One in three marriages end in divorce. For this reason, understanding some of the complexities in superannuation and tax law surrounding divorce, is important to get the best possible outcome for your clients. The family court order or superannuation agreement determines how the SMSF is to be split between the members. Having an understanding of this process can assist with obtaining the best outcome for clients before they go to court or complete an agreement.
David (age 65) and Jennifer (age 60) are members of an SMSF and going through a divorce. The SMSF has an unlisted asset that doesn’t appear to be recoverable, so has been valued to nil. David’s member account is 100% unrestricted non-preserved and 100% tax-free. Jennifer’s member account is 100% preserved and 100% taxable-taxed.
The first step is to determine if one or both members will remain in the SMSF or, if it will be wound-up. Let’s assume David wishes to remain and keep the unlisted asset, as he believes it is still recoverable, whilst Jennifer wants to leave. Consideration needs to be given to the potential recoverability of the asset. If member balances are split based on a nil valuation of the unlisted asset but there’s a chance it could still be recoverable in the future, then any future proceeds would be allocated solely to David’s account.
The second step is to either prepare interim accounts or provide the latest audited financial statements, to determine the member balances. At this point it would be useful to also consider any potential capital gains tax should assets need to be liquidated. Assuming Jennifer would like to take her entitlement as part cash and also rollover other assets, such as shares, she can exercise rollover relief per S 126-140 Income tax Assessment Act 1997 (Cth) (ITAA97) allow Rollover relief for the transfer of assets following divorce. However, following the changes surrounding pensions in 2017, s125-140 rollover relief may not be available for the receiving member if their spouse was affected by this change. As a result, capital gain tax may be payable if the assets are transferred to another fund, even as part of a divorce.
The third step is to consider the tax and preservation components of the member balances and not just the amount of the split. Considering that David and Jennifer have very different tax and preservation components, it might make more sense to adopt a different strategy. Assuming they have agreed to split $50,000 from David to Jennifer, to get a better outcome for her, the split could be structured as follows:
As David is over 65, the preserved component he receives from Jennifer becomes unrestricted non-preserved. Jennifer also receives David’s previously unrestricted non-preserved components, providing the ability for her to take lump sum payments from her new fund.
As part of the split, David also received Jennifer’s taxable-taxed component. To convert this to tax-free, and assuming he meets the work test, he could take the $50,000 as a lump sum and then re-contribute it as a non-concessional contribution.
Moreover, the member spouse may have multiple superannuation accounts, with very different tax or preservation components. It is important to be specific and specify which superannuation account is to be split as well as the amount.
Finally, apart from a court order or superannuation agreement, the trustees must also provide all other relevant documents as requested and ensure the deadline in the court order or agreement is met.
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