By Mark Ellem
It was reported in the Australian Financial Review on 14 January 2015 that the self managed superannuation fund (SMSF) for Don Argus (previous Chief Executive of National Australia Bank and former Chairman of BHP Billiton) received an adverse tax adjustment to its 2010 tax return for a claim for exempt pension income in the amount of $1,176,991, for failing to pay the minimum pension. Whilst the calculation of the minimum pension payment is not really that complex, there are some simple traps that can result in significant adverse tax consequences. We discuss a number of these traps in this article.
Paying the correct minimum pension is crucial to the fund claiming exempt current pension income (ECPI). Failure to pay the minimum pension results in the fund being ineligible to claim any ECPI in relation to that pension, for the whole income year. Further, per TR 2013/5, the pension is deemed to have ceased back at the start of the income year (in which the fund failed to pay the minimum pension) and from a tax component perspective, means that there is a mixing of the former pension interest’s tax components with any other failed pensions and accumulation tax components, belonging to the same member.
Let’s consider Dan, aged 76 (1 July 2014), a member of his SMSF, with his wife Mary, aged 72 (1 July 2014). Dan has three interests in his SMSF, as follows:
Mary’s benefit in the fund is as follows:
Calculating Dan and Mary’s respective minimum pension for the 2014/15 income year is relatively straight forward, it’s simply:
1 July balance of pension interest x relevant minimum pension %
The minimum pension % is obtained from a table at item 5 of Schedule 7 to the SIS Regulations and is based on the member’s age as at the start of the income year, or where the pension is commenced during the income year, their age at commencement of the pension.
Based on Dan’s age at 1 July 2014 of 76, his relevant % is 6% and consequently his minimum pension for each pension interest is as follows:
ABP 1 - $1,567,500 x 6% = $94,050
ABP 2 - $686,500 x 6% = $41,190
Note that item 5 of Schedule 7 also requires the amount calculated to be rounded to the nearest $10. If the amount ends in an exact $5, it is to be rounded up to the next $10. So, for Mary, aged 72 with an account based pension balance of $734,975 as at 1 July 2014, the required minimum pension percentage factor is 5%. By simply doing the basic calculation you get a result of $36,748.75. If this is advised to Mary and this is the amount the fund pays her, then the fund will have not met the minimum pension payment requirement as it is required to be rounded to the nearest $10, which in this case is $36,750.
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(TRIS). In fact, rounding the maximum may cause the payment to actually exceed the 10% maximum limit, which would result in an adverse tax outcome |
For the fund, we would expect, based on using the unsegregated method, that the percentage of income to be claimed as ECPI to be around 86.71%. Let’s say that the fund had assessable income for 2014/15 of $275,758 (no assessable contributions and no non arm’s length income), including franking credits of $34,285.
Applying the ECPI %, the fund’s claim for ECPI would be $239,109, reducing the fund’s taxable income to $36,649. Fund income tax would be $5,497.35, then less the franking credits, resulting in a refund of tax of $28,787.65 (before applying the ATO Supervisory Levy).
 Trap 2 – not obtaining an actuarial certificate for ECPI%. A fund in not eligible to claim ECPI if it does not hold the relevant tax certificate from an Actuary at the time of lodging the return. Simply using the Actuary’s calculator to determine the ECPI% is not enough, you must have the certificate. |
If the fund failed to pay the correct minimum pension, for all pensions, then it would not be entitled to claim any ECPI for that income year. This has the effect of changing the fund’s net tax position from a refund of $28,787.65 to tax payable of $7,078.70. However, the other substantial effect for the members is that for tax purposes, their respective pension will be deemed to have ceased as from 1 July 2014. Consequently, all income earned by each pension will be allocated to the taxable component, rather than split per the components established when each pension was commenced. Further, for Dan, he will have a mixing of tax components across his pension and accumulation interests.
After failing to pay the required minimum pensions in 2014/15, provided the fund met the pension requirements in 2015/16, the re-calculated tax components of Dan and Mary’s superannuation interests would be as follows, as at 1 July 2015:
The above calculations of balances as at 1 July 2015 utilise the following:
o Dan payment from ABP No 1 (treated as lump sum) $60,000
o Dan payment from ABP No 2 (treated as lump sum ) $20,000
o Mary payment from ABP (treated as lump sum) $30,000
As can be seen, the effect for Dan is that he no longer has separate pension interests. As they were deemed to cease, with effect from 1 July 2014, when a “new” pension is commenced on 1 July 2015, the proportionate rule requires the tax components to be calculated for his entire accumulation interest, which is all of his benefits, then applied to the amount used to commence the pension. Not having the separate pension interest may mean that his estate plan will have to be reviewed.
| Trap 3 – cessation of pension results in the mixing of tax components with other failed pensions and accumulation interests. This can affect tax strategies for members under age 60 and estate planning strategies, regardless of age. |
As each pension would have been deemed to have ceased with effect from 1 July 2014, all payments would be treated as lump sum benefit payments. As their pensions were TRISs, with 100% preserved benefits, the fund has breached the preservation rules, as lump sum benefit payments cannot be paid from preserved benefits. In addition to the fund not being eligible to claim ECPI and the mixing of tax components, Dan and Mary will be fully assessed on the amounts that they have received from the fund in accordance with section 304-10 of the 1997 Tax Act. This will tax fully their respective benefits at their marginal tax rate (MTR) with no reference to tax components. There is also no 15% tax offset or application of the Low Rate Cap. This is because section 304-10 treats the benefits as ordinary income, like interest income, and not as a superannuation benefit payment. Consequently, even though part of the benefit received by Dan and Mary represents a tax free amount, this is ignored and fully assessed at the MTR.
This outcome would also be the same if Dan and Mary had exceeded their 10% maximum TRIS pension allowance.
| Trap 4 – not paying the minimum pension on a TRIS or exceeding the 10% maximum results in tax penalty for members. |
Picking the correct Minimum Pension % for a Reversionary Pension
When a pension recipient dies during the income year and the pension was set up as reversionary, the minimum percentage factor is based on the age of the member who was in receipt of the pension as at 1 July of the current income year, not the reversionary pensioner.
For example, assuming Dan’s pensions are reversionary to Mary and Dan died in August 2014, the applicable minimum pension percentage to use for the 2014/15 income year is 6% and not 5%. This is because the applicable minimum pension percentage is determined at the start of the income year and at this time Dan was alive and due to his age, the applicable percentage is 6%. However, come 1 July 2015 the applicable minimum pension percentage will be based upon Mary’s age at that time and consequently will be 5%.
| Trap 5 – Using the wrong minimum pension % in the year of death of a member with a reversionary pension. This can result in an underpayment of the minimum pension. |
SIS Regulation 1.07D(1)(d) requires a minimum pension payment prior to the full commutation as calculated in subregulation 1.07D(2). This subregulation effectively apportions the annual minimum pension, as calculated per schedule 7, over the number of days that the pension was in place during the income year.
No similar apportioning is required where there is a partial commutation of a pension.
| Trap 6 – Failing to pay the pro rata minimum pension before a full commutation of the pension. Note: where a pension recipient dies during the income year and the pension was non-reversionary, regulation 1.07D(1)(a) of the SIS Regulation provides that no minimum pension is required to be paid. The fund is still entitled to claim ECPI. |
Whilst not a tax issue, for any clients who were receiving Centrelink benefits, either the Age Pension or the Commonwealth Seniors Healthcare Card (CSHC) before 1 January 2015 and are also receiving a pension from their SMSF, that commenced prior to 1 January 2015, a full commutation of that pension can affect their entitlement to those Centrelink benefits. The full commutation may be voluntary, for example as part of a pension and accumulation account “sweep” or a result of failing to pay the minimum pension.
| Trap 7 – Post 1 January 2015 full commutation of a pension can affect member’s entitlements to Centrelink benefits, where they were in receipt of such prior to 1 January 2015. |
It is vitally important to ensure that a pension payment will count in the income year that it’s meant to. Making one annual pension payment at the end of the income year via electronic transfer can easily (and has on many occasions) lead to the pension payment not going through until the next financial year. The ATO has on several occasions outlined their view of the timing of pension payments, as well as contributions. Make sure that clients attend to the required minimum pension payment well before 30 June. A prudent strategy would be to set up an automatic monthly direct pension payment from the fund’s bank account to the member’s bank account such that come 30 June at least the minimum pension has been paid. Of course there may be a time lag as to when the actual minimum pension for the current year is determined, however, this can be based on an estimate and then adjusted once the prior year’s financials are completed and the 1 July member pension balance is known.
| Trap 8 – leaving the minimum pension payment to be paid as one annual lump sum at the end of the income year by electronic transfer. |
SuperMate has a number of features to help make pension establishment and administration a simple process, including:
Our pension commencement wizard helps you correctly establish a member’s pension within SuperMate in 3 clicks of the mouse. The payment requirements are calculated automatically based on the type of pension and purchase price.
As stated earlier in this article, the calculations for determining the minimum and maximum pension payments for your clients are not overcomplicated but if your software cannot automatically calculate these amounts, then it can be very manual and in turn, time consuming. The SuperMate pension review process calculates the pension requirements for the next financial year at the click of one button; select new record and the review for the current year is complete.
You can also create a new pension review record across all funds you administer via our Multi-Fund function, saving you more time and ensuring that all pensions are compliant for the coming financial year.
SuperMate will apply the correct minimum pension percentage to each pension. The calculation will take into consideration whether the pension is an existing pension, commenced during the year, or whether it’s a reversionary pension.
SuperMate’s minimum pension calculation correctly applies the requirement to round the minimum pension payment to the nearest $10.
Actuarial certificates are automated and integrated within SuperMate. Rather than wasting time finding information in your admin system and then needing to key it into an actuary’s form or spreadsheet, SuperMate does it all for you - fully automated.
SuperMate’s pension commutation wizard makes the commutation of an existing pension simple and ensures compliance with the relevant rules. Prior to the full commutation of a pension SuperMate will check to ensure the required pro rata minimum pension has been paid. It will also correctly record the tax components of the commuted amount as part of either a lump sum benefit payment or roll back to accumulation.
In accordance with ATO rulings, SuperMate will count partial commutations of a pension towards the minimum pension payment, ensuring that when pension reviews are done, these partial commutations are included in determining whether the minimum payment has been made. Further, SuperMate will not count a partial commutation towards the 10% maximum pension payment for a TRIS, also per the ATO rulings.
When setting up a pension in SuperMate you can record it as reversionary, for example, to the pension member’s spouse. In the event of the pension member passing away, SuperMate has a simple process to revert the pension to the reversionary beneficiary spouse, ensuring correct pension details are retained as well as calculating the correct minimum pension amount.
With the changes to how pensions are assessed for the Centrelink income test from 1 January 2015, commutations to pre 1 January 2015 pension may have significant consequences for members receiving Centrelink benefits, e.g. Age Pension or the Commonwealth Seniors Healthcare Card. SuperMate provides a warning on the commutation of any pre 1 January 2015 pension.
The pension monitor report provides a view of all pensions you administer detailing their minimum and maximum pension requirements, the amount already paid and any amounts that still need to be paid for the year. This alleviates the time consuming need to review each pension one by one and insures the pension requirements for all your funds have been met.
SuperMate offers an extensive range of data checks, known as DAWs (Data Audit Wizards), which automatically review pension data and provide a confirmation report once complete. The reports highlight any funds with pension data that may need to be corrected. This means you only have to focus on the funds with exceptions.
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