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One of the benefits of retirement is that you can usually start to withdraw your superannuation tax free. That doesn’t mean it’s a rule-free zone.
Note that this article focuses only on SMSFs, so does not consider tax consequences of untaxed funds or capped defined benefit income streams.
How are super pensions taxed?
Provided your super pension complies with the annual minimum payment requirements, there is no tax payable on either the income you receive or earnings (including capital gains) on the investments supporting a retirement phase pension.
However, if you fail to withdraw the required minimum, pension income and assets will lose their tax-free status for the full financial year and all withdrawals will be treated as lump sums. Lump sums generally include taxed and tax-free components.
If you fail to make the minimum payments one year but comply the following year, the tax benefits will be reinstated but you will need to start a new pension. To start a new pension, the fund trustee will need to revalue pension assets at market value and recalculate the minimum pension payment.
The tax commissioner may show leniency and allow an income stream to continue if certain conditions are met. If the failure to pay the minimum pension amount was an honest mistake resulting in a small underpayment, or outside the control of the trustee, and a catch-up payment is made within 28 days of becoming aware of the oversight, the income stream may continue without needing to be restarted. If the income stream was in retirement phase, there will be no loss of tax exemptions for the year the oversight occurred. A small underpayment is deemed to be not more than one twelfth of the annual minimum.
If you have an SMSF paying more than one pension, both need to meet the minimum payment requirements. If one pension complies and the other fails to pay the annual minimum amount, only that one will need to apply for leniency or lose its tax exemptions.
Tax and transition-to-retirement pensions
The taxation of transition-to-retirement (TTR) pensions is a little different.
Since 1 July 2017, earnings on assets supporting TTR pensions are taxed at 15%. Income remains tax free if you are aged 60 or over. If you are younger than 60, the taxable portion of your pension income will be taxed at your marginal rate less a 15% tax offset.
Once you retire after your preservation age or reach age 65, your TTR becomes a retirement phase pension and is eligible for tax-free investment earnings as described above.
If your TTR pension pays out less than the annual minimum, then the consequences discussed above apply. If it pays more than the maximum, your fund may be found to be non-compliant and have its total assets subjected to the highest marginal tax rate.
Pension strategies to reduce tax
In some cases, there may be tax benefits in the timing and amount of pension income and lump sum withdrawals in retirement phase.
This is especially so for SMSFs since the changes to the Exempt Current Pension Income (ECPI) rules, where at least one fund member has an amount in retirement phase that is being drawn as an income stream and an amount in accumulation phase.
Strategy 1
Graeme Colley, executive manager SMSF Technical and Private Wealth at SuperConcepts, says that for someone withdrawing more than the minimum pension amount, there can be a tax benefit in taking additional amounts as a lump sum from their accumulation account early in the financial year. That’s because income from the accumulation account is taxed by up to 15% whereas income from the pension account in retirement phase is tax free. By reducing the balance in the accumulation fund you effectively increase the tax-exempt proportion of your fund.
Colley gives the example of Liam, 62, who is the only member of his SMSF. He is drawing an account-based pension with a balance of $1.7 million on 1 July 2022 and has an accumulation account of $300,000 at that time. That is, the total balance of his fund is $2 million, the tax-exempt portion is 85% ($1.7 million as a percentage of $2.0 million) and the taxable portion is 15% ($300,000 as a percentage of $2.0 million).
Liam wants to withdraw $100,000 from super in the 2023–24 financial year to meet his living expenses. The minimum pension he is required to take is $68,000, which means he will need to withdraw an additional $32,000 to meet his expected living costs.
Liam could withdraw the full $100,000 from his pension account or take $32,000 as a lump sum, either before or after the pension. Depending on how he withdraws the amounts the fund will end up with different tax-exempt percentages. If he takes it all as a pension, the tax-exempt amount would be 84.21% as the tax-free portion of his pension balance has reduced from the original 85% at the start of the year.
The best outcome is where he takes the lump sum of $32,000 on 1 July and takes the pension payment the following 30 June, resulting in a tax-exempt portion of 86.38%. By taking the lump sum from his taxable accumulation account as early as possible, he has reduced the taxable proportion of his fund. And by drawing a pension from his pension account as late as possible, he maximises the tax-exempt portion of his fund.
Strategy 2
In some cases, Colley says it may make sense to take any payments that are required in excess of the minimum as partial commutations. This will reduce the value in your transfer balance account and make space to use further funds to commence a pension in the future.
He gives the example of Haley, 60, who commences an account-based pension on 1 July 2023 with $1.7 million and the income in the fund is all tax free. She wants to withdraw $100,000 each year for the next five years, which is more than her $68,000 minimum pension amount. The best strategy would be to withdraw the $68,000 as a pension and the remaining $32,000 as a lump sum by commuting it from the pension. The commutation would reduce the amount counted against her transfer balance cap and allow her to commence a pension at a later date with the cap space that becomes available.
Strategy 3
Another strategy worth considering is the timing of asset sales to maximise tax exempt income. Where a fund is wholly in retirement phase for part of the year when it is 100% tax exempt, and wholly in accumulation phase for another part of the year with 0% tax exemption, it makes sense to sell assets when the tax-exempt portion is the highest.
The bottom line
The good news is that there is no tax payable on either the income you receive from your superannuation pension or earnings (including capital gains) on the investments supporting the pension, provided you comply with the annual minimum payment requirements. You may need to seek independent financial advice on the strategies that will provide the best after-tax outcome for your circumstances.
IMPORTANT: All information on SuperGuide is general in nature only and does not take into account your personal objectives, financial situation or needs. You should consider whether any information on SuperGuide is appropriate to you before acting on it. If SuperGuide refers to a financial product you should obtain the relevant product disclosure statement (PDS) or seek personal financial advice before making any investment decisions. Comments provided by readers that may include information relating to tax, superannuation or other rules cannot be relied upon as advice. SuperGuide does not verify the information provided within comments from readers. Learn more
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