In addition to giving you greater control over your retirement savings, SMSFs offer a range of valuable tax advantages that allow you to maximise your returns.
Note that SMSFs are subject to strict regulations set by the Australian Taxation Office (ATO), and failing to meet these rules can result in significant penalties. However, certain circumstances allow for tax-free treatment or concessions.
It's all a matter of employing effective tax strategies to maximise investment returns while ensuring the fund remains compliant.
Read also: How to Set Up and Ensure Compliance for your SMSF
1. Take advantage of concessional tax rates
Contributions made to the SMSF including your employer's super contribution, salary sacrifice contributions, and personal superannuation contributions benefit from a concessional tax rate of 15% during the accumulation phase ONLY IF you don't exceed the limit set by the ATO.
The current cap on concessional or pre-tax contributions is $30,000 per financial year from 1 July 2024. It increases in increments of $2,500 in line with the average weekly ordinary time earnings (AWOTE).
What happens if you exceed the limit?
The excess amount will be taxed at your marginal tax rate, which is typically higher than the concessional tax rate. Alternatively, you can notify the ATO if the concessions contributions made in the financial year were not allocated until the next year so that they will be counted towards the cap for the next FY.
Additionally, net capital gains earned from the sale of an asset held by the SMSF for at least 12 months are eligible for a one-third capital gains tax (CGT) discount.
Once a member transitions into the pension phase, investment earnings on assets supporting the retirement income stream are tax-free.
2. Maximise tax-effective non-concessional contributions
Making non-concessional contributions can increase your tax-free earnings in retirement. These contributions come from income that has already been taxed and thus are not taxed again when received by the SMSF.
To ensure that you're getting the most of this tax benefit, you have to stay within the limit per financial year. As of FY 2024-25, it's $120,000, which, similar to the concessional contribution cap, is also reviewed annually to remain in line with the AWOTE.
What happens if you exceed the limit?
You may have to pay extra tax or you may be eligible to access your future year caps using the "bring-forward arrangement". Available to individuals under 75, this allows you to bring forward the equivalent of one or two years of annual cap from future years, depending on the total super balance (TSB).
From 1 July 2024, if your TSB on 30 June of the previous year was:
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Less than $1.66 million, you can contribute up to three times the annual cap ($360,000).
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Over $1.66 million but less than $1.78 million, you can contribute up to two times the annual cap ($240,000).
However, you can't bring forward any amount if your TSB exceeds $1.78 million (and not exceeding $1.9 million) but you can make a current year contribution of up to $120,000.)
Take note, super balances above the $1.9 million cap need to be held in an "accumulation phase" where earnings are taxed at up to 15% or removed from the fund. Assessable earnings will then be taxed at your marginal tax rate.
3. Avoid excess contributions
While there are ways to circumvent certain rules, avoiding exceeding the limits altogether can be the simplest option.
Excess concessional contributions (ECC) are taxed at your marginal tax rate less a 15% tax offset to account for the contributions already paid by your super fund.
Excess non-concessional contributions (ENCC) are taxed at the highest marginal tax rate plus Medicare levy (currently 47%) unless withdrawn, which you can do 60 days after receiving the determination letter from the ATO.
4. Use the retirement phase to minimise tax
A complying SMSF in the accumulation phase normally pays a concessional tax rate of 15%. However, it can receive further concessions (or tax exemption) once it begins paying pensions to members in the retirement phase.
For instance, investment earnings on assets supporting pensions - or superannuation income streams to members who are in the retirement phase - are tax-exempt, provided the balance remains within the transfer balance cap (TBC).
Once the fund begins paying pensions to at least one member, you can claim the exempt current pension income (ECPI) in your annual return.
5. Review your SMSF's pension arrangements
If you start an account-based pension - the income paid from a super account held in the member's name - ensure you meet the minimum annual pension withdrawal requirements to maintain its tax-free status. If you fail to do this, the earnings you make on all assets supporting your pension payments may be taxed up to 15%.
The minimum annual payment depends upon the member's pension account balance and age. According to the ATO, the minimum amount is worked out by multiplying the pension account balance as at 1 July in the financial year by a percentage factor.
If your SMSF is paying a transition to retirement income stream (TRIS), you also need to pay the minimum pension amount.
6. Consider investing in franked dividends
Investing in Australian shares that pay franked dividends can be a highly effective tax strategy for SMSFs. Franking credits, also known as imputation credits, represent the tax already paid by a company on its profits before distributing the dividends to shareholders.
In Australia, most companies are taxed at 30% (or 25% for companies with annual turnover below $50 million).
Franking allows you to reduce your tax liability, and in the event of having zero income, can be used as a small income stream. This, as well as the dividends themselves, can be then invested back into the SMSF's investment pool.
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If your SMSF in the accumulation phase (earnings are taxed at 15%) receives fully franked dividends, the 30% franking credit will effectively exceed the fund's tax rate. This means the fund can use the excess credit to offset other taxable income. If no other tax liabilities exist, the ATO refunds the excess franking credits.
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If your SMSF is in the retirement phase (earnings are taxed at 0%), the ATO refunds 100% of the franking credits.
Assuming your SMSF is in the accumulation phase and holds shares in an Australian company that declares a fully franked dividend of $7,000 with attached franking credits of $3,000 (representing the 30% corporate tax paid), here's what your refunds will look like:
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Total assessable income - $10,000 (dividend + franking credit)
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SMSF tax payable (15%) - $1,500
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Franking credit offset - $3,000
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Net tax position - $1,500 refund from ATO
If you're in the pension phase, the entire $3,000 will be refunded.
Investing in companies that provide fully franked rather than partially franked or unfranked dividends ensures the highest tax efficiency. Better yet, align the investment with the pension phase so the franking credits convert directly into cash refunds.
Note however, that relying too heavily on dividends can expose the SMSF to market fluctuations or company dividend cuts, thus it remains best to have a well-structured investment strategy that balances franked dividends with other growth assets.
7. Use leverage through an SMSF loan
With a regular retail or industry super fund it's not possible to direct your investment to residential property. However, with an SMSF you can. If you don't have the cash to pay for a property upfront, you likely need what's called a limited-recourse borrowing arrangement (LRBA), otherwise known as an SMSF loan.
SMSF loans allow you to leverage investments to provide retirement benefits to trustees and SMSF members.
Why is it tax friendly?
As the investment is leveraged, you can potentially magnify any gains made while being able to write off certain expenses. This includes maintenance of the property, interest costs, depreciation of fixtures and fittings, and more.
Further, capital gains tax on a property sale held within an SMSF can be lower than property held outside one, typically 15% as opposed to up to 45% outside the fund.
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8. Review your SMSF regularly
Tax laws and contribution caps change frequently, as such reviewing your SMSF ensures compliance with ATO regulations to avoid penalties, and enables you to utilise new tax-saving opportunities should they arise.
Review your investment strategy every six or 12 months to determine if it still aligns with your fund's goals.
Enlist the help of an accredited adviser or tax professional when reviewing your investment strategy. They can provide you with insights and explain anything you may find too complex.
Photo by Towfiqu Barbhuiya on Unsplash
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