When should an SMSF obtain an actuarial certificate?

A trustee needs to obtain an actuarial certificate if the "proportionate method" is used to exclude all or part of a fund’s investment income from its assessable income. But should a trustee always obtain a certificate if it’s entitled to?

A complying self-managed superannuation fund (SMSF) that pays retirement phase pensions may be entitled to exclude some or all its investment income from its assessable income – aptly named exempt current pension income (ECPI). This article explores which method a fund may use to determine a fund’s ECPI and whether it is always appropriate to treat fund income as ECPI – there are some instances where it may be better not to treat income as exempt. As there have been a few changes to the law on these matters we will consider how the rules apply for the financial year ending 30 June 2022 and onwards only.

Tax law provides two approaches to determine what a fund’s ECPI is – the "segregated method" and the "proportionate method" (sometimes called the "actuarial certificate method" because you need to obtain an actuarial certificate if you use this method). Under the segregated method, all the investment income (excluding NALI) from the fund’s segregated pension assets is automatically exempt from tax. Whereas under the proportionate method, a proportion of the relevant investment income (excluding NALI and income on segregated current pension assets) is exempt from tax based on the tax exempt % stated on the actuarial certificate. Sometimes one method will obtain a better outcome than the other and you can pick the preferred method. Sometimes you can use both methods in the same year and sometimes you don’t get a choice at all!

When don’t you have a choice?

If all of a fund’s assets are solely supporting retirement phase pension liabilities at all times during a financial year, then all of the fund’s assets are regarded as “segregated current pension assets” during that year. In this case, the segregated method must be used to claim ECPI.

Funds in this situation will have no monies remaining in members’ accumulation accounts at the end of each day, every day of the year (these funds are often called 100% pension funds). The fund will not require an actuarial certificate as all of the investment income will be ECPI. This is the case regardless of the size of the members’ total superannuation balances and whether they had pensions in place at the previous 30 June (this is one of the rule changes that apply from 1 July 2021 onwards).

Another type of fund that won’t have a choice about the method they use to determine ECPI are those paying defined benefit pensions (such as lifetime or life expectancy pensions). A superannuation fund which has defined benefit pensions will always need to use the proportionate method to determine ECPI and obtain an actuarial certificate – reserves maintained for defined benefit pensions are akin to accumulation accounts for ECPI purposes (to extent they don’t represent future pension liabilities) and confirmation the fund has adequate reserves to continue to maintain these types of pensions for the following year is also required (it’s compulsory).

Another scenario where a trustee won’t be able to choose the method used to calculate ECPI is when, at the previous 30 June:

• any member of the SMSF had “total superannuation balances” of more than $1.6m (across all of their superannuation interests combined),
• that member was in receipt of a retirement phase pension from any fund (not necessarily the SMSF), and
• the fund was not a “100% pension fund” (see above).

In this case, the assets of the fund will be “disregarded small fund assets” and do not qualify as segregated current pension assets. As such, the fund must use the proportionate method and obtain an actuarial certificate if it wants to claim ECPI for that year. Please note, the $1.6m threshold is not indexed (it is not tied to the general transfer balance cap).

So when do you have a choice?

If a fund does not have “disregarded small fund assets” and is not a “100% pension fund”, then the trustee will have a choice about which method to use – segregated or proportionate method, provided the fund had some segregated current pension assets during the year.

If a fund does not have segregated current pensions assets, it will only be able to use the proportionate method to claim ECPI in the particular income year.

Remind me, when does a fund have segregated current pension assets?

In most cases, segregated current pension assets exist because the whole fund is supporting retirement phase pension accounts (it’s a 100% pension fund). But segregated current pension assets can also be created by identifying a specific asset or portfolio of assets and earmarking them for one or more of the members’ pension accounts. This is only possible if:

• the fund is allowed to have segregated current pension assets in a particular year (ie the fund doesn’t have disregarded small fund assets),
• the decision to set aside the specific asset is made in advance, and
• the trustee hasn’t made a choice to use the actuarial certificate method for the whole year (note, this choice is only possible from 1 July 2021 onwards).

A trustee might still choose to use the actuarial certificate method for the whole year, despite being eligible to use the segregated method for part of the income year if it obtains a better result. However, if the trustee does not make this choice, then it may be eligible to use both methods in the same financial year so that:

• the segregated method is used to determine ECPI in relation to income generated in such parts of the year where the fund’s assets are segregated current pension assets, and
• the proportionate method is used to determine ECPI on income generated in any other part(s) of the income year (with the actuarial certificate % only being applied in those part(s)).

The trustee will “make” the relevant choice based upon how the fund’s annual return is prepared and lodged.

So which funds are going to use the proportionate method to determine ECPI?

Common situations where the proportionate method is used to determine ECPI (and an actuarial certificate will be required) include:

• an SMSF has a retirement phase pension in place at some stage during an income year and it holds disregarded small fund assets in that year, or
• an SMSF holds a combination of accumulation/TRIS accounts and retirement phase pensions for an entire income year, or a part of an income year, or
• an SMSF that can use the segregated method chooses not to (remember this choice is only available after 1 July 2021).

So when should I think about not claiming ECPI?

Sometimes there might be cases where a fund is entitled to use the proportionate method but will be better off if they don’t claim ECPI at all.

But when would this make sense? This could occur in cases where:

• the fund’s investment income is so low that it would be more cost effective to not obtain an actuarial certificate and simply pay the usual 15% tax on the fund’s investment income instead, or
• the proportion of investment income that would be exempt from tax (ie the “tax exempt %”) will be so low that it would be more cost effective to not obtain an actuarial certificate and simply pay the usual 15% tax on the fund’s investment income instead, or
• the SMSF has a tax loss - if a fund’s allowable deductions for the year exceed the fund’s assessable income, a tax loss may arise. When calculating the amount of this tax loss, you need to reduce the tax loss by adding back the fund’s ECPI less any expenses incurred in earning that exempt income. That is, obtaining an actuarial certificate and claiming ECPI may be of no tax benefit in that year.

It is important to remember that unless the fund is paying complying pensions, a trustee is not always required to treat the fund’s income as exempt current pension income when using the proportionate method – they are able to do this by simply choosing not to obtain an actuarial certificate if the costs of doing so will outweigh any tax saved.

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