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Disclaimer

This is not advice. Items herein are general comments only and do not constitute or convey advice per se. The information contained in these articles is for guidance only and should not be relied upon without obtaining professional advice having regard to your direct circumstances.

 

Understanding your super pension

When SMSF members reach their preservation age, currently 55, it is a good idea for them to sit down with a financial advisor to consider the merits of starting a pension.

What are the options?

Most SMSFs will allow members to draw a standard Account Based Pension (ABP) or a Transition to Retirement Stream (TRIS). Unlike other funds, SMSFs can commence pensions with ease and pay multiple pensions to one member.

Members can generally commence an ABP when they have reached their preservation age and have retired from the workforce. AN ABP is an extremely flexible income stream that requires members to withdraw a minimum amount each year based on the member’s age and account balance at the beginning of the financial year. There is no maximum limit imposed on the amount withdrawn, therefore if needed, a member could access 100 per cent of their funds from this account in the one financial year.

A TRIS is an option for people who have reached their preservation age, but are still working more than 10 hours per week. Unlike an ABP, members can only withdraw 10 per cent of their TRIS account balance in each financial year. This type of pension is ideal to supplement the reduce take home pay of small business owners who may be winding back their working hours or undertaking a salary sacrifice strategy.

What is the minimum draw down rate?

As mentioned above, a member must ensure they withdraw a minimum amount from their ABP or TRIS each year. The minimum amount is calculated by applying a percentage rate (shown in table 1) to the member’s account balance on 1 July or on the date the pension is started (if partway through the year).

If a member starts or stops a pension during the financial year, the minimum amount is pro-rated on a daily basis. It is interesting to note that the 10 per cent maximum for a TRIS does not have to be pro-rated. Therefore, a member who commences a TRIS on 28 June is able to withdraw the same amount as a member who commences a TRIS on 1 July in the previous calendar year. This provides members with excellent planning opportunities if they require extra money from their SMSF.


Flexible pension payments

One of the advantages of having an SMSF is the flexibility afforded to members in taking their pension payments. Members can choose exactly when to take their pension payments. This could be weekly, fortnightly, monthly or as ad hoc payments as the need arises.

How is the pension income taxed?

The tax payable by members in respect of pension income is determined by reference to the member’s age and taxable status of their pension account.

Members aged between 55 and 59 will not pay any tax on the proportion of pension income coming from the tax free component. Pension income from the taxable component will be taxed at the member’s marginal rate of tax less a 15 per cent rebate. This ensures the maximum rate payable is 31.5 per cent.

Pension income received by members aged 60 and above is completely tax free, regardless of the pension’s tax components.

Benefits of starting pensions

Reduced tax paid by SMSF

When an SMSF has pension and accumulation accounts, the effective rate of tax paid by the SMSF is determined by the relative value of the accumulation and pension accounts within the fund. When a fund is 100 per cent in the pension phase, all earnings will be tax free and unrealised capital gains (brought forward from the accumulation phase) can be realised by the fund without triggering a tax liability. This represents a saving of 15 per cent on investment income and a saving of 10 per cent on accrued capital gains.

Consider the following example:

Tom, aged 56, draws a wage of $30,000 from his small business. Tom has $350,000 in his SMSF (100 per cent taxable) which derives investment income of 8.5%. If Tom elects for his super fund to stay in the accumulation phase, his SMSF will have to pay 15 per cent tax on investment earnings which totals $4462. If however Tom chooses to commence a TRIS on his $350,000 superannuation balance at the beginning of the financial year, his SMSF will not pay any tax on investment earnings.

As Tom has commenced a TRIS, he is required to withdraw 4 per cent of his account balance during the financial year. Therefore, Tom will have to pay tax on $14,000 at a maximum rate of 16.5 per cent (Tom’s marginal tax rate of 31.5 per cent less a 15 per cent tax offset). In this case, Tom will pay $2310 in his personal income.

The total tax saved from implementing this strategy is $2152.

What if you don’t need the extra money?

Some people can be reluctant to start a pension if they do not need the extra money provided by the minimum pension payments. In these situations, assuming the member is under 65 and is within their contribution limits, they can re-contribute the money straight back into their SMSF. Alternatively, if the member is salary sacrificing into their SMSF, they can use the pension payments to help meet day-to-day living expenses.

Coordinate the timing of contributions

Members can help to reduce the tax paid by their SMSF by ensuring they carefully coordinate the timing of contributions with the commencement of pensions. However, members should note that until the SMSF is in pension phase for 100 per cent of the year, the fund will still be liable for some tax based on the proportion of time and value of funds in accumulation.

Compare the following two scenarios

Scenario 1: A member makes two $50,000 contributions during the financial year, one on 1 August and the other on 1 January.
Scenario 2: A member makes a random number of contributions throughout the year that totals $100,000.

In Scenario 1, the SMSF can commence a pension on each of the contributions as soon as they are received by the fund. This ensures the contributions do not sit in the taxable accumulation phase and minimises income tax paid by the SMSF.

In Scenario 2 however, the random nature of the contributions make it impractical to commence a separate pension at the time each contribution is made. Rather, it would be more practical for the SMSF to commence one pension after all he contributions for the year have been received. Accordingly, these contributions stay in the taxable accumulation phase until the pension is commenced and will contribute to a larger tax bill for the SMSF.

Another issue to consider is the proportioning rule. As mentioned above, a member’s interest in a superannuation fund is split into a taxable and tax free component. If the timing of contributions is not precise, the proportioning rule can have the undesired effect of watering down a member’s non-concessional contribution. This can have unfavourable tax consequences for the member if they wish to access their funds prior to age 60 or on the member’s death if the benefits are paid to non-dependants.

To see how this works, consider the following scenario. A member, aged 57, has accumulated $100,000 in concessional contributions throughout the years. On winding up their business, they realise they have $200,000 of surplus funds that they wish to contribute to their SMSF as a non-concessional contribution. Given they have retired, the member has big plans to withdraw money from their SMSF in the next couple of years to fund a worldwide trip.

If the member makes the non-concessional contribution while the $100,000 of taxable income money sits in accumulation, the $200,000 “tax free” contribution will be added to the existing accumulation account. In this case, the member’s pension will be 33.3 per cent taxable and 67.7 per cent tax. When the member is 59 and decides to draw down extra money to fund their trip, 33.3 per cent of this money will be subject to tax.

If however the member was to start a pension on their existing accumulation account prior to making the non-concessional contribution, the $200,000 would be added to a separate accumulation account. The member would then have two pensions: one for $100,000 that is 100 per cent taxable, and another for $200,000 that is 100 per cent tax free. In this case, the member can choose to take extra money for their trip from the 100 per cent tax free pension account. This money will be completely tax free, even though the member is still under 60.

By Linda and Tina Wilson
MyBusiness, July 2008

 


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