Q: If I start a Pension in my SMSF after 1 July 2023 with a Transfer Balance Cap (TBC) at $1.9 million and Transfer Balance Account (TBA) at $1.9 million (but do not take a Pension payment until after 1 June 2024,) does it means that I do not have to use any of my 4% minimum pension drawdown for the 2023-24 year? If that is the case, does my total balance account increases by the earnings allocated to my Pension Account as at 1 July 2024? If the above is correct, how does this affect my tax-free status of earning in Pension Account for the 2023-24 year? I am assuming the tax free status remains in place?
A: I think this is probably a really good opportunity to give some assistance in regard to general advice around this question, but also a good opportunity to explain some of these concepts in more detail. If you’re listening and going, What is this all about? Hopefully I can unpack some of these issues.
First of all, I just want to give some background, starting with some definitions. What’s the Transfer Balance Cap (TBC)? That’s the limits that we can move into the tax-free earning stage of Super, which used to be called pension phase. It’s now just referred to as the retirement phase.
The transfer balance cap is the limit on what can be moved into that tax-free stage. Then you’ve got your personal transfer balance cap. Now, your personal transfer balance cap is your own personal limit on the amounts that you can personally move into the tax-free earning stage into retirement phase. You have to have a personal transfer balance cap because it gets affected by things like indexation.
Currently, the general transfer balance cap, the transfer balance cap, it sits at the moment at $1.9 million from 1 July 2023. When it first started, it kicked off at $1.6 million. It then got indexed to $1.7 million and indexed again this 1 July 2023 to $1.9 million. That’s why you need to have separate to the overall transfer balance cap, you need to have a way of assessing what your personal transfer balance cap is. I’m about 50 years of age. I’ve never commenced a retirement phase income stream. My personal transfer balance cap is currently $1.9 million. I haven’t used any of my personal transfer balance cap. My current TBC is $1.9 million.
Others of you may have started pensions at certain times during the last four or five years. Your personal transfer balance cap would range between $1.6 and $1.9 million. I hope that concept makes some sense.
Now, the way we track that is through our Transfer Balance Account (TBA). Just think of it as your personal record of all the transactions that have affected your own transfer balance cap. It’s the lump sums that we’ve taken from pensions. It’s the pensions balances that we’ve started.
Now, the ATO tracks that for us. We can get that at any time by going into MyGov and looking at what our transfer balance account is amongst other superannuation information that’s provided by the ATO. The transfer balance account is like the ledger, like the bank account statement that shows you what’s gone in and what’s come out of your personal transfer balance cap. I hope those three things make some sense.
Now, in the question that was asked, it was talking about, if I start a pension, but I don’t take out payments until later. We also need to consider what the pension requirements are, what the pension rules are. There is a minimum amount that each of us has to take each year, and it’s based on the age. When we’re under 65, we need to take a minimum of 4%. Once we get older, 95 or more, we have to take 14% of our pension balance every year. There are specific rules that must be met, including the requirement for that minimum at least to be paid each year.
The way that the minimum is calculated is it’s your age when the pension starts and the pension balance on the date that pension starts. Let’s just say, if I start a pension at 1 July with a transfer balance cap of $1.9m, your pension balance should have said $1.9m. I’m assuming that you would fall into one of those age brackets. We know your minimum pension by multiplying the $1.9m by your minimum percentage. We know how much you have to take out.
If you don’t take that minimum each year, if you fail to take the minimum, then your pension ceases to exist. You no longer have a pension. If you don’t meet the pension rules, including the requirement to take at least a minimum, that pension stops from the start of the year. Your fund would not be eligible to get that tax-free earning status. What we refer to is exempt current pension income. All earnings attributed to that pension would be taxable because the tax office will say, No, you don’t have a pension because you didn’t pay the pension requirements.
Now, just to add a little bit of confusion here, the pension ceases at 1 July for tax purposes, but the transfer balance account event that will appear in your personal transfer balance account will be the balance at 30th of June. If your pension has, for instance, gone from $1.9m that you said to $1.8m, then you will only ever be able to start a pension with $1.8m again. I’ll cover that issue in another question later, but that is just something to think about. You will lose your exempt income.
Going back over the question, it mentions that if I don’t take any payments until after 1 June, it was quite specific about that. What I was wondering is whether, you were referring to the 1 June rule. What the 1 June rule says out is that if you start a pension in your fund on 1 June of the financial year or later, so if you start a pension on 1 June or after, you don’t need to take a minimum pension payment in that first year. I don’t think it’s relevant for the question here because you said you started your pension on or after 1 July, but I just wanted to include this one general just in case.
Again, what you need to think about is what your fund says around when a pension commences. A pension will start in your fund when you’ve done all the things that are necessary for a pension to exist, usually contained in your trust deed. That process would usually include a member request, so an application for a pension, trustees acceptance and signing off, would create separate member accounts in the fund, so your pension account separated from the accumulation account, and we would lodge our transactions to a balanced account report because we’ve started a pension. There was a lot that was in your question there, so I hope that’s answered it.
What I did here is just a quick revisit of the wording of your question just to make sure that I addressed all those issues. Point one, you must pay at least the minimum pension each year in order for your pension to exist and continue. If the start date of the pension is on a date other than the 1st of July, then it’s pro-rata based on the number of days in the year. If I start a pension on 1st of July, it would be the 4% of my opening balance at that time. If I start my pension on 1st of January, it’s only half the financial year. It’d be 4% of my opening balance and then times 50%. The second bit was if the pension minimum is met and the pension continues post that, then all the earnings will be allocated to your pension account. If you start a pension, you meet all the requirements, any income generated on those pension assets obviously go back into your pension. It won’t affect your transfer balance account because earnings don’t get allocated to your transfer balance accounts, only the pension balances. The last point is if the pension minimum is met and the pension continues, then all the earnings will be tax-free inside the fund. You will get those tax-free earnings. There was a lot to unpack there, a lot of information. I hope that’s answered your question, but it might have hopefully helped some of you, other listeners, around the differences between transfer balance caps, transfer balance accounts and pensions.