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When a self-managed superannuation fund’s first member moves from accumulation to retirement phase and wants to start a pension, there are steps the fund and the member need to consider.
SMSF trustees also have a considerable amount of flexibility. For instance, you can decide what assets will be supporting the pension and how much pension will be paid.
Factors to consider before starting a pension
There are a number of factors to consider when paying a pension from an SMSF in order to set one up correctly.
First you should understand the eligibility factors for paying a pension. You must still meet a condition of release for super, such as reaching your preservation age and being retired. Reaching age 65 is also a condition of release, permitting you to access super even if you are still working.
You can also pay yourself a transition-to-retirement pension (see section below), even if you haven’t retired, as long as you have reached your preservation age.
Discover your preservation age in the table below:
|Date of birth
|Before 1 July 1960
|1 July 1960 – 30 June 1961
|1 July 1961 – 30 June 1962
|1 July 1962 – 30 June 1963
|1 July 1963 – 30 June 1964
|From 1 July 1964
Minimum pension amount
There is also a minimum annual pension you must pay yourself each year. There is no maximum pension amount unless it is a transition-to-retirement pension and then the maximum is 10% of the balance.
|Age of beneficiary
|65 to 74
|75 to 79
|80 to 84
|85 to 89
|90 to 94
|95 or more
Source: SIS Act
The assets supporting a pension are fixed at the pension start date. This means you cannot keep contributing into the pension account, or transfer an asset from an accumulation account into the pension account, once the account-based pension has commenced. This would be considered stopping the existing pension and starting a new one.
Also, the introduction of the transfer balance cap, currently $1.9 million, places a limit on the maximum total amount you can use to commence pensions, on which earnings are generally tax free. If you have a balance exceeding the transfer balance cap, you may wish to leave the remainder of your retirement savings in accumulation phase (and be taxed at 15% on investment earnings) or withdraw it from the superannuation system.
Once you start a retirement pension, future increases to the transfer balance cap are applied in proportion to the amount of the cap you have not already used. This means that if you commenced a retirement pension prior to 1 July 2023 when the cap was last increased, your personal transfer balance cap is lower than $1.9 million.
Your trust deed also needs to allow an account-based pension. Some older trust deeds may not accommodate transition-to-retirement pensions so you need to check your trust deed and update it, or change it, if necessary.
Starting a pension
1. Value the assets
After making sure your trust deed can accommodate a pension, and amending it if it doesn’t, you need to value the assets that will be supporting the pension. This valuation is also the amount that will count towards your transfer balance cap.
The market value of the account balance needs to be determined on the start day of the pension and should be based on objective and supportable data.
You don’t need to get an independent valuation unless there are collectibles and/or personal use items in the fund, which need to be valued by a qualified independent valuer.
2. Do the paperwork
You need to notify the trustee in writing that you wish to start a pension, record this in the fund’s minutes and draw up a pension agreement. The pension agreement should be annexed to the fund’s trust deed. This agreement needs to specify such things as the frequency of the pension, the pension start date, documents that need to be supplied to the member from the trustee, such as an annual pension statement, how the pension could be commuted to a lump sum and how variations could be made to the pension.
A product disclosure statement (PDS) also needs to be supplied to the member starting the pension. Like any other PDS, this document needs to include key benefits, features, costs and risks of the product.
Earnings on pension assets are tax free, so if there is more than one member in the SMSF and the fund has both accumulation and retirement assets, then exempt current pension income – ECPI – will need to be calculated.
A transfer balance account report will also need to be lodged as the commencement of a pension is a transfer balance event.
3. Calculate ECPI
There are two methods for calculating ECPI – the segregated method and the proportionate method. If the segregated method is used, then the assets supporting the pension are known and are separated from the assets in accumulation phase. If the assets are mixed, then the proportionate method needs to be used. This requires an actuarial certificate to determine the proportion of assets in each stage, and therefore the proportion of income that is tax free.
Since 1 July 2021, the ATO has allowed SMSFs that are fully in retirement phase for part of the year, but also in retirement phase and accumulation phase for part of the year, to choose whether they use the proportionate method or the segregated method to calculate ECPI.
However, if a fund has disregarded small fund assets it must use the proportionate method to calculate ECPI.
The ATO says an SMSF is deemed to have small fund assets when:
- The fund is paying at least one retirement phase income stream during the income year
- A fund member has a total super balance over $1.6 million immediately before the start of the relevant income year
- That member is receiving a retirement-phase income stream from any source including the small fund or another super provider
- After 1 July 2021, the fund is NOT in 100% retirement phase at all times of the income year.
A fund using the proportionate method to calculate ECPI will need an actuarial certificate each year to clarify which assets support the pension and therefore how much income is exempt from tax (ECPI), and which assets are in accumulation phase.
Estimated cost of setting up a pension
Many SMSF advice groups or service providers will offer templates that can be used for the main documentation for setting up a pension. Platform providers may also include the documents as part of their package. Here is a rough price guide.
|Trust deed amendment (if required)
|Trustee notification letter
|Pension payment agreement
|Product disclosure statement
|Actuarial certificate (if required)
Some SMSF service providers also offer pension commencement documentation packs starting from approximately $500, depending on what is included. However, a qualified actuary will need to provide the actuarial certificate.
Starting a pension before you turn 60
As you can see in the above table on preservation age, there are still some people whose preservation age is under 60. However, by 1 July 2024, preservation age will be 60 for anyone who has not already reached it.
To access your super before you turn 60, regardless of whether it is as a lump sum or a pension, you need to have met a condition of release.
For someone who hasn’t turned 60, but who has reached their preservation age, they need to cease gainful employment and have no intention of becoming gainfully employed for more than 10 hours each week in the future.
Anyone under 60 who want to start a full pension will need to calculate their taxable and tax-free components. All super (from a taxed source) is tax free after the age of 60. If you’ve reached your preservation age but are not yet 60, your tax-free component is the total of all the non-concessional contributions you have made to your super fund over the years.
One of the benefits of accessing your super before you turn 60 (if you meet a condition of release of course) is that you will be eligible for a 15% tax offset on the taxable component of that income stream.
Transition-to-retirement pensions (TTR or TRIS)
If you’ve reached your preservation age but have not yet fully retired, you are still eligible to pay yourself a transition-to-retirement pension. The tax treatment of these pensions is no longer as favourable as it was, but they are still useful tools for people wishing to transition to retirement gradually.
Earnings on super funds supporting a transition-to-retirement pension prior to your retirement are now taxed at 15% (it used to be 0%), just like funds in the accumulation phase. Once you have retired for super purposes, or reached age 65, the transition-to-retirement pension is converted into a retirement pension and the income earned is tax free. At that time the balance will be counted against your transfer balance cap.
If you are over 60, then any pension payments you receive will be tax free. If you are not yet 60, the payments will be taxed at your marginal tax rate, however you will receive the same 15% tax offset you would be eligible for if it was a regular account-based pension.
Transition-to-retirement pensions have the same requirements around minimum pension payments (see table above) and have a maximum annual pension payment of 10% of the pension account balance.
Starting a pension after age 60, but before you turn 65
To access your super, either as a lump sum or pension, after you turn 60 but before you reach 65, you just need to leave a job; you don’t need to be permanently retired. And as long as you don’t start pensions with more than the transfer balance cap amount, any income earned on your pension account balances will be tax free.
If you haven’t left a job, you may still commence a TTR, as described previously.
Starting a pension after 65
On starting a pension once you hit the age of 65, the ATO says: “A member who has reached 65 years old may cash their benefits at any time. There are no cashing restrictions, which means the benefits can be paid as an income stream or a lump sum.” And again, earnings on the pension account balance(s) will be tax free.
Simple account-based pension commencement pack
- Pension establishment checklist (read more about each point below here)
- Check eligibility
- Check your trust deed
- Value the assets
- Understand the transfer balance cap
- Get across event-based reporting
- Understand the minimum pension amount
- Apply to start a pension
- Minute the commencement
- Start paying the pension
- Supply the product disclosure statement (PDS) if required
- Obtain an actuarial certificate if required
- Draft member request to start a pension
- Draft trustee minutes to start a pension
Most members in an SMSF will eventually need a retirement income stream to live off, so it’s a good idea to understand what’s involved and prepare for it before you retire.
Draft member request to start a pension
To the trustees of XYZ SMSF, I A Nguyen, [DOB 1 July 1960] of 5 Cando St, Candotown NSW 1234, wish to start an account-based non-reversionary pension commencing on 1 July 2023 supported by the full amount of my accumulation balance – currently valued at $1 million.
I plan to draw an amount of 5% of that asset pool over the 2023–24 financial year in fortnightly instalments.
Signed A Nguyen _________
Draft trustee minutes to start a pension
Meeting of XYZ self-managed superannuation fund
[Whether the trustees sign a minute or resolution will depend on the terms of the fund’s trust deed in some cases.]
Date: 13 February 2023
Venue: 1 Main St, Your Town, ACT
Attendees: A Nguyen, B Nguyen and C Smith
Agenda: Commencement of pension for A Nguyen
Meeting chair: B Nguyen
It was noted that A Nguyen wishes to commence a pension on 1 July 2023, as per their request to start a pension dated 10 February 2023.
It was agreed that A Nguyen will start their pension on 1 July 2023 supported by their superannuation balance currently valued at $1 million and to be revalued just prior to the commencement of the pension.
It was agreed that A Nguyen will start their pension with an annual drawdown of 5% of the assets supporting the pension. This will be reviewed annually to ensure A Nguyen makes the minimum annual payment.