Don’t leave ECPI considerations in the too-hard basket

One of the things to consider for the next year is ECPI, and there are several factors that can affect the amount a fund can claim which, once allocated, is unable to be changed.

He said it is for this reason SMSFs should consider as early as possible all the options it may have to help maximise ECPI for the current income year.

These options include segregation, the timing of realising income, and maximising the exempt income proportion.

“There have been a number of changes to segregation over the last several years which have seen an increase in the complexity of segregation and the possible impact on ECPI,” he said.

The segregation of assets for tax purposes can essentially be done in two different ways the first being the elected segregation method.

This is where fund assets or a pool of fund assets are set aside to support a retirement phase interest has really seen no change.

“The SMSF trustee(s) can choose to allocate a specific asset or assets to solely support retirement phase pension interests, with the income earned on these assets being entirely exempt,” Mr Richardson said.

However, he warned that to segregate an asset this way, it must be set up in advance.

“It is not possible to segregate an asset after the fact,” he said.

“If there is any intention to have segregated assets during an income year it must be done before the intended start of the segregation.”

Mr Richardson warned that any elected segregation should be in line with the fund investment policy and serve a purpose other than to solely minimise tax paid.

“For example, the SMSF trustee(s) may offer different investment strategies; one for members in retirement phase and drawing a pension; and one for those members in accumulation phase, still building their retirement nest egg,” he said.

“The covenants in section 52B SIS Act and operating standard SIS regulation 4.02(2) permit an SMSF trustee(s) provides the requirements for investment strategy choice.”

However, he said there have been changes in deemed segregation.

“From the introduction in 2018, to the addition of ECPI choice in 2022, these measures have all impacted on how ECPI can be claimed,” he said.

“ECPI choice from 2022 has made deemed segregation less of an issue for most funds, providing some flexibility after year-end.

“However, for a fund looking to take advantage of having both periods of deemed segregation and proportionate periods, this will take appropriate planning.”

If a fund has both deemed segregation and proportionate periods there could be capital gains implications that may impact ECPI.

“As with other assessable income, capital gains are subject to the fund’s exempt income proportion,” he said.

“However, as the fund may have some flexibility with when to realise the sale of an asset there are some factors to consider.”

Firstly, a fund which is aware that it will have a deemed segregated period should ensure any capital gains occur in this period, which will make it entirely exempt.

Alternatively, a fund should not want to realise a capital loss in a deemed segregated period as it would also be disregarded.

It is not just the timing of income which can affect ECPI, Mr Richardson warned.

“The calculation of the tax-exempt income proportion is based on a daily weighted average of the fund’s pension liabilities, divided by the total fund liabilities,” he said.

“So, it is not just the amount of the fund transactions which will impact the fund tax exemption, but also the timing of these transactions.”

While things like employer contributions may not be out of the control of a member, they can also influence the timing of others, such as personal contributions or pension payments and it here that SMSF trustees and their advisers must think more strategically to improve any tax outcomes.

“Actions which increase the pension interest and decrease the accumulation interest should be done earlier in the year and actions which decrease the pension interest and increase the accumulation interest should be done later in the year,” Mr Richardson said.

“For example, a member of the Nest Egg SMSF is aware that they will need to withdraw $500,000 from their fund in the current income year.

“The member has both an accumulation interest and an account-based pension and will be able to withdraw the amount from either. As the required minimum pension standards must be met on the account-based pension, this amount will be paid as part of the $500,000 withdrawal.

“To maximise ECPI they decide to take the amount above the requirement minimum as a lump sum benefit from their accumulation interest. However, it is not just deciding how the payment will be split but also the timing of the withdrawals which is important.

“Assuming there are no specific timing requirements for the withdrawals, in order to maximise ECPI the withdrawals should be made at different times.

“The first withdrawal, being the amount in excess of the required minimum pension, should be made from the accumulation interest and as early in the current income year as possible. “This will help to minimise the average total fund liabilities. For the amount which is to be a pension payment, this withdrawal should be made as late in the current income year as possible to maximise the average pension liabilities.”

Mr Richardson said any decision regarding fund transactions should only be made after considering all relevant factors and not purely based on tax considerations.

“Exempt current pension income will generally be the largest deduction available to an SMSF with retirement phase pensions,” he said.

“Being proactive, considering the fund circumstances and intended transactions, and planning accordingly may allow a fund to improve the ECPI outcome for the current 2023–24 income year.”