SMSFs reserves: What are the rules?

The most commonly used reserves in an SMSF are investment reserves and complying pension reserves. Investment reserves work by allocating some of the SMSF’s annual investment returns to a reserve and some to the fund members. In a later year, these investment reserves can then be allocated to the fund members to “smooth” the overall annual returns of the fund.

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In years of good return, higher amounts are allocated to the investment reserve and in years of poor returns, higher amounts are allocated to the members from the reserve.

Pension reserves are used as a means to provide liquidity and solvency for SMSFs paying complying style pensions.

Specific requirements for SMSF reserves

Where reserves are held in an SMSF, trustees must:

• Clearly articulate the purpose for holding them, and
• Manage them in accordance with the fund’s investment strategy.

When allocating reserves, trustees should ensure:

• It is allocated in a fair and reasonable manner
• The amount of annual allocation is less than 5% of the member’s total account balance or recorded as a concessional (pre-tax) contribution for that member
• Allocations are not made to an account-based pension.

Concessional contributions are taxed at 15% inside super, which is lower than Australia’s lowest marginal tax rate.

What is the ATO’s view?

The ATO’s view is that SMSFs should only use reserves in limited circumstances, whereas they believe APRA-regulated funds have a greater need to use them. This is because APRA-regulated funds have much larger member bases than SMSFs. Using reserves helps them to spread their costs and returns among these members more accurately.

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The ATO’s potential concern is that reserves could be misused by SMSFs for the purposes of avoiding tax on fund income, that is, member contributions and fund earnings.

Examples of SMSF reserve use that will attract ATO scrutiny

• Using reserves to reduce a fund member’s total superannuation balance to enable them to make non-concessional (after-tax) contributions. Where a fund member had a total super balance that exceeds the general transfer balance cap on the prior 30 June, they will have a non-concessional contributions cap of $0 in the current year. This would mean that any non-concessional contribution that is made would be deemed as an excess contribution. Non-concessional contributions aren’t taxed inside super.
• Using reserves to reduce a fund member’s total superannuation balance below $500,000 so they can make catch-up concessional contributions under the carry-forward rule.
• Using reserves to reduce a fund member’s transfer balance account so it is below the transfer balance cap. The transfer balance cap is the maximum amount that can be transferred from a super accumulation account into a tax-exempt super retirement account.

Updated position for legacy pensions

Changes have been made to the rules that relate to older style ‘legacy pensions’ that commenced prior to 20 September 2007. The changes are relevant for lifetime, life expectancy and market-linked pensions and annuities.

As part of these changes, if a member decides to exit their legacy pension during the five-year amnesty period that began on 7 December 2024, the fund trustee can now allocate ‘reserves’ to that member and the amount allocated will be exempt from both the concessional and non-concessional contributions cap. This would only apply to reserves that were being held to support the legacy pension that was being paid.

The bottom line

SMSF trustees need to be very careful when using and allocating funds as reserves because the ATO pays close attention to how this is done and is on the lookout for any attempt to use reserves to avoid tax.

The information contained in this article is general in nature.