The relationship between preservation and the taxed components of a superannuation benefit is something that can be poorly understood. Some trustees and their advisers who are new to superannuation try to combine the two concepts but end up finding it is similar to mixing oil with water.
To be frank, there is absolutely no relationship between preservation and taxed components, apart from the fact they have a link to a person’s superannuation balance. The preservation component is a child of the Superannuation Industry (Supervision) Act (SIS Act) and, quite independently, the taxed components are from the Income Tax Assessment Act 1997 (ITAA ’97). Because of this they work in different ways and must be considered strictly in that context. Therefore, it is necessary that the fund records include information about the preservation components and the tax-free component of a member’s benefit.
In relation to the preserved components, a person may have a superannuation benefit consisting of preserved, restricted non-preserved and unpreserved benefits. The operation of the SIS Regulations allows a person to choose which component they wish to use when drawing down particular benefits, for example, a transition-to- retirement (TTR) income stream.
In some situations, once a condition of release is satisfied, the relevant preserved components may convert immediately to unrestricted non-preserved benefits. An example would be a member who has reached age 65, or the member’s death, which is a universal condition of release subject to any stricter provisions
in the fund’s trust deed. It may be necessary to continue to maintain records as some preservation components of the member’s balance remain intact where part of a member’s balance may be paid, such as hardship or temporary invalidity.
Taxbable and tax-free components
Calculation of the taxable and tax-free components of a superannuation interest is determined under the ITAA ’97. In contrast to the preservation components, it is not possible for a person to choose only the taxable or tax-free component of a superannuation interest, where both components are present, to pay a lump sum or commence an income stream.
The taxable and tax-free components are calculated immediately before payment of a lump sum and/or commencement of the income stream at any age, although the relevant payment may not be taxed. This is based on the taxable and tax-free components of the member’s benefit existing in accumulation phase at the time. The calculation is relatively simple, but requires the fund to retain information concerning the tax-free component. The taxable component is the balance of the member’s accumulation account, less any tax-free amount, and is used to determine the taxable and tax-free proportions under the proportioning rule.
Just a note on the proportioning rule, once the taxable and tax-free proportions have been calculated for a lump sum or at the commencement of an income stream, they are fixed. Some creative types interpret the rules in their own way and split the taxable and tax-free components into two amounts and then allocate the income earned by the fund over the two components. The fact that the fund may have had a good or bad year does not upset the proportions which were calculated just prior to the lump sum being paid, or the income stream commencing.
Transition to retirement
While the lump sum or account based income stream paid to the member must consist only of an unrestricted non-preserved component, it is possible to select a particular preserved component or components in the case of a transition to retirement income stream. For example, a person’s superannuation balance may consist of preserved, restricted non-preserved and unpreserved benefits. If they commence a transition to retirement income stream it is possible to select the amount representing the preserved and/or restricted non- preserved benefit(s) to pay the income stream and leave the unrestricted non-preserved benefit in the superannuation fund for a rainy day.
The reason for adopting this strategy, is that the SIS Act requires any amount of a person’s income stream comes rst from the unrestricted non-preserved component, then the restricted non-preserved component and finally the preserved component. By using only the preserved components to pay the TTR income stream means that the unrestricted non-preserved component will remain in accumulation phase, to be drawn down when required without restriction.
If a member decides to use all of the preservation components to commence the TTR income stream, it may result in the unrestricted non-preserved benefit being exhausted, first leaving the remaining preserved components to support payment of the TTR income stream. This will restrict the amount available to be drawn down as a lump sum, because the remaining components must remain preserved until another condition of release is met.
Close neighbors
The result of paying a preserved amount as a lump sum, or in excess of the maximum TTR income stream, may result in an illegal release of the payment or the income stream not meeting the requirements of the SIS Act. If this is the case, then the income earned by the fund, on assets used to provide the TTR income stream, will be taxed at 15 per cent, rather than being tax-free if no breach had occurred.
Announcements in this year’s Federal budget proposed to tax the income earned by the fund on assets supporting a TTR income stream at 15 per cent. If the proposal was made law, it could result in an interesting outcome if the TTR income stream did not meet the requirements of the SIS Regulations for any reason. It would result in the relevant income always being taxed at 15 per cent, unless it was decided a higher rate should be imposed because of the breach. However, in the case of self-managed superannuation funds, the ATO is able to impose administrative penalties for a breach of the SIS operating standards.
So there it is, making sure the preservation components and taxable components of a superannuation benefit remain close neighbours – but not related – is how the legislation operates.
