Self Managed Super Funds (SMSF)

A guide to starting a pension in your SMSF

By Graeme Colley
Executive Manager, SMSF Technical and Private Wealth, SuperConcepts Sydney, Australia

If you’re thinking of starting a pension from your SMSF, you have a couple of options as there are different types of pensions – all with different features.

The most common types of pensions in SMSFs are account based pensions and transition to retirement income streams (TRIS). A TRIS is like an account-based pension but has some additional restrictions.

Account based pensions

Account based pensions are calculated by using your superannuation balance at the time it commences and at the beginning of each financial year thereafter.There is a minimum payment that is required to be paid each year but there is no maximum to what you can take out. The minimum pension of your account based pension for the year is based on your age as a percentage of its opening balance. If the account based pension is paid for part of the year it is prorated on a daily basis.

You can start an account based pension once you meet a condition of release which includes retirement after reaching your preservation age, currently age 57, or from the time you reach 65 -whichever happens first. You can also receive an account based pension if you are totally and permanently disabled at any age.

The commencing value of your account based pension is measured against your transfer balance cap, which for most people is $1.6 million. If the total value of your pensions in retirement phase is greater than your transfer balance cap you may have to move the excess plus a penalty tax to accumulation phase in your fund or withdraw it as a lump sum. The income on investments used to support pensions in retirement phase is tax exempt.

After you reach 60 your account based pension is totally tax-free to you. However, if you are under 60 the taxable proportion of the pension, if permitted under the rules, is taxed at personal tax rates less a 15% tax offset.

Transition to retirement income streams (TRIS)

A TRIS is calculated in the same way as an account based pension and a minimum amount is required to be taken each financial year, but they do have some additional restrictions. The main benefit is that a TRIS can be commenced from your preservation age and you don’t have to retire. Until you retire or reach 65, whichever happens first, you are required to take a minimum amount equal to 4% of the account balance just like an account based pension. However, there is a maximum that you can take which is limited to 10% of the opening balance when the TRIS commences or the balance on 1 July in each financial year thereafter.

The commencing value of a TRIS is not measured against your transfer balance cap, however, the income on investments that are used to support the TRIS are taxed at 15%.

If you are between your preservation age and 60 the taxable component of the TRIS you receive is taxed at personal rates less a 15% tax offset. However, once you reach 60 the TRIS paid to you is totally tax-free.

Working out the accumulation balance

Whether it’s an account based pension or TRIS, there are some things that each has in common at the start. You will need to work out your accumulation balance in your SMSF because this will be used to start your pension or TRIS. You don’t have to use all of your accumulation balance and don’t forget you need to stay within your transfer balance cap. Your transfer balance cap takes into account any other pensions you may be receiving from your SMSF or other superannuation funds.

You need to work out a person’s accumulation and pension balance, the impact on their transfer balance cap, their age, and other personal details.

Value the fund’s assets

To work out your accumulation balance in the fund you will need to work out the value of all investments of the SMSF to ensure they are ‘current’ under the ATO’s ruling. The ‘current’ value of an investment can relate to the value of the asset today or its value at the beginning of the financial year. It just depends on how easy it is to get the value or whether there has been a substantial change to it since the last valuation.

Working out the value of the SMSF’s assets must be in line with the ATO’s market valuation of assets for tax purposes. Most assets are reasonably easy to value such as bank accounts, shares listed on the stock exchange and units in public unit trusts. Other investments may be harder to value like real estate, private companies and trusts as well as artworks and collectables, if the fund has any. With the more difficult to value investments the ATO is willing to accept a value that reflects a fair value negotiated in an open market between parties acting at arm’s length. Sounds technical, I know, but a reasonable value supported by information on how the value was determined is what the ATO is after.

Value of a member’s superannuation account

The next step is to work out the value of the member’s accounts which could include the amount they have in accumulation phase and the balances of any pensions in the fund. The amount a member has in accumulation phase will be used to work out how much can be used to start the pension.

In addition, a calculation is made at this stage to work out the proportion of the fund which is the taxable portion of your accumulation account and its tax-free portion. These are important to work out the proportion of the pension that is taxed if you are under 60 or for the taxing of any death benefit lump sums which are paid to your adult children.

Starting the pension

Once you have worked out the amount of your accumulation account that you will use to commence your pension as well as the taxable and tax free proportions the next thing is to calculate the amount to be paid to you in the financial year.

If the pension is an account based pension you would calculate the minimum amount based on your age and if it’s a TRIS you would calculate the minimum and maximum amount that the rules allow you to draw down. If you don’t pay enough pension, or pays too much if it’s a TRIS, the fund will run into compliance issues and you don’t want to get into that territory.

The minimum percentages of the account balance based on your age are:

 Age  Minimum % withdraw
 Under 65  4%
65–74 5%
75–79 6%
80–84 7%
85–89 9%
90–94 11%
95 or more 14%

If you commence the account based pension or TRIS on 1 July in a financial year, the minimum amount is calculated on the above percentages. However, if the pension or TRIS commences during the year the minimum percentage above is pro-rated on a daily basis.

Payment of the pension

Now you’ve done all the calculations, it’s time to start paying the account based pension or TRIS. You can have your SMSF paying the pension weekly, fortnightly or even just once each financial year if you wish. The important thing is to make sure you pay at least the minimum and if it’s a TRIS that you don’t go over the maximum. Make sure your SMSF has enough cash to pay the pension when the time arrives.

It is possible to convert part or all of your account based pension to a lump sum if you wish. This is called a commutation of the pension and there are rules about how much of the minimum pension is required to be paid prior to commutation. If you are receiving a TRIS it is usually not possible to draw down a lump sum as the TRIS balance is subject to the preservation rules. These rules do not permit the payment of a lump sum to you until you have met a condition of release that you have retired for superannuation purposes or reached age 65, for example.

Checklist

Here’s a short 10 step checklist to give you a brief idea of what is required to get a pension up and running.

  1. Make a request to the fund to commence a pension or TRIS
  2. Value the fund’s assets
  3. Work out the accumulation and pension balances of fund members
  4. Calculate the taxable and tax free components of your accumulation account
  5. Decide what type of pension you wish to start, account based pension or TRIS
  6. How much of your accumulation account you wish to use to start your pension or TRIS
  7. Calculate the minimum amount of your account based pension, or the maximum and minimum amounts if it is a TRIS
  8. Decide how the pension will be paid to you – weekly, fortnightly or as you prefer
  9. Keep a record of the calculation and the terms of the pension
  10. Review the pension on 1 July each year to recalculate the minimum and maximum amounts as appropriate.

Case study

Emma, aged 60, has just retired with $900,000 in her SMSF which is in accumulation phase. She wishes to start an account based pension. As the pension is to commence on 1 July in the financial year, she can use the value of the fund’s assets as at 30 June which are shown in the fund’s accounts for the previous financial year.

The next thing is for Emma to decide how much of her account balance she wishes to commence her pension and she thinks $600,000 is about the right amount. The remaining $300,000 will stay in her accumulation account. The amount used to commence Emma’s account based pension will be counted against her transfer balance cap.

Over the years Emma has made concessional and non-concessional contributions to superannuation which means that she will have a tax-free amount in her accumulation account. She has made $300,000 as non-concessional contributions to the fund, which means that 1/3rd of the amount she uses to start the pension will be made up of a tax free amount and 2/3rd’s as a taxable amount. Even though Emma is 60 and any pension she receives will be total tax exempt, it still has a taxable and tax-free component in case any death benefit lump sum is paid to an adult child.

Emma then calculates the minimum pension amount which is equal to 4% of the $600,000 used to commence the account based pension. This amount is $24,000 and she has decided to have it paid to her monthly at $2,000 each month. The amount she receives will be totally tax free.

It’s now up to you

Starting an account based pension or TRIS is not that difficult as you can see, providing you do it in the right way and follow the simple rules that apply. If you fail to meet the requirements and are not prepared to plan properly then you may end up paying unnecessary tax and making a mess of things. Of course, you can always seek help from your accountant, financial adviser or fund administrator to guide you along the way.

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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