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When it comes to your super benefits, tax is always at the heart of it, whether it’s when you make a contribution, or when you take your money out at the other end.
As the super system offers special tax benefits to help Australians save for their retirement, there are strict rules in place about how much tax you pay at every stage.
The proportioning rule is one of these tax rules. It governs how you get to split the components of your super benefit when you withdraw from your super account before you reach age 60.
For more information on tax and your super before age 60, see SuperGuide articles Your tax guide to accessing your super under age 60 and When can I access my super? All conditions of release explained.
If you are aged 60 or over, making a withdrawal from your super account is generally tax-free. This applies whether you take your super benefit as a lump sum or a pension. Which means you don’t normally need to worry about the tax treatment of the different components of your super benefit, or the impact of the proportioning rule.
There are different tax rates applying to untaxed funds, such as government super funds.
What’s the proportioning rule?
The main idea behind the proportioning rule, is to prevent super fund members under age 60 from trying to lower their tax bill, if they decide to make a withdrawal from their super benefit.
Your super benefit consists of both tax-free and taxable components (see explanation below).
As there is no tax payable on the tax-free components of a lump sum, the proportioning rule is designed to stop you from cherry picking between the tax-free and taxable parts of your super benefit and taking more of your benefit from the tax-free component.
Under the proportioning rule, the amount you withdraw from your account is considered by the ATO to have been paid to you in the same proportions as the tax-free and taxable components in your super interest.
For example, if 30% of your super account is a taxable component and 70% is a tax-free component, if you withdraw a lump sum amount, it must also have a 30% taxable component and a 70% tax-free component.
Tax-free or taxable: What are the different components of your super benefit?
Your super account is broken up into tax-free and taxable components depending on how the original contributions were made into your super account:
- Tax-free component – This mainly consists of your non-concessional (after-tax) contributions, as these amounts come from income on which you have already paid tax. (If you were a member of a super fund before July 2007, you may also have other tax-free amounts in your super account.)
Within your tax-free component there are two different elements:
- Contributions segment – This is generally all contributions made into your super account after 30 June 2007 that have not been included in the super fund’s assessable income. These are mostly contributions where you have not claimed a tax deduction, such as non-concessional contributions.
- Crystallised segment – This is usually amounts that would have been tax-free, if they had been paid to you before 1 July 2007 – examples being undeducted contributions made before 30 June 2007, CGT exempt components and pre-July 1983 components. These amounts are now uncommon for most super fund members.
- Taxable component – This typically comes from concessional (before-tax) contributions. These include employer contributions (such as SG contributions), salary sacrifice contributions and any super contributions for which you claimed a tax deduction. It also includes the investment earnings, so the value of this component changes regularly.
Within your taxable component there are two different elements:
- Taxable component – taxed element – This is the taxed element of your taxable component, as in most cases your super fund will have paid the 15% contributions tax on the super contributions or investment earnings making up your taxable component.
- Taxable component – untaxed element – If your super fund has not paid tax on the contributions or earnings making up your taxable component, those amounts are called the untaxed element of your taxable component. This generally only applies to members of an untaxed super fund run by the Commonwealth, or a state or territory government department.
Your annual statement from your super fund will normally indicate both the tax-free and taxable components of your super account. If not, call your fund and they will work it out for you.
The ATO’s Superannuation Benefit Component Calculator can help you to determine the tax-free and taxable proportion of a super benefit and, if required, calculate the tax free component and the taxable component of your benefit.
Where does the proportioning rule come in?
Once you know the tax-free and taxable component percentages of your super benefit, the proportioning rule requires any lump sum withdrawals you make to be in the same pre-determined percentages. For example, if the total value of your super benefit has a 40% tax-free component and an 60% taxable component, your benefit must also comprise a 40% tax-free component and 60% taxable component.
You can’t choose the component from which you would like your benefit to be paid, so you can’t choose to withdraw just from your tax?free component.
The proportioning rule does not apply to the payment of super benefits that consist entirely of a tax-free or a taxable component. These include:
- Government co-contribution payments made up only of a tax-free component
- Superannuation Guarantee (SG) payments only consisting of a taxable component
- Contribution-splitting payments only consisting of a taxable component.
Note: The proportioning rule is modified when it comes to payment of disability lump sum benefits and super lump sum benefits that contain an untaxed element.
For information on the tax rates that apply to the taxable component, see SuperGuide article Your tax guide to accessing your super under age 60.
Case study 1 – Lump sum withdrawal
Aldo is 56 years of age and retired from the workforce. He’s met a condition of release, so he can access his super benefit.
In April 2019, Aldo decides he would like to withdraw a lump sum of $50,000 from his super account, which has a value of $400,000.
When he checks with his super fund, Aldo finds the components of his super interest are:
- Tax-free component – $100,000
- Taxable component – $300,000
To calculate the tax-free component percentage of his super interest, his super fund uses the following formula:
Tax-free component ÷ value of super interest = Tax-free component percentage
($100,000 ÷ $400,000 = 25%)
To calculate the taxable component percentage of his super interest, his super fund uses the following formula:
100% – Tax-free component percentage = Taxable component percentage
(100% – 25% = 75%)
This means 25% of Aldo’s super benefit is tax-free and the remaining 75% is the taxable component if he withdraws money from his super account before age 60.
To work out the dollar amounts, Aldo multiples the amount he wants to withdraw ($50,000) by the percentage for both his tax-free and taxable components.
Tax-free component: $50,000 x 25% = $12,500
Taxable component: $50,000 x 75% = $37,500 (or $50,000 – $12,500)
If Aldo decides to withdraw future lump sums, his super fund will work out the tax-free and taxable proportions of his super interest each time before paying his benefit.
Case study 2 – Income stream withdrawal
Aisha is 58 years of age and retiring from the workforce. She’s able to access her super benefit and plans to start a monthly super pension or income stream using her super account balance.
After contacting her super fund, Aisha finds her tax-free component percentage is 25%, while her taxable component percentage is 75%.
If Aisha’s monthly super income stream benefit is $2,000, the tax-free and taxable components are:
Tax-free component percentage x super income stream benefit = Tax-free component
25% x $2,000 = $500
Monthly income stream benefit – Tax-free component = Taxable component
$2,000 – $500 = $1,500
These proportions apply to all benefits paid from the super income stream to Aisha, so the tax-free and taxable components are locked in on the date the pension commences.
What impact can the proportioning rule have on super strategies?
The rules around tax and super benefits are complex. Before implementing any investment strategy with your retirement benefits, you should always seek appropriate advice from an independent licensed financial planner or tax accountant professionally qualified in this area.
You need to be very careful not to exceed the relevant super contributions caps and to confirm with your adviser that you are eligible to contribute the money back into the super system before making a withdrawal.
The information in this article is of a general nature only and cannot be considered financial advice.
The proportioning rule is important when it comes to retirement income as it can influence the effectiveness of many superannuation retirement strategies relying on altering the tax-free and taxable components of your super benefit.
For example, if you have a significant tax-free component in your super interest, it may be better to start a super pension as early as possible, as this high tax-free component percentage is locked in when the pension commences.
Using a re-contribution strategy is also affected by the taxable component of your super interest. With a re-contribution strategy, the taxable component of the super benefit withdrawn from your super account is converted into a tax-free component when it is re-contributed back into your account.
For more information, see SuperGuide article Re-contribution strategy: What is it and how can I use it with my super?