members drawing a retirement income stream, their investment earnings are exempt from tax, which include capital gains!
A common trap that many people fall into, not necessarily solely with SMSFs, but with superannuation accounts across the board, is failing to hold a member's tax file number (TFN).
If contributions are made for a member of a super fund, including SMSFs, and the member's TFN isn't held on file, then they are taxed at the highest marginal tax rate.
Your SMSF will also pay tax at the highest marginal tax rate for activities and investments that the ATO determines fall outside of the 15% tax rate, which includes non-arm's length income.
Non-arm’s length income is taxed at the highest rate when:
The income amount is higher than what the SMSF would have been expected to derive if the transaction had occurred at arm's length.
Income that's been attained by the SMSF as the beneficiary of a discretionary trust.
Income is the result of an investment or scheme where the party's dealings aren't at arm's length.
As you're probably well across by now, all transactions involved with an SMSF need to be at 'arm's-length' if you want to avoid getting taxed at the highest marginal tax rate.
All superannuation accounts, whether they are SMSF or APRA-regulated funds, are categorised into tax-free and taxable components.
When members start accessing their superannuation benefits, they are accessed in proportionate amounts out of their tax-free and taxable components.
Avoiding penalties is not only good for stress levels when running an SMSF, but makes sound financial sense. There are some strategies that you can adopt to not only help avoid penalties, but minimise tax in your SMSF too!
1. Don’t lend money to yourself or other trustees of the fund
It's important to remember that your SMSF can't lend money to yourself personally, or any other trustees of the fund. This rule also extends to relatives of trustees! If you do, the ATO might deem your SMSF to be non-compliant, which attracts significant penalties and tax.
2. Allocate no more than 5% of your fund’s total assets
When setting your SMSF investment strategy's asset allocation, no more than 5% of your fund's total assets can be invested in 'in-house assets', such as an investment in a business you own.
3. Take a good look at the timing of your investment decisions
Take a look at timing your investment decisions. The flexibility that SMSF ownership has over traditional funds is the ability to time your investment decisions, which lends itself to tax advantages for your fund.
Unlike a traditional fund, the trustees of an SMSF can opt to defer a particular investment asset's purchase or sale in a particular year to reduce the fund's income tax for that year.
The ability to time decisions around buying and selling investments within your SMSF was likely one of the biggest attracting factors to establishing your fund in the first place, and we agree.
Perhaps one of the tax benefits of self-managed super funds that is not commonly discussed is that contributions tax can be deducted once per year, when you lodge your fund's annual SMSF tax return.
This provides the maximum time opportunity for those funds to be invested prior to tax being deducted. In a regular superannuation fund, the contributions tax is withheld immediately upon the contribution hitting the fund.
Another strategy that SMSF trustees hold up their sleeve in terms of timing tax activities is to crystallise investment losses to offset a capital gain prior to the end of the financial year.
In an SMSF, the fund can (subject to some tax rules) rebuy the investments in the next financial year.
There is a certain amount of timing risk involved here, though — if the price of the assets increases during the period where you do not hold them, you will be losing money by rebuying them.
For super members who have reached their preservation age, but haven't yet turned 60, a common tax-effective strategy to perform is a re-contribution strategy.
The re-contribution strategy is effectively a withdrawal of your superannuation benefits (once you've met a condition of release) and then a re-contribution of the funds back into super as a non-concessional contribution.
The outcome is that the member's revised superannuation balance (after the re-contribution has been made) potentially consists of all tax-free components.
This significantly reduces the tax on superannuation income streams during a transition to retirement phase and for lump sum withdrawals.
This strategy is also very effective from an estate planning perspective. If your super is set to be inherited by beneficiaries who aren't considered to be tax dependants (such as adult children), a re-contribution strategy will help reduce the tax payable to them when they receive your death benefit proceeds.
Holding a self-managed superannuation fund makes re-contribution strategies much easier than an APRA-regulated fund, and is one of the benefits of holding an SMSF that not many investors realise up front!
One reality for any investment ownership, including ownership within an SMSF, is capital gains tax (CGT). In a nutshell, capital gains tax applies when your fund makes any net capital gains from selling certain assets. Similar to the timing of your investment decisions, timing the sale of particular assets can help reduce the SMSF capital gains tax payable.
CGT is not a separate tax, with all capital gains and losses included in the fund's yearly tax return as it counts towards the fund's assessable income. Generally speaking, if a fund's gains are more than its capital losses, and it's in the accumulation phase, it would normally have to pay CGT of 15% on the excess amount. However in some circumstances, a fund may be required to pay tax at a higher or lower CGT rate.
The ability to offset future capital gains is one strategy that some SMSF trustees use to help reduce their CGT liability. However, given the complexity of tax law, it's crucial to seek personal financial advice before employing any SMSF strategies, including those involving CGT.
For assets held longer than 12 months, an SMSF may be entitled to a 'discount' on the capital gain of one-third. This means that only two-thirds of the capital gain amount would be subject to capital gains tax. For an accumulation account, this would effectively reduce the capital tax rate down to 10% from 15%.
Depending on the fund members' circumstances, an SMSF may also be entitled to a CGT exemption. This occurs when members have entered the retirement phase and started receiving a superannuation income stream. For these members, the SMSF trustee may be able to claim an exemption on the capital gain from the disposal of any pension assets that went towards paying the pension account.
One of the tasks and responsibilities involved in SMSF ownership is the requirement to lodge an SMSF tax return each year. Even if your SMSF does not have a tax liability, it is still required to lodge a return for the financial year.
Lodging a tax return for a self-managed superannuation fund has many steps, but the Australian Taxation Office releases instructions for SMSF annual returns each year.
SMSF annual returns can be a lot more complex than a regular income tax return (depending on the individual's situation, of course). One of the main differences is that an SMSF return will need to have an SMSF audit report provided as part of the tax return.
An SMSF audit helps to ensure the accuracy and validity of the SMSF's financial records and ensures that it remains compliant with superannuation law. Only a registered SMSF audit can complete the report.
Preparing all the information required for a self managed super fund return can be a large task. All members' information needs to be provided, such as member balances, employer contributions and member contributions, along with all of the fund's assessable income, gains, losses, trust elections or interposed entity selections.
Gathering information on the funds' investments and assets can be exhaustive, not to mention the risk of being charged penalties for missing or incorrect information in the return. This is why many SMSF Trustees use the services of a specialist SMSF tax agent to prepare and complete the return.
Learning the tax landscape for your self-managed super fund, and how your SMSF investment strategy decisions affect your fund's overall tax is made simpler when the guesswork is taken out of investment selection.
Equipping yourself with knowledge is a good base, but equipping yourself with investment management software is one of the best tools to confidently build your SMSF for growth, now and into the future.
HALO Technologies is dedicated to building world-leading investment technology accessible for all types of investors, no matter where you are in your SMSF investment journey.
There are many aspects of compliance when it comes to SMSF and tax, but with the right tools, professional advice when needed, and sound investment objectives, an SMSF can provide more freedom and flexibility regarding investment strategy and asset classes compared to regular super funds.
Tax is a part of life, and the financial nature of SMSFs means there will always be tax considerations to make.
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