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One of the benefits of having a self-managed superannuation fund (SMSF) is its ability to pay members an income stream, or account-based pension.
Of course, any super fund can do this, but paying a pension from an SMSF offers members more control and flexibility. The trustee can decide what assets will be supporting the pension and how much pension will be paid, provided you withdraw the minimum annual amount required by law.
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.
Eligibility
First you should understand the eligibility factors for paying a pension. You still have to meet the conditions of release for super, such as being permanently retired and having reached your preservation age. Unless of course you are over 65 and can access your super even if you are still working full time.
You can also pay yourself a transition-to-retirement pension (see section below), even if you haven’t permanently retired, as long as you have reached your preservation age.
Discover your preservation age in the table below…
| Date of birth | Preservation age |
|---|---|
| Before 1 July 1960 | 55 |
| 1 July 1960 – 30 June 1961 | 56 |
| 1 July 1961 – 30 June 1962 | 57 |
| 1 July 1962 – 30 June 1963 | 58 |
| 1 July 1963 – 30 June 1964 | 59 |
| From 1 July 1964 | 60 |
Source: ATO
Minimum pension amount
There is also a minimum annual pension amount you need to 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 | Temporary percentage factor (2019-20 to 2022-23) | Normal percentage factor (2013-14 to 2018-19) |
|---|---|---|
| Under 65 | 2% | 4% |
| 65 to 74 | 2.5% | 5% |
| 75 to 79 | 3% | 6% |
| 80 to 84 | 3.5% | 7% |
| 85 to 89 | 4.5% | 9% |
| 90 to 94 | 5.5% | 11% |
| 95 or more | 7% | 14% |
Source: SIS Act
Pension assets
The assets supporting a pension are fixed at the pension commencement 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 $1.7 million, places a limit on the maximum total amount you can have to commence pensions, and on which earnings are 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%) or withdraw it from the superannuation system.
Trust deed
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 the transfer balance cap.
The market value of the account balance needs to be determined on the commencement 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 commencement 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 proportional 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 proportional 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.
From the 2017–18 income year, if there are members in accumulation and retirement phase, or a fund member has a total superannuation balance over $1.6 million before the start of the relevant income year (and that member is receiving a retirement phase income stream from any fund), the SMSF must use the proportionate method to calculate ECPI.
In these instances, the fund’s assets are disregarded small fund assets, and will not be segregated current pension assets even if the fund is 100% in retirement phase.
The fund 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.
A fund that only has members in retirement phase and at all times during the income year the only retirement phase income streams were allocated pensions, market-linked pensions or account-based pensions, can use the segregated method to calculate ECPI and will not need an actuarial certificate.
Estimated cost of setting up a pension
Many SMSF advice groups or service providers will offer templates, which 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) | $250–500 |
| Trustee notification letter | $50 |
| Pension payment agreement | $250–400 |
| Product disclosure statement | $250–350 |
| Actuarial certificate (if required) | $200–1,000 |
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
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.
Any 58 to 59 year old who wants 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 (currently age 58) 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 stage. Once you have retired for super purposes, or reached age 65, the income earned on your transition-to-retirement pension accounts 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 58 or 59 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.
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 mean 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.
The bottom line
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.
Very informative newsletter about retirement, and account based pensions.
Regards