SMSF pension failures: Why missing a payment can be costly

So many trustees assume that missing a pension payment is a small fixable mistake, but when does a shortfall actually become a serious compliance failure?

Yeah, that’s a great question, because sometimes really small shortfalls can cause big problems. And the reason why they suddenly can cause a bigger problem is because when your pension doesn’t meet the rules, like it doesn’t draw enough pension, you don’t take enough pension out that year, it means it stops being a pension for tax purposes. And that means you don’t get to access some of the lovely tax breaks that we’re used to enjoying.

So that could be things like not being allowed to get a tax exemption on the fund’s income. It can do things like if you’ve got a few pensions, it can change the taxable components underneath. And sometimes that’s not a bad thing for pensioners, but other times it can impact estate planning outcomes, just different things they plan for. So, yeah, it can unfortunately have a bigger impact than you might first think.

So if a pension fails the minimum standards, what are the real world consequences for the fund? For example, ECPI, transfer balance caps. Not just paperwork, I guess.

Yeah, it’s not just paperwork. And like you say, that exempt current pension income, that’s usually can be a big one. It really depends on the funds. Like sometimes, you know, in funds there may not be a lot of income that year. Like the actual true cost might not be so significant. But if you had a lot of big sales, a lot of big capital gains that year, it could be very costly not to be entitled to that exemption. So it does have a lot of other implications and it’s always a little bit fund dependent. But yeah, so it does have a cost. It’s not just paperwork.

Trustees might just think, ‘can’t I just top it up later?’ Why is timing so critical when it comes to pension payments?

Yeah, a common question, because we think I’ll just take up a debtor for that, we’ll play catch up. But unfortunately the rules are very specific. They need them to be paid on time. So before on or before 30 June. The money has to be paid in cash as well. It has to leave the fund’s bank account and land in the pensioner’s account. So there’s unfortunately there isn’t really an option to play catch up.

Sometimes if you don’t meet the minimum rules, sometimes there are some exceptions. The Commissioner might give permission to overlook it and give that discretion. But it’s often hard to come by. But if you go down that pathway, sometimes a condition of that is that you do make a catch up payment. But typically as a general rule, you’ve got to get all those cash payments out on time ahead of the 30th of June.

Obviously the best thing to do is to regularly take pension payments through the year and allow a lot of time for that. Try not to leave big chunky payments till June. And also (beware of) banking limits – just give yourself plenty of time and don’t lock it all up in a term deposit!

So if someone is making payments through the year and they just missed the last one, is that a black and white failure?

Yeah, that’s a great question. So the ATO recognise that. They tried to basically say, look, sometimes if there is a very small shortfall, they’ll give your fund a one-off discretion. There is a number of other conditions that you have to meet in addition to it being a small shortfall. But what it does mean is, talk to your accountant. So as soon as you realise that you’ve got a shortfall, the best thing to do is talk to your accountant and work out if it is a fail or if you’ve got any discretion there, any ability to get a different outcome.

So once a pension fails, why is it described as being ‘permanently tainted’?

Yeah, you’ve got to love the super industry for how we coin things. ‘Permanently tainted’. I call it ‘dead for tax purposes’. But essentially the view from the ATO with that is, if your pension stops meeting the rules, it can never get the tax benefits ever again, so you can’t fix it. Which is why we say it’s permanently tainted. So if you want to keep getting that exempt current pension income, you would need to talk to your accountant, your adviser about actually physically stopping the tainted pension and restarting with a new one because otherwise it’ll never give you exempt current pension income again.

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And does that affect the member themselves?

Of course, yeah, it’s a big impact for them. It can impact, as I said, their tax-free and taxable component because they all, if they’ve got a number of different accounts, they literally for tax purposes can end up being all lumped back in together. It can impact how much they can get back into pension with their transfer balance cap. So you know there’s that lifetime limit about how much you can put into a pension and if you stop meeting the pension rules, it takes a long time to work out you haven’t met the pension rules. By the time you get things back on track, if your value in your account’s picked up, it might mean that you can’t get all your account back into pension again. It’s a tricky business. Yeah, best avoided.

So if trustees discover a problem after 30th of June, what are the first decisions they shouldn’t rush and what should they prioritise instead?

Yeah, that’s a great question. So the sooner you work out you’ve got a problem, the better, because it means the sooner you can get things back on track, whether that’s stopping and restarting the pension and so forth. So I think in my mind the thing is really is to pick up the phone, talk to your accountant and talk to your adviser and just confirm your understanding. Check that you know, have you failed that exemption, or that discretion is a better word. Sorry before I mentioned there about seeing if you can be overlooked or given a free pass. I’d check to see if you qualify for that exemption as well and then go from there.

So when a failed pension is later commuted and restarted, how can the tax free and taxable components change?

Yeah, so it really impacts, probably a more noticeable example will be if you’ve got multiple pensions, so you’ve got more than one, and sometimes they have different tax free components. Sometimes people make a point of having pensions that are entirely tax-free even. And so when you fail those rules, all those amounts, they used to be ring fenced and kept in their own buckets. But a consequence of not meeting the pension rules is they all get mushed back together. A very technical term, they’re mushed back together and basically it’s like you can’t unscramble an egg, if that makes sense. You can’t cherry pick out the tax-free again. So when you restart pensions, you essentially restart with those combined components. So depending on how old you are, the type of pension you’ve got, that may be worse than other times. It really just depends. Sometimes it’s more just impacting estate planning as well.

How does a pension failure flow through to a member’s transfer balance account? And why do trustees often underestimate that?

Yeah, the impact with your transfer balance cap is just understanding that the timing is different so that when you stop meeting the pension rules, you essentially get some space back in your cap, which is great. That happens at the 30th of June, at the end of the year when you fail the rules. But if you don’t restart a pension again till sometimes later, and you can’t do that until you actually consciously make that decision to say, hey, I’m going to stop this tainted pension and re go again with a new one. If there’s a period of time where that happens and your balances have increased, that’s where you might have the ability not to get all the money back into your pension account.

Are death benefit pensions treated differently when something goes wrong?

Yeah, death benefit pensions add a layer of complexity. The reason for that is they are supposed to be always cashed. So when you don’t meet the pension rules, the ATO view that as not cashing. So that often means that you’ll be breaching a rule around having to cash death benefits again. You can rectify that as best you can by getting the death benefit pension stopped and restarted again if that’s how you want to cash that benefit and receive those death benefits. But it is more rules that are that are being breached.

A little bit of a different outcome though is those tax-free tax components we talked about before, they all get mushed together. Death benefit pensions are like Teflon coded. They have a strange rule which means that they don’t get mushed back in together. So sometimes that’s good, they can be kept separate. They have to be kept separate from the other member benefits. So sometimes the damage is not as bad but there’s an extra breach in there.

Any final tips to avoid a pension problem?

Oh, if I have not convinced trustees to make sure they carefully give lots of time and care in making pension payments, then I haven’t done my job. But yeah, just lots of time to make pension payments. Take them regularly through the year, keep your accountant and adviser up to date. If you open new bank accounts or change anything, just keep them up to date with what’s happening in your fund, and stay on the right side.