SMSF Technical Education & Strategies

 

Allocating funds from a SMSF reserve - what are the rules & how is it treated ?

As explained in the "SMSF reserves" article, a reserve is simply an amount of money or assets inside your SMSF that does not form part of any member’s account. There are a number of reasons for creating a reserve, and several types of reserves. However, once it comes time to actually allocate money from a reserve to a SMSF member account, what are the rules and how is the allocation treated ?

The main rule involved with allocations of funds from a reserve to member's accounts is that such an allocation will be treated as a concessional contribution (and count toward the concessional contribution cap) unless:

 

- it is allocated in a fair and reasonable manner to an account for every member of the fund, or an account for every member in a class of members, and;

 

- the amount allocated for the financial year is less than 5% of the value of the member’s interest in the fund at the time of allocation.

 

The next obvious question is, "what is fair and reasonable" ?

 

There is an explanatory statement in the Tax Regs that addresses this :

 

'In determining what is fair and reasonable it is necessary to have regard to members' proportionate interests in the superannuation plan. It would ordinarily be expected that the allocation would be in proportion to the existing interests of the members, so that particular members are not favored over others.'

 

Further to this the Tax Office has said that to be fair and reasonable the allocation of an amount from a reserve should be allocated to each member’s interest in proportion to that interest in the superannuation fund. So in other words, if Mum and Dad's member accumulation accounts in their SMSF account for 60% and 40% respectively of the aggregate member balance in the fund, then an allocation from a reserve must be in the same proportion - unless of course your happy for the allocation to be treated as a concessional contribution.

 

Note that the proportionate allocation must be in regard to all of a member's interests - its not just at the member level. For example, say a member has an accumulation account, and two pensions which collectively make up 40% of the SMSF member balances. The proportionate allocation must be across all of his interests - not just allocating the 40% to say his accumulation account.

 

Which tax component does it go to for accumulation funds ?

For an accumulation interest, an allocation to a member account will form part of the taxable component of the member's account balance.

 

What about income streams ?

This is where it gets interesting. Remember, you can not add capital to an income stream once it has commenced. So what happens in the above example where you make an allocation from reserves, but you must do it on a proportional basis to every member's interest, and one member has one (or two) income streams ?

 

The ATO has recently expressed their view that an interest supporting an income stream can accept an allocation from reserves because an allocation from a reserve is not considered an increase to the capital of the fund and therefore is not considered a superannuation contribution. Neither is it an addition to the capital supporting the pension by way of a rollover. This is assuming of course that the allocation is made subject to the rules we discussed above, which if not followed will cause the allocation to be treated as a concessional contribution instead.

 

The common method therefore of allocating reserves to income streams is to provide an enhanced investment return as part of the superannuation income stream interest, where the tax components will be determined based on the tax free component of that interest. For example, a reserve allocation to a pension which is 100% tax free would therefore also be entirely tax free.

Further to all of this, the allocation won't affect the respective proportions of the tax free and taxable components of the income stream established at its commencement.