Disclaimer: the information provided here is not intended as financial product advice or legal advice. It is offered on a best-effort basis only, and should be used only as starting point to consider the options available to SMSFs. Consult your financial adviser or a lawyer before acting on any information in this document. Always consult closely with Centrelink/DVA before altering asset-test exempt income streams. There are significant penalties for breaching the strict compliance conditions imposed on these income streams.

What to do with an unallocated reserve?

Unallocated reserves in SMSFs can be purposely created, such as investment smoothing reserves, or left-over as a result of expired pensions or left-over after commuting some types of pensions. Unallocated reserves are not benefits of the members, but they are under the control of the trustees. Trustees should ensure they comply with the terms of the trust deed, if any, that relate to the treatment of reserves in their fund.

The SIS Act 1993 s115 explicity gives trustees the right to create reserves unless prohibited by the trust deed.

The taxation treatment of allocations from unallocated reserves to fund members is dealt with by ITAR 1997 Regulation 291-25.01 (formerly numbered 292-).

This regulation describes several methods for allocating amounts from unallocated reserves that do not attract adverse taxation consequences. Two methods that are relevant to this article are:

1. lump-sum allocations to one or more members, up to each member's concessional contribution limit; or
2. distribute amounts to all accounts in the Fund so as to inflate each account by less than 5%.

You can use one method or the other, but not both.

If you use method (1) you must remember that the allocation will be added to the member's total concessional contributions for the year. The amount allocated in this way will be grossed up by 1.176 to determine the value of the equivalent concessional contribution. For example, an allocation of $8,500 is equivalent to a concessional contribution of $10,000. See ITAR 291-25.01(6) and the example therein.

Importantly, the age and work-test do not apply to this allocation because the source of the allocation is already in the super system. The age and work-tests (see SISR 7.04) limit who can contribute into a super fund, not allocations from reserves that are already in the fund. See for example NTLG Superannuation Technical Sub-group minutes - 3 December 2008.

Method (2) is widely known as the "5% distribution rule." Normally the distribution will be to all accounts of all members of the fund, but the regulation does include provision for the definition of a "class" of members. See 291-25.01(4)(a)(i)(B).