Your self-manage super fund (SMSF) can pay benefits to a member as an income stream (pension) if the member has met one of the conditions of release.
This information explains the pension standards that apply to self-managed super funds (SMSFs) in relation to account-based pensions – also known as a super income stream.
What you need to know about SMSF Pensions
Like all super funds, self-managed super funds (SMSFs) can provide you with pension or lump sum benefits in retirement. Retirement is a condition of super release if you have reached your preservation age. Your preservation age is between 55 and 60, depending on your date of birth. Super benefits are tax-free if you’re over the age of 60.
If you start a super pension income stream, you need to transfer funds from your accumulation account to your retirement account to fund your pension. The earnings on these funds are tax-free. You can transfer up to the transfer balance cap (up to $1.6 million) into your retirement account. You need to withdraw a minimum percentage of your retirement account balance each year, ranging from 4 to 14% depending on your age.
Transition-to-retirement (TTR) pensions can be commenced once you have reached your preservation age while you’re still working. However, the earnings on funds that support TTR pensions are still taxed at 15%, unlike the funds that support your super pension are if you have retired.
A recent ruling from the Commissioner has highlighted the importance of administering a pension correctly, with severe tax consequences for those that fail to comply.
The Commissioner has revealed that failing to make the required pension payments could jeopardise the tax-free status of a self-managed superannuation fund (“SMSF”) not just from the date of shortfall but for the whole financial year.
Commencement and cessation of a pension
With over 500,000 SMSFs in Australia and more than 58%1 of the SMSF member population over the age of 55, administering a pension (formally known as a ‘superannuation income stream’) is becoming increasingly common.
The date on which a pension commences or ceases is crucial to the tax outcomes within the SMSF:
- When a pension has commenced, it enters ‘pension phase’ and can access the current pension income exemption – resulting in a tax rate of zero on any earnings.
- Prior to commencement or following cessation, a superannuation fund is in ‘accumulation phase’ and subject to 15% tax on earnings and concessional contributions.
Confusion often arises as to when a pension technically commences or ceases, particularly if an unusual event has happened during the year, such as a shortfall in pension payments.
In order to provide more guidance relating to the commencement and cessation of a pension, the Commissioner has released taxation ruling TR 2013/5: Income Tax: when a superannuation income stream commences and ceases. The Ruling applies retrospectively from 1 July 2007.
When does a pension commence?
In the ruling, the Commissioner explains that a pension exists only where the SMSF trustee has a liability to pay the member a series of ‘periodic payments’ (that relate to each other) over an identifiable period of time.
The Commissioner clarifies that ‘periodic payments’:
- Do not need to be paid at set intervals (e.g. the 1st of every month);
- Can vary in amount; and
- Could include a single payment for a year, provided that this pattern is recurring over a number of years.
It is not uncommon for an SMSF pension member to draw down one annual payment. However, SMSF trustees should take care in this regard; the Commissioner has implied that such payments will not be treated as an ‘income stream’ if a pension commences and then ceases after one year.
When does a pension cease?
Generally, a pension will cease when there is no longer a member (or beneficiary of that member) who is entitled to the superannuation income stream. The following is a list of some common circumstances where a pension ceases:
- Failure to comply with the pension rules;
- Payment standards of the superannuation law;
- Exhaustion of capital;
- Where a member fully commutes their pension; or
- On death of the member (bearing in mind that there is an extension of the exempt current pension tax exemption immediately following the death of a member).
One common example where a pension could inadvertently cease under the above circumstances is where an SMSF Trustee fails to pay the minimum pension for an income year.
It is critical that pension members make their minimum pension payments for the year in order to retain pension status in that year. A question that has often arisen is are the pension payment received, for the purpose of the minimum pension payment standards, when a cheque is honored by the bank, or when it is received by the member.
The ATO has released a determination SMSFD 2011/1 that addresses when a cheque or promissory note is actually received by a member.
The ruling indicates that it is ‘cashed’ if:
• at that time, money is payable immediately and available for payment;
• the trustee takes all reasonable steps to ensure that the money is paid promptly;
• the money is paid; and
• the requirements of the Superannuation Industry (Supervision) Regulations 1994 (SISR) are otherwise satisfied.
Example - Payment using a cheque
Karlie is a member of the Black Rock SMSF based on Asburton, Vic. As at 30 June 2011, financial year 1, the Black Rock SMSF is required to make a benefit payment to Karlie of $15,000.
The trustee writes a cheque for $15,000. Karlie receives the cheque on 30 June, financial year 1, but does not present it for payment until 5 July 2011, financial year 2. The cheque is subsequently honoured.
The benefit was cashed on 30 June 2011, financial year 1 when Karlie received the cheque. Objectively, the trustee intended to transfer funds from the SMSF to Karlie at that time by issuing the cheque and money was paid promptly.
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. Hillier Riches are local SMSF accounting specialists who provide accounting services to SMSF clients and businesses in Asburton.