Understanding the complexities of untaxed elements

My client is about to rollover an “untaxed element” into his SMSF. Where did it come from and what do I do with it?

The investment earnings of superannuation funds are generally subject to tax at the rate of 15%. Many contributions to superannuation funds are similarly taxed.

However, there is a small number of superannuation funds which do not pay any tax on their earnings or contributions. These funds are commonly referred to as “untaxed funds” and include public sector superannuation funds and constitutionally protected funds.

To compensate for the fact that otherwise assessable contributions and earnings of an untaxed fund are exempt from tax, a portion of the benefits paid from these funds consists of an “untaxed element”. 

Untaxed elements are generally subject to higher tax rates on withdrawal.

For example:

If a super lump sum is paid to a member aged 60 or over, it is usually tax free (provided the member had satisfied a condition allowing them to access the lump sum eg retirement, reaching age 65). However, if that super lump sum includes an untaxed element, the first $1.515m in the 2019/20 year (called the untaxed plan cap) is subject to tax at a maximum of 15% (plus medicare levy) and the remainder is taxed at 45% (plus medicare levy). Untaxed elements paid to members under age 60 are subject to even higher rates of tax.

Some individuals choose to rollover their untaxed element to another fund to minimise the tax payable. This is because no tax is generally payable when a superannuation lump sum is rolled over from one fund to another. However, if like your client, the rollover includes an untaxed element (as shown on the Rollover Benefits Statement), this amount (up to the untaxed plan cap) must be included in the receiving fund’s assessable income in the year of the rollover and subject to tax at 15%.

If the amount of the rollover exceeds the untaxed plan cap, the excess is taxed in the individual’s hands at the rate of 45% plus medicare levy. Note, this tax on the excess is withheld by the paying fund.

When your client’s benefits are eventually withdrawn from the receiving fund (as a lump sum or a pension), there will not be an untaxed element in the withdrawal. This is because tax was paid on the rollover and the rollover amount is then treated like any other “normal” superannuation benefit.