How to start a pension in your SMSF

SMSF trustees have a lot of flexibility when starting a pension for a fund member. For instance, they can decide what assets will be supporting the pension and, together with the member, can determine how much pension will be paid.

There are, however, a number of steps that must be followed and issues to consider when a member starts a pension and moves from accumulation phase to retirement phase.

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

You will need to meet a condition of release for super, such as reaching your preservation age (currently 60 for everyone) and being retired. From age 65 you can access your super even if you are still working.

You can also pay yourself a transition-to-retirement pension, even if you haven’t retired, as long as you have reached your preservation age. From 1 July 2024, the preservation age is 60 for anyone born after 1 July 1964.

Minimum pension amount

There is a requirement to pay a minimum pension amount for each year a pension is in place. This is determined by two factors:

1. Your age at the start of your pension, and then your age on 1 July
2. Your pension balance.

The minimum pension amount is calculated by applying the relevant age-based percentage factor (see table below) and multiplying this by your pension balance.

Source: SIS Act

There is no maximum pension amount applied unless it is a transition-to-retirement pension and then the maximum is 10% of the balance.

Cashflow position of the SMSF

SMSF trustees will need to consider the cash flow required to meet the pension payments for the year. There needs to be sufficient and regular return on the fund’s assets to make these pension payments as required and at least annually.

The cashflow requirements should be covered in the fund’s overall investment strategy documentation.

Pension assets

The assets supporting a pension are fixed at the pension start date. This means you cannot keep contributing to the pension account or transfer an asset from an accumulation account into the pension account once the account-based pension has commenced.

Also, the introduction of the transfer balance cap 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.

Should you nominate a reversionary beneficiary?

Most SMSF trust deeds allow members to nominate an eligible dependent to automatically take over their pension on their death. This nomination would usually need to be made on the establishment of the pension, so it needs to be considered before the pension paperwork is completed.

Trust deed

Your trust deed also needs to allow the relevant pension to be established and paid.

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.

It is recommended that SMSF trustees review their trust deed for any fund-specific rules, requirements or processes that need to be addressed or followed when establishing a pension for a fund member.

Starting a pension

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.

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 should 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) should also 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.

A transfer balance account report must also be lodged as the commencement of a retirement phase pension is a transfer balance event.

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’s a rough price guide:

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.

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 TTR 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 ease into retirement gradually.

Earnings on super fund assets supporting a TTR pension prior to your retirement are taxed at 15%, just like funds in the accumulation phase. Once you have retired for super purposes, or reached age 65, the TTR pension is converted into a retirement phase pension and the income earned by the fund is tax free. At that time, the balance will be counted against your transfer balance cap.

Pension payments after age 60 are tax free to the recipient.

TTR pensions have the same requirements around minimum pension payments, but they also 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 age 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 start a TTR, as described previously.

Starting a pension after 65

Once a member turns 65, their superannuation benefits become unrestricted non-preserved, removing all cashing restrictions. This means benefits can be paid as an income stream or a lump sum or a mixture of the two.

Simple account-based pension commencement pack

• Pension establishment checklist (read more about each of the points below)
  • 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

The bottom line

Most members in an SMSF will eventually need a super pension to provide retirement income, 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 202X supported by the full amount of my accumulation balance – currently valued at $X.

I plan to draw an amount of 5% of that asset pool over the 202X–202X financial year in fortnightly instalments.

Signed A Nguyen _________

Date _________

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 202X
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 202X, as per their request to start a pension dated 10 February 202X.

It was agreed that A Nguyen will start their pension on 1 July 202X supported by their superannuation balance currently valued at $X 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 X% of the assets supporting the pension. This will be reviewed annually to ensure A Nguyen makes the minimum annual payment.



Signed by

Trustee A

——————

Trustee B

——————

Trustee C

——————

Date: