SMSF Legacy Reserves Strategies

SMSF Legacy Reserves Strategies

SMSF residual reserves are a challenge to trustees wishing to distribute them. It is expected that, when the regulations allow the rollover/cessation of legacy SMSF defined benefit pensions, the number of funds with this issue will increase.

One solution is to make a reserve distribution to member accounts. Provided the distribution is prorated across all eligible members, and is less than 5% of the value of the member’s interests in the fund at the time of allocation, the distribution will be fine. If either of these conditions is not satisfied then the distribution is counted against the recipient’s concessional contribution cap. There are no age or work test limitations, and no contributions tax is levied, but any breach of the cap will require the amount to be paid out of the fund to the member and assessed as income in the year of distribution (or remain in the fund and be assessed against the non-concessional cap as well). Rather than being a disadvantage, breaching the concessional contribution cap can be a reserve distribution solution provided it coincides with a recipient’s low taxable income year. The assessable income also contains a 15% tax offset (even though no contributions tax was levied) so the opportunity to deliberately exceed the concessional contributions cap can be a useful strategy.

Another reserve reduction strategy, which could be used in conjunction with the above, works a little differently.

Subject to the deed, it should be allowable to exclude reserves from earning allocations with any such earnings being allocated, pro-rata, to members’ accounts. A private binding ruling (PBR 1051731834033), as well as an analysis of the relevant legislation, supports this approach. As earnings have not been allocated to the reserve, there is no reserve allocation to a member so there is no concessional cap consequence. This would effectively prevent the reserve from growing. SMSF software does not easily accommodate this process so documented work-arounds would be required.