Q&A: How do we structure our SMSF to collect rent as a pension if my wife is under preservation age?

Q: My wife and I run an SMSF. The fund owns 2 properties. My wife is 56 and I am 61. My wife owns 30% and I own 70% of the SMSF value. I have reached pension phase while my wife is in accumulation phase. How can we structure/split the fund between pension and accumulation phase so I can draw rent as pension for me? (This is only an issue now. In 4 years’, time when my wife also comes in pension phase, we will be draw out complete rent as pension for both of us). I am also mindful of the minimum 4% pension withdrawal rule for myself. What if the rent is less than 4%?

A: We got similar queries from multiple readers so we chose this one because I think it encompasses most of the issues that other questions were looking at as well. Just as an additional comment here, if I can, you’ve mentioned that you are 61 reached pension phase. Look, I’m assuming that you’ve retired or you’ve met another retirement or another condition of release that allows you full access to your benefits and not just via transition to retirement pension. That’s important for what we’re looking at here, particularly this need to keep in mind that earnings on transition to retirement pension assets aren’t tax-free, whereas earnings on assets in retirement phase or full pension phase are tax-free. I just wanted to make sure that that was clear. Just being 61 doesn’t allow you access, you’d need to look beyond that.

The other thing that I need to mention is as you’ve identified, the properties are held as assets of your SMSF. They’re not specific assets of any particular member of the fund. Now you’ll see the asterisk there, which we’ll look at asset segregation in a further question later on.

In most cases, when an SMSF owns assets, they’re held for all the members, not for any one particular member. When that rental property income comes into the fund, it’s simply added to the overall SMSF fund income. Then that income that the fund gets from all its assets is then used to pay all the fund expenses, which would include your pension payments and other things like bank fees, accounting expenses, etc.

As we do start to get older and we start to access our money from our SMSFs as pensions or lump sums, whatever it might be, we need to make sure that we have a relevant and updated investment strategy that we know what’s happening in the year ahead and will the rent be sufficient, as you’ve mentioned, to cover those pension payments and other expenses.

Now, you ask that if the rental income is not sufficient to meet your minimum pension payment, and as you’ll see there, it’s the 4% because you’re under 65, but it goes up all the way to 14% of your account balance when you hit 95.

If the income that you get from the pension, from the rent is not enough, then you’re going to have to use other amounts, other fund income or cash or sell assets, whatever, to fund those pension payments. You ask the question, What if it’s not enough? Well, if it’s not enough, then you’re going to need to fund it with other income.

Now, when we’re looking at these pension payments and the question that you’ve asked around, How do I do it? How do I structure the fund? What do I need to do? Well, first of all, you’re going to need to request that a pension commences for you from your benefits and your fund. That would then result in your fund being holding both assets – pension assets for you and accumulation assets for your spouse. To set the pension up, follow any of the required steps or processes in your trust deed, things like member request, the trustee acceptance, valuation of assets and so on. Don’t forget your transfer balance account report that you need to lodge. That’s the report to the ATO to say, “Hey, in the last quarter, one of our members accessed retirement phase”. That’s just the part to cover what do I need to do. You need to establish that pension. Again, check your trust deed for any particular fund details. My SMSF trust deed actually has an application for pensions attached to it. I will use those pension application forms.

Now, the starting of the pension for you results in a new account. By starting, requesting a pension, and setting up that pension, it then meets your question, which is, how do I structure and split the fund? That is done essentially through your SMSF software, your accountant and your admin provider. They’ll tick a box that says that this date you started a pension and it will therefore create that pension interest for you.

These are the issues that you need to consider, which is the establishment of the pension, making sure that it’s going to meet the needs of you in regards to minimum pension obligations, etc.

There are quite a few resources that are available on our website. I directly take you to the webinar, which was run around starting an account-based pension. All subscribers who are into the SMSF part of the website, you can access that webinar there. There are other issues here around how to start a pension and a pension checklist.