SMSFs: How to start a pension

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.