Paying a pension from a self-managed superannuation fund is not difficult, but you do need to know what you are doing. As a market leader in SMSF pension documentation, we’ve compiled a list of commonly asked questions regarding SMSF pensions to help advisers and trustees make more informed decisions.
Q. What types of Pensions are there?
A. The most common types of pensions and income streams currently being commenced by members of SMSFs are Account Based Pensions and Transition to Retirement Income Streams. Market Linked Pensions can also still be commenced in limited circumstances and while some Allocated, Transition to Retirement Allocated, Lifetime, Life Expectancy and Flexi-Pensions remain in place, they can no longer be commenced.
Q. What are the characteristics of an Account Based Pension (ABP)?
A. An ABP will be paid from the Retirement Phase of the SMSF.
The recipient of an ABP receives regular payments (subject to a legislated minimum each year – discussed below) that are drawn from a pension account within their SMSF.
The payments continue until death, the account is empty or the pension is otherwise commuted or stopped (as discussed below). Upon death, any account balance will be paid to beneficiaries of the deceased in the form of a lump sum or pension. A significant strength of an ABP is the flexibility to draw income and access the capital sum supporting the pension.
Q. What are the benefits of commencing an Account Based Pension?
A. The major benefits are as follows:
- Your SMSF does not pay tax on the investment earnings or capital growth in the Fund relating to your pension balance.
- Your SMSF still receives refunds of franking credits.
- You can access any level of income from your SMSF, subject to an age based minimum amount.
- The income you access is tax free if you are over age 60.
- A portion of the income you access may be tax free if you are under age 60.
- If you are under age 60, the part of the pension that is not tax free will be taxable but the recipient is entitled to a tax offset of 15%.
- You can take lump sum amounts whenever you want, with no limitation.
- You do not need to change your SMSF investments when you start an Account Based Pension.
Q. Are there any benefits in salary sacrificing into the SMSF and also commencing a Pension?
A. There may well be significant taxation benefits relating to salary sacrificing where your marginal tax rate is at 19% or higher and then commencing an income stream.
Q. How do Allocated Pensions (APs) differ from Account Based Pensions?
A. A number of the characteristics of an AP are similar to those of an ABP, a significant difference being that regular AP payments are subject to a maximum amount each year as well as a minimum amount. As noted above, while many APs remain in place, they can no longer be commenced.
Q. Can an existing pension be converted to another kind of Pension?
A. Providing that the Fund’s trust deed empowers it to do so, the Trustee may, using appropriate documentation, convert an existing Allocated Pension to an Account Based Pension without commuting it and commencing a new pension, but is not obliged to do so.
Q. Should you convert from an Allocated Pension to an Account Based Pension?
A. There are a number of factors to consider:
- Allocated Pensions require a higher minimum annual payment compared to Account Based Pensions.
- Allocated Pensions have a maximum annual payment. Any payments above that figure would need to be Superannuation Lump Sum payments. For Account Based Pensions there is no maximum limit.
- The calculation of the minimum and maximum pension amounts is more complicated for Allocated Pensions than for Account Based Pensions.
Q. How do Transition to Retirement Income Streams (TRISs) differ from Account Based Pensions?
A. A number of the characteristics of a TRIS are similar to those of an ABP, a significant difference being that the regular TRIS payments are subject to a maximum amount each year and the TRIS cannot be commuted to cash except as detailed in the question ‘Can an existing pension be commuted?’ below.
Additionally, a TRIS may be in either the Accumulation Phase or the Retirement Phase, depending on the circumstances of the Member, whereas an ABP will always be in Retirement Phase.
Q. How do Market Linked Pensions (MLPs) differ from Account Based Pensions?
A. A number of the characteristics of an MLP are also similar to those of an ABP, significant differences being that the term or length of the MLP is set according to legislated criteria, that the regular payments are set at an amount calculated by formula each year, with a 10% variance, either higher or lower, permitted. The ability to commute is also limited (as discussed below).
Q. What are the benefits of commencing a Market Linked Pension?
A. As Centrelink exemptions no longer apply for new MLPs, the only reasons generally for commencing a Market Linked Pension are:
- where the commutation amount of a complying pension is required to be applied in commencing another complying pension; or
- to stop and re-start a MLP so as to:
- o change the term of the pension; or
- o for Transfer Balance Cap reasons.
An MLP can only be commenced in an SMSF with funds from the commutation of an existing complying pension.
Q. Who can commence a Transition to Retirement Income Stream?
A. To commence a TRIS, a member of an SMSF who has not yet retired must simply have reached their preservation age (as set out in the following table).
Date of Birth Preservation Age
Before 1 July 1960 55
Between 1 July 1960 and 30 June 1961 56
Between 1 July 1961 and 30 June 1962 57
Between 1 July 1962 and 30 June 1963 58
Between 1 July 1963 and 30 June 1964 59
After 1 July 1964 60
Q. Who is able to commence an Account Based Pension?
A. To commence an ABP, a member of an SMSF must have access to their accumulation account balance, i.e. generally they must have:
- an unrestricted non-preserved component as part of their superannuation balance; or
- reached preservation age (set out in the following table) and retired from the workforce; or
- reached age sixty and terminated an employment arrangement; or
- reached age sixty-five; or
- become permanently disabled.
Q. Can the Pension commence before the documentation is completed?
A. Yes. Agreement can be reached between the member and the trustee to commence a Pension from a particular date, with the documentation being completed once the commencing balance has been determined.
In the ATO Tax Ruling TR 2013/5, the ATO states that a member and the trustee are required to agree to the terms and conditions of the income stream, including commencement date.
That date must not precede the member’s request for application for payment of the income stream.
Any funds being contributed to commence the income stream must be held in the SMSF before the commencement date of the income stream.
Q. How are the different preservation components of a Transition to Retirement Income Stream applied?
A. The SIS Regulations require that the benefits be cashed as follows:
- firstly, unrestricted non-preserved benefits;
- secondly, restricted non-preserved benefits; and
- thirdly, preserved benefits.
Q. When commencing a Transition to Retirement Income Stream, is it possible to select only preserved component is to provide the capital for the Pension?
A. Yes. Unrestricted non-preserved benefits do not need to form part of the TRIS. They can be applied to commence an ABP at the same time the TRIS is commenced on preserved benefits, or else the non-preserved benefits can remain in the member’s accumulation account.
Q. Who can be a reversionary beneficiary for a Pension?
A. Broadly, a reversionary beneficiary must satisfy the Superannuation Industry (Supervision) Act 1993 (SIS Act) definition of dependant, limited further by the Superannuation regulations in the context of children, to include (at the time of death of the member):
- a spouse (including a de facto spouse and/or same-sex spouse);
- a child (including a step child) who is less than 18 years of age or between 18 and 25 years of age and financially dependent on the deceased or permanently disabled;
- any other person (except a child) who lived in an ‘interdependency relationship’ with the deceased; or
- any other person (except a child) who was financially dependent on the deceased.
Q. When a Pension has reverted to a child under age 18, who was not financially dependent on the deceased, must they take a lump sum when they turn 18?
A. No. Although they may access the benefit as a lump sum after turning 18, there is no compulsion to access the benefits until they reach age 25. If they do want to access a lump sum between the ages of 18 and 25, they must access the entire benefit – they are not permitted to withdraw a series of lump sums.
Q. Can a reversionary beneficiary transfer their Pension to another Fund?
A. Yes. Legislation introduced from 1 July 2017 enables any reversionary beneficiary (previously only a spouse) to rollover their Pension to another Fund.
If they wish to do so, they should seek advice, as some unintended consequences of the legislative change may cause issues in some instances.
Q. How are Account Based Pension payments calculated?
A. ABP payments are not subject to any maximum limit. Payments in any given year can be up to 100% of the Pension account balance. Payments are, however, subject to an annual minimum which is calculated by multiplying an age-based percentage (as set out in the following table) by the Pension account balance, at commencement of the Pension and then on 1 July of each year.
The required minimum is pro-rated in the first year and no payment needs to be made in the first year if the commencement date of the pension is between 1 June and 30 June, inclusive.
Age Minimum Annual Payment*
Under 65 4%
95 or more 14%
Q. How are Allocated Pension payments calculated?
A. Minimum and maximum annual payments are calculated, based on the pension account balance and life expectancy of the pensioner, at the start of each financial year. Note that minimums may be significantly higher than the minimums for ABPs and that APs are designed to be paid out to zero earlier than ABPs. These are some of the reasons Trustees convert APs to ABPs.
Q. How are Transition to Retirement Income Stream payments calculated?
A. Annual TRIS payments are subject to the same minimums as Account Based Pensions. Unlike ABPs, however, annual TRIS payments are also subject to a maximum, i.e. 10% of the pension account balance, calculated at commencement of the pension and then on 1 July of each year.
Q. How are Market Linked Pension payments calculated?
A. At the commencement of the Pension, an election is made as to a term of years the Pension will run.
The term elected is based on the life expectancy of the primary or reversionary pensioners or the term between the primary or reversionary pensioner’s age and 100 years.
An annual MLP amount (plus or minus 10%) is determined by applying a formula, based on the number of years of pension remaining, to the account balance each year.
Q. What documentation is required to commence a Pension?
A. A comprehensive pension documentation package should comprise a pension application form, pension agreement, pension product disclosure statement (as required by section 1012B of the Corporations Act 2001), trustee resolutions, fully completed ATO documentation, including PAYG Withholding registration and TFN Declaration documentation (when pension recipients are under age 60) and calculation of the minimum (and, if applicable, maximum) pension payments for the first year of the pension. The taxable and tax free components of the pension are also calculated.
Q. What ongoing administration is required for Pensions?
A. Actuarial certificates may be required if there are accumulation amounts in the Fund (unless pension assets are segregated). Annual pension payment calculations and appropriate minutes are also required. Specialist SMSF Accounting packages such as BGL Simple Fund, Class Super or SuperMate should automatically calculate the Exempt Current Pension Income (ECPI).
Q. Can I make contributions into a Pension account?
A. An SMSF paying a pension may accept further contributions from the member subject to legislative requirements and contribution limits.
However, any new contributions must not be added to the Pension capital. Instead they form a new accumulation balance within the fund. This balance is liable for income and capital gains tax.
Q. Can I combine Accumulation and Pension accounts?
A. Subject to the SMSF providing authority to do so, an existing Pension may be commuted (stopped) back to accumulation phase at any time.
The member’s account balances (pension and accumulation) are then combined and a new ABP is commenced. This is also known as resetting the Pension.
In this way, tax benefits accrue within the fund, as the accumulation balance is converted to provide for a Pension, making income and capital gains from those assets tax-free.
Transfer Balance Cap limitations may restrict the ability to combine all pension and accumulation balances – this should be considered before resetting the Pension(s).
Q. How are Pensions treated by Centrelink?
A. Payments from Account Based, Allocated, Market Linked Pension and Transition to Retirement Income Stream accounts, less a deductible value, are counted as income for the Centrelink and Department of Veterans’ Affairs income test purposes.
Account Based, Allocated or Market Linked Pensions commenced after 19 September 2007 or Transition to Retirement Income Stream account balances are included as an asset for the purposes of the assets test, with the account balance being revalued every 6 months. A 50% assets test exemption applies for Market Linked Pensions commenced prior to 20 September 2007.
Q. How are Pension payments taxed?
A. The tax free component of the pension payments will be tax free.
Tax payable on the taxable component of pension payments depends on the age of the recipient, as summarised in the following table:
Age Tax applied
Age 60 or over Tax free and not assessable
Preservation age to age 59 Taxed at the recipient’s marginal tax rate plus Medicare levy and eligible for a 15% tax offset
Under preservation age Taxed at the recipient’s marginal tax rate plus Medicare levy
Income and capital gains generated on Account Based, Allocated and Market Linked Pension balances within the fund are tax exempt. Defined Benefit Pensions may have reserve components in the fund that are taxable.
Q. What are the taxable and tax free components and how are they calculated?
A. The tax free component of the pension is determined as a percentage of the balance in a Member’s account at the commencement of the pension. That percentage remains for the duration of the pension.
The taxable component is the remaining percentage of the total balance at commencement of the pension. That percentage will also remain the same for the duration of the pension.
Q. What is Exempt Current Pension Income?
A. Ordinary income and statutory income that a complying SMSF earns from assets held to provide for superannuation income stream benefits in Retirement Phase is exempt from income tax. This is referred to as exempt current pension income, or ECPI.
Q. Can an existing pension be commuted?
A. Account Based Pensions, Allocated Pensions and Transition to Retirement Income Streams in Retirement Phase are fully commutable and can be paid out partially or in full at any time.
Transition to Retirement Income Streams in Accumulation Phase can be stopped but the commuted amount cannot be paid out unless the recipient satisfies a condition of release, such as turning 65, retiring from the workforce or other trigger event. The income stream can then become a Transition to Retirement Income Stream in Retirement Phase, with full commutation rights.
Market Linked Pensions cannot be commuted except within 6 months of commencement, on death or to commence another Market Linked Pension.
Q. Can Defined Benefit Pensions be commuted?
A. Commuting Defined Benefit Pensions requires careful thought and experts should be consulted.
Generally speaking, Defined Benefit Pensions can be commuted. Complying Pensions are restricted in that the commutation value can only be commuted if the commutation value is transferred directly to commence a Market Linked Pension.
Q. What happens when a pensioner dies?
A. For Complying Lifetime and Life Expectancy Pensions, the remaining capital supporting the pension will be held in a reserve, as the pensioner transferred their benefits at commencement of the pension, for an entitlement to income for a period of time.
The reserve can then be distributed to members of the fund, subject to limitations such as the concessional Contributions Cap limits.
Subject to the terms of the trust deed and the pension documentation, if a recipient of an Account Based Pension, Allocated Pension and/or Transition to Retirement Income Stream dies while there is still an amount standing to the credit of their pension account, the trustee may be able to continue to pay the pension to a nominated reversionary beneficiary, pay a new pension or a lump sum to one or more of the deceased’s dependants or a lump sum to the deceased’s estate.
Note, however, that the trustee must comply with a valid Pension Reversion Nomination or, failing that, a valid Binding Death Benefit Nomination.
SOURCE, All rights reserved to – Top Docs, Wednesday, 26 September 2018, Copyright © 2013 Topdocs, SMSF Pensions Qs and As, https://www.topdocs.com.au/advice-and-training/technical-articles/smsf-pensions-qs-and-as
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