Paying a pension: alternatives for trustees
Don’t be fooled into thinking that the only way you can pay a pension income stream is with cash. There are a number of ways SMSFs can pay a pension. Find out how different pension structures can affect your SMSF's long-term wealth.
There is a number of ways self-managed super funds (SMSF) can pay a pension and it’s important that SMSF trustees think through the right option for the fund’s members.
“Best practice dictates that you can only pay a pension income stream with cash but you can fund a member’s income needs via pensions or lump sum commutations or a combination of both,” says Liam Shorte, Financial Planner and SMSF Specialist with advice firm Verante.
Lump sums – which are partial withdrawals – can be taken as cash or in-specie transfers of assets out of the fund, which is an important distinction.
“Also, under the new reporting rules and $1.6 million transfer balance cap a pension income payment is not reportable and does not affect the transfer balance cap.”
“But a lump sum commutation, for members with balances over $1 million, will have to be reported shortly after the end of each quarter from 1 July 2018 and do affect the cap,” he adds.
Shorte says most of his clients want to keep as much as possible in pension phase so he often recommends they take the minimum pension amount as an income stream. If they require more than that it is better to take additional amounts as lump sum commutations.
“For example if they take $50,000 to buy a car then by taking this as a lump sum commutation that will reduce the amount of their cap that they have used and they may be able to add more to pension phase if they meet the contribution rules now or later,” he explains.
What’s more, from 1 July 2017, earnings on assets supporting a transition-to-retirement (TTR) pension will no longer receive a tax exemption and will be taxed at the accumulation rate of 15 per cent. Therefore, if the SMSF already has a TTR pension and they meet a full condition of release, it may be worth them considering moving to a normal account based pension.
Factoring in goals
There are other considerations to factor in when you make your decision. The first is your goals.
“If you have funds in both accumulation and pension phase and have met a condition of release then in most cases you want to maintain as high a pension balance as possible, so you want to take the minimum from the tax free phase,” Shorte advises.
But remember, trustees cannot wait until the end of the year to decide which payments to treat as pensions and which as lump sums. They must make the election before the payment is made.
“Before the caps were introduced many people were used to just taking money out during the year and deciding on the allocation at the end of the year. With the new caps you have to plan ahead and the introduction of quarterly reporting means you must be on top of this each time payments are made,” he adds.
Shorte says to avoid missing a deadline he includes a minute in the fund’s records for a request from SMSF members from 1 July each year that they wish all amounts above the minimum pension to be treated as lump sum commutations unless specifically requested otherwise.
“This will ensure they remain compliant and maximise their opportunities to keep more in tax-free phase and possibly add more over time.”
He does see cases where trustees transfer shares from the SMSF to themselves as they want to retain the holding.
Says Shorte: “They often believe they can treat this as a pension payment, but they can’t. This must be treated as a lump sum commutation so you still need to meet your minimum pension requirements separately. Seek advice before starting to draw on your account to decide the best options for you and document the decisions.”
The impact of a 'grandfathered' pension
If you are in receipt of a Centrelink payment, it is important to know whether your income stream has ‘grandfathered’ income test rules, meaning your SMSF pension is income tested under a formula decided at the start of your pension rather than deemed.
“If you are withdrawing more than the minimum pension you need to make a decision as to whether you wish to treat it as a commutation, which will affect this formula each year, or as an increased pension payment, which will affect your income test in the year it is taken,” says Rhiannon Kanoniuk, Director and Practice Principal with financial advice firm Pekada
She says you don’t need to worry about this from a Centrelink perspective if your pension is not grandfathered, as the asset is now deemed and how you take the additional funds has no effect on the end income test.
“For estate planning purposes, it may be beneficial to think through whether you have the option of splitting up how you structure pensions between members, or even multiple pensions per member, particularly if you plan to draw above the minimum to fund your lifestyle,” she adds.
For example, you may have a current balance within your SMSF that is a mainly taxable component pension, but then you make a non-concessional contribution to super following this.
Sasy Kanoniuk: “It may be better to start a separate pension with this amount rather than commute the existing one and join the funds together, and retain this as a completely tax-free component, and then proceed to take any additional amounts above the minimum from the taxable pension. This will mean less tax payable to end beneficiaries who are not your spouse or dependants.”
Pensions are a complex area and how they are structured can affect SMSF members’ long-term wealth. Consider seeking advice to ensure your retirement is as comfortable as possible.