Are you trying to determine how much of your pension income is exempt pension income?
Either way, this article will cover off on both.
There are two forms of exempt pension income. As mentioned, there is exempt pension income for tax purposes and exempt pension income for Centrelink/Social Security/Department of Veteran Affairs (DVA)/ Aged Care purposes.
Exempt pension income for tax purposes refers to the amount of your pension income that is not assessed for tax purposes.
Exempt pension income for Centrelink (or DVA) purposes, as well as aged care, refers to the amount of your pension income that is not assessable under the ‘Income Test’. Reducing the amount assessed under the Income Test may increase your Centrelink/DVA entitlements.
Exempt Pension Income for Tax Purposes
When you commence a pension income stream using your superannuation savings, the pension will consist of two components:
– the ‘Exempt’ component (sometimes referred to as the ‘Tax-Free’ component)
The proportion of your balance that relates to each component will be determined by the contributions that were made to your account, as well as any earnings, prior to commencing the pension.
Once the pension income stream has commenced, the component proportions will be crystallised and remain the same for the life of the pension. All withdrawals will need to be made proportionately from each component.
The Exempt component of your superannuation pension is made up of all of the contributions made to your account with after-tax dollars (i.e. where a tax deduction was not claimed).
The difference between your account balance and the Exempt component will equal your Taxable component. The taxable component of your superannuation balance is effectively made up of contributions where a tax deduction was claimed (e.g. SG contributions, employer contributions, salary sacrifice contributions, personal deductible contributions) as well as investment earnings.
READ: ‘Difference Between Concessional and Non concessional Contributions‘ – this article will help you understand how different tax components come about.
What is Exempt Pension Income?
Once you start a pension, the portion of your income that is made up of the Exempt component will not be assessed for tax purposes.
Let’s say that you commence an account based pension with a balance of $500,000 and the proportions of this balance were 80% Taxable and 20% Exempt component.
If you decided to draw an income of $30,000 in the first year, $6,000 of this would not be assessed for tax purposes. The remaining $24,000 would be assessable and taxed at your marginal tax rate (MTR), less a 15% rebate. However, if you are over age 60, none of the income would be assessable, apart from the taxable (untaxed) component – if any.
Exempt Pension Income for Centrelink/DVA/Aged Care purposes
The Exempt Pension Income for Centrelink or DVA purposes is vastly different to how it assessed for tax purposes.
Centrelink/DVA often use an Income Test and an Assets Test for determining the benefits that you are entitled to. The majority of a person’s investment assets are ‘deemed‘ to earn a particular rate of income. Centrelink then add this ‘deemed’ income to other sources of income in assessing entitlements.
However, when it comes to pensions, the income is assessed differently.
Post 1 January 2015 Pensions
For pension income streams commenced prior to 1 January 2015 (where the recipient was also in receipt of social security payments on that day), the amount assessed is the Annual Pension Income, less the Exempt Pension Income. The Exempt Pension Income can be calculated using the Centrelink Deductible Amount Formula, as follows.
(Purchase Price of the Pension – Any Commutations since Inception) divided by the Relevant Number (RN).
So, using the example above, if you were to receive an Annual Pension Income amount of $30,000 p.a. and calculated your Exempt Pension Income as $18,500 (using the Centrelink Deductible Amount Formula), only $11,500 of your pension income would be assessed for Centrelink/DVA purposes. This is intended to reduce the income amount that represents return of capital.
(note: An investment property is also not deemed. In this instance, the rental income less expenses are counted as income).
…..and it’s a big but
Post 1 January 2015 Pension Income Streams
Pensions commenced after 31 December 2014 will be treated like most other investment assets under the Income Test, in that they will be ‘deemed’ rather than having the Deductible Amount reduced from the Gross Pension Payment for Income Test Purposes. While this may benefit some, it is generally an unfavourable legislative change for most.
However, if you commence a pension prior to 1 January 2015, your income stream will continue to be assessed under the former assessment. You should beware of rolling over a Pension account from one superannuation provider to another after 1 January 2015, as this may often constitute a rollback to accumulation phase a commencement of a new Pension, which would then fall under the deeming rules. Some providers may permit a ‘Pension Liability Transfer’ to/from another account, which involves retaining the Pension that was initially commenced, yet having it paid by another provider (or SMSF).
If you would like anything clarified or have any further questions about the Exempt Pension Income or any other topics, please do not hesitate to leave a comment in the section below.