Should you start a pension in your SMSF? Weighing up the pros and cons

Investment returns, including earnings and capital gains, on fund assets supporting a retirement-phase pension will usually qualify as exempt current pension income (ECPI), meaning those earnings are not taxed inside the fund.

These tax concessions are only granted where the pension is established and maintained in accordance with the superannuation rules.

It is worth noting that there is a lifetime limit imposed on amounts that can be moved from accumulation phase into retirement (pension) phase, referred to as the transfer balance cap.

Control over pension assets

Most SMSF trust deeds would allow trustees to decide which assets support the pension, which can be useful where the fund holds direct shares, property, term deposits or other tailored investments.

This is often referred to as asset segregation. It allows specific fund assets to be allocated to specific fund members or to a class of fund membership, such as pension interests or accumulation interests.

Estate planning flexibility

There are several estate planning options and strategies available when an SMSF member commences a pension. Reversionary pensions, binding nominations and non-binding nominations can all form part of a personalised retirement and estate plan.

This could allow specific benefits that you hold in a pension account to be treated in a specific way on your death and other benefits that are held in accumulation to be dealt with separately.

As always, the SMSF trust deed, nominations and pension paperwork must all align, and trustees should not assume a simple form or checklist is enough. This is an area where specific and personally tailored advice is extremely valuable.

Manage your SMSF smarter – for free

Access practical, independent guides and checklists to help you run your fund with confidence with a free SuperGuide account.

Find out more

Issues specific for transition to retirement pensions

A transition to retirement pension (TTR) can be commenced when a fund member attains preservation age, generally age 60, without the need to cease their employment. These pensions allow access of up to 10% of the pension balance each year.

They are not classified as retirement-phase pensions. This means fund earnings on assets supporting this style of pension are not exempt from tax, and the transfer balance cap is not relevant when moving member benefits from accumulation to a transition to retirement pension. As a result, there is no limit imposed on the commencement value of a TTR.

But even without the tax concessions, there are a number of reasons and benefits that can be achieved by using a TTR in your SMSF.

Commencing a TTR could allow you to reduce the hours spent in paid employment and supplement this reduced employment income with TTR pension payments.

They could also allow access to additional income and reduce financial stress if and when needed, which may assist with ongoing cost-of-living pressures.

Other reasons to commence a TTR include:

• Accessing pension payments to reduce outstanding debts like your mortgage or other loans. This should be assessed against retirement income needs.
• Gaining earlier access to the recontribution strategy by drawing pension payments and then re-contributing those amounts back into the SMSF.

Reasons against starting a pension

Minimum pension obligations

Once a pension is commenced, a compulsory minimum amount must be paid each financial year for as long as the pension exists. The minimum pension is based on the member’s age and their pension balance at the commencement of the pension and then recalculated on 1 July each year.

This compulsory drawdown will of course have an effect on the member’s balance. The minimum pension ranges from 4% for those aged under 65 up to 14% for those aged 95 or older.

If the minimum pension requirement is not met for the financial year, then the pension may lose its concessional tax treatment for that year, and the fund may need to pay tax on its earnings.

Cash flow pressure

The requirement to pay at least a minimum pension amount each year can result in a cash flow issue for some SMSFs, hence the need to plan ahead and hold enough liquid assets to fund the required pension payments.

SMSFs that hold direct property or other illiquid assets may need careful planning to avoid forced sales.

Higher administration costs

Some SMSF service providers or administrators may charge additional fees for funds that have pension members. It would be worth checking this and assessing these costs against the benefits that the pension provides.

Potential Centrelink and aged care impacts

Starting a pension from your SMSF may affect Age Pension entitlements for you or your spouse and could impact any relevant aged care costs. This would depend on your personal circumstances.

It is important that you review these outcomes and seek relevant advice before making the decision to start a pension.

The bottom line

For many SMSF members, commencing a pension when allowed may provide a better outcome than remaining entirely in accumulation phase, including improved tax treatment and access to regular income payments in retirement. However, the decision should be tested against eligibility, cash flow needs, minimum pension obligations, administration costs and any Centrelink or aged care implications.

Ongoing trustee monitoring of the fund’s asset allocation and cash flow requirements will help maintain these benefits over the longer term.