Holding more control over your investments and taxation is arguably the main drawcard for having a self-managed super fund (SMSF) 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. From there, you can steadily improve your investments' capital gains -- the profit that comes from selling an investment for more than you bought it for -- leading to a larger pool of retirement savings in the future.
There is a range of assets you can gather through your SMSF, each generally acquired to provide capital gains once the shares, property, or business is sold. However, since these gains are considered taxable income, they thus must also be subject to capital gains tax.
Tax rates are applied in a couple of ways within an SMSF. Understanding these circumstances can help you manage your assets accordingly and bolster your SMSF annual return without being subject to excessive tax.
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.
All superannuation accounts, whether they are SMSF or APRA-regulated funds, are categorized 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.
All of your SMSF's assessable income is thus subject to being taxed at this 15% rate if there are any gains throughout the financial year. Assessable income usually comes in the form of:
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.
However, there are some cases where an SMSF tax rate will be lower or higher than this predetermined 15%.
When an SMSF fails to follow the legal obligations of super funds, as outlined by the ATO, then they are not eligible for concessional tax treatment. This means, that regardless of their SMSF's assessable income, they will have to pay a higher tax rate on all assets, including capital gains.
Non-compliance usually causes a tax rate of 45% to be applied, but further penalties or consequences may still occur.
As we've touched on, the earnings tax within a superannuation fund that's in the accumulation phase is 15%. Yet, for members who have reached their preservation age and have shifted into the pension phase, there are even further tax concessions.
Members drawing a retirement income stream can enjoy the benefit that their investment earnings are exempt from tax, which includes capital gains!
This allows you to save more on your SMSF income in the crucial years of your life.
If an asset owned by an SMSF is sold within 12 months of its purchase, the ATO may grant the capital gain a 'discount' of sorts. This comes in the form of only two-thirds of the gains being subject to tax.
Essentially, your SMSF tax will only come to 10% on all 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:
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.
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!
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.
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.
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.
All SMSFs are required to ensure their investment strategy is diversified. Not only because it lowers the overall risks involved with investing your super fund into assets, but also because the ATO legally requires it.
All SMSF portfolios must diversify their asset classes, so complying with this necessity will allow you to avoid ATO penalties. It will also put your super fund on the right foot towards greater capital gain without increasing your financial risks.
Now that you know the basics of SMSF annual returns and taxes, it is time to delve into how you can maximise the potential gains of your assets.
While there are no special rules for greater tax returns or avoiding the baseline tax rate, the following strategies can help you avoid significant capital losses. Try one or multiple of these strategies and find what works best for you and your SMSF:
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 sleeves 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!
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 in the future.
HALO Technologies is dedicated to building world-leading investment technology accessible to 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. Contact us today if you want to learn more about SMSF tax and how you can maximise your benefits.
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