By Graeme Colley
Thinking of starting a pension in your self-managed super fund?
Then, you should understand your options and what’s involved. There’s a way of setting up a pension correctly – and many ways of getting it wrong.
Let’s look at the two most common types of pensions permissible in an SMSF – account-based pensions and transition to retirement income streams.
With an account-based pension (ABP), there’s a minimum amount you must receive – an age-based percentage of the opening balance. Once your pension is up and running, the minimum payment is re-calculated at beginning of each financial year – again an age-based percentage of the total value.
There are no maximum payment limits – you’re free to take as much as you want, either as pension payments, lump sum withdrawals or a combination of both.
You can start an ABP once you meet a condition of release which includes retirement after reaching your preservation age, currently age 57, or from the time you reach 65, whichever happens first. You can also receive an ABP if you’re totally and permanently disabled at any age.
The commencing value of your ABP is measured against your transfer balance cap, which for most people is $1.6 million. If the total value of your retirement-phase pensions is greater than your transfer balance cap, you may have to move the excess plus a penalty tax to an accumulation phase account, or withdraw it as a lump sum. The income on investments used to support retirement-phase pensions is tax-exempt.
After you reach 60, your ABP is totally tax-free to you. However, if you’re under 60, the taxable proportion of the pension, if permitted under the rules, is taxed at personal tax rates less a 15% tax offset.
A transition to retirement income stream (TRIS) is similar to an ABP in that you’re required to take a minimum amount – 4% of the account balance until you retire or reach 65, whichever happens first.
However, unlike an ABP, there is a maximum you’re allowed to take – capped at 10% of the opening balance when the TRIS commences or the balance on 1 July in each financial year thereafter.
The main benefit of a TRIS is that it can be started from your preservation age without the need to have retired.
The commencing value of a TRIS is not measured against your transfer balance cap, however, the income on investments that are used to support the TRIS are taxed at 15%.
If you’re between your preservation age and 60, the taxable component of a TRIS is taxed at personal rates less a 15% tax offset. However, once you reach 60, your TRIS is totally tax-free.
To start either type of pension you’ll need to calculate your accumulation balance in your SMSF.
And don’t forget you need to stay within your transfer balance cap. Your transfer balance cap takes into account any other pensions you may be receiving from your SMSF or other superannuation funds.
To work out your accumulation balance you’ll need to calculate the value of all investments of the SMSF to ensure they are ‘current’ under the ATO’s ruling. The ‘current’ value of an investment can relate to the value of the asset today or its value at the beginning of the financial year. It just depends on how easy it is to get the value, or whether there has been a substantial change to it since the last valuation.
Working out the value of the SMSF’s assets must be in line with the ATO’s market valuation of assets for tax purposes. Most assets are reasonably easy to value such as bank accounts, shares listed on the stock exchange and units in public unit trusts. Other investments may be harder to value like real estate, private companies and trusts as well as artworks and collectibles, if the fund has any. With the more difficult-to-value investments the ATO is willing to accept a value that reflects a fair value negotiated in an open market between parties acting at arm’s length. Sounds technical, I know, but a reasonable value supported by information on how the value was determined is what the ATO is after.
The next step is to work out the value of the various members accounts which could include the amount they have in accumulation phase and the balances of any pensions in the fund. The amount a member has in accumulation phase will be used to work out how much can be used to start the pension.
In addition, a calculation is made at this stage to work out the proportion of the fund which is the taxable portion of your accumulation account and its tax-free portion. These are important to work out: they define the proportion of the pension that is taxed if you are under 60, and they’re needed in respect of the taxation of any death benefit lump sums which are paid to your adult children.
Once you’ve worked out the amount of your accumulation account that you’ll use to start the pension, as well as the taxable and tax-free proportions, the next thing is to calculate the amount to be paid to you in the financial year.
If you don’t receive enough pension – or in the case of a TRIS you receive too much – the fund will run into compliance issues and you don’t want to get into that territory.
The minimum you must receive for either type of pension is an age-based percentage of the account value, with the percentages shown below.
If either pension type is commenced part way through the financial year, the minimum percentage is pro-rated on a daily basis.
| Age | Minimum % withdrawal |
| Under 65 | 4% |
| 65–74 | 5% |
| 75–79 | 6% |
| 80–84 | 7% |
| 85–89 | 9% |
| 90–94 | 11% |
| 95 or more | 14% |
Now you’ve done all the calculations, it’s time to start paying the pension.
It can be paid weekly, fortnightly or even just once each financial year if you wish. The important thing is to make sure you pay at least the minimum, and if it’s a TRIS that you don’t go over the maximum. Make sure your SMSF has enough cash to pay the pension when the time arrives.
It is possible to convert part or all of your ABP to a lump sum if you wish. This is called a commutation of the pension and there are rules about how much of the minimum pension is required to be paid prior to commutation.
If you’re receiving a TRIS it is usually not possible to draw down a lump sum as the TRIS balance is subject to preservation rules. These rules do not permit the payment of a lump sum until you’ve met a condition of release – for example that you’ve retired or reached age 65.
Starting a pension or TRIS is not that difficult as you can see, providing you do it in the right way and follow the simple rules that apply. If you fail to meet the requirements and are not prepared to plan properly, then you may end up paying unnecessary tax and making a mess of things.
Of course, you can always seek help from an accountant, financial adviser or fund administrator to guide you along the way.
