Under the previous law from 1 July 2017, Ms Oakes explained that if a fund was eligible to use the segregated method and there were periods during the financial year solely supporting retirement phase, those periods were deemed segregated, so the fund had to use the segregated method for those periods.

“Those periods outside of the full retirement phase periods would be unsegregated. Now, the issue with this is that some funds were going into full retirement phase and then back out of full retirement phase, and it would create multiple deemed segregated periods. This left the trustees and the fund administrators with the tricky task of trying to identify all the income received in the deemed segregated periods and then identify all the income received in the unsegregated periods to calculate exempt current pension income,” she told the SMSF Adviser Show.

The government has addressed this issue, she said, by allowing trustees with a fund that is eligible to use the segregated method and has periods during the financial year solely supporting retirement phase to choose to keep those deemed segregated periods or to treat the fund as unsegregated for the entire financial year. 

“It’s important to highlight though, that you don’t get to pick and choose which full retirement phase periods are segregated and which ones are unsegregated. You’ve got two choices; you can keep all deemed segregated periods, or you just use the unsegregated method for the entire financial year,” she clarified.

Example

Ms Oakes said the timing of income plays an important role in deciding which option to go with.

She gave an example of a one-member SMSF that has $400,000 in accumulation at the start of the 2022 financial year and $500,000 in the retirement phase.

“Let’s say that on 1 January, that member moves all their accumulation money into retirement phase. So, what we have here [are] two periods. We’ve got from 1 July to the 31 December, where there’s a mix of retirement phase and accumulation, and then from 1 January to 30 June, the fund is fully in retirement phase. Now, if we say that this fund is eligible to use the segregated method, then the trustees of this fund will have a choice,” she explained.

“Option one is that they can keep the deemed segregated period, which will be that full retirement phase from 1 January to 30 June, and then from 1 July to the 31 December, that’s going to be unsegregated and have the actuary’s tax-exempt percentage applied to it.”

In this scenario, the actuary’s tax-exempt percentage would be 56 per cent, she said.

“So, all the earnings received during that period will have 56 per cent tax-exempt applied to it.

“Now, option two is that the trustees [decide] they want to use the unsegregated method for the entire financial year, and in this case, the actuary’s tax-exempt percentage applied for the full financial year would be 76 per cent tax-exempt,” she said.

Looking at the two options, Ms Oakes said the decision really comes down to the timing of income and whether any capital losses have been incurred.

Ms Oakes gave another scenario from the same example where the member owns a property and sells that property on 15 January. When they sell the property, they incur a large capital gain.

“If they were to go with option one and keep that deemed segregated period, then the capital gain will be 100 per cent tax-exempt under the segregated method, and then any other smaller income received earlier on in the year during the unsegregated period would have 56 per cent tax-exempt applied to it,” she said.

“Option two, if they go with that and have the fund unsegregated for the entire financial year, then as the capital gain was realised during the unsegregated period, it would be 76 per cent tax-exempt. So having a look at those two options, you can see that it’s clearly better to go with option one and keep that deemed segregated period so that the capital gain realised can be 100 per cent tax-exempt under the segregated method.”

If, on the other hand, the trustee sold the property and there was a capital loss, it may be better to go with option two, she explained.

“With option one, if we keep the deemed segregated period, any losses incurred from segregated assets have to be disregarded and can’t be realised, so they would have to completely disregard the capital loss if they go with option one,” she noted.

“Whereas option two, if you have the fund unsegregated for the entire financial year, then as a capital loss would be realised off unsegregated assets, the capital loss could be realised and carried forward for future financial years.”

Importance of preserving capital losses

Speaking in the same podcast, Smarter SMSF chief executive Aaron Dunn said that thinking about what can be done with future capital losses is very important, particularly where there might be excess transfer balance issues.

“If you think about the context of a mum-and-dad fund and the fact that one individual, when they pass away is going to have that superannuation benefit go across to the spouse, in many instances, you’re going to end up with an excess transfer balance, which means you’re going to have an amount into accumulation,” said Mr Dunn.

“So, if assets then get sold again in the future, that capital loss is actually going to have value attached to it.”