Example:
Smart Family SMSF has set an investment crediting rate of 8 per cent for members’ accounts. Earnings above this rate are allocated to a reserve account. Therefore, if the SMSF earns 12 per cent for the year, 8 per cent will be allocated to member accounts and 4 per cent will be allocated to a reserve.
Set-up steps:
1. Check that reserves are not prohibited under the Trust Deed or governing rules.
2. Develop a reserving strategy for reserves and decide if assets will be segregated.
3. Build reserves using investment earnings or insurance proceeds (contributions can be used temporarily). Accounting records should show the build-up of reserves.
THE IMPACT ON CONTRIBUTION CAPS
Amounts allocated from a reserve to a member’s account will be assessed as a concessional contribution against the concessional contribu- tion cap (ITAA97 sec 292-25(3)) unless:
• the amount is allocated across all members (or all members in a particular class) in a fair and reasonable manner; and
• the amount allocated in the financial year is less than 5 per cent of the value of the member’s interest in the SMSF at the time of allocation.
It is up to the trustee to prove that any allocation is “fair and reasonable”. This could be determined by:
• equal allocations to each member, or
• proportionate allocations to each member based on account balances or membership period.
If the allocation is assessed as a concessional contribution, the whole amount allocated counts against the contribution cap, not just the amount above 5 per cent of the account balance.
Two other exceptions apply:
• Amounts allocated from reserves to satisfy a pension liability (including a commutation) do not count towards any contribution cap.
• Non-concessional contributions paid into a contribution reserve will count against the non- concessional contribution cap when allocated to the relevant member’s account. These contributions need to be allocated within 28 days from the end of the month in which the contribution was made.
A question has existed over whether allocations can be made to a pension account or whether they can only be made to accumulation accounts. A National Tax Liaison Group superannuation technical sub-group meeting in September 2009 supports the view that allocations can be made to a pension account.
The allocation to a pension account is not deemed to be a contribution or rollover for SIS purposes and so can be added to a pension that has already commenced, but it can count as a contribution against the concessional contribution cap if the amount exceeds 5 per cent of the balance of the member’s interest and is not allocated in a fair and reasonable manner.
If a member has a pension account and an accumulation account, each account is deemed to be a separate interest and the allocation needs to be fair and reasonable across both interests, as well as across the interests of other members.
Allocations made to an accumulation account will add to the taxable component. An allocation made to a pension account will be added in the same proportions that already apply to the pension account.
Reserves are important as an estate planning tool to shift wealth across generations and provide taxation concessions, but they will add to the expense of the fund and may only add marginal value to some clients. Advisers and trustees need to be aware of the interaction with tax law in relation to allocations and the contribution caps.
Example:
Scott and Bec set up an SMSF and both became members at the same time. They are both over age 50. Scott has a balance of $400,000 and Bec has a balance of $100,000.
